Private sector fails to take on losers …

Interesting series of quotes on the disaster that was think big.

The years of media coverage have not been kind to the “think big” projects of the early 1980s – speculated to have cost taxpayers about $7 billion.

“It’s a peculiarity of New Zealand that both our main parties have been interventionist and it was partly because time and again the private sector failed to provide.”

The private sector failed to ‘provide’ by investing in projects that lost $7bn … that is fair enough in my opinion.  The question is, why did the public sector feel like we should have to throw money down the toilet as taxpayers 😉

I’m being a little facetious here of course.  Rather than evaluating the loss, we need to ask if ‘ex-ante’ – given the risks and the information at the time, and given societies preferences/taste for risk, was this a good idea.

And here we have the kicker – the fact the private sector was unwilling to do it, when they would have to face the risks, suggests that it probably wasn’t a good idea to start with.  Even if think big had “succeeded” it was still bad policy.

Nowadays, I like to think that we base policy on evidence and logical argument – lets hope that actually is the case.

  • “…the fact the private sector was unwilling to do it, when they would have to face the risks, suggests that it probably wasn’t a good idea to start with.”

    I’m sure you don’t just mean that the government shouldn’t do things that the private sector wouldn’t do.

  • @rauparaha

    There are definitely other relevant factors – but I’m too tired to write them down 😉

  • Chris B

    But then again, there are plenty of wildly successful big projects that the government has had to do that the private sector would not get into because of the risk:
    The US Highway system
    The Transcontental Railway
    New Zealand’s Telecommunication Infrastructure (both the original and the new Fibre rollout)
    The Internet
    And many more that i can’t think of right now.

    Rather than looking at the failure of the think big projects and taking the lesson that Private Enterprise is infinately wise in its assessment of risk/reward, i think that it’s more a case of private enterprise being far more risk averse than they’d like to let on.

  • @Chris B

    In part, as I said:

    “I’m being a little facetious here of course. Rather than evaluating the loss, we need to ask if ‘ex-ante’ – given the risks and the information at the time, and given societies preferences/taste for risk, was this a good idea.”

    In the case of roads, I think we have a situation where network externalities play a large role – and provide justification for private involvement.

    Many of the think big projects were not based on fair economic evaluation – that is my true problem. This post is meant to be primarily derogatory about think big, and any push towards mindless interventionism – both things that I felt were getting a boost in this article, when it randomly decided to attack the private sector.

  • @Chris B
    There are definitely public goods and projects with big positive externalities that the government might want to get involved in. However, if the net social cost is $7 billion then it would be hard to justify the project.

    I interpret Matt’s post to mean that, if the private sector isn’t willing to engage in a project, we should carefully think about why that is and why the government might want to get involved. He’s not saying that the government should emulate the private sector’s work but rather than it should attempt to be fiscally responsible and only spend money on projects that are expected to yield a net societal benefit. At least, I think that’s what he’s saying.

  • jh

    @Chris B
    The Mackenzie canals and hydro stations.

  • Miguel Sanchez

    This is the quote that I found bizarre:

    The projects were hit by an incredible stroke of bad luck, Easton says.

    “The price of oil was against us.”

    According to BP the price of crude oil in 2009 dollar values rose from about US$10 a barrel in 1970 to more than US$90 by 1980, before falling back to about US$30 in the mid-1980s.

    “[If] they’d been in position five years earlier [or] 10 years later they would have been a success.”

    Uh, isn’t the whole point that five years earlier or ten years later they wouldn’t have been done at all?

  • steven

    Uh, isn’t the whole point that five years earlier or ten years later they wouldn’t have been done at all?

    no, its that 5 years earlier or 10 years later they wouldn’t have cost us $7b.

    The point that matt’s making is that it doesn’t matter whether it cost $7b or whether it was postitive. it was a risk that was too great to take so it was bad policy.

    @rauparaha
    good point on positive externalities, i’m not sure the $7b includes the social cost/benefit. I suspect there are some social benefits that reduce this $7b, which explains why the private sector didn’t do it, and is not necessarily about risk. but again you are right if the benefits aren’t enough then govt was not being fiscally responsible. I think Matt’s wrong on it being about risk though. the private sector doesn’t take account of the externalities and this is the reason for not entering many of these projects. in the case of think big for many of the projects I think its more the regulatory system (for electricity), perhaps a coordination prob which added to the uncertainty of the private sector.

  • @steven

    I recognise the regulatory reasons for intervention – but those that often push intervention seem to ignore the fact that private agents are often better informed about, and more responsive too, risk. Given that the article I was discussing ignored this point, it was the point I focused on.

    A short blog post on a specific article is never going to be a complete analysis of the reasons for intervention – the argument is multi-faceted for sure. One subjective statement I will make is that government overestimates its ability to improve outcomes in New Zealand at the current time – and by government I mean the technocrats, not the elected officials.

    Not the most popular statement to make when I live in Wellington, especially since I believe that technocrats are well intentioned, intelligent, and thoughtful. But it just seems to have been an unintended consequence of the independence of the public service.

    This is a political economy issue I plan to write about at some time, which is why I guess I just started blabbing about it 😉

  • @Matt Nolan
    Suppose that you are correct and public servants overestimate the likely impact of regulation. would that cause them to regulate too much or too little? I can think of plausible, ad hoc arguments for each side but I don’t have a good framework for assessing the net effect. Perhaps that will be the subject of your post. I imagine Eric has some useful things to say on that matter, too.

  • @rauparaha

    Indeed. It is really just a public choice issue right – so we are asking where the cognitive biases of technocrats and the institutional structure they are working in influences their recommendations relative to “optimal policy”.

    It will depend on the policy issue as to whether there is too much or too little intervention – but just in this specific case where intervention involves government investment, I would say that technocrats are likely to push for overinvestment, given their aprori views on private sector investment and belief in their own ability.

    The main catch with this argument is that governments share of the total capital stock has fallen over the last 40 years (it has risen marginally in the last decade – but it is an overwhelming downward trend). So a quick look at the data does not support that view.

  • @Matt Nolan
    Hmmmm, I just don’t have a good sense of the variables that are under the control of a public servant and how they might have systematically incorrect beliefs across their impact. What does ‘too much intervention’ mean? Does it mean too many regulations or regulations that are too restraining? Presumably the range of possible private actions may decrease more with more powerful regulation but the transaction costs of compliance may increase more with a greater number of regulations. Do more regulations increase the ‘overlap’ or are they usually additive with previous regulations?

    I just don’t have a good mental model of regulation that lets me figure out what ‘over-regulation’ might be and how it might relate to beliefs. I look forward to your posts on the topic 🙂

  • @rauparaha

    It is simply a case of taking a counter-factual and applying behavioural relationships – just like we do with market failure.

    The hard thing, as I think you are implying, is to decide whether any public servants incentive to push for overinvestment exceeds any inherent belief that the private sector is underinvesting. It is the net impact that matters – which is why one-sided views are no use for policy analysis.

    In this case you are also mentioning regulation, when I said the specific discussion was one simply of private investment – which is why a claim like overinvestment could have more credence. In the comments I’ve had no intent on describing the full range of potential public choice issues in society.

    These posts will be a while away, as I have other issues that need to be blogged on first – and I still need to pin down my views more solidly. In the interim you could post on the issues if you wish.

  • I live in India and this debate has always been there. For 50 years the public sector dominated the industry and I believe yielded good results but inefficiency and corruption were order of the day. Now We have a good thriving private sector and even the public sector is competing with them successfully however in the process the social benefits that public sector provides are being ignored.

    There has to be a way out for sure.

  • Greg

    It’s absurd to say that the private sector is better at perceiving risk; public servants are notoriously cautious. Any differences in outcome are due to different goals. (And here let me say that I am very sceptical of public choice doctrine in the NZ central government context; that may change iff our rankings for corruption and transparency slip.)

    The greatest difference between public and private investment is the ability of the investor to capture the benefit of investment. The private sector won’t invest in something if the investor can’t capture enough of the benefit; the government will (er, should) invest if the benefit to the country at large is sufficently great. For example, how many private enterprises are offering student loans? If the government did not offer them, how how big would our universities be? How would that affect our growth path over the next three decades?

    OK, enough generalities.

    Easton is right about Motunui. The alternative appears to have been paying for Maui gas and watching it be flared off.* Any positive ROI (to the country as a whole, remember) was better than that. GDP did, in fact, grow due to Think Big – just not as much as it would have done if the money had been better invested. (Of course, we’re all so much more sophisticated and foresighted now.) And at the time people really thought that high fuel prices were here to stay and oil supplies could be cut off without warning. So maybe Motunui was also thought of as an insurance premium – risk reduction for the country. (This was before the International Energy Agency and the formation of fifty-day oil reserves.) What’s your ROI for your house insurance premium, Matt?

    Secondly, the policy-making part of the bureaucracy was acutely conscious of the need to diversify the economy. Britain had joined the EEC, NZ’s meat-butter-wool economy was at risk. (A balance of risks; imagine that.) The private sector was doing its stunned mullet impression, or was in denial. Whatever, it wasn’t investing appropriately. Forcing the creatiion of a heavy engineering sector and making use of non-agricultural resources seemed like an appropriate part of diversification.

    Jeepers, never in a million years did I think I’d be defending Bill Birch! But that’s what logic gets you.

    —————————-
    * This was a case where the public sector did fail to plan for a risk: the risk of too-great success. If you want to blame anything, blame this. But given that Maui had happened, Motunui was a defensible response.

  • “It’s absurd to say that the private sector is better at perceiving risk; public servants are notoriously cautious”

    The private sector has to face the direct costs and benefits of their actions, and so can respond to market signals. The public service is not nearly as responsive to these signals.

    The counter argument by people who want intervention appears to be “the private sector is stupid”. If this is the case I would seriously say “as stupid as the public sector – but at least they are the ones paying for their mistakes”.

    “The greatest difference between public and private investment is the ability of the investor to capture the benefit of investment. The private sector won’t invest in something if the investor can’t capture enough of the benefit; the government will (er, should) invest if the benefit to the country at large is sufficently great.”

    If there are large “external” benefits that can’t be priced then yes, there is scope for government. However, the Think Big projects were, largely, not an example of this logic.

    I am actually a fan of the idea that government should get involved when there is a distinct and quantifiable market failure – careful interventions can be helpful. However, the main role of state is one of redistribution given societies view of what redistribution is appropriate – not one of arbitrarily investing in projects because they feel like it.

    “So maybe Motunui was also thought of as an insurance premium – risk reduction for the country”

    It is fine to ex-post justify things by throwing around arguments – but did they actually quantify these things at the time. The people I’ve talked to say no.

    Remember, by the time Muldoon was finished NZ was facing a currency crisis and was stuck with a large structural government deficit – he took peoples tax dollars and drove us into a hole.

    “What’s your ROI for your house insurance premium, Matt?”

    I don’t pay for my insurance with other peoples money now do I.

    “Secondly, the policy-making part of the bureaucracy was acutely conscious of the need to diversify the economy.”

    The government doesn’t control the economy – as long as they make sure that clear incentives are in place, the economy will move along an ex-ante appropriate path. The “economy” is simply the aggregation of a bunch of individuals making decisions – not a firm that is run by a bunch of bureaucrats in Wellington 😉

    “The private sector was doing its stunned mullet impression, or was in denial. Whatever, it wasn’t investing appropriately.”

    Given the uncertainty the private sector would have been faced with, with an alcoholic prime-minister that was determined to be popularist and interventionist, I’m not surprised individuals in society were cautious …

    The justification for think big, and your defence of it in the comment, are based on a lack of faith regarding the private sectors ability to spend its own money – this is something I don’t, and probably never will, agree with. That is the essential value judgment of it – it has nothing to do with the relative logic of our arguments.

  • “The “economy” is simply the aggregation of a bunch of individuals making decisions – not a firm that is run by a bunch of bureaucrats in Wellington ;)”

    That’s a quote of the day, if ever I saw one! It’s such a worthwhile point to make, too: you have 98% of the population spending their own money and 2% spending everyone’s money. If you observe that 98% think it’s a bad idea to spend on something but the 2% think it’s worth spending someone else’s money on it then what would you do?

    Obviously you’d need to ask why the 98% don’t want to spend their money but ‘because they’re the idiots and the 2% are just smarter’ is unlikely to be the right answer to that question.