Asset sales

There has been a lot of commentary on asset sales around the place, so much so that I didn’t feel like I need to write anything.

Dim Post mentioned a lot of the people against asset sales and also Geoff Simmons recently wrote against them.  Furthermore, both Anti-Dismal (*, *, *, *, *) and Roger Kerr (*, *, *) wrote a series of insightful posts regarding the issue.

On the left there seems to be an inherent bias against any selling at all – selling is bad.  On the right there is an inherent bias against government ownership – government ownership is bad.

So, where do I fall on the issue?  I have to admit that I am relatively in the middle – I see it as a case by case issue.  There is nothing inherently wrong with privatisation, at all.  Furthermore, I agree that generally privately run firms will “meet the market” more efficiently – implying that they either/both provide the same outputs more cheaply, provide more outputs for the same cost, and/or provide higher value outputs.

At the same time there is no doubt that some assets have social values/external benefits that are not captured by private agents.  If the cost of indirect regulation (taxes and competition policy) is too high, it may be preferable for the government to run said agencies directly – I view it as direct regulation.

In New Zealand at the moment there is definite scope for opening up SOE’s to private sector investment – that is where we are sitting now.  However, even given this I cannot go as far as Roger Douglas and say that the price does not matter – in fact, price is THE issue that the government should use when deciding whether to sell assets.

Why do I say this?  I have already said that I believe that, in the absence of external benefits, the private sector is more than likely to run the organisation more efficiently.  However, just because the evidence says this happens on average, and just because I have a value judgment that individuals are more responsive to incentives than government, isn’t sufficient to justify policy when we have prices available!

Effectively, a private purchaser will be willing to pay up to their reservation price for an asset.  This reservation price will be based on the dividend yield they expect to get from the asset, and the relevant opportunity cost of investment.

At the same time the government know that, if it keeps hold of the asset, it expects to make some dividend yield from said asset through time.  As a result, the government can price the asset – they can say they would not accept a bid below the discounted expected return from holding the asset.

If the government sticks to its guns, and a private sector agent is willing to pay MORE than this then we know that – ex ante – the private agent will be able to run the business more efficiently/add more value.  This implies that the government SHOULD NOT sell for less than their discounted expected return (not the should, so I’m being all prescriptive 😉 ).

In essence, pricing the assets (including relevant external benefits) and then seeing what price people are willing to pay gives us information regarding what can be run more efficiently in house – and more efficiently in the private sector.

Looking backwards and saying “this business is paying dividends overseas, wahhh” or “this business ended up making more than what we sold it for, wahhh” is a rubbish argument against privatisation  – but so is saying “the private sector is better, so give it the assets for free, wahh” is a poor way of justifying privatisation.

At the moment, the type of debate we are hearing in public sounds like the above quotes – and as a result the two sides appear to be talking past each other, making the debate feel more like ideology than reasoned analysis.

If we sat down and just explained the dividend example to people in society, I do not think they would be averse to a government stock take.  The tough questions will then be “how do we value external benefits” and “what is the expected dividend yield” rather than is selling blanket good or bad.

Update:  Anti-Dismal points out that there are other factors that need to be taken into consideration beyond the starting point of comparing dividend streams – that is why this is very much a case-by-case issue.

Update 2:  I somehow missed this piece by Eric Crampton (even though I did check the site while writing the post).

  • raf

    I think Bernard posted up the yield differentials (from memory returning 7% ish against interest cost of below 6%…so no reason to sell on that number.

    But I don’t believe it’s a simple financial/economic analysis (though that helps). I think we first have to start with what it is government should be involved in supplying to the citizens. For me, and this may be very much a political position, the provision of core (common good) services is exactly what the state should be supplying. Power is absolutely one of those core services.

    I would actually propose the state supplies power at the lowest possible cost or even better simply as a physical dividend (this would be in the form of a domestic tradable quota).

    This is just a bad policy supported by very lazy argument.

  • @raf

    “I think Bernard posted up the yield differentials (from memory returning 7% ish against interest cost of below 6%…so no reason to sell on that number.”

    The yield differential that is relevant is the one implicit in the price the asset is sold for – so the government has a willingness to sell based on their expected return, and will only sell if a private agent will pay that (and can thereby receive a higher return).

    “I think we first have to start with what it is government should be involved in supplying to the citizens”

    The government shouldn’t “supply its citizens” with anything, it is a redistributive and efficiency focused institution that works with society. Example in next part of comment:

    “I would actually propose the state supplies power at the lowest possible cost or even better simply as a physical dividend”

    I disagree. Why subsidise the price of power relative to other goods and services? If we believe “the poor and too poor, and they consume a lot of power, and have inelastic demand for it” then the solution still isn’t subsidising power – it is transferring more income to poor people.

    The government should only take on the provision of services directly when:

    1) There are significant external benefits that a market cannot price,
    2) The cost of indirect regulation to price these benefits is excessive, relative to the cost of direct regulation (provision).

    “But I don’t believe it’s a simple financial/economic analysis”

    FYI, everything is an economic analysis 😉

    If we don’t discuss the costs and benefits of policy (all of them of course, not just the ones we see priced), we are relying on ideology and blind faith – hardly conducive to improving outcomes 😉

  • Kimble

    Do you think there is any validity in the argument that sale of the assets to foreign buyers represents a national security risk, and that this must be included in the price the government must demand from any potential buyers?

  • @Kimble

    This depends on the real politik view regarding foreign investors – it is a value judgments I’m not qualified to make a pick up, this is where we need political scientists that are trained in the dark arts of economics

  • Matt
    Good contribution
    Roger

  • @Matt Nolan
    I don’t really understand this argument: the sovereign power can always just forcibly repossess the assets if it feels threatened.

    I’m glad you’ve pointed out that the relevant comparison is not between the cost of borrowing and expected dividend yields; those numbers seem to be far too popular on some blogs.

  • @Kimble

    I would add to this that it is only a national security risk issue if we are talking about “selling the asset at the appropriate value” – if we sold it below the associated dividend yield then there would also be a transfer to foreign owners.

    @Roger Kerr

    Thanks

  • @rauparaha

    That is a good point Rauparaha – essentially, the sovereign power still owns the land and so can take control. The cost of said action is a reputational one.

    However, the idea of nation states and national security is an issue I don’t think I can add much value on – it should be included and analysed as objectively as possible – which is why we need a political scientist that uses the economic framework 😉

    “I’m glad you’ve pointed out that the relevant comparison is not between the cost of borrowing and expected dividend yields; those numbers seem to be far too popular on some blogs.”

    I am surprised with the popularity of that comparison as well, as it doesn’t really seem to capture the essence of the decision process involved here.

  • While it may be the case that the yield/cost of borrowing issue may not necessarily be an issue if we consider distribution across the whole NZ economy but surely at least in the short-term it matters because governments like ours with poor fiscal positions are subject to both considerable short-term political AND economic risks should the debt position weaken (even if it is in the short-term) vis-a-vis international institutions/political actors? Nevertheless a sensible analysis and I liked your point regarding the appropriate price point.

    “we need a political scientist that uses the economic framework”

    🙂

    Problem is that for us political scientists our unit of analysis is “power” rather than “utility” but its incredibly situational and difficult to quantify despite attempts by realists to do so (Hence why those of us attempt to take a scientific looking approach really are not true scientists IMHO). The example you use above in regards to reputational costs provides a good example. The problem with identifying a concrete reputational cost to any action (economic or political) lies a lot of the time in that the reputational cost will depend on who you are and you relationship to the international system that you inhabit at a given time – ie Chinese renationalizing a business in a given circumstance would be viewed very differently and would probably follow a different narrative resulting in different consequences than say if it was Sweden doing it – even if the fundamental issues at stake were the same. It would require a lot of creativity to measure these kind of effects, which we are only now starting to kind of understand them.

  • @Sigma1

    “Because governments like ours with poor fiscal positions are subject to both considerable short-term political AND economic risks should the debt position weaken”

    Selling assets, and reducing future cashflow, was something we had to do in the early 1990s when we were under pressure – but it isn’t really the best thing to do when there are other options, as is the case now.

    In the current situation we only need to look at whether it is a good deal – the government’s stock of debt relative to its asset position (stock vs stock) is very low, and I don’t think the world would bemoan the government that. If our national position is not as hot, it is likely to be private actors that are punished – unless the world believes our government is going to socialise the debt. However, given most of the debt stock is held in the Australian owned banking system I don’t think the world see this as the case – which is why our credit default spreads follow the Aussie ones so closely 😉

    “It would require a lot of creativity to measure these kind of effects, which we are only now starting to kind of understand them.”

    I agree – that is the area where political scientists and the such build knowledge and specialise. Economists specialise at trying to provide a framework of the economy – but it would be the height of arrogance to suggest we could fill in the gaps with the appropriate value judgments to make policy on everything. That is why, ultimately, it is the interdisciplinary people who should be policy makers.

  • @Matt Nolan
    “…but it would be the height of arrogance to suggest we could fill in the gaps with the appropriate value judgments to make policy on everything.”

    I know some economists who would call it common sense 😉

  • raf

    @sigma1 “that is the area where political scientists and the such build knowledge and specialise. Economists specialise at trying to provide a framework of the economy – but it would be the height of arrogance to suggest we could fill in the gaps with the appropriate value judgments to make policy on everything. That is why, ultimately, it is the interdisciplinary people who should be policy makers.”

    Yep. I wouldn’t trust an economist to make policy decisions 🙂

    @matt “everything is an economic analysis”. and that’s why 🙂

  • @raf

    What is the alternative though – if you don’t use the general economic method of comparing costs and benefits, then you are just sticking a finger in the air and doing what “feels right” – I know which alternative I’d prefer 😉

  • “As a result, the government can price the asset – they can say they would not accept a bid below the discounted expected return from holding the asset.”

    But they may want to accept a lower offer. Yes, selling assets at a low price can be good. If fact selling at a (almost) zero price can be a good thing!! For example, Anbarci and Karaaslan put forward An Efficient Privatization Mechanism:

    In this paper, we consider the privatization of State-Owned Enterprises (SOEs) that are legal monopolies but not natural monopolies; their markets can be opened to competition once privatization takes place and other competitors can emerge and compete successfully against them in a few years. But until that happens, these privatized SOEs can have a significant level of market power. The currently used “Revenue Maximization (RM)” privatization scheme maximizes the government revenue from privatization but does not provide sufficient incentives for the privatized SOE eiher to charge a price lower than the monopoly price or to improve production efficiency until competition arises. We propose a new scheme to privatize such SOEs. We term this new scheme the “Welfare Maximization (WM)” scheme. The WM scheme practically yields no revenue to the government from the privatization of any such SOE; however, it induces the privatized SOE to charge a competitive price in the absence of any regulation. It also turns out that the WM scheme provides greater incentives for post-privatization process invention (i.e., for post-privatization cost reduction) than RM scheme. (emphasis added)

    The point is that just trying to maximise the price received for an asset is not necessarily a good idea. So price isn’t the issue. In the above example welfare is maximised while revenue is basically zero.

  • @Matt Nolan
    It depends whose finger it is, surely.

  • @Paul Walker

    Fair point.

    I would note that I avoided the conclusion that the government should try to maximise the revenue they get from the sale either – just that they work out a reservation level they would sell at, and if someone is willing to pay more we can infer that they will provide efficiency gains.

    I would also note that the paper appears to discuss a very specific situation – namely when the monopoly power is time limited, and the government can exert some influence on the price that is set during that time when they set up the initial sale.

    @rauparaha

    Preferably a finger that supports my priors

  • raf

    @matt i love numbers as much as the next economist BUT they simply provide the monetary facts and often lack any context.

    the context here is that energy is a basic human need. we should be supplying it at cost. personally i prefer a domestic tradable quota. i also believe the “soe” model is rubbish….it’s almost the worst of both worlds…way too many overpaid people in those businesses.

    i prefer to see the energy system fully nationalised…no doubt sacrilege round here but i clearly have a different perspective on how society works.

    roger may be really excited about this but creating purposeful and efficient organisations does not rely on them being owned by owners focused on extracting the highest profit possible.

  • @raf

    “i love numbers as much as the next economist BUT they simply provide the monetary facts and often lack any context.”

    Any economist that does not try to provide context, and reach out as broadly as they can with costs and benefits, is missing some of the point of doing economics.

    Economics refers to the methodological individualistic framework we use to “frame” an issue, so that we can pin down the different factors and discuss the trade-offs – it doesn’t tell us to do anything, but it does help clarify our thinking on how society, and policy, work.

    “the context here is that energy is a basic human need. we should be supplying it at cost.”

    I disagree – even though I agree with the sentiment. I believe in a society where we make sure everyone has enough income to afford basic human needs – but I DO NOT believe that we should mess around with prices.

    By messing around with prices we wreck the price signal that tells us about scarcity, value, and gives people the incentive to adapt and change. However, I want people to have at least a level of income to meet what we view as needs in a modern society – and this is how government transfers work.

    “roger may be really excited about this but creating purposeful and efficient organisations does not rely on them being owned by owners focused on extracting the highest profit possible.”

    But we do know that if organisations respond to price signals, changes in demand, and underlying value – then they provide what people in society want, and are more likely to innovate and adapt to the constant change in the environment.

    “i prefer to see the energy system fully nationalised…no doubt sacrilege round here but i clearly have a different perspective on how society works. ”

    I wouldn’t call it sacrilege, I just don’t see how nationalising a resource because we define it as a “need” makes any sense – if there are excessive competitive issues, external costs/benefits, or there is no institution that can redistribute then I can see a possibility. But when we have a government that can redistribute income, that should be the first port of call – not messing around with price signals.

    Truly, subsidising individual goods and services without finding a true external cost/benefit that cannot be taken into account is not the way of policy – the subjective bit we should add it “what is the minimum income we should ensure people in society get” NOT “what services should we socialise and subsidise because we think they are important”.

  • @Matt Nolan

    “just that they work out a reservation level they would sell at, and if someone is willing to pay more we can infer that they will provide efficiency gains.”

    I take you point. The only thing a would argue is that no one may be willing to pay the government’s reservation level if that level is based on, say, the firm being currently a monopoly but being a competitive firm in the future.

  • @Paul Walker

    That is an excellent point. The counterfactual I used didn’t take into consideration changes in levels of competition – a factor that will be relevant for some case-by-case asset sale decisions. Thanks for that – I will keep it in mind for future use.

  • thanks matt, the article and the comment really inspired me..

  • Miguel Sanchez

    Good points from the paper that Paul linked to. I have an even better approach though: sell the SOEs as monopolies, THEN open them up to competition, then repeat and hope that the buyers don’t twig to what’s going on… 😛

    I wonder how relevant it is to New Zealand though – are there any SOEs left that have a legal but not a natural monopoly? I imagine that would have been the case for, say, TVNZ back in the day, but not any more.

  • @Miguel Sanchez

    “I have an even better approach though: sell the SOEs as monopolies, THEN open them up to competition, then repeat and hope that the buyers don’t twig to what’s going on”

    Hahahaha, love it.

    “I wonder how relevant it is to New Zealand though – are there any SOEs left that have a legal but not a natural monopoly? I imagine that would have been the case for, say, TVNZ back in the day, but not any more.”

    I think that is probably the case as well – however, when it comes to policy analysis it is definitely something to keep in mind, while the government makes choices on a case-by-case basis.

    I believe that this entire issue has illustrated that doing a “stock take” of state assets is actually a good idea.

  • raf

    @matt

    “I believe in a society where we make sure everyone has enough income to afford basic human needs”. well that’s a very good place to start.

    And i agree the price signal is key to making economic decisions. However, in the case of energy I don’t think that is helpful (or water for that matter which I think should be priced). i favour a mixed approach with a domestic tradable quota with a price on top for the rest. why?

    because in this case the consumers are the owners and therefore it makes much more sense to take the “dividend” in kind rather than going through some convoluted pricing mechanism (do we want an enron type system being run here?) and a bunch of middlemen.

    i’ll take my kwh thanks and yes we can sell the rest.

    obviously to run a system like this you need national ownership. any sale will just see yet further widening of inequality which kind of puts in a dent in the opening sentence. of course that’s just my opinion 🙂

  • @raf

    “because in this case the consumers are the owners and therefore it makes much more sense to take the “dividend” in kind rather than going through some convoluted pricing mechanism (do we want an enron type system being run here?) and a bunch of middlemen. ”

    There are two points here. If one is that we should have the consumer as the owner, I still feel we should redistribute the income directly rather than lowering the relative price of power – as it leads to overconsumption of energy relative to other things.

    The second is whether we should have the consumer/taxpayer as the owner in the first place.

    So even if we accepted that second point, I’m still not sure I agree on the idea of changing the relative price – market prices are a great way of allocating resources relative to how people value them.

    “any sale will just see yet further widening of inequality which kind of puts in a dent in the opening sentence. of course that’s just my opinion”

    Income inequality is an interesting issue, in the same way as the notions of absolute and relative poverty are interesting – there is something there, but changing industry policy on their basis is not quite the right mechanism. If we want to reduce inequality we can do it through income transfers – we just have to accept that the overall pie will be a little smaller. The equity-efficiency trade-off always exists.

    I like democracy as I believe it gives us an indication of the sort of trade-off society wants. But I think it has to be established transparently at the macro level, not through the use of industry policy which is both less clear and likely to lead to a greater number of unintended consequences.