Bad business decisions by CEO Key

Asset sales are in the papers again today:

If New Zealand’s Government were a business, it would have no case to sell stakes in its energy generation firms… Sustento director and economist Raf Manji said. It was admirable for the Government to lower debt, but the numbers around selling stakes in energy firms to do so did not add up, he said.

No more important public good existed than energy, as it was essential to people and businesses, so it was dangerous to raise the firm’s focus on profits.

Much like Raf, I’m not ideologically opposed to the government selling assets. However, we clearly disagree about the rationale for selling energy assets. He makes two points: it’s a bad business decisions, and energy is a public good so public provision is required.

On the first point, economists have long argued that the country is not a large company and shouldn’t be treated as such. If we wanted governments to be highly leveraged investors to return a profit then they should probably stop taxing high productivity people and giving the money to people with lower productivity. I’d ditch the welfare system, too: a loss-making business if ever I saw one! Obviously the government’s not an investor trying to turn a profit so let’s focus on what can do to improve social welfare and equity. Raf’s second argument seems to implicitly acknowledge that by appealing to the government’s role in providing public goods.

The public goods argument is far stronger because it is widely acknowledged that public goods are under-provided by the public sector. The reason is to be found in the two defining characteristics of public goods:

  • One person’s use doesn’t decrease the quantity available for everyone else. For instance, however much I enjoy clean air in New Zealand, there is no less for you.
  • You can’t stop people from using it, so property rights over it become fairly meaningless. You can’t own clean air here and sell it, so there’s no private incentive to generate it. That’s why we need environmental regulations to deal with pollution.

What’s striking about these two characteristics of public goods is that energy fits neither of them! When I use energy, you can’t use that energy. When I don’t pay my power bill the power company can cut me off. So energy isn’t a public good and the arguments for public provision that apply to public goods don’t apply here.

Update: Matt and I have written about asset sales previously, as have Paul Walker and Seamus Hogan.

23 replies
  1. Paul Walker
    Paul Walker says:

    James. I would argue there is a third problem with Raf’s argument. Privatisation isn’t about lowering debt, it is about getting the most efficient allocation of resources. Now if that mean giving assets away and thus getting no money, then so be it.

    • jamesz
      jamesz says:

      Sure, that’s the main justification that’s given for active privatisation programmes. I didn’t really want to delve into the whole issue here so much as just point out the fallacy in Raf’s arguments. I’ve now added some links down the bottom for people who want to know more, though.

  2. Hutchison
    Hutchison says:

    As you’ve shown, it’s clear that energy is not a public good.  However, the case is less clear-cut for security of energy supply – a high probability that if I want it and I’m prepared to pay for it, it will be available whatever the circumstances.  The nature of energy supply means that that requires an overcapacity on the supply side which it’s never really been shown that even a well-functioning market will provide, let alone one as topographically problematic as New Zealand’s.  Sadly, politicians in the UK, which had been furthest along the track of finding out, seem to have lost their nerve 

    • jamesz
      jamesz says:

      I don’t really know the energy markets that well, but it seems unlikely that partial sale of some generation companies will have anywhere near the impact of the UK reforms, doesn’t it? I’m also not aware of significant supply problems in NZ–particularly after the construction of Whirinaki–despite all of the generators being privately owned or operated as SOEs. Is security of supply really such a major concern in NZ if we move to the proposed MOM?

      • Hutchison
        Hutchison says:

        I would certainly agree that the partial sale of some generation companies is not going to turn New Zealand into a full-blown energy market and therefore that it is not likely significantly to change the equation as regards supply security.  Mine was more of a theological point.  If energy really was bought and sold in a truly liberalised competitive private market, such as there isn’t in practice anywhere since ministers everywhere are too frightened to let go of the reins, would it deliver security of supply? 

  3. Carter
    Carter says:

    Haa ! Paulo, best allocation of resources huh ? really ? Oh thats what im paying for when i get slapped with a capital cost of paying for a new underwater power cable to link South with North island demand ! I wish i could add 6.2 % (PLUS GST so Key gets his cut ) to all my customers on my database by simply sending em all a letter telling em I need to upgrade my fleet so as you all are my customers and you need me, you will all be paying for it ! If the govt is telling us its a good investment to buy shares in its  state powercos  why then is it selling off shares in them ? If they claim its to raise capital then that will mean capital is invested in state run powercos that would otherwise be available to invest. in new science and new products here. Oh well those smart overseas venture capitalists will just have to keep doin that. Cant wait to collect my free assets for nothing too Paulo !

  4. Carter
    Carter says:

    Wheres that Matt Nolan when ya wanta augh !> The guy would reckons NZ govts have nothing to answer for for where NZ INc is at and it all those outside foreign forces fault ! Haaaaa
    \Its called GOVT POLICY . and our GOVTs Policy sucks. Muchlike one million condoms for free

    • Matt Nolan
      Matt Nolan says:

      When you blamed the government for the global financial crisis I stated that this crisis was the result of external factors rather than an internal policy faliure – I’m sorry but do you actually ever read comments and posts, or do you just jump on a post and write whatever pops into your head?

  5. Raf
    Raf says:

    Fair points James but I would take issue on this statement”:

    When I don’t pay my power bill the power company can cut me off”

    I would argue that where cutting off the supply would endanger life (as in the Mercury energy case) does present energy as a type of public good (though clearly not in the purely defined meaning). How many of our elderly suffer ill health and worse from being unable to afford energy? You might argue that has nothing to do with how the energy market is structured and whether it’s delivered by the public or private system. For me, the core issue is over goods, which I regard as basic to living. Water is one, energy is another. So I’m taking a different slant on the term “public goods”. Perhaps I should define them differently so as not to cause apoplexy in the economics department 🙂

    As for the argument that privatization is about efficiency, I think that is rather fallacious. I think it’s more based on the idea that governments shouldn’t be involved in business. This may be a bit chicken and egg but I think the efficiency argument came after the “government is evil” one. Privatization seems to induce a pavlovian response from some sectors of the business community, as the thought of fees, higher executive salaries and other benefits for the few flow through their minds. The thoughts of a highly efficient and productive enterprise, supplying a “basic necessity” at the lowest price are likely to be found only in the miss of a few dreamers! 

    Fire away 🙂


    • jamesz
      jamesz says:

      Thanks for the reply, Raf. I guess you could explain it away as a different definition of public goods, but I think that opens up more questions than it answers. Obviously there are benefits to slotting your argument into pre-existed frameworks for thinking about the benefits of government provision. For example, you’re absolutely right that I consider the affordability of energy has little to do with public/private provision. If we’re worried about the welfare of low income people then we can deal with that through transfers, rather than ad hoc market interventions. In saying that I have a lot of scholarship to rest my case on, which you don’t when you deviate from established frameworks. So I think you actually increase your burden when you argue for a different definition of ‘public goods’. I have to say that I’m unconvinced by the case for public provision of your ‘public goods’ so far, but perhaps you can point me to persuasive work on the matter.

      Paul will probably have more to say on the efficiency of privatisation, but I don’t think the existence of bonuses negates the possibility of welfare gains. After all, you could see it as growth in the taxable income available to subsidise power for poor people 😉

      • Paul Walker
        Paul Walker says:

        “Paul will probably have more to say on the efficiency of privatisation, […]”

        A short response on the efficiency of privatisation is William L Megginson “The Financial Economics of Privatization” , Oxford: Oxford University Press, 2005.

        “The 87 studies from nontransition economies discussed in this chapter offer at least limited support for the proposition that privatization is associated with improvements in the operating and financial performance of divested firms. Most of these studies offer strong support for this proposition, and only a handful document outright performance declines after privatization. Almost all studies that examine post-privatization changes in output, efficiency, profitability, capital investment spending, and leverage document significant increases in the first four measures and significant declines in leverage.” 

        • Raf
          Raf says:

          Thanks Paul.

          Some “limited support” perhaps?  I’m not sure I have time for a literature review but here’s a few alternate views to consider:

          Serbia’s experience with privatization (2011). “Results have been devastating despite netting 2.6 billion euro”.

          World Bank paper from 2009 “Most important policy implication of our survey is that privatization per se does not guarantee improved performance” 

          2007 Paper on performance of electricity and water privatization   “The theoretical and empirical validity of the assertion that privatization enhances competition and hence efficiency remains dubious” 

          And so on.

          I don’t think the case is proven to the extent that it provides a strong argument for privatization. Now, at the same time, that doesn’t mean a case by case analysis will not show some assets that may improve performance and some that clearly won’t. 

          I would also reiterate that I am, regardless of syntatic issues, concerned with energy and water (defined as public goods within the Millennium Development Goals framework – we could debate this forever). If you want to sell the airport (no doubt Christchurch airport will be on the block soon!), I wouldn’t specifically be opposed on these grounds. 

          I am not a fan of ad hoc transfers (dealing with low income people) but I am a fan of a universal basic income and the potential delivery of domestic quotas for basic goods (is that a better term?). That might open up a different conversation.


        • Paul Walker
          Paul Walker says:

          “Some “limited support” perhaps? ”
          The important bit “Most of these studies offer strong support for this proposition,” There are always cases where things are done badly, eg privatisation in Chile mid-70s. But overall I would argue that the empirical evidence shows gains from privatisation.

    • Paul Walker
      Paul Walker says:

      “How many of our elderly suffer ill health and worse from being unable to afford energy?”

      But is government ownership of the energy sector the answer to this? Why not just increase transfers to the elderly to cover energy costs? 

      • Raf
        Raf says:

        Hi Paul,

        Fair question. That creates an incentive for private companies to jack up prices, knowing the government will subsidize low income people. A domestic quota for energy provided as part of a universal income might be more interesting for me. Company contracts to provide x kwh of energy per person at agreed price (people can trade or sell back their quotas) and then operate open market above that. 

    • Hutchison
      Hutchison says:

      Raf, have a look at the performance – the actual performance, not the popular perception – of the UK energy supply industry post-privatisation.

      • Raf
        Raf says:

        You’d have to provide me with some data/literature. I haven’t seen anything conclusive so far. 

  6. steve
    steve says:

    I don’t think it makes a difference whether the government owns it or not.  either way, it borrows money and pays interest.  provided the sale price reflects the riskiness of the asset, it’s a zero sum either way.  The only argument I have considered in favour of partial ownership is the shallow capital markets.  i.e the govt has a role to play the big institutional investor, in order to provide those “blue chip” mid range risk investments which for some reason aren’t being provided by the market.  But I don’t know enough details about financial markets (or market failures) to know if this is truly a convincing argument.

    I have not heard any other convincing argument for the government to own or not to own electricity companies. 

  7. Swan
    Swan says:

    “If energy really was bought and sold in a truly liberalised competitive private market, such as there isn’t in practice anywhere since ministers everywhere are too frightened to let go of the reins, would it deliver security of supply? ”

    I guess it depends on if people are willing to pay the price for security of supply. Presumably energy companies could/would offer guaranteed supply contracts with suitable liquidated damages clauses for a premium, if the demand was there.

    In NZ we have a bit of this playing out with Genesis and Huntly. Huntly doesn’t make a good return for Genesis as a lot of the time prices are too low to make money burning relatively expensive coal or gas. But Huntly is important in NZ’s overall security of supply. So Genesis has been trying to sell “insurance” in the market to get others to pay for this security. (I am not sure of the details of this insurance, whether it is a futures contract or something else). But in order for it to be worth the other companies buying this insurance, Genesis needs to charge very high spot prices when it is the supplier of last resort. But as we know when it tried to do this, the regulator wrote down the spot prices! So if we end up with a security of supply problem in NZ it may be because of not enough free market, rather than too much.

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