Saturday, March 28, 2015
On the question of privatisation, mindless prejudice is no substitute for rational analysis of the pros and cons. On the tricky question of the "asset recycling" being promoted by Joe Hockey to all state governments with businesses left to sell, careful analysis is essential.
Premier Mike Baird's hugely controversial proposal to sell most of NSW's electricity transmission and distribution network businesses – the "poles and wires" – and use the proceeds to finance $20 billion worth of public transport, road and other infrastructure is a classic example of asset recycling.
It offers a good case study in thinking through the issues, even to people who won't be voting in Saturday's state election.
You must cover all the relevant major considerations for and against, ignoring considerations that aren't relevant (or are common to both alternatives). You have to remember to take account of opportunity costs as well as actual costs and to avoid any double counting.
It will avoid confusion if we consider the two sides of the proposition separately. First, is it a good idea to sell the poles-and-wires businesses to private owners? Second, assuming the planned infrastructure projects are worthwhile, is privatising businesses the only way available to finance them?
The obvious starting point for consumers is: would selling the businesses lead to electricity prices being higher than they would be under continued public ownership? Or would there be a decline in the quality of service, such as blackouts?
In this particular case, the answers are more certain than usual: no and no. That's because, the networks being natural monopolies, the prices they charge are controlled by the Australian Energy Regulator, which believes they're already too high. Service quality is also tightly regulated.
The regulator's determination to get efficiency up and prices down suggests there will be job losses – in other states as well as NSW – whether or not the businesses are privatised.
This being so, the main issues of contention concern state government finances. The critics of privatisation stress that it's no magic pudding: sell these profitable businesses and you lose the dividends they were paying the government, along with the equivalent of the company tax they were paying to the state (because state-owned businesses don't pay tax to the federal government).
That's obviously true. But remember that, according to economic theory, the sale price of any business should be the "present value" of the stream of income it's expected to earn in coming years.
If so, the seller is perfectly compensated in the sale price for the loss of future dividends. Why else would they sell?
But does the theory work in practice? Not perfectly. For one thing, who can be sure what income will be earned in the future? The seller ought to have a better idea than the buyer, but if there aren't many potential buyers and the seller is anxious to sell, they may settle for less than they should.
Alternatively, if there are a lot of potential buyers, the seller may get more than the business is worth. Almost all buyers of established businesses are confident they can run it more profitably than the present owner.
Point is, provided the sale price is adequate, there's no financial reason to regret the loss of dividends. A complication is that a fair price would not compensate the state government for its loss of tax equivalent payments.
That's because a new private owner would be liable to pay real company tax to the federal government. This is part of the rationale for Hockey's scheme to give federal grants – $2 billion, in this case – to states that take part in his asset-recycling incentive scheme.
A factor having a bigger (downward) influence on the amount of the fair sale price is that the flow of annual profits from the network business in coming years is likely to be much lower than the recent $1.7 billion a year that Labor's Luke Foley keeps quoting.
That's partly because the regulator has signalled its intention to crack down on the excessive profits being earned by the nation's electricity network businesses, but also because the demand for electricity from the grid is falling and will fall further as people move to solar and the introduction of smart meters helps homes and businesses limit their demand for power.
(This demonstrates the economic truth that natural monopolies are a product of the existing technology. The network businesses' monopoly is being eroded by climate-change-driven technological advance.)
Some critics argue that selling profit-making assets and replacing them with roads and loss-making public transport reduces the state government's "net worth" and weakens its balance sheet.
This is true arithmetically, but is a strange argument. Governments aren't profit-seeking businesses. Their job is to meet the social and economic needs of their community by, among other things, ensuring the provision of adequate infrastructure – directly profitable or otherwise.
Turning to the predicated link between the sale of network businesses and the spending on needed infrastructure, it rests on an assumption it would be unthinkable for the state government to lose its AAA credit rating, which would happen if it simply borrowed another $20 billion.
For decades, federal and state treasuries have used credit ratings to beat off unworthy proposals for vote-buying capital works. But I think we have little to lose by causing the discredited rating agencies to lower our rating by a notch or two.
But though their limit on our debt level may be too low, there does have to be some safe limit. And the doctrine that state governments may acquire assets but, once acquired, they may never ever be sold off, strikes me as weird.