Wednesday, 4 July 2012

Council asset sales

There is much heat and little light being generated over the funding of the Christchurch City Council's spending plans via increased debt or asset sales. I think part of the problem with the discussion is that there are in fact two issues here and not just one. The first is, for a given spending plan, should more debt be issued or should revenue be increased? And the second is, Should the council sell assets? These two question can being seen as related but they don't have to be. It is possible, for example, that the council could in increase revenue by, say, selling assets to another council. This would raise cash without privatisation. Or it could privatise assets by giving them away which would result in no revenue. Also even if the council had no problems with its budget it still would face the issue of asset sales.

Actually there is a third option, cut spending. No I don't see the council going for that option! But you do have to ask, do we really need a new rugby stadium or a new convention centre, for example.

One of the big issues to do with debt has been the discussion of the difference between the rate of return on the council assets and the cost of debt. But as Eric Crampton has noted its more really possible to compare the two given the way the rate of return on assets is worked out.
“It’s a bit of a shame that so much of the discourse around asset sales has focused on differences between dividend rates and the interest rate on Council borrowing. First, it’s harder to put a fair value on assets held by government because they’re not traded on the open market; the recent rather large reduction in the book value of KiwiRail points to some of these difficulties. Where we are less certain of the asset’s value, we have less confidence around the actual dividend rates. Further, where reported dividend payments include a lot of booked capital gain rather than actual cash payments, it’s not entirely a fair comparison with bond payments. But more fundamentally, ownership of assets comes both with risk and with ongoing maintenance liabilities; gaps between dividends paid by Council enterprises and interest on Council debt is largely explained by that the former is riskier.”
There is little point in keeping the "family silver" as a hedge against bad times if you're not willing to sell it when bad times hit.
As to the should the council privatise question, the answer is, it depends. Privatisation makes sense when the private sector is more efficient than the public sector. Incomplete contracts models show that even when the government sets out to maximise welfare there are still times when it makes sense to privatise (Klaus M. Schmidt (1996) 'The Costs and Benefits of Privatization: An Incomplete Contracts Approach', Journal of Law, Economics, & Organization, Vol. 12, No.1 (April), 1-24 and Klaus M. Schmidt (1996) 'Incomplete contracts and privatization', European Economic Review, vol. 40, 569-579.) . This is because there is a trade-off bwteen allocative efficiency - which the government is good at achieving - and productive efficiency - which the private sector is good at achieving. If the gain in productive efficiency is greater than the loss in allocative efficiency then privatisation makes sense.

As a general guide, Hart, Shleifer and Vishny ("The Proper Scope of Government: Theory and an Application to Prisons", Quarterly Journal of Economics, 112(4): 1127-61, November 1997) argue that the case for government provision of goods or services is generally stronger when non-contractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant and when corruption in government procurement is a severe problem. It has been argued that the case for government production is strong in such services as the conduct of foreign policy, police and armed forces. The case can also be made reasonably persuasively for the case of prisons. The case for private sector provision is stronger when quality reducing cost reduction can be controlled through contract or competition, when quality innovations are important and when patronage and powerful unions are a severe problem inside the government.

The Christchurch City Council ownership of assets is controlled by Christchurch City Holdings Ltd (CCHL) which is the commercial and investment arm of the council. CCHL manages the ratepayers' investment in these seven fully or partly-owned council-controlled trading organisations: Orion New Zealand Ltd – 89.3 per cent shareholding. Christchurch International Airport Ltd – 75 per cent. Lyttelton Port Company Ltd – 78.9 per cent. Christchurch City Networks Ltd (trading as Enable Networks) – 100 per cent. Red Bus Ltd – 100 per cent. City Care Ltd – 100 per cent. Selwyn Plantation Board Ltd – 39.3 per cent.

It's hard to see how any of these assets are in anyway like foreign policy, the police or the armed forces. It is difficult see how non-contractible cost reductions would have negative effects on quality and it seems likely that quality innovations are important in these areas, so (local) government ownership is not justified.

So if the council can not justify keeping assets in terms of it is the most efficient owner of them, then it could use the revenues gained from a sale to offset spending. Or it could buy another asset which it is the most efficient owner of and thus increase returns. But, on the other hand, if the council is the most efficient owner of an asset then selling it just to get money doesn't make sense.

So asset sales or increase debt? If some the assets the council controls are not those it can economical justify owning then increasing revenue by selling them should be on the table. If the council can justify owning these assets then increasing debt should be on the table. I would remind the council however there is option three: cut spending your spending plans.


Horace the Grump said...

One suspects that the Council would far prefer to load its ratepayers up with debt rather than cut spending or make asset sales. I agree that there is no good reason from an allocative point of view that the Council should own any of them.

In Auckland we have Len Brown trumpeting his mad rail loop scheme, which incidentally includes the sale of about $100m of property - now mad Len would never entertain the idea of selling shares in Auckland Airport of Ports of Auckland, but here he is selling land for what must be the dumbest 'investment' by a local council in the last 50 years.

Len plans to saddle the rate payers and tax payers (and likely petrol/diesel users) with higher costs to fund this folly - a bit like the plan for the new stadium and convention centre in Chch.

Sadly economic logic and local authorities are mutually exclusive.

Eric Crampton said...
This comment has been removed by the author.
Eric Crampton said...

Ha, sorry. Comment was meant for the another post.

You're right here.