Thursday, 23 July 2009

Should Meridian be privatised?

This question is asked by Seamus Hogan over at Offsetting Behaviour. Seamus writes,
This story in yesterday’s Press suggested that the SOE, Meridian Energy, is being restructured in preparation for being privatised after the next election, although this has been denied by John Key.
He goes on,
The reaction of the regular “public finance” economist in me to the suggestion that an electricity company will be privatised is to cheer loudly: the government has no business owning shares in companies providing private goods while at the same time maintaining a large portfolio of debt. The “public choice” economist in me, however, hopes that Meridian and the other two SOE electricity generators (Mighty River Power and Genesis) will remain government owned.
The theory of the firm economist in me says yes to privatisation.

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. Electricity doesn't look much like these services to me.

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.

On these grounds I can not see why the government needs to be involved in the production of electricity. The incentives look better under private ownership. Electricity production is not a area where cost reductions come at the expense of quality - its difficult to see what low quality electricity would be; where innovation is unimportant - we always want better, more efficient, environmentally friendly ways of producing power; or where there are any problem with government procurement - its not clear that we need government procurement in this case. So why have the government owning Meridian, Mighty River Power or Genesis? It is hard to see competition lessening under private ownership, having the government owning three of the big players in the industry doesn't look like a highly competitive market place. Also privatisation maximises the "distance" between the government and the industry. This makes political interference more obvious and thus more politically costly than under state ownership.

For electricity production, private provision makes sense to me.


Seamus Hogan said...

But what do Hart, Schleifer and Vishny say about industries where political pressure is more likely to lead to stupid regulation if profits are privately earned?

Paul Walker said...

But are there not just as many political pressures when government owned companies are making those profits? In fact there may be more since voters may believe that the government can directly affect the operations of an SOE? Thus the possibility of stupid regulation may be just as great with SOE's as with private firms.

Peter Metcalfe said...

"low quality" electricity was experienced in Berlin after reunification. Power sourced from former east german power plants had varying oscillations such that there were power surges and shortages and clocks on such power (like those in the subways) sped up and slowed down.

Paul Walker said...

Pete I'm not sure that's low quality electricity as much as low quality power generation and given that such things are obvious, especially if you're in a train at the time, they should be able to be contracted upon.

Eric Crampton said...

Seamus is right that the IO argument misses the point he was making; you're right that there are political pressures on SOEs as well. I'd expect Seamus to reply, though, that we've observed little expropriation of Meridian's profits through regulatory activity under the current system: the devil we know isn't that bad and we don't know what insanity voters would demand under a private system if a private power company were profiteering.

I worry that the argument could be used to justify any inefficient status quo if the "stupid voter" threat is big enough.

Rocket Boy said...

You seem to be under the mistaken belief that we have competition in the electricity market. With the massive profits the electricity companies are making we clearly don't have competition.

Also you ask what is 'low quality electricity', that would be when the supply is not 100% secure. Where is the incentive for an electricity provider to supply power 100% of the time including the winter peaks? Only regulation would guarantee this.

And then you just assume that private electricity companies will provide environmentally friendly electricity, why would they do this? Again this would have to be regulated.

It annoys me that we pay a premium for power in this country but at least those profits mostly stay here in NZ. I would annoy me more if we were over charged for power and the profits headed off to overseas shareholders.