Tuesday, 31 May 2011

Bad thinking on privatisation

In a recent posting on privatisation at his blog Roger Kerr writes
Thus in a recent letter to the Dominion Post, investment analyst Garth Ireland wrote:
Labour leader Phil Goff says that, under Labour, there will be no asset sales (May 2). He says: “It is economic madness. The power companies return $700 million in dividends every year – that is lost forever”. But is it?

Surely the sale price received today is equivalent to the future expected dividends? Nothing is lost. Dividends of $700m a year at a rate of return of, say, 10 per cent are equivalent to $7 billion today.

Mr Goff claims that the dividends “pay for 10,300 teachers, 12,600 new police officers or 33,000 hip replacements”. He can still spend the $7b sale proceeds or the $700m each year forever. They are equivalent.
This drew the following comment on the Dominion Post website:
“Surely the sale price received today is equivalent to the future expected dividends?” I think you sir may in fact not get it. “The future expected dividend” is infinite. Inflation happens, and so does increasing dividend.

If we sell it for 7 billion, that is ALL we ever get and it will end up like kiwi rail, run down by the owners to maximise profit. The 7 Billion will become worth less and less. And we will become asset poor.

If we keep it, the value will increase, dividends will increase as electricity becomes our primary fuel source (Oil crisis), and because we (the NZ government, and by default the NZ people) will invest in it, it will not become run down.

Would you sell your kidney for short term profit? I think you would. Think long term, thinking short term led to the current problems.
Kerr then makes the point that we need to think in terms of the discounted value of the future (infinite?) dividend stream. A dollar tomorrow is not worth the same as a dollar today.
The future expected dividend may indeed be infinite (if the SOE performs well). But what Garth Ireland was pointing out is that to compare the value of the asset to the Crown if it remained in public ownership with the value to the Crown of a sale, you have to discount the future (infinite) dividend stream to express it in net present value terms. People value a dollar today more than they value a dollar in 100 years’ time.

On that basis, the Crown’s financial position is no worse as a result of the sale.
Kerr also notes that the government could gain from a sale,
because the new private owners of the business are likely, on average, to operate it more efficiently, the Crown is likely to be better off financially (relative to keeping the asset) because in a competitive sale process it will capture some of the likely efficiency gains.
But there seems to be other problems with the quote from the Dominion’s website. First, obviously the future income stream is not infinite as this would require the firm to exist forever. Firms tend not to be around for that length of time. So we can't get the $700 million forever. Secondly the $7 billion is not all that we get if an SOE is sold as taxes on the private firm’s profits will be taken by the government. Thirdly there seems to be confusion as to the relationship between the dividends of $700 million per year and profit maximisation. The writer of the Dominion posting says “If we sell it for 7 billion, that is ALL we ever get and it will end up like kiwi rail, run down by the owners to maximise profit” which seems to indicate that the writer thinks maximising profits is a bad thing. But if the firm doesn’t maximise profits where does the writer think the dividends are going to come from? We only get the $700 million each year because the SOE sets out to maximise profits. So even if we have public ownership we still have to have profit maximisation to get the $700 million in dividends. So if it is bad for the private firm to maximise profits it must also be bad for the SOE to maximise profits, so we can have either profit maximisation by the SOE and the $700 million in dividends or non-profit maximisation by the SOE and miss out on the dividends. The actions of a profit maximising SOE will be the same as the actions of a profit maximising private firm. Both will do whatever they need to to maximise profits.

There are good reasons for not liking partial privatisation but those given in the comment on the Dominion Post website are not some of them. Kerr is right when he says,
One of the difficulties of debunking myths about privatisation is that some people do not get basic factual or economic points even when they are clearly explained.

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