Nolan on asset sales

Matt Nolan has an interesting piece on Asset Sales up at the TVHE blog. In his article Matt writes,

In New Zealand at the moment there is definite scope for opening up SOE’s to private sector investment – that is where we are sitting now. However, even given this I cannot go as far as Roger Douglas and say that the price does not matter – in fact, price is THE issue that the government should use when deciding whether to sell assets.

and adds

At the same time the government know that, if it keeps hold of the asset, it expects to make some dividend yield from said asset through time. As a result, the government can price the asset – they can say they would not accept a bid below the discounted expected return from holding the asset.

What I would argue is that the government may  - in some circumstances - want to accept a bid below the discounted expected return from holding the asset. One example as why it could want to do so is given by Anbarci and Karaaslan's idea of An Efficient Privatization Mechanism:

In this paper, we consider the privatization of State-Owned Enterprises (SOEs) that are legal monopolies but not natural monopolies; their markets can be opened to competition once privatization takes place and other competitors can emerge and compete successfully against them in a few years. But until that happens, these privatized SOEs can have a significant level of market power. The currently used “Revenue Maximization (RM)” privatization scheme maximizes the government revenue from privatization but does not provide sufficient incentives for the privatized SOE eiher to charge a price lower than the monopoly price or to improve production efficiency until competition arises. We propose a new scheme to privatize such SOEs. We term this new scheme the “Welfare Maximization (WM)” scheme. The WM scheme practically yields no revenue to the government from the privatization of any such SOE; however, it induces the privatized SOE to charge a competitive price in the absence of any regulation. It also turns out that the WM scheme provides greater incentives for post-privatization process invention (i.e., for post-privatization cost reduction) than RM scheme. (emphasis added)

This is a very specific situation but it helps make the point that just trying to maximise the price received for an asset is not necessarily a good idea. In the above example welfare is maximised while revenue is basically zero. So I would say that the price doesn't matter or at least the price is one of the least important factors in privatisation. The issue when thinking about whether to privatise or not is not price, but productivity. It is more important to get the regulatory environment right so that competition can breakout in the industry than it is to maximise the price for which the asset is sold.

Basically, I guess, I'm arguing we should have lexicographic preferences, with price low on the list.

EconTalk this week

Arnold Kling of EconLog talks with EconTalk host Russ Roberts about a new paradigm for thinking about macroeconomics and the labour market. Kling calls it PSST--patterns of sustainable specialization and trade. Kling rejects the Keynesian approach that emphasizes shortfalls in aggregate demand arguing that the aggregate demand approach masks the underlying complexity of the recalculations that periodically take place in a dynamic economy. Instead, Kling invokes the mutual exploration between entrepreneurs and workers for profitable opportunities that pay well using the workers' skills. This exploration takes time, involves trial and error, and can have false starts because businesses sometimes fail or employees are difficult to find or match with employment opportunities. Kling applies these ideas to the current crisis to explain why labour market recovery is so sluggish and what might policies might improve matters.

What use administrators?

Economic Logician over at the Economic Logic blog comments on the problems he has with administrators who insist that he should go around applying for grants.

My administrators do not care about the impact on my research, or my welfare for that matter. They want the overhead. They are begging for money to justify their existence. I already bring lots of money to the college by teaching many, many tuition paying and public funding attracting undergraduates. In fact, from a back of the envelope calculation, my pay should double just for that. I am already subsidizing the administrators, why would they need grant overhead? They need to feed a machinery that deals with those grants. The office of research, which manages the grants, is twenty people strong. And if I hire a research assistant among the graduate students, I have to pay his or her full tuition before anything can be assigned. I cannot hire outside the university. So why would I want to hire anyone?

In some way, the administration wants me to pay for my salary through grants, a salary I have already more than earned with teaching to overflowing classrooms. To be honest, if I were successful in obtaining grants, I would leave the university and keep everything for myself. I would then be able to concentrate on research instead of putting up with all the red tape. But most funding agencies do not accept submissions from independent researchers, so I continue doing my research without grants and try to ignore these administrators. Let them show their self-importance elsewhere.

This is not just a problem at this guy's university. Sadly it's a worldwide issue. One has to ask if the growth in the ratio of administrators to academics seen in universities really has increased the quantity and quality of useful research or has it just resulted in more output of the least publishable unit? Have schemes like PBRF added to the sum total of the useful knowledge of mankind or just lead to the needless death of countless trees to feed the growth in academic journals that no one reads.

Wine production

The table below - which comes from an entry by Elliott R. Morss at the Wine and Food Economics blog - provides the total wine production by country for 2008. Note just how little wine New Zealand does produce, but as Morss notes in his article, "New Zealand does well in export markets for how much it produces."

	Wine Production
	2008	2004-08	2008
Country	(milhectltrs.)	% Change	per hectare
Italy	46,900	-6%	56
France	42,950	-25%	50
Spain	34,850	-19%	30
USA	20,550	2%	50
Argentina	14,680	-5%	65
China	13,005	17%	26
Australia	11,700	-20%	68
Germany	10,400	4%	102
South Africa	9,890	7%	75
Chile	7,860	25%	40
Romania	6,300	2%	31
Portugal	5,400	-28%	22
Greece	3,750	-12%	32
Brazil	3,500	-11%	35
Hungary	3,400	-22%	47
Austria	2,400	-12%	47
Bulgaria	1,800	-8%	19
New Zealand	1,700	43%	49

Italy, France and Spain are the big boys on the block. The size of Chinese production surprised me but Morss points out its mainly for local consumption. The growth in New Zealand's production over the 2004-8 period is pretty amazing and may help explain the current wine glut.

The law of unintended consequences, again

This new NBER working paper by Julie Berry Cullen, Mark C. Long and Randall Reback looks at Jockeying for Position: Strategic High School Choice Under Texas' Top Ten Percent Plan and give a nice example of the law of unintended consequences. The abstract reads:

Beginning in 1998, all students in the state of Texas who graduated in the top ten percent of their high school classes were guaranteed admission to any in-state public higher education institution, including the flagships. While the goal of this policy is to improve college access for disadvantaged and minority students, the use of a school-specific standard to determine eligibility could have unintended consequences. Students may increase their chances of being in the top ten percent by choosing a high school with lower-achieving peers. Our analysis of students’ school transitions between 8th and 10th grade three years before and after the policy change reveals that this incentive influences enrollment choices in the anticipated direction. Among the subset of students with both motive and opportunity for strategic high school choice, as many as 25 percent enroll in a different high school to improve the chances of being in the top ten percent. Strategic students tend to choose the neighborhood high school in lieu of more competitive magnet schools and, regardless of own race, typically displace minority students from the top ten percent pool. The net effect of strategic behavior is to slightly decrease minority students’ representation in the pool. (emphasis added)

Good intentions are not enough, you have to think through the likely effects of your policy. Changing incentives changes behaviour, often with unintended consequences.

Incentives matter: things not to say to the wife file

From Greg Mankiw's blog:

With the tremendous amount of snow we have had lately, my roof has started to develop some ice dams. So a little while ago, I climbed out onto the roof to shovel off as much snow as I could. The conversation as I exited through the window went something like this:

My wife: Be careful.

Me: I will.

My wife: It's slippery out there. I don't want you to fall.

Me: Well, remember that I have a lot of life insurance.

My wife: Ha. Ha.

Me: But I don't have nearly as much disability insurance. So if I do have an accident, make sure the fall kills me.

John Nye on the new institutional economics and economic development

John Nye, speaking last December on the New Institutional Economics and economic development.


(HT: Oo\rganizations and Markets.)

Setting up of Kiwibank

Andrew Cardow, David W.L. Tripe and William R. Wilson, of Massey University, have a working paper on Ideology or Economics: Government Banking in New Zealand. The abstract reads:

We argue that in the short history of New Zealand banking, political experimentation, based at first upon socialist ideology of the 1940’s led to the nationalisation of The Bank of New Zealand (BNZ), followed by a period of neo-liberalism in the 1980’s and early 1990’s in which the bank was privatised. We further argue that the establishment of Kiwibank Ltd (Kiwibank) in New Zealand at the dawn of the 21st Century was a return to the political ideology of the 1940’s. In this article we discuss the nationalisation and subsequent privatisation of the BNZ and draw a parallel between the perceived banking environment as it existed in New Zealand in the 20th Century and as it existed at the establishment of Kiwibank. By way of context setting we also discuss the political environment as it relates to the nationalisation of the Bank of England. We find that in New Zealand political experimentation, not commercial pragmatism was the underlying motivating factor for the state’s involvement in banking. The article contributes to the pool of knowledge regarding the political motivations behind nationalisation and state ownership of banking assets. The article is of interest to economic and political historians as well as those who study New Zealand political party history. Future policy makers could do well to reflect upon the motivations for state ownership of banking assets by asking if their decisions are driven by ideology or economics.

In their discussion of the reasons for the setting up of Kiwibank, Cardow, Tripe and Wilson write,

Thanks to the popular political rhetoric of Jim Anderton, Kiwibank became a reality. It is clear however that the decision to proceed with Kiwibank was a political decision. The business case was considered weak by the independent auditor and by banking commentators. It was the appeal to popular opinion and the image of being a New Zealand bank for New Zealanders that was the turning point. Like the BNZ and BOE nationalisation, the appeal to the ‘people’ was more successful than the appeal to economics.

and

The rhetoric employed by the main cheerleader Jim Anderton MP would not have been out of place 60 years earlier. Again the spectre of foreign owned banks was used as a rallying cry. Jim Anderton was able to point to the very dominant position that Australian banks held in New Zealand. It would be fair to comment that Australian banking interests controlled the retail banking market in New Zealand at the time. Again Jim Anderton was able to use the rhetoric of a ‘people’s bank’ – the same phrase first used by Nash when campaigning to nationalise the BNZ. Finally Anderton was able to suggest that a state owned bank would be more sympathetic to the plight of ‘ordinary’ new Zealanders than the large Australian owned banks.

As a result of political, and to a certain extent, marketing pressure from the New Zealand Post Office, Kiwibank was established. The new bank grew a presence quickly by utilising the branch network of new Zealand Post retail outlets. In establishing Kiwibank as a state owned bank, the government acted in a politically expedient manner rather than out of economic necessity.

Thus there was no economic necessity for Kiwibank but it was politically expedient and so once again we see politics trumping economics when it comes to policy.

Mises on fractional reserves

It is often argued that Ludwig von Mises was in favour of a 100% reserve requirement for banks. Such a view is put forward in Huerta de Soto's Money, Bank Credit, and Economic Cycles. Now this interpretation is being challenged. Nicolas Cachanosky has a new working paper out on Mises on Fractional Reserves: A Review of Huerta De Soto's Argument. The abstract reads:

The interpretation that Mises preferred banking with a 100% reserve requirement finds strong support in Huerta de Soto’s Money, Bank Credit, and Economic Cycles. This article seeks to review his arguments concluding that it is in fact more feasible to interpret that Mises preferred free banking with fractional reserves to the 100% reserve requirement.

Empirical evidence on privatisation

On RogerKerr.wordpress.com it is noted that

[...] the unequivocal findings of economic research are that on average and over time, privately owned businesses outperform publicly owned ones (see here for relevant references). What matters for policy is this general result. Government should not bet against the odds with taxpayers’ money.

In addition to the Phil Barry reference Kerr gives the empirical evidence on privatisation is discussed in William L. Megginson's book, The Financial Economics of Privatisation, 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.

The studies examined here are far less unanimous regarding the impact of privatization on employment levels in privatized firms. All governments fear that privatization will cause former SOEs to shed workers, and the key question in virtually every case is whether the divested firm's sales will increase enough after privatization to offset the dramatically higher levels of per-worker productivity. Three studies document significant increases in employment [Galal, Jones, Tandon, and Vogelsang (1992); Megginson, Nash, and van Randenborgh (1994); and Boubakri and Cosset (1998)], but most of the remaining studies document significant-sometimes massive- employment declines. These conflicting results could be due to differences in methodology, sample size and make-up, or omitted factors.

However, it is more likely that the studies reflect real differences in post-privatization employment changes between countries and between industries. In other words, there is no "standard" outcome regarding employment changes.

Perhaps the safest conclusion we can assert is that privatization does not automatically mean employment reductions in divested firms, though this will likely occur unless sales can increase fast enough after divestiture to offset very large productivity gains. Since the empirical studies discussed in this chapter generally document performance improvements after privatization, a natural follow-up question is to ask why performance improves. For utilities, the need to introduce competition and an effective regulatory regime emerges as key, but there is no "silver bullet" answer for what makes privatization successful for firms in competitive industries. As we will discuss in the next chapter, a key determinant of performance improvement in transition economies is bringing in new managers after privatization. No study explicitly documents systematic evidence of this occurring in nontransition economies, but Wolfram (1998) and Cragg and Dyck (1999a,b) show that the compensation and pay-performance sensitivity of managers of privatized U.K. firms increases significantly after divestment. Studies that explicitly address the sources of post-privatization performance improvement using data from multiple nontransition economies tend to find stronger efficiency gains for firms in developing countries, in regulated industries, in firms that restructure operations after privatization, and in countries providing greater amounts of shareholder protection.

Another overview of the empirical literature is Sunita Kikeri and John Nellis's An Assessment of Privatization, "The World Bank Research Observer", vol. 19, no. 1 (Spring 2004)

This article takes stock of the empirical evidence and shows that in competitive sectors privatization has been a resounding success in improving firm performance. In infrastructure sectors, privatization improves welfare, a broader and crucial objective, when it is accompanied by proper policy and regulatory frameworks.

Mary M. Shirley and Patrick Walsh write in Public versus Private Ownership: The Current State of the Debate, Working Paper, The World Bank,

Our review found greater ambiguity about ownership in theory than in the empirical literature. In the debate over the effects of competition, theory suggests that ownership may matter and if so, that private firms will outperform SOEs. The empirical studies squarely favor private ownership in competitive markets. Theory’s ambiguity about ownership in monopoly markets seems better justified, since the empirical literature is also less conclusive about the effects of ownership in such markets. Theories that assume a welfare maximizing government suggest that SOEs can correct market failures. In contrast, public choice theories are skeptical of the benevolent government model. Corporate governance theories suggest that even well intentioned governments may not be able to assure that SOE managers do their bidding. The empirical literature favors those skeptical of SOEs as a tool to address market failures. In studies of industrialized countries, where we might expect more developed political markets to motivate greater government concern with welfare maximization or better information and incentives to overcome corporate governance problems, private firms still have an advantage. The private advantage is more pronounced in developing countries, where market failures are more likely.

As to the empirical evidence for New Zealand let me deal with one obvious recent and controversial example: Kiwirail.

In the July 2009 issue of Competition and Regulation Times put out by the New Zealand Institute for the Study of Competition and Regulation (ISCR) the question is asked, Kiwirail: strategic asset or strategic blunder? The article summaries an ISCR research paper "The history and future of rail in New Zealand" by Dave Heatley.

We seem to be nearer the blunder end of the scale than the asset end. The Times article and the research paper argue along similar lines. Heatley opens his Times article by noting that back in 1999 one of the first projects undertaken by the ISCR was a study of the long-term economic performance of New Zealand railways.

Public rail ownership was characterised by declining performance, beginning in the 1920s and culminating in a very poor prognosis in the 1990s. There were signs that since 1993, privatisation had led to improved productivity and profitability; however, the business was still far from achieving financial sustainability. The ISCR report predicted that private-sector ownership would result in better incentives for productivity-enhancing decision making, but in the long run it was unlikely that in its current form the business would be able to generate returns sufficient to cover the costs of the very large sums of capital employed. Given these facts, a rational private owner would likely rationalise services and reduce the scale of the network to the point where it constituted a sustainable long-run business. Revenues freed up from repeated cycles of historic government-funded capital injections and operating subsidies could then be applied to more productive uses, to the wider benefit of the New Zealand economy.

Given that rail is again in the hands of the government it is timely to re-examine the assumption that government ownership will result in superior long-term outcomes for the long suffering taxpayer owners. Heatley writes,

The 2009 analysis reveals little evidence to suggest that overall the economic outlook for rail has improved since 1999. Despite gains in operational productivity, rail's share of the land freight task has declined over the period examined. Profitability has remained poor, suggesting an ongoing lack of competitiveness vis-a-vis other freight modes.

and continues

Rail networks offer benefits from economies of density (increasing use of existing tracks), but not necessarily from economies of size (increasing size of the network).' In a rail network with uneven patterns of use, such as New Zealand's, the economics of density means that the closure of lightly used lines will, in general, improve the overall economic performance of the network.

Importantly Heatley notes that

It proved difficult for private owners to rationalise the size of the network efficiently, due to poorly aligned incentives and political intervention in operational decisions such as exiting from the provision of certain long-distance passenger services.

The retention of land ownership by the Crown at the time of privatisation muted private incentives to rationalise the network as the private operator was unable to access the potential land-sale benefits from closing unprofitable lines. Private-sector owners have been incentivised to persevere with a strategy (originating under public ownership) of retaining otherwise uneconomic lines for their current income-generating potential, but refraining from investing in replacement infrastructure such as sleepers, tracks and bridges.

A return to integrated land, infrastructure and operational ownership resolves the incentive misalignment, enabling its new owners to rationalise network infrastructure efficiently. Yet perversely, extensive recapitalisation has followed re-nationalisation. The government has invested $2.9 billion in rail since 2002, and has committed a further $0.9 billion through to 2013. It is unlikely that the government will earn a reasonable financial return on this investment, as the strong incentives of private owners for ongoing productivity improvements will likely be muted under government ownership, and the scope for political intervention in strategic and operational activities has increased.

The consequences of political intervention are evidenced in the targets set for a modal shift from road to rail freight in the New Zealand Transport Strategy. Any increases in rail freight's share must ultimately come from substitution at the margins away from competing transport modes. Extensive competition from both road and sea freight restrains the ability of rail to set prices. Rail exhibits few apparent cost advantages, even with subsidies from the written-off opportunity cost of capital. So modal shift can only be driven by increasing the level of subsidies in order to lower prices artificially and therefore induce movement of marginal freight away from more efficient road and sea freight. Such shifts will be to the detriment of the overall economic performance of the transport sector and the wider New Zealand economy.

There is little evidence that the real costs of the current government ownership and investment strategy have been adequately assessed in terms of foregone benefits in other taxpayer-funded areas, such as health and education.

After this, an obvious question to ask is, Is there light at the end of the tunnel? Heatley comments,

The 2009 analysis confirms that the issues identified in 1999 still remain, and are unlikely to be addressed by recent changes in governance, ownership and policy direction. Yet rail still remains a viable transport medium for those segments to which it is intrinsically well-suited - long-haul carriage of heavy, bulky freight (coal, logs, manufactured goods, etc.) and high volume urban commuter services. The challenge for rail's new owners is to find a viable subset of the current rail network. Given current and projected freight and passenger types and volumes, it appears a viable subset exists at around 1500-2000 kilometres in length - less than half the present size. Line closures and land sales could fund upgrading of the core network to 21st-century standards.

So, rail makes sense for a small portion of the current network. However I can't see the changes in government policy and public perceptions need for rationalisation of the network coming to pass any time soon. So the taxpayer gets stuck with yet another white elephant

Another question worth asking, as partial privatisation is on the table, is, Why don't mixed ownership firms do as well as fully privately owned firms? Aidan Vinning and Anthony Boardman's "Ownership and Performance in Competitive Environments: A Comparison of the Performance of Private, Mixed, and State-Owned Enterprises", Journal of Law and Economics vol. XXXII (April 1989) concludes 'The results provide evidence that after controlling for a wide variety of factors, large industrial MEs [mixed enterprises] and SOEs perform substantially worse than similar PCs [private corporations].' The basic problem is that partial government ownership politicises the firm.

As to the performance of state-owned banks Marcio I,. Nakane and Daniela B.Weintraub and look at Bank privatization and productivity : evidence for Brazil. Their abstract reads:

Over the past decade, the Brazilian banking industry has undergone major and deep transformations with several privatizations of state-owned banks, mergers and acquisitions, closing down of troubled banks, entry by foreign banks, and so on. The purpose of this paper is to evaluate the impacts of these changes in banking on total factor productivity. The authors first obtain measures of bank level productivity by employing the techniques due to Levinsohn and Petrin (2003). They then relate such measures to a set of bank characteristics. Their main results indicate that state-owned banks are less productive than their private peers, and that privatization has increased productivity.

Rafael La Porta, Florencio Lopezde-Silanes and Andrei Shleifer also look at the Government Ownership of Banks. They write

In this paper, we investigate a neglected aspect of financial systems of many countries around the world: government ownership of banks. We assemble data which establish four findings. First, government ownership of banks is large and pervasive around the world. Second, such ownership is particularly significant in countries with low levels of per capita income, underdeveloped financial systems, interventionist and inefficient governments, and poor protection of property rights. Third, government ownership of banks is associated with slower subsequent financial development. Finally, government ownership of banks is associated with lower subsequent growth of per capita income, and in particular with lower growth of productivity rather than slower factor accumulation. This evidence is inconsistent with the optimistic development' theories of government ownership of banks common in the 1960s, but supports the more recent political' theories of the effects of government ownership of firms.

This however has to be the coolest paper ever on the trying to workout if there is a difference between the performance of government-organised production versus privately organised production. Jonathan M. Karpoff, "Public versus Private Initiative in Arctic Exploration: The Effects of Incentives and Organizational Structure", Journal of Political Economy, February 2001, v. 109, iss. 1, pp. 38-78.

Karpoff's paper exploits a very interesting and unique natural experiment to compare the performance of government-organised versus privately organised production. Karpoff studies a comprehensive sample of 35 government-funded expeditions and 57 privately funded expeditions to the Arctic from 1818 to 1909 seeking to locate and navigate a Northwest Passage, discover the North Pole, and make other discoveries in arctic regions. I guess these are the cold hard facts!

He finds that the private expeditions performed better using several measure of performance. Karpoff shows that most major arctic discoveries were made by private expeditions, while most tragedies - in terms of lost ships and lives - were on publicly funded expeditions. Karpoff notes that the public expeditions might have had greater losses because they took greater risks, but then the public expeditions would have had a greater share of discoveries, which did not occur.

Karpoff also estimates regressions explaining outcomes in several ways-crew deaths, ships lost, tonnage of ships lost, incidence of scurvy, level of expedition accomplishment - controlling for exploratory objectives sought, country of origin, the leader's previous arctic experience, or the decade in which the expedition occurred. In essentially every regression, the dummy variable for private expedition is significant, with a sign indicating that the private expedition performed better. Karpoff concludes that the incentives were better aligned in the private expeditions, leading to systematic differences in the ways public and private expeditions were organised. While the uniqueness of the sample limits its generality, Karpoff provides an interesting illustration of the impact of ownership on the performance of an organisation.

While it is true that the effect of changes in ownership on the performance of firms is still debated in some quarters, most of the evidence suggests that firm performance improves when SOEs are privatised. This is a result that should be kept in mind with thinking about the current discussion on the merits of privatisation.

Taxpayers as "owners"

When discussing privatisation Roger Kerr writes on his blog that

Taxpayers are indeed the true owners of SOEs (and other government assets).

I have to disagree.The taxpayers or the "public" do not own government assets in any meaningful sense of the word "ownership". All of the attributes of ownership, such as control, the right to determine what use is made of it and under what conditions, is determined by the government or the bureaucracy in control of the asset in question.

The important point here is that without control you don't have ownership. As Oliver Wendell Holmes Jr. put it,

But what are the rights of ownership? They are substantially the same as those incident to possession. Within the limits prescribed by policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one. (The Common Law, p193, (1963 edn.))

Clearly the "public" does not have the rights Holmes refers to. The government (or its bureaucracy) has these rights. Following Grossman and Hart ("The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration", 'Journal of Political Economy', 94:691-719) economist's tend to define the owner of an asset as the one who has residual rights of control over the asset; that is, whoever can determine what is done with the asset: how it is used, by whom it is used, when they can use it etc - note that ownership is not defined in terms of income rights. Under "public" ownership it isn't the "public" who has the control rights, its the government. The "public" can not determine what use is made of a "public" asset, rather its use is determined by the politicians and managers in command of it. As Madsen Pirie has noted

The term 'public ownership' is a misnomer. The state sector may have the name of the public filled in on the dotted line, but the public do not own it in any meaningful sense of the word. All of the attributes of ownership, such as control, the right to determine what use is made of it and under what conditions, is determined by the bureaucracy in command of it. Far from being owned by the public, it is owned in effect by the people who administer it. The public actually has more influence, via its choices and purchasing decisions, on private sector businesses than it can ever have over state industries and services. In those cases its influence is diffuse and diluted through the political process.

Just think of any of the SOEs in New Zealand, what control does the "public" have over them? Control rests with either the government or the bureaucracy or the firm's managers. The SOEs "(non)owners" - the taxpayers - have the least say of anyone in their running.

Kerr's comment was in reaction to a letter to the editor in Dominion Post which asked

Why should Kiwi mum and dad investors buy something which we already own?

The obvious answer is because they don't own them. By buying into SOEs they gain not only a share in the future profit stream of the firm but they also gain control rights over the firm and thus they become true owners of the firm.

The economics of revolution

Gerard O'Neill at the Turbulence Ahead blog writes,

Has the price of revolution fallen? Gary North thinks so. In a brilliant analysis of the current situation in Tunisia and Egypt he observes that:

When the cost of political mobilization falls, more is demanded. When people can mobilize thousands of protesters without any centrally directed agency and without any organization that can be infiltrated and subverted, they are in a position to impose enormous political damage on any existing regime, as long as the regime really is corrupt, tyrannical, and hated.

So demand curves do slope downwards, even for revolutions!

Technology has lowered transaction costs so much that we seem to be at the point where revolutions can be a decentralised "market" transaction. There is no need any more for central control or leadership, revolutions have taken on a spontaneous order of their own.

Price controls cause chaos in Ethiopian markets

But is anyone surprised by this news? This is from www.voanews.com:

Price controls on many staple food items ordered by Ethiopia's government early this month have reduced grocery bills for many low-income families. But now shopkeepers are upset and some basic items are disappearing from store shelves. Economists are concerned about the long-term effect of the government's price-fixing strategy.

Confusion has been the order of the day at shops and markets across the Ethiopian capital this month. The government surprised businesses on January 6, the Ethiopian Christmas Eve, by announcing price caps on such items as meat, bread, rice, sugar, powdered milk and cooking oil.

Prime Minister Meles Zenawi said the caps were a response to price gouging by merchants taking advantage of global price hikes. He vowed to put a stop to what he called "market disorder.”

Consumers respond

The news was seen as a Christmas gift by many cash-strapped consumers, who had seen food prices jump after the government devalued the local currency, the Birr, by 17 percent in September.

In the first days after the price controls went into effect, Shenkut Teshome was among shoppers who rushed to markets to scoop up goods at newly lowered prices. He applauded government intervention as the only way to save impoverished Ethiopians from starvation.

"People are hoping they can buy with their salary a fair material at a fair price," said Shenkut. "[Prices] were exaggerated and people cannot afford to buy with their salary and live at the same time, paying rent, this and that. The main thing is that they have enough food for their children."

The price controls, however, have triggered chaos and tension in the local marketplace. Arguments, even occasional fistfights have been reported between irate shoppers and business operators as price controlled goods, such as cooking oil and oranges, have disappeared from shelves.

One customer at a local shop, who spoke on condition of anonymity, quipped that the net effect of the price controls is that nothing has changed. He said that earlier, goods on the shelves were too expensive to buy. Now the prices are lower, but the goods have disappeared.

Shopkeepers discouraged

Business owners said the past few weeks have been unbearable. Customers are unhappy, some products they bought before the price caps must be sold below cost, and neighborhood government representatives drop by several times a day to check that they are in compliance.

Shopkeepers contacted for this report all said they were afraid to give their names, but one who agreed to speak anonymously said she was ready to give up.

She said, "This is way too much for us. We are small traders. We don’t make much money. We get everything on credit, so when this stock is gone, we are closing up shop."

Government defends

Representatives of Ethiopia’s Trade Ministry did not respond to numerous interview requests for this report. But government officials have been quoted as saying price controls were needed because retailers had raised prices blaming global price increases and the devaluation, although such factors had had no influence on the availability of their products.

In addition, four economists not affiliated with the government, all of whom have previously spoken to VOA on the record, declined to be quoted this time, saying the subject was too sensitive. But all four privately predicted that price fixing would not help in solving Ethiopia’s deep-rooted economic problems.

Temesgen Zewdie, finance chairman of one of Ethiopia’s main opposition parties and a former Member of Parliament, called the price controls a step toward a Communist-style command economy.

In a free market economy, the preferred way of doing this is to increase the supply and increase competition," said Temesgen. "But the government did not do that. Instead they went directly to the producers and retailers, telling them to reduce prices and supply these products. These practices happen in Communist states, not in western democracies."

So let me get this right: the government devalued the local currency and prices went up (entirely predictable), consumers complain about prices increases (entirely predictable), the government puts price controls in place to stop "price gouging" (entirely predictable), goods start disappearing from market shelves (entirely predictable). So, no surprises here; market chaos was predictable.

(HT: Knowledge Problem.)

Radio 4 documentary on the Austrian School

The BBC Radio 4 has produced a documentary on F. A. Hayek and the Austrian school of economics. The programme is Radical Economics: Yo Hayek!

Jamie Whyte looks at the free market Austrian School of F. A. Hayek. The global recession has revived interest in this area of economics, even inspiring an educational rap video.

"Austrian" economists believe that the banking crisis was caused by too much regulation rather than too little. The fact that interest rates are set by central banks rather than the market is at the heart of the problem, they argue. Artificially low interest rates sent out the wrong signals to investors, causing them to borrow to spend on "malinvestments", such as overpriced housing.

Contributors:
Prof Steven Horwitz, St Lawrence University, New York
Prof Larry White, George Mason University, Washington DC
Robert Higgs, Independent Institute, California
Philip Booth, Institute of Economic Affairs
Steve Baker, Conservative MP
John Papola, co-creator Fear the Boom and Bust
Lord Robert Skidelsky, economic historian and biographer of John Maynard Keynes
Tim Congdon, founder, Lombard Street Research

But why?

Brian Gaynor writes in the New Zealand Herald that,

The Government has to convince the public that these companies will remain majority Crown and New Zealand controlled.

And I ask, But why? All this will do is, ceteris paribus, lower the amount that the government gets for the shares it sells. And then, of course, people will complain about the amount of money raised by the asset sales. 50.1% of a firm is worth a lot more than 49.9% so forcing SOEs to remain Crown owned reduces the return on a sale and the xenophobic requirement for New Zealand control reduces the number of bidders for an SOE and thus again lowers the amount that will be received.

While on the topic of "New Zealand control" of these firms, what happens if a New Zealander buys shares and then moves to, say, the U.S., will they be forced to sell their shares before they are allowed to leave New Zealand? Or what happens if a Canadian living in New Zealand buys shares - will they be allowed to by Gaynor? - and then returns to Canada. Must they sell their shares before leaving to ensure the same amount of "New Zealand control". Both these situation could result in less "New Zealand control", in some sense. When is there too little "New Zealand control"? Or does Gaynor equate "New Zealand control" with "state control"? If "New Zealand control" is "state control" then why worry about what happens to the non-state shares? Why not just sale them to the highest bidder, regardless of where they come from? Why would you want to incentivise "domestic investors"?

Gaynor goes on to make things worse by arguing that we should incentivise "domestic investors"?

Domestic investors should be incentivised to invest in the IPOs, either on their own accounts or through their KiwiSaver schemes. This can be achieved by offering shares at a discount to individual New Zealand investors and KiwiSaver funds.

Which would yet again lower the amount the government would receive for any sale. If "domestic investors" need to be "incentivised to invest" then may be its just because they don't believe that the shares are worth buying. As to KiwiSaver funds being "incentivised to invest" the aim of any such fund is to maximise the return to their investors and if the funds need to be incentivised it means that they too don't believe the investment is one worth making. Handing taxpayer money to these groups to bribe them to invest - this is what Gaynor's idea amounts to - doesn't sound like a optimal policy move. The whole point of a sale is to bring market discipline to these firm, distorting the market with taxpayers money seems an odd way of achieving market discipline.

EconTalk this week

Investigative journalist Brian Deer talks with EconTalk host Russ Roberts about Deer's seven years of reporting and legal issues surrounding the 1998 article in The Lancet claiming that the MMR vaccine causes autism and bowel problems. Deer's dogged pursuit of the truth led to the discovery that the 1998 article was fraudulent and that the lead author had hidden payments he received from lawyers to finance the original study. In this podcast, Deer describes how he uncovered the truth and the legal consequences that followed. The conversation closes with a discussion of the elusiveness of truth in science and medicine.

Private v. public ownership (updated)

Bernard Hickey, who wishes to lecture all of us on things economic, writes:

I wonder too, why can't Treasury and the government appoint boards that apply the same rigour as NZX listed companies? Other non-listed entities can do it.

If I interpret this question correctly (and, of course, I may not) then it seems odd that New Zealand's great economic guru has to ask it. The reasons for different outcomes, no matter who is on the board, under public and private ownership have been well known for the last 20 years. Since the early 1990s there has been a well known literature which explains the difference between private and public firms utilising an incomplete contracts framework. Within a complete contracts model - eg a principal-agent type model - the performance of private and public firm will be the same. This is because complete or comprehensive contracts cover all relevant state of the world and ownership is irrelevant in such a situation.

In an world of incomplete contract not all sates of the world are covered and this gives us a role for ownership - the owner is whoever gets to determine what happens in the situations not covered by the contract. 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.

Its not clear that the government's interventions have been in areas where the Hart, Shleifer and Vishny arguments would suggest the government should be involved. Rail or banking, for example, are not a areas where cost reduction come at the expense of quality, where innovation is unimportant or where there are any problem with government procurement. So why have the government owning KiwiRail or Kiwibank? Also government involvement in Air New Zealand is hard to justify on these grounds. As noted above, the case for private sector provision is stronger when quality reducing cost reduction can be controlled through competition, and the airline industry is very competitive, when quality innovations are important, and we want a high quality and innovative airline industry, and when patronage and powerful unions are a severe problem inside the government, which are things we wish to avoid with an airline. Here private provision makes sense.

The Hart, Shleifer and Vishny argument applies to contracting out as well as outright privatisation. A question that arises therefore is, Why would private ownership ever be more efficient than public? As to why private provision is superior, there are two results that need to be explained. Oliver Williamson's idea of selective intervention and the 'Fundamental Theorem of Privatization' by Sappington and Stiglitz. (Sappington, David E. M. and Stiglitz, Joseph E. (1987). 'Privatization, Information and Incentives'. Journal of Policy Analysis and Management, 6(4): 567-82.) These tell us that there should be no differences in efficiency between a privatised and a nationalised firm. Thus any explanation of the relative efficiency between the two must explain why these ideas cannot be applied.

The first notion, of selective intervention, argues that the government can reach the same level of productive efficiency as the private sector by mimicking the private owner. Is this what Hickey is getting at with this question? If the government organises the firm in exactly the same way as a private owner would, if it gives the same incentive schemes to managers and workers, and if it deviates from such a policy only if there is the possibility of doing something strictly better than a private owner, then a nationalised firm should produce at least as efficiently as a privatised one. Think about what the SOE model was all about.

The second idea is concerned with allocative efficiency and says that a public firm will choose a socially more efficient production level because the government cases about social welfare and internalizes externalities, whereas a private owners just maximizes private profits. However, this argument implicitly assumes that the government cannot regulate the firm. Sappington and Stiglitz suggest a privatisation and regulation procedure that perfectly overcomes the problem of different objective functions. The government could auction a contract that entitles the private owner to receive a payment for the firm's output that exactly equals its social valuation. Thus, the owner fully internalizes social welfare and chooses a socially efficient production level. Furthermore, if the bidding process is competitive, the government will extract all the rents form the contract through the auction ex ante even if it doesn't know the cost function of the firm.

At this point the argument tells us that efficiency should be the same for both private and state firms. Why then does the empirical evidence tell us otherwise? Well, both arguments are based on the implicit assumption that it is possible to write a comprehensive contract for the entire horizon of the firm - otherwise the involved commitment problems could not be overcome. To illustrate this point, consider again the auction suggested by Sappington and Stiglitz. For such an auction to work, the government must be able to commit at the stage of privatisation to actually pay the social valuation of output to the private owner in the (possibly distant) future. That is, it must be possible to specify unambiguously in a contract the social benefit of production for all possible state of world such that this agreement can be enforced by the courts. Otherwise, the private owner will rationally expect that once she has made a relationship specific investment the government will exploit the fact that investment costs are sunk and will expropriate her quasi-rents; therefore she will not invest efficiently. However, if comprehensive contracts are feasible, it is not surprising that there is no difference in efficiency, since it is well known that any organizational mode can be copied by any other organizational mode through a comprehensive contract. Therefore, if there is any difference, it must be due to the fact that only incomplete contracts are feasible at the stage of privatisation.

A simple example is the paper by Klaus Schmidt, "The Costs and Benefits of Privatization: An Incomplete Contracts Approach". (The Journal of Law, Economics & Organization, 12(1): 1-24, 1996.) The intuition is roughly as follows: Suppose the manager of the firm has to make a private investment in cost reduction before production takes place. For example, he may have to expend effort to restructure the firm and to organize production more efficiently. Assume also that the manager derives some private benefit from a higher production level, either because he is an "empire builder" or because he is afraid of the firm being liquidated, in which case he loses his job and his reputation may be damaged. To improve the manager's incentives, the government may want to commit ex ante to a subsidy scheme that punishes the manager if costs are high by cutting back production or even closing down the firm. However, under nationalization this commitment is not credible. If the government could observe the cost function - and it can in this case -, it would always choose a production level that is ex post efficient, thus forgiving high costs and paying more subsidies than announced ex ante. Anticipating this, the manager has little incentive to save costs because he faces a "soft budget constraint". Under privatization, however, the government is not informed about the costs of the firm whereas the private owner is. It is shown that the optimal subsidy scheme under incomplete information distorts production below the socially efficient level if costs are high. Furthermore, there is a positive probability that the firm will be liquidated, even though this is inefficient ex post. Thus, under privatization allocative efficiency is clearly lower than under nationalization. The more surprising result is that productive efficiency may be enhanced. The manager faces a harder budget constraint because he rationally foresees that subsidies will be cut back if costs turn out to be high. Thus he has a stronger incentive to invest in cost reduction to avoid the low production level or possible liquidation. To summarize, there is a trade-off between a less efficient production level (lower allocative efficiency) and better incentives for the manager to save costs (higher productive efficiency).

This article makes a very strong assumption about the role of government. The government is modelled as a benevolent, fully rational, and unitary decision maker. There are no conflicts of interest between politicians, ministries, and regulatory agencies; no rent-seeking lobbyists trying to get subsidies; and no self-interested politicians struggling for power, bribes or a larger share of the electoral vote. This assumption is clearly unrealistic. therefore the main result of the paper should be seen as an existence theorem: It shows that privatization can be can be strictly superior to nationalization even in the best of all words for government. Thus, even if it were possible to fix all the deficiencies of the political system a case for privatisation could still be made

I'm not sure if this answers Hickey's question but it does give us insights as to why the performance of public and private firms differ, which I assume is what he is worried about.

Update: Roger Kerr discusses problems with the discussion of privatisation by journalists here and here.

The low standard of debate

The standard of debate on the topic of asset sale isn't great but this extract from a letter to the Editor of the DomPost (thanks to The Inquiring Mind for this quote) really shows just how bad the debate can get:

‘Obviously the Government is planning to sell the majority of the shares overseas to either the Americans or the Chinese.

If power companies go to the Americans, how long will it be before some smart boy in Wall Street does an Enron and figures that more money can be made by not making electricity?

If the companies go to the Chinese, how long will it be before elements of the Red Army are sent to New Zealand in order to protect their asset? How long before coal or oil, destined to power a thermal station here is diverted to China?’

The economic understanding of the general public isn't great at times but this type of xenophobic misinformation and outright rubbish is just too bizarre for words.

Roger Douglas gets the point

Previously I wrote about the aims of privatisation programs and said:

Another issue which is getting much press is how much would the government get for the shares it would sell and what will it do with the money. A problem here is that talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that's unlikely to do much for welfare.

Now I see from this article from the New Zealand Herald that Roger Douglas at least has also come to this conclusion:

"Privatisation is not really about how much money you get for the asset, that's important, but the more important issues are to get the regulatory environment right so that competition can take place in the industry.

"What you measure your success by is the productivity that flows following the corporatisation / privatisation process."

Well said that man!

Partial privatisation

There has been a lot of rubbish written recently about the idea of the partial privatisation of some state assets. There has also been some good stuff written. On the good side Roger Kerr has pointed out some of the problems with the idea, as have I previously. Now Eric Crampton makes good sense over at Offsetting Behaviour. Eric writes,

On the one side, besides the usual knee-jerk opposition to any kind of privatization and fearmongering about that foreigners might buy shares, there's the claim that we lose money by selling an asset that currently pays the government a dividend higher than the government's net borrowing costs. So if some SOE pays a 7% dividend to the government and the government's cost of borrowing is 5%, they reckon it makes more sense to keep the asset and to borrow money to cover shortfalls.

Forget SOEs for the moment. If any firm is providing a rate of return that seems to consistently be beating the market, we'd expect the stock price to rise until the rate of return falls into line with market norms, right? And if that doesn't happen, it's probably because there's something a bit nasty hiding in the risk profile. Now think about the SOEs. If they're earning a high return, it's either because their valuation is out of whack or because there's some risk. In the former case, the government can do well through an IPO - they'll get more for it than they thought it was worth. If instead it's just that the assets are risky, looking at the gap between funding costs and rate of return misses something a bit important.

Now, a reasonable counterargument is that the stock market rate of return is higher than the government's borrowing costs in general, so the asset price won't be bid up sufficiently to make the difference. But note two big problems. Sovereign debt from reasonable countries is safer than most stock market investments: the market index has to pay investors for the additional risk they take on. So selling a very safe asset (a bond) at a low interest rate while buying a riskier one (keeping an SOE) isn't a "Hey! Free Money!" deal. If it were, we'd also have proven that the government should borrow heavily on the international markets and buy up shares on the NZX. Most of us don't think that would work. So why do we think there's anything particularly special about the government's current set of asset holdings? If the argument for keeping Solid Energy in government hands is that the government's rate of return on coal investments is higher than its borrowing charges, then the government should also buy up any other firm providing a high enough expected return.

Another issue which is getting much press is how much would the government get for the shares it would sell and what will it do with the money. A problem here is that talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that's unlikely to do much for welfare.

With partial private ownership of an SOE you run into the "a man can not serve two masters" problem. The aims of the private owners and the government are unlikely to be the same. Private investors will want to maximise profits while the government may well have political objectives it wants met. A firm can not do both and if it were to try it would just fail to achieve either.