Is it time for governments to launch a new wave of privatizations?

Defending the motion

Bernardo Bortolotti  

Professor of Economics, University of Turin; Director, Sovereign Investment Lab, Bocconi University

A large-scale privatisation programme alleviates public finances because cash revenues can be used to redeem public debt, and savings in interest payments may give leeway to expansionary fiscal policy.

Against the motion

Elliott Sclar  

Urban Planning Professor and Director, Centre for Sustainable Urban Development, Columbia University

The motivational misalignment between long-term public needs and shorter-term private needs for investment return is at the core of all the instances of failure in public-asset sales and leases.

The moderator’s opening remarks

Feb 4th 2014 | Matthew Valencia  

Our debate tackles a perennial economic question that is also inherently political. Privatisation has long been championed by proponents of laissez-faire capitalism, usually on the political right, and opposed, often bitterly, by trade unions and others on the left. Over the past quarter of a century it has ebbed and flowed, in line partly with the complexion of governments and partly with the state of financial markets. (Who wants to sell when prices are in a slump?) Global privatisation receipts have been strong in recent years, but much of the action has been in large developing countries, such as China and Brazil. Is it time for advanced economies to rediscover the boldness of the 1980s and the early part of the last decade?

They could certainly do with some extra revenue. In many OECD countries, public debt is at its highest peacetime levels. In Italy, for instance, it stands at more than 130% of GDP, far above the level that most economists deem sustainable. Where economies are on the mend, recovery looks fragile.

Contrary to the widespread perception that most of the juiciest assets have already been flogged, governments still have plenty of potentially attractive stuff on their books. Fully or partially state-owned enterprises in OECD countries are thought to be worth $2 trillion. Add to that another $2 trillion-worth of sub-national assets, such as regional utilities. Dwarfing these corporate holdings are publicly held buildings, land and other so-called “non-financial assets”. Their precise worth is unknowable because many are held at questionable book value while others aren’t even recorded. Most governments don’t produce balance-sheets.

With such gems in the closet, and those holding them fiscally troubled, the arguments for sticking more on the block might seem straightforward. But privatisation offers only brief respite for a government that is addicted to overspending. And though some sales have been clear successes (who would argue that Europe’s telecoms companies would be better off if still in state hands?), others have produced questionable value and a few have been unmitigated disasters. If privatisation is poorly designed—particularly if an appropriate regulatory framework isn’t first put in place—undeserved spoils are likely to go to a small group of insiders, sparking a backlash. Witness past turmoil in Latin America.

We are delighted to have two distinguished experts to debate the issue. Arguing the case for another burst of divestment is Bernardo Bortolotti, associate professor in economics at the University of Turin, director of the Sovereign Investment Lab at Bocconi University in Milan and founder of the Privatization Barometer. Mr Bortolotti sees a virtuous circle in properly structured sales: the paying-down of excessive debts, rising credit ratings and greater competition. Moreover, market conditions are right, with global stockmarkets near historical highs and investors’ appetite for equity, relative to other asset classes, likely to remain strong.

Elliott Sclar, professor of urban planning at Columbia University and author of “You Don’t Always Get What You Pay For: The Economics of Privatization”, weighs the short-term financial gains of selling against the possible social costs, and finds them largely wanting. One reason, he argues, is a misalignment of time-horizons and incentives between seller and buyer. Using the example of Chicago’s parking assets, he suggests that privatising management while retaining ownership—an increasingly common approach—is not the answer.

Some questions that I’d like to see addressed include: What types of “strategic” or “heritage” assets should be off-limits in any circumstance? What do examples of successful state capitalism, notably in Scandinavia, tell us about the merits and demerits of privatisation, or about how to improve the management of stuff that remains in public hands? When does it make sense to lease, securitise or form public-private partnerships rather than sell outright? And, in the light of their poor accounting and data collection, what can governments do to develop a better understanding of what they hold?

Over the next ten days our panellists will present their most persuasive arguments, but the result of our debate rests in your hands. Do not be afraid to vote immediately—you can always change your mind. Even better, once you have cast your vote, add your voice to the debate and explain your decision. I look forward to reading the comments of all those who participate.

 

The proposer’s opening remarks

Feb 4th 2014 | Bernardo Bortolotti  

Stars are realigning (again) for the start of a new big privatisation wave. The key factors explaining state sell-offs are well-known: deteriorating public finances; financial market conditions; and a large portfolio of state-owned assets. Under present circumstances, governments of all stripes may decide to put on the market large chunks of the national economy any time soon.

The financial crisis, with its lethal mix of credit crunch, decreased tax revenues, huge economic stimulus programmes and bank bail-outs, led to a dramatic increase in public debt for most advanced economies. Public debt as a percentage of GDP in OECD countries, hovering around 70% during the 1990s, rose to 113% in 2013, and it is projected to grow even more in the next year. This trend is visible not only in countries chronically affected by debt problems, such as Japan, Italy, Belgium and Greece, but also in countries where public finances were well under control before the crisis, such as America, Britain and France. A large-scale privatisation programme alleviates public finances because cash revenues can be used to redeem public debt, and savings in interest payments may give leeway to expansionary fiscal policy. Rising interest-rate expectations reinforce the argument, along with the positive effect on credit ratings of a sustained privatisation programme.

Market conditions are equally important because no government, like any other asset owner, will sell shares in a depressed market. And again the compass points in the same direction. Global stockmarkets are today at historical highs. Last year American stocks posted the best annual return since 2007, and valuations have gone ballistic for several listed assets in mature economies. Given the current growth prospects, the outlook is still positive. Under current market conditions, governments could thus take the opportunity to get good prices for their listed stocks, and significant revenues in the primary markets in case of initial public offerings (IPOs), given the high appetite for equity of global investors. The recent highly oversubscribed IPO of Britain’s Royal Mail represents an interesting forerunner of this trend.

The boundaries of state ownership have moved considerably in the past few decades, with the large privatisation waves of the late 1900s followed by the more recent government bail-outs in advanced, crisis-hit economies, and sovereign wealth fund investments in emerging countries. At any rate, residual state ownership in listed and non-listed firms, real estate and infrastructure is valued at around $9 trillion.

So governments have property left to sell and an interesting window of opportunity to seize. However, they should remember the hard lessons learnt from past privatisations.

First, divesting governments should always apply the basic financial rule for privatisation: privatise only if the sale improves the net worth of the state. A state-owned asset should be sold only if its expected return in private hands exceeds the interest rates on public debt. The corollary of the rule is that governments should auction the assets in competitive tenders to get the best price in the market. Giveaway privatisation, sales to insiders like those implemented in some transition economies (notably in Russia), or strongly underpriced offerings in public markets violate the rule and should be avoided.

Getting high prices is an important objective to square public finances, but turning a giant state company into a private monopoly in order to raise cash is an economic disaster. Unfortunately, privatisation history is littered with botched sales in network industries where efficiency considerations have been neglected in favour of immediate financial relief. The usual method is a partial sale of a badly regulated monopoly. Under this scheme, the divesting government gets immediate revenues from the sale, and a future stream of rent in the form of dividends from its residual stake in the company. Monopolistic rents, extracted from captive consumers of public services, are thus shared by the treasury and a happy few private shareholders. The announced partial privatisation of Italy’s Poste Italiane, a large state-owned financial conglomerate and postal operator slated for sale as an integrated monopoly, seems to fit perfectly in this scheme. Liberalise, regulate and then privatise is the right timing.

The current crisis has raised questions about the role of the state in the economy and disparaged the economic paradigm based on laissez-faire, unfettered markets and unrestrained financial capitalism. In the 1980s and 1990s, privatisation was often shaped by right-wing ideology. This is not a time to resurrect old ideologies, but rather a time to adopt a policy that can deliver to citizens and taxpayers. The devil will be in the details of implementation, but it is definitely worth a try.

The opposition’s opening remarks

Feb 4th 2014 | Elliott Sclar  

Is it time for governments to launch a new wave of privatisations?

While privatisation might make sense in some instances, a massive sell-off of public assets is not one of them. Privatisation is fundamentally a variation on a simple technical outsourcing question: should government make or buy products or services such as computer hardware or painting contracting that are readily available in the marketplace? However, once the discussion moves from the straightforward to such uniquely governmental functions as communications monitoring and security-clearance certification, more philosophically complex questions arise pertaining to the proper role of government in the life of society. Over the past three decades, privatisation proponents have deployed the outsourcing for efficiency argument in the service of varying policy ends: reining in the incomes of public employees, putting state-owned enterprises into the private sector and, most recently, solving state fiscal crises by selling public assets.

Repurposing privatisation to resolve public-sector budgetary constraints is the issue I address here. The policy prescription calls for reducing public debt via the sale or lease (ie, privatisation) of publicly owned assets. The justification is made by analogy. Private firms facing debt crises are expected to sell assets to avert bankruptcy. The same should hold true for governments. Firms are not governments. Firms easily arise and as easily liquidate. Governments can do neither easily, if at all. Governments have abiding social obligations to deliver important public goods and governance. Asset dispositions to meet current budget gaps must be weighed against the future costs of enduring responsibilities.

Privatisation always involves establishing a relationship between government, the agent of society’s collective interests, and a private entity motivated by self-interest. The critical issue in evaluating this deployment of outsourcing is appreciating the time-sensitive motivations of the parties involved.

A major proportion of saleable public value is locked into the infrastructure that is critical to animating vibrant urban societies. The prices private investors willingly pay for control over such assets reflect their estimates of the revenue streams they expect from tolls, fees and other charges. The freer the hand the public sector extends to private investors in operating the asset, the more the latter will offer. Is government seeking maximum sale value at the cost of something more enduring?

There is no readily obvious alignment between the long-term public needs of a vibrant urban society and the shorter-term private needs for investment return and protection of capital. This motivational misalignment is at the core of all the instances of failure in public-asset sales and leases. Failures are more common than is popularly understood.

Consider Chicago’s experience with its 2008 75-year lease of its street-parking meters for $1.157 billion. Almost everyone regards that sale as a poor bargain. Chicago now reportedly has the highest parking rates of any city in America, never a good economic omen in an auto-dependent country. The consensus is that the city badly mishandled the leasing process. Chicago’s inspector general put the value of the deal at just over $2 billion. For privatisation advocates, the lesson is that Chicago officials failed to negotiate well. Incidentally, that is the standard advocate response to all such failures regardless of specifics. Accumulated evidence of serial failure never proves to be an intellectually powerful enough reason to reconsider the rationale. It is dismissed as just so many poorly executed anomalies.

But that framing of the contract debate misses the larger lesson here. Chicago, in leasing its parking meters effectively, relinquished critical control of its most vital public good, its streets. Leasing its street space, regardless of price, breaches an important public fiduciary responsibility. The worst aspect of this privatisation is that Chicago must guarantee revenue from its street space to a private investment partnership for the equivalent of three generations. The city cannot take parking space away for transit, cycle lanes or other purposes. Given new technologies such as self-driving vehicles and smartphone-accessible demand-responsive taxis, it is unlikely that we will still need much, if any, on-street parking towards the end of this century. But Chicago will still be reimbursing a private investment partnership with real taxpayer dollars for the imaginary lost revenue of what will in effect be phantom parking spaces.

We will not resolve the larger philosophical questions here about the proper scope of government. But let’s agree that when governments engage in any public-asset privatisation, for whatever reason, it is vital that public aims remain paramount. These aims should not be compromised for the sake of private-sector profit-making or rent-seeking, as is now the case in Chicago.

The core problem remains one of mission misalignment between the parties. Because this difference is so fundamental, the contractual terms become critical. All public-asset lease and sale contracts must do three things: explicitly protect public options in the face of changing conditions; specify exactly how transparency will be maintained; and make explicit provision for ongoing oversight and accountability. These provisions will, of course, diminish the attractiveness of such sales and leases to the private sector and raise public-sector contract enforcement costs. This lesson was recently driven home when Chicago, stung by its misadventure in parking-meter sales, sought to impose more contract accountability in the sale of its municipal airport. Once the new terms of engagement became known, the number of interested bidders rapidly fell from 16 to one. With no competition there was no sale. And that is the point. More upfront revenue means higher future social costs. No free lunches here.

 

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About Koon Boon Kee
Bamboo Innovator Institute is set up to establish the thought leadership of resilient value creators around the world. KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia. The Moat Report is developed together with our European partners The Manual of Ideas (www.manualofideas.com), the idea-oriented acclaimed monthly research publication for institutional and private investors. The MRA’s paid-subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities and savvy private individual investors. KB has presented his thought leadership as a keynote speaker in global investing conferences with speakers including famed serious investors Donald Yacktman, Howard Marks, Jean-Marie Eveillard etc. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, macroeconomic and industry trends in Singapore, HK and China. KB has been rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm since 2002. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Mirae Asset Global Investments, Korea’s largest mutual fund company. He holds a Masters in Finance and degrees in Accountancy and Business Management, summa cum laude, from the Singapore Management University (SMU). He had also taught accounting at the SMU. He had published cutting-edge empirical research in the Special Issue of Istanbul Stock Exchange 25th Year Anniversary of the Boğaziçi Journal, Review of Social and Economic Studies, as well as wrote articles about value investing and corporate governance in the media.

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