The superannuation industry is getting very excited about the prospect of a ‘wave’ of privatised infrastructure creating low risk assets for fund investment. NSW looks like it will privatise some generation assets as well as Port Botany and Port Kembla. The super industry wants more and appears to have union backing to turn state-owned enterprises (SOEs) into ‘mum and dad owned’ enterprises via super fund investments. Thus:
Signalling a shift in thinking on asset ownership, the ACTU has backed the campaign on the grounds that “social privatisations” can transfer government assets to the community using super funds that represent “mum and dad” owners.
There strike me as two issues here:
First, the issues of asset ownership and regulation are inseparable. Rohan Pitchford from ANU and I have done some research on this over the years. Regardless of ownership, key infrastructure assets often need regulation. But the underlying incentives that drive a privatised firm differ from those that drive a SOE. So privatisation is only desirable if the regulated privatised enterprise will operate in a way that raises economic surplus compared to a regulated SOE. Put simply, there is no point privatising something if overall it makes us worse off.
For example, consider emergency services provision (ambulance, fire service, etc). A for-profit service will have less incentive to keep ‘spare capacity’ than a government-owned service. Spare capacity is costly and the private owners pay that cost. But from a social perspective we may want the spare capacity as insurance against rare but calamitous events. Public servants and their political masters have strong incentives to avoid and respond to these types of events. So there is a trade off between a privatised service that may ‘under weight’ extreme events and a public service that may ‘over weight’ extreme events.
There are a number of factors that favour privatisation. For example, if there is already competition and private provision is working (not perfect, but working, as in the case of electricity generation) then privatisation is probably a good idea. If government interference is a problem then privatisation makes that interference harder (or at least improves transparency). Of course, there are factors pushing in the opposite direction particularly where cost minimising private owners create negative externalities for the rest of us.
So privatisation is not a simple solution – it just changes the problem. And having Mum and Dad owners via superannuation funds does not change the principle of profit maximisation that should drive the privatised firm.
Second, while privatised assets usually provide a stable revenue stream, privatisation crystallises some risks. This is well reflected in Kenneth Davidson’s article here. Davidson argues:
To reveal what is at stake, assume that, as state monopolies, these assets earn 5 per cent on capital for the government and would be expected to earn 10 per cent on capital for private investors.
This means that the assets worth $100 billion on the government’s books, would only be worth $50 billion to the private operators if the prices for the services remained the same. The government might get $100 billion for the assets if it allowed the new owners to double prices for the services.
This argument is really only a starting point. The real question is ‘why does the return to a privatised business have to be higher?’
Privatisation transfers risk from the tax payer to the private owners. The government can borrow at low rates because it has taxing powers. If a SOE gets into financial trouble then the government can fund it via tax income. The private owners do not have this option. So the increased return required of a privatised asset partly reflects a risk that was hidden and being borne by tax payers. Privatisation improves the transparency of the risks.
Further, a privatised asset faces sovereign risk. The SOE also faces sovereign risk but as the state owns the asset it does not need to be compensated for its own actions! Of course, sovereign risk may not be bad for society. State intervention may lower private profits but raise welfare. However, part of the increased return to a private owner reflects the sovereign risk being ‘crystallised’ by the privatisation process.
Finally, for regulated private assets, the allowed return is often set through a regulatory process. In the twenty or so years of Australian experience we have learnt a lot about regulating private utilities and the types of risk they should face and be compensated for. These are reflected in the regulated company’s allowed return. So, a simple comparison with the government borrowing rate, as Davidson does, is not very useful.
Overall, the superannuation industry needs to be careful what it wishes for. Privatisation comes with lots of regulatory strings attached. And simply privatising assets to create something for the funds to invest in would be bad public policy. But there are clearly some SOEs that should be privatised – and the NSW electricity generation assets are a good place to start.