Mr Speaker, I claim to have been misrepresented

After Ross Gittins’ recent generosity to me, I can’t complain. But this column is a bit – um . . . simplistic.

He begins thusly.

YOU don’t have to be very bright to pick holes in the arguments Morris Iemma and Michael Costa have been using to sell their plan to privatise electricity.

But it seems you have to be wiser than some of our brightest economists to comprehend the deeper issues involved.

Against the furious opposition of Unions NSW and many in the Labor Party, the Iemma Government is proposing to sell the state’s power stations under long-term leases and sell outright the retailing sides of EnergyAustralia, Integral Energy and Country Energy.

Iemma and his Treasurer have argued that these businesses will need new investment of up to $15 billion over the next 10 to 15 years, which state taxpayers can’t afford. They suggest that such additional borrowing could jeopardise the state’s triple-A credit rating.

They further argue that selling off the electricity businesses would permit the proceeds – say, $10 billion – to be spent on much needed infrastructure such as a new urban public transport system and water and sewerage upgrades.

Various economists, including Professor John Quiggin of Queensland University and Dr Nicholas Gruen of Lateral Economics, lost no time in blowing these arguments out of the water.

Now I thought that this was a kind of ease in line, and that we’d be let off the hook later on in the piece. But Ross goes on a bit later on that “it doesn’t seem to have occurred to my learned friends that they’ve been busy demolishing a straw man. They may be economic geniuses, but they have more to learn about the politics of economics.”

Well I can’t be sure, but I think John fancies he’s got a reasonable idea as to what’s going on. We were just arguing the various arguments on their merits.  That doesn’t mean we think they’re offered in good faith.  It’s obvious they’re not.  My own case was a little different to John. As I was at pains to point out, I’m not fundamentally against selling the electricity assets but was taking the opportunity to hop into the one way we’ve gone clearly backward since economic reform started – we’ve become irrational about debt.

Ross goes on to say this:

In theory, it’s a recipe for infinite growth in the public sector (something many public sector Laborites would be delighted to see); in practice, it would mean inadequate funding for many of the things governments should be doing and the neglect of new areas they should be entering.

And that brings us to the pointy end of this argument: opportunity cost. Our learned economists seem to imply there’s no limit to how much state governments can do and how much they can borrow.

Retain the electricity businesses and borrow hugely to finance their future needs? Sure, why not? Borrow heavily to finance all other infrastructure needs? Sure, why not?

In reality there are limits. Who’d be silly enough to believe that, should the state retain the electricity businesses and borrow to meet their needs, the consequence wouldn’t be that other, more pressing infrastructure needs went begging?

Trouble is, economics can’t tell us in advance where those limits are. It can’t identify the dividing line between the responsible and the irresponsible. Of course, every mug can tell you where the line should have been after you’ve come unstuck – as many state governments did in the ’90s.

Now there are a bunch of things thrown in here, and I for the sake of the arguments I wish that Ross had tried to follow through with them a bit more as I think his treatment is a bit of a dumbing down of a point that is important to me, and that I have thought about quite a bit. So I’ll just go through some of the statements.

In reality there are limits.

Yes, but they’re very different for assets that don’t generate a commercial return and those that do.  To take a very simple example, if you borrow to invest in houses that earn rent you can borrow around three times as much as you can if you’re living in the house.  Of course there are still limits, but I constantly run into people who argue that a dollar borrowed to invest in assets that generate a commercial return is at the cost of borrowing to own assets that don’t. They’re different assets and they imply quite different things for one’s capacity to service a loan and so to borrow.

Trouble is, economics can’t tell us in advance where those limits are.

This is true in a way, but then what are we doing borrowing the money we’re already borrowing? How do we know we’re not beyond our prudent limit already? In fact commercial firms face this issue every day. They can invest in assets that have higher returns than it will cost them to borrow, and so they borrow and invest. But they must decide how much of this to do. So they look at their balance sheet and consider the risks they are running and adopt a level of prudence that seems appropriate.

It’s always mystified me that Government’s don’t do the same.  Somehow we’re supposed to gain succour from the knowledge that we’re making a decision by default – as the residual of our revenue and spending in any one year, rather than, as private sector firms do, by design.  Having considered Ross’s point a Government might decide that since economic science can’t tell it how much to borrow, it will sell its assets to liquidate any debt it has, and simply cease investing in capital items unless they can be funded from this year’s (balanced or surplus) budget. But I think they’re more likely to end up doing something less superstitious. And if you’re on the prudent side, like Ross and me, they would probably want to stay within bounds that are widely considered very safe – like AA. As I pointed out, that would enable the NSW Government to fully fund its super liabilities (from debt) netting the budget an expected half billion dollars a year. But you might come to a different judgement – and end up going for a AAA rating, and (possibly) forswearing borrowing to fund super. In twenty years time the government would almost certainly be tens of billions of dollars better off. But you can’t be absolutely sure, it’s true.

Finally, one might argue, I suspect Ross would argue, that governments can’t be trusted with such power. Fair enough. I think the same thing. That’s why I’ve argued that we develop institutions to deal with these issues and while we’re about it we could design those institutions to assist us in finessing the same political problems when fiscal policy is used to help lean against the wind of the economic cycle.

That’s why in the material I wrote on this subject, having argued for the NSW borrow more to fund assets, I went on:

Thats not to endorse the loose practices of the past or to oppose privatisation per se. Ive argued elsewhere for greater independent scrutiny or even control of both the operating and capital aspects of the budget. Governments fear this for the disciplines it would impose. But they would be different and better disciplines than those of the rating agencies. They might encourage higher surpluses now, but if theres a downturn they would better enable governments to justify and prudently maintain the substantial deficits that are warranted in such circumstances deficits the rating agencies wont fancy.

I hope Ross takes up some of those points in future columns.

I don’t think you need to be any wiser than our most engaging economic journalist to comprehend the deeper issues involved. ;)

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14 Responses to Mr Speaker, I claim to have been misrepresented

  1. Pingback: CoreEcon » Blog Archive » NSW Electricity Privatisation

  2. David says:

    I enjoy Gittins’ articles but sometimes I think he just thinks everyone is stupid.

  3. SJ says:

    I can’t say I was very impressed by Gittin’s column.

    We elect politicians to implement policies on our behalf. If a particular policy is a good one, it should be possible to explain why it’s good, without having to resort to lying about it.

    And to criticise people who point out that the government is lying, whilst agreeing that the government is lying, as Gittins does, doesn’t do much for transparency in government. It’s more of an open invitation to incompetence and corruption, and we could do with a lot less of both of these things from NSW Labor.

  4. SJ says:

    Gittins also proceeds from a Friedman style argument, that privatisation is good in and of itself.

    But the task that Costa was given was to ensure the ongoing provision of electricity in an economically efficient fashion, and there’s absolutely zero evidence that the course he’s proposing is going to result in the outcome he was supposed to achieve.

    Costa’s been conned by Treasury, where Chicago reigns supreme, and by companies like AGL and Origin, who are looking to reduce competition in the market by removing the NSW government as a competitor.

  5. Patrick says:

    and by companies like AGL and Origin, who are looking to reduce competition in the market by removing the NSW government as a competitor.

    What, and replacing the NSW government with Intergen, Macquarie, International Power, B&B, Temasek, Suez or whoever else?

    Am I the only person to struggle to see the immediate advantage to AGL or Origin?

  6. SJ says:

    Well, yes, Patrick, the potential list of bidders is large. A collective of buddhist nuns might submit the winning bid. But the incentive to bid high is largest for the larger existing participants. AGL, Origin, China Light & Power, and some of those on your list, like International Power. They’re the ones who stand to gain the most from a reduction in competition.

    There’s money to be made from reducing competition. If you believe that people won’t try to take advantage of that, well, write me a large cheque and I’ll sign over ownership of the Sydney Harbour Bridge to you.

  7. SJ says:

    Actually Patrick, I trust you completely, of course, but there’s a temporary glitch with my account. Instead of a cheque I’ll need small denomination unmarked bills, delivered to a phone box in Kensington. It’s standard procedure nowadays, BTW. Ask anyone. ;)

  8. Peter Wood says:

    A problem with privatisation is that in the lead up to privatising the asset there is a perverse incentive to not properly regulate the industry so that the government can get a better price. I suspect that this might be a reason why the NSW government has stopped reducing the cap in the NSW greenhouse gas abatement scheme (GGAS).

  9. Patrick says:

    SJ, that’s a ridiculous point of view. If the world worked the way you thought it did we would still be in the 1700s.

    If existing participants to a market always had higher incentives to participate in related markets or to expand their participation inthe market then there would be no markets, just monopolies.

    And I don’t think that the NSW government constitutes a serious competitor, either, except inasmuch as they get the advantages of writing most of the rules.

  10. SJ says:

    So Standard Oil never existed? Microsoft doesn’t exist? Phew. That’s a relief. Whatever was I thinking?

  11. Fred Argy says:

    Whatever politicians might think and say, an economist needs to keep an open mind on privatisation. People on the socialist left (and I am certaintly not including Quiggin in that group) seem often to start with a presumption against privatisation (putting the onus of conclusive proof on the advocates) while people on the Right seem to start with a presumption in favour of privatisation (starting with “public choice” propositions and putting the onus on opponents to prove them wrong). I believe Nicholas Gruen was taking precisely this stance on the NSW privatisatin case – questioning silly arguments put by politiicans e.g. about AAA’s and the alleged intrinsic superiority of private ownership as risk bearers but keeping an open mind on efficiency issues.

  12. Fred Argy says:

    I meant to say Gruen was taking precisely “the right stance” on the NSW privatisation issue etc..

  13. SJ says:

    I note that Kenneth Davidson agreed with the comments I made yesterday in a story in <a href=””today’s Age:

    ROSS Gittins (BusinessDay, 17/3) ignores the main reason why privatising the NSW electricity generating and retailing industry is not in the public interest.

    The Government-owned generators in NSW set an effective cap on the wholesale price of electricity on the east coast, preventing the privatised Victorian assets getting the returns that were expected when they were sold at apparently inflated prices in 1995 to foreign generating companies.

    Privatising the NSW system will make electricity on the Australian east coast more expensive, the supply less reliable and the whole operation more profitable…

    Generators want the NSW Government out of the NEM to be able to game the market.

    It’s a bit more complicated than that, but he’s done a good job of summarising in a limited space.

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