The NSW privatisation debate

The AFR published a letter of mine today on this topic. It is reproduced below. It was brief so in this post I elaborate on why I think Iemma and Costa messed up their arguments very badly.

MY AFR LETTER

The debate on electricity privatization in NSW has gone off the rails, with a lot of silly claims and counter claims by both sides of the fence about abuse of Union or Business or Political power (depending on ones ideological position).

The simple test which should be applied is this: will privatization improve the efficiency of the utilities and do it fairly for consumers and workers? The fairness issue can be addressed whether the government assets are privatized or not.

The efficiency issue has not been satisfactorily resolved. One reason is that Iemma and Costa have engaged in blatantly misleading arguments about the possible loss of credit rating and the inability of the Government to finance other high priority infrastructure such as in public transport and hospitals. This is a red herring (and they should have known better.

The better argument to put would have been in terms of the special benefits the private sector might be able to bring to cost minimization in a more competitive market place. But that one was harder to argue so our politicians resorted instead to political spin. Iemma and Costa deserved to lose because they were not honest.

EXPANDING ON THE ABOVE

My AFR letter had to be brief but in a piece I wrote earlier this year this is what I said about the debt furphy which so worried Iemma. Text follows.

One alleged cost of net public borrowing is that it would hurt the credit standing of governments.

However net public debt – the difference between the governments stock of financial (mainly debt) liabilities and its financial assets – is not (except in extreme cases) an appropriate measure of a governments balance sheet strength. The focus should be on net public worth – all financial and non-financial assets minus all liabilities. If governments borrow money to invest in real productive assets with a comparable life to the debt, this adds to net public debt but it does not detract at all from net worth and, depending on the investment, could even increase net worth in the long term.

Prudentially, the only requirement on governments should be to ensure that over the medium term, they run a net operating surplus (an excess of current revenue over current expenses) and borrow only to invest in physical or human capital projects that have met the standard cost-benefit criteria and have the potential to increase the revenue base in the long term. This should ensure net government worth is stable or rising and that public debt levels are kept at a sustainable level in terms of capacity to service.

This is the stance adopted by most other OECD governments. UK governments, for example, seek only to keep the operational account (current budget) in balance (zero saving) or in surplus (positive saving). If they need to invest in excess of their annual savings as is normally the case they simply borrow. That is why the UK has had relatively stable levels of public debt of around 40 to 50% of GDP for several decades. Again, the EU countries are bound not to exceed a cash deficit of 3 per cent of GDP over the cycle, leaving plenty of room over the medium term for debt-financed public investment.

Ironically, Australias overall (state and federal) public debt levels are among the very lowest in the developed world (less than 1/20 of the OECD average relative to GDP) and all Australian governments have very strong, if lazy, balance sheets. This suggests that Australia should have more – not less – freedom to borrow than other 0ECD countries.

It is not surprising to find that, if one beleives their recent public declarations, our credit rating agencies are generally relaxed about some increase in state or federal government borrowing for appropriate investment purposes.

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Patrick
Patrick
13 years ago

Again, the EU countries are bound not to exceed a cash deficit of 3 per cent of GDP over the cycle, leaving plenty of room over the medium term for debt-financed public investment.

Uh, that should be past tense. France and Germany both simply ignored that, and so the stability pact can’t credibly be said to exist anymore. Which does not, of course, stop it being a good idea.

I am a little confused – I admit that I don’t know much about government accounting. Surely Governments gear on the basis of their gross liabilities to gross assets? Ie if you buy a power station at 80% debt-funding, you have an asset of $X and a liability of $.8X (or maybe between .75 and .9 depending)?

If it is as I understand you to say, that governments would record that as a liability of $.8X only, that is absurd. They aren’t measuring indebtedness then but (very crudely) practical liquidity. Maybe banks should have to report that! But it is hard to see why 150 year old governments with investment grade ratings should.

observa
observa
13 years ago

There are obviously bigger Iemma dilemmas than a Labor man can truthfully say here. Firstly it makes sense for State govts to handball anticipated future power price rises due to Federal cap and trade blue sky pricing, over to private enterprise whipping boys. Then Rudd can wear the cost of more ACCC public servants to wring hands and breast beat with the battlers as the inevitable ensues. In that respect, no govt wants to be a supplier and policer of CO2 caps and a user at the same time. Messy conflict of interest there. More importantly, Iemma would implicitly understand that little old NSW, needing another power station pronto, will unlikely have access to the global expertise and latest technology, let alone the risky financial wherewithall to put it all together for 25-30 years, especially now other states have accessed that global knowhow and they’ll be competing with NSW now. It’s a bit like him coming out and saying- ‘Hey, we can make cars in Oz, so today the NSW Govt has decided to set up its own carmaking plant in NSW for all the good Labor reasons.’ He’d be lambasted from pillar to post if he did. Ditto with the new power station now.

charles
charles
13 years ago

Your writing is sane, unfortunately the markets isn’t. Victoria fixed it’s credit rating by selling assets. The state was smart the market was dumb.

The real question is, does the state need to invest in electricity generation to make it happen, the answer is clearly no. The sate has enough to worry about without getting involved in things that it could be taxing.

stephen bartos
stephen bartos
13 years ago

patrick, government accounting does (as you suggest it should) record both the asset and the liability in the balance sheet. As Fred has argued the key measure of performance ought to be net worth, and net worth figures are presented in budget papers. This is a useful measure of the government’s stewardship of its resources. But what gets reported on in much of the media, and discussed in a very crude way in political commentary, is unfortunately just the total level of borrowing. You could blame Margaret Thatcher – her government targeted as its major fiscal goal a reduction in what was termed the Public Sector Borrowing Requirement (PSBR); the aim was simply to reduce debt, and of course it became a media obsession. The contemporary equivalent is a focus only on the size of a government’s surplus, not the quality of the fiscal stance it has adopted.

Sukrit
13 years ago

Fred,

What does it matter to you that Iemma is intellectually dishonest? Were you considering voting ALP? It’s not a unique or new insight that politicians lie or twist the facts. Mankind has known this for some centuries. Politicians are professionals at reading public sentiment. So they often run with side arguments about credit ratings. Iemma obviously thought this would wash better with a public ignorant about economics.

What is relatively new, in the greater scheme of things, is clearcut evidence – from abroad and our very own Productivity Commission – that privatisation of government assets and a competitive market leads to improved service quality and possibly lower prices. Unless you have some new insight to add on this latter point that disproves hundreds of peer-reviewed studies, I find it odd that you’re devoting so much effort to knocking down a side argument.

Perhaps you have some ideological bias against privatisation and couldn’t find the evidence to back up your beliefs, so are instead attacking the side argument to cast doubt in the public’s mind about the whole exercise of privatisation?

Incidentally in my hometown in India (Guwahati), the power goes out every few hours. That’s what it’s like living with publicly owned electricity assets.

Petering Time
13 years ago

Labor has betrayed regional areas, the working poor, retirees and every other b**ger in New South Wales.
This is also going to end up as a fire sale because Iemma has signalled a supposed financial urgency to sell quickly.
The big multinationals interested in expanding into the state will smell blood in the water, toss a few thousand into Labor political donations account and then nail us all to the wall.

NPOV
NPOV
13 years ago

Sukrit, Fred quite explicitly stated:

“The better argument to put would have been in terms of the special benefits the private sector might be able to bring to cost minimization in a more competitive market place”

Does that sound like some whose ideologically opposed to privatisation?

I actually doubt there are many serious commentators these days that are “ideologically oppposed to privatisation” at all. Nobody thinks airlines, for instance, should be run by governments anymore. But there are plenty of reasons to be concerned about specific attempts at privatisation, and what the risks may be. In the case of selling of power generating units, I think we have sufficient reason to be confident that private operators will do a satisfactory job of running them in Australia (as they do in Victoria, SA and parts of Queendland), however there is one item for genuine concern: that once a publicly-listed corporation is running a coal-fired power station, its obligation to shareholders is to keep making as much profit as possible from that investment as long as it can. That seems somewhat in conflict with the need to reduce CO2 emissions, something I’ve not even seen mentioned in the debate as yet.

Fred Argy
Fred Argy
13 years ago

Thanks all for your contributions, especially Stephen and NPOV for coming to my defense. I have posted a follow-up today.

Colin Master
Colin Master
13 years ago

I agree the debate on NSW privatisation side steps the main issues. The NSW government have got themselves into a very difficult position in my opinion.
The Victorian and Queensland governments were very successful in maximising revenue from the sale of the various retail businesses to the private sector. NSW will struggle for a number of reasons. Tariffs are well below market largely due to the cross subsidy between retail and generation companies under the current ETEF arrangements. This market inefficiency is reflected in the low levels of churn relative to the other states. The government has been forced to maintain price controls for the forseeable future to counter concerns that prices will increase following privatisation and this will in turn reduce the price that the private sector will be prepared to pay.

The debate over price controls also misses the point that prices will inevitably increase as a direct result of any emissions trading scheme. Australia has the lowest power prices in the developed world and is also one of the highest emitters of carbon. Therefore a high carbon impost is required to provide the right price signals to encourage investment in cleaner generation (eg gas) and reduce coal fired generation as a proportion of Australias overall energy supply. However for this to occur steep price increases should be expected to flow through to customers (with some compensation for lower income households). However maintaining price controls will raise concerns that retailers will be squeezed. This in turn will reduce the value that the private sector places on the retail assets. In addition, forcing through the sale before the full details of the emission trading scheme are published will also potentially increase the risk and reduce the value that the private sector will be prepared to say.

This all adds up to a poor outcome for Lemma and Costa although I agree that privatisation is the right path. Private operators are far better placed to manage the risks in the highly volatile national electricity market (note that one NSW retailer lost around $60m in June last year as a result of insufficient hedging). The next few months will be very interesting……..