Things are quiet in financial planners and stockbrokers offices at the moment - there certainly don't seem to be too many good reasons to buy shares given the uncertainties prevailing.
Whilst the problems in Europe are making the headlines the elephant in the room is what Longview Economics labels "The Definancialization of the West". Longview reckons that, for example, the total debt to GDP ratio in the USA will need to fall from its current level of 353 per cent of GDP to around 250 per cent and perhaps as low as 150 per cent.
Deleveraging means much lower levels of economic growth and probably continued poor returns from the world stockmarket. However there is one very bright light on the horizon for local financial intermediaries and that is of course the forthcoming firesale of various state owned enterprises. Unfortunately however the logic behind the sales, apart from further enriching the finance sector, looks, well, stupid. The three main reasons given for selling State Owned Assets are:
- To achieve efficiency gains within the SOE's sold
- To reduce debt
- To kick-start the stock market
Let's take a closer look at these assumptions. What has prompted this week's story is a recent article in the London Financial Times entitled "Number of State Sell-offs Cut in Half". The article reported on a recent paper by the Privatisation Barometer (PB), a joint project between KPMG and a Milan based research
institute headed up by Professor Bortolotti at the University of Turin.
According to PB "the pace of privatisation around the world has slowed sharply with an increasing number of asset sales delayed or cancelled due to volatile markets". For "volatile markets" read unacceptably low prices.
Commenting on the study Professor Bortolotti stated the obvious that selling in a depressed market is not a good move as sellers are better to wait. Contrast this with the mad rush the Government seems to be in to get rid of Mighty River - latest silly reason for urgency came from Bill English who said that our government debt to GDP ratio concerned him at the 30 per cent level.
Well hello, the debt to GDP ratios of virtually all the other highly rated Western countries with the exception of Australia are double or treble that level. What is more, whilst the sale of an asset like Mighty River will of course reduce debt, at 30 per cent that shouldn't be a high priority. The key point is that the sale of the asset will reduce New Zealand's ability to service our debt and that is more of an issue. Then there is the fact that sellers in a hurry generally don't get top prices.
Next item on the agenda of non-reasons to sell SOE's is the illusion of efficiency gains from privatis ation. The Financial Times article contained particularly interesting comments from Professor David Hall of the Public Services International Research department at the University of Greenwich Business School. In an email he
said that on the basis of much research "there is no clear proof that the involvement of the private sector delivers higher efficiency or productivity or a lower cost of capital".
Professor Hall sent me a paper entitled "Public Private Partnerships in the EU - a critical appraisal" where he looked at the performance of PPP's in the EU. He investigated whether PPP's "provide a way of financing or running private services which is better for the public and the services". Professor Hall concluded that the private sector can't borrow money more cheaply than the government and in fact the opposite is true.
Furthermore he states that "the empirical evidence shows that the private sector is not more efficient than the public sector". Professor Hall says that any PPP always starts with a handicap of a higher cost of capital which can only be offset by lower operating costs ie greater efficiency. These points have been noted by the OECD, the IMF and Martin Wolf from the Financial Times. This is good stuff and we will cover Professor Hall's findings in more detail in a future article.
Professor Hall also referred me to an analysis of UK privatisations entitled "The Great Divestiture" by an academic from the Massachusetts Institute of Technology which meticulously examines all the companies privatised by the Thatcher Government and finds no evidence whatsoever of efficiency gains but clear evidence of regressive redistribution.
Professor Hall said that "many other comparative studies echo this finding and these findings are especially relevant for capital intensive services like electricity". Hmmmm - not quite what we are being told is it. Recall also that a study by our own New Zealand Treasury found that there was "little evidence of systemic underperformance" in our SOE's.
Let's have a look of some of the conclusions reached by Professor Florio in "The Great Divestiture". One of the most striking conclusions is that the privatisations in the UK resulted in "clear evidence of regressive redistribution". This means taking money from the poorer sections of society and giving it to the wealthy.
This conclusion particularly resonates at present given the recent revelations about the systemic bad behaviour in the banking sector globally and the fact that wages in the finance sector have grown much faster than wages in the broader economy.
The other important conclusions in Professor Florio's book are that the assets sold were underpriced, there was a large rise in management salaries and most important of all privatisation made little difference to long term trends in productivity and prices. No wonder all the chief executives of the SOE's to be sold are enthusiastic about the idea - they stand to benefit from high salaries and no doubt huge bonuses via employee share purchase plans.
If the efficiency argument looks silly the "reduce debt" rationale is even more ridiculous. The electricity SOE's like Mighty River Power are going to be sold at valuations whereby the net profit as a proportion of the share price is around 7 per cent after tax.
Today the Government can borrow for 10 years at just 3.45 per cent so it doesn't take a finance degree to work out that the Government could retain the asset, service the debt out of the 7 per cent return and pay off debt with the balance. In cash flow terms the contrast is even more stark - the companies like Mighty River Power have substantial depreciation charges so the cash flow yield at which the companies are sold could be 8, 9 or 10 per cent - much higher than the government's cost of borrowing.
This raises another issue and that is the fact, also highlighted by Professor Hall, that the cost of capital of a privatised asset is much higher than a publicly owned asset. Financial economics says that a higher cost of capital requires a higher return of capital which means higher prices for consumers, pure and simple.
The case for selling our SOE's looks flimsy at best and a travesty from the perspective of young people and those other sectors of society who stand to lose from the transactions. This is likely to be at least half that population. If this Government truly has the interests of all New Zealanders at heart it is time to admit it has made a mistake.