Jamie Whyte: Economic ignorance skews asset victory

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Keep our Assets campaign based on nationalisation ideals bordering on communism, writes Jamie Whyte.

The Keep our Assets campaign is forcing a referendum on the sale of state-owned companies. Photo / APN
The Keep our Assets campaign is forcing a referendum on the sale of state-owned companies. Photo / APN

The Keep Our Assets campaign, backed by Labour and the Greens, has signed up enough petitioners to force the Government to hold a referendum on its planned sale of Air New Zealand and energy firms such as Meridian and Genesis Power.

Some say this is a victory for democracy. Maybe so. It is also a victory for economic ignorance.

Go to the Keep Our Assets website and you will discover their "economic" reason for opposing the proposed privatisations.

They claim the Government should own energy companies because it can borrow at 4 per cent whereas private energy firms must pay 8 per cent on their debts. To cover their higher cost of borrowing, private energy firms must charge higher prices. So, a few profiteers aside, we will all be better off if energy companies remain in state ownership.

Perhaps the leaders of Labour and the Greens, David Cunliffe and Russel Norman, do not know enough about economics to see where this argument goes wrong.

But it should be obvious to anyone that the argument has gone wrong somewhere.

For it is completely general in its application. The Government can borrow at a lower cost than any private firm in any industry. So, by the reasoning of Keep Our Assets, all businesses should be owned by the Government. The Government should not only abandon these privatisations, it should nationalise all privately owned firms: farms, fashion houses, software designers and the rest.

In short, this argument implicitly commits Labour and the Greens to communism, which is surely further to the left than even Cunliffe or Norman want to go. Something must be wrong with the argument. But what?

Start with an apparently unrelated question about military spending. Which is less costly: an army of voluntary professional soldiers or a conscription army?

Until the 1960s most people thought conscription armies cost less. Because conscripts were, in effect, temporary slaves, the Government could pay them token salaries. By contrast, voluntary soldiers must be paid a market wage.

As the economist Milton Friedman explained, however, this line of reasoning conflates costs and prices.

The cost of having someone in the army is the value of what this stops him from doing. Suppose that, if not conscripted, John Smith would have worked as a builder. Then what he would have built is the cost of his being in the army.

Suppose now that a client or employer would have paid John $80,000 for his work as a builder. Then this is the cost of his being in the army. It makes no difference if the Government pays him only $10,000. What is lost by his conscription is still $80,000.

Of that cost, $10,000 is borne by the Government and $70,000 is borne by John. Those who think conscription armies cost less than professional armies simply ignore the costs to the conscripts.

Things get yet worse with conscription armies. Because governments do not pay the full cost of conscripted soldiers, such armies are effectively subsidised. As always, subsidies result in over-consumption and inefficiency. Conscription armies tend to be large, plodding and careless with their conscripts' lives.

Alas, Labour and the Greens have not learned Friedman's lesson. When they claim that the cost of borrowing is lower for governments than for private firms, they are making the same mistake as fans of conscription armies. They are considering only the price paid by the Government, while ignoring the costs borne by others.

Why can an energy firm owned by the Government borrow at 4 per cent when it must pay 8 per cent if privately owned? The answer, of course, is that the Government is a safer borrower. If a privately owned firm does not service its debts, creditors will lose some or all of the money they lent it. If the firm is state-owned, however, its creditors will lose nothing because the Government will pay them out of tax revenues.

In other words, state-owned firms enjoy a credit guarantee from taxpayers. The value of that guarantee is the 4 per cent difference between the cost of borrowing for private firms and for the Government. The Government pays nothing for this guarantee but that doesn't mean it comes at no cost. As anyone in the insurance business could tell you, providing a guarantee is costly. Those who say state- owned firms have a lower cost of borrowing than private firms simply ignore the costs that fall on those who are "conscripted" to provide state-owned firms with credit guarantees.

State-owned firms borrow at lower rates of interest because they are subsidised by taxpayers. Firms in receipt of a subsidy rarely pass much of it to consumers in the form of lower prices; most normally goes to management and staff in the form of lax practice.

But suppose Kiwi energy firms resisted this temptation and translated their credit subsidy into lower prices. State ownership would then amount to a tax-funded subsidy for energy consumption.

It is deliciously funny to see befuddled Green Party politicians advocating policies that subsidise precisely what they want to discourage. They are reminiscent of Soviet politicians, who combined economic ignorance with a penchant for meddling in the economy to hilarious effect. But as Russians from that era could tell you, the joke should not be taken too far.

Jamie Whyte is a fellow of the Institute of Economic Affairs and a senior fellow of the Adam Smith Institute. He has been a management consultant for Oliver Wyman and the Boston Consulting Group, a philosophy lecturer at Cambridge University and a foreign currency trader.

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