There has been a lot written recently about the interaction between the upcoming public share offer for Mighty River Power and the blackmail tactics of Rio Tinto to use this event as a means of extracting a further subsidy from our national government. I wish to focus here on a couple of the underlying economic issues involved here: the economic purpose of privatisation programmes and the economic impact of a closure of the Tiwai Point Smelter.
The financial impact of the proposed privatisation of government-owned power companies is simply an adjustment of the mix of assets and debt on the Crown’s balance sheet. The potential economic benefit from this financial redeployment comes from two areas: a reduction in Crown (ie taxpayer) risk exposure and a potential gain in economic efficiency.
The ownership of commercial entities exposes the Crown to higher risks than normal public assets. Taxpayers underwrite public assets. For non-commercial assets, the risk is essentially spread across the whole of the economy. Our ability to fund public education and public health systems are underpinned by the overall performance of the economy and the ability of citizens to pay required taxes. For commercial assets there is the added risk of commercial performance within a specific market. Financial performance depends on both the latent demand for the product or service, and on the commercial performance of the specific organisation. Thus the return to government is influenced by factors such as the demand for electricity, coal or TV advertising, the performance of the state-owned enterprise compared to competitors, and the quality of management.
The upside is of course higher returns on assets than is available from other public assets, but this comes at the expense of higher risk exposure. It is the nature of risk exposure that in most years investors receive reasonable returns, but every now and then a series of circumstances leads to a catastrophic situation for the enterprise. Most companies have a limited life, even the once mighty do not last forever (eg Kodak). When privately owned, business failure allows a process of “creative destruction” to take place where resources are re-deployed to better (or luckier) management teams and activities that yield higher returns for investors.
Public ownership tends to undermine this creative destruction process. Political considerations cloud commercial considerations, typically resulting in a taxpayer funded bail-out of the failing enterprise. These bail-outs occur infrequently, but are typically large enough in scale to offset the apparently good returns of previous years. This risk exposure is inherent in all government funded commercial investments. The implication is that the figment of high returns is a poor basis for government funded investments, and the sell-down of the government commercial assets will reduce their exposure to these risks.
Another argument for the sale of government owned commercial enterprises is to promote economic efficiency. By increasing private ownership, one is likely to increase the profit motivation of the organisation, thus increasing incentives for cost reductions and expansion into new product areas. There is debate about the extent that such efficiency gains will materialise through partial sale of an enterprise, rather than its complete privatisation, but at least some efficiency gain should materialise from privatisation. Whether such potential gains justify privatisation is likely to be case specific.
It may also be the case that many of the benefits of efficiency gains could accrue to others rather than the new owners. This depends on the nature of the enterprise and competitive pressures, ie the extent that gains benefit clients (eg reductions in electricity prices) rather than owners (higher profits). An implication is that the price received for the sale of a state owned enterprise may have little reflection on the potential economic benefit. An apparent low price may actually reflect a higher long term economic benefit as the price might reflect the extent that efficiency gains will be shared around the economy.
In the case of the sale of electricity generation companies, the probability of a closure of the Tiwai Point Aluminium Smelter and the financial implications for the profitability of electricity generation activities needs to be factored into the price willing to be paid by potential investors. The favourable price paid by the smelter for electricity means that this need not be a negative impact for all electricity generation companies. However, the implicit reduction in demand for electricity should favour the generation companies with lower marginal generation costs. The implicit increase in electricity capacity should place downward pressure on the electricity price paid by electricity consumers (or at the very least less upward pressure), which will have competitive advantage benefits for New Zealand based industry as well as purchasing power benefits for retail consumers.
The closure of Tiwai point would of course have a disproportionate impact on the Southland economy. Although, this will cause some short run discomfort for the region, the harm for medium term prospects for Southlanders is likely to be minimal. To begin with the Southland economy is performing well. Despite falling production levels at the smelter, Infometrics estimates that Southland economic activity expanded by 5.4% in the year to March 2012 (compared with national growth of 2.3%).
There will of course be sizeable impacts for members of the Southland community. To begin with, the smelter directly employs around 800 workers (representing 1.5% of employment in Southland). There are also a number of businesses who benefit from having the smelter in the region. However, closure would not have the 3,200 job impact intimated by smelter propaganda. To begin with Southland has one of the best performing labour markets with an unemployment rate in December 2012 of 4.6%, compared with a national average of 6.9%. The implication is that prospects of finding alternative work are probably better in Southland than in most other places in New Zealand. In addition the 3,200 job impact figure is based on regional multiplier analysis, which is likely to overstate the job impact of a closure. Closure would reduce the demand for services from Southland firms, and this might touch many workers, but this does not mean that the impact will be sufficient for so many to lose their jobs or mean that those impacted are unable to find alternative employment.
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