Sunday 27 April 2008

A reply to Crampton

In a comment on Matt Burgess's posting on National's broadband plan, Crampton raises an interesting point:
I can imagine a second-best argument for a lot of public investment in fibre. Simply put, the government cannot credibly commit to refraining from expropriating the returns to private investment in this area, either via nationalization or regulation of access.
For another example of Crampton's non-credible commitment point consider the public ownership of waterworks in the US. Usually the reasons for public ownership are placed into one of three categories: market failure, regulation problems or transaction cost reasons. An interesting case study of waterworks is offered in the Troesken and Geddes paper "Municipalizing American Waterworks, 1897-1915". This paper provides support for a transaction cost interpretation of municipal acquisition of private waterworks. The incentives facing local government and the private companies are an important factor in the government take over.

The basic Troesken and Geddes story is that municipalities were unable to credibly precommit to not expropriating value from private water companies once (sunk) investments were made. This gave the private firms an incentive to reduce investment in water provision. This rational under investment was then used by local governments as a pretext for municipalising the private water companies.

Now if we accept Crampton's second-best argument that its right and proper (or at least, least bad) for governments to own broadband networks and waterworks, where does it end? The government cannot credibly commit to refraining from expropriating the returns to ANY private investment and following Crampton's (second-best) logic the government owns everything.

But maybe its even worse. What incentives does Crampton's argument give to governments? Consider the waterworks example. If the government wanted, for its own reasons, to take over the private works all it need do is to refuse to credibly precommit to not expropriating value from private water companies and use the resulting rational under investment by private firms as an excuse for municipalising the private companies.

Thus if we accept the Crampton argument, are we not giving the government the tools and incentives to nationalise everything! Would it not be better to try to find ways of giving governments a disincentive to nationalise rather than the incentive to do so? Crampton's whole argument underlines how important property rights are and why governments must forced to respect them.

In fact in the case of New Zealand, wasn't the reason for many of the changes made during the post-84 reforms about trying to restrain government. The Public Finance Act, the Reserve Bank Act, the State Owned Enterprises Act and, more recently, the Regulatory Responsibility Bill can be seen as attempts, all be they imperfect, to do this. As the former Secretary of the New Zealand Treasury Graham Scott has written recently
It is also important to continue the search for more stable and predictable policy frameworks where the role of the state is prescribed and procedures defined for the use of its powers of intervention. Examples are the fiscal responsibility provisions in the Public Finance Act, The Reserve Bank Act, the State Owned Enterprises Act and the Commerce Act. New rules to stabilize the share of the state in the economy and impose a national benefit test on regulatory powers in the manner of the Regulatory Responsibility Bill before the Parliament would also help to establish a sounder basis for economic policy than the haphazard intervention of ministers with short political fuses.
Tying the hands of government, as best we can, seems the best approach to the issue of protecting the returns to private investment. Having well defined and enforced rules as to when and how the state can use its powers of intervention and coercion are needed not just to ensure an efficient and growing economy, but perhaps even more importantly they are needed to protect our individual freedoms from abuse by the state. I fear Crampton's argument is a counsel of despair.

6 comments:

Eric Crampton said...

I said "I can imagine". I didn't necessarily say I supported the policy, nor that any such policy is "right and proper". I just put some weight on that it may be the best solution given the constraint that we seem not able to constrain government.

Counsel of despair? Maybe.

I've not checked the details of the National policy anywhere near closely enough to be able to comment. But my immediate reaction isn't as negative as for a lot of other potential large infrastructure spends.

Paul Walker said...

Set aside the issues Matt raised for the moment. If we can not constrain government why should we believe it will action as we would like with regard to this investment project? Will it not just act in its own best interest?

Matt Burgess said...

What does the literature have to say about the things a government can do to restore investors' confidence in property rights?

For example, if, by some miracle, an incoming National government recognised the importance of property rights, what could it do undo some of the recent damage?

It could probably not get a large proportion of Parliament to vote in a Constitution that gave due protection to private property.

What else?

It could pass laws that require compensation for takings. It could encourage foreign investment, since in principle it is more costly for a government to expropriate foreigners because it risks retaliation from their government and may breach international treaties (though that did not save Telecom). It could sign up to agreements with particular industries that rule out future takings in exchange for their investment in desired assets (like fibre networks, or perhaps more usefully any means of data transmission).

I'm not sure how useful most of these ideas are when New Zealand lacks a legal framework that rules out at least some behaviour by a government that can muster 51% of the vote in Parliament at any given time. Could Parliament not simply vote to rip up whatever agreements past governments have entered into?

Eric Crampton said...

Paul:
Yes, the government would likely screw up a fibre-to-home network relative to how a private company would operate it. Is suboptimal fibre > no fibre?

Matt:
I'd be very nervous about attempts to get a written constitution. The reason being that we're not really at an appropriate constitutional moment. The 1980s could have been. Appetite for change was large, public willingness to set strong controls in place might have been sufficient. Today, though, any constitutional document enacted would have to suit the current constitutional mood, which isn't exactly friendly to property rights or economic liberty. Suppose that National opened up some constitutional process -- town hall meetings and such that would culminate in a written constitution. Would that process be more likely to augment our historical British constitutional freedoms or to enshrine a bunch of touchy-feely positive rights and eco-consciousness? I'm very pessimistic.

Yes, an ideal constitution is preferable. We just can't get there from here.

Passing a law against takings or require compensation for same would be nice. Entrenching it would be nicer. Double-entrenching it, such that the legislation enacting the entrenchment is itself entrenched, would be even nicer. I don't think any such things ever give permanent safeguard: you could still in a later parliament kill the legislation that entrenches the entrenchment by majority vote, then use majority vote to get rid of the entrenchment then the protection against takings. But, the stink of doing so would likely be pretty large.

Why do you think that the incoming National government, should one be elected, would have anywhere near the guts to do something like protect property rights? I thought Key gave up any attachment to property rights so as not to look scary.

Paul Walker said...

Crampton: is private investment with government constrained as best we can > suboptimal fibre > no fibre? And this bring me to ...

Matt: How do we constrain government? I'm not sure I would want a written constitution, just think of all the pc crap which would end up in it. As an example just look at the Canadian constitution. If we could get something along the lines of the US example, yes it would be better. But there is no way that constitution would be written today, even in the US.

Which brings me back to where I started, How do we constrain government? I think the things we can do are things like the Public Finance Act, The Reserve Bank Act, the State Owned Enterprises Act, the Commerce Act and the Regulatory Responsibility Bill. Far from perfect, but they are doable and offer some hope. Also we can remove or amend bad laws, eg RMA. These things should help restore investors' confidence in property rights.

Eric Crampton said...

Paul,

I put the likelihood of further constraint sufficiently low that I don't dismiss proposals for government-built fibre out of hand. I don't automatically think them a good thing, but they're at least potentially worthwhile over a reasonable range of likely world-states.