Saturday 12 November 2011

And why do we care about the price?

At the TVHE blog recently there has been activity base around the question of asset sales, see for example here and here and the comment sections of these posts. The big issue seems to be the price that we get for the sale of any state assets.

But why, I ask, do we care about the price? The logic behind the sate of state assets is about efficiency not the price. As Anbarci and Karaaslan point out in their paper "An Efficient Privatization Mechanism":
In this paper, we consider the privatization of State-Owned Enterprises (SOEs) that are legal monopolies but not natural monopolies; their markets can be opened to competition once privatization takes place and other competitors can emerge and compete successfully against them in a few years. But until that happens, these privatized SOEs can have a significant level of market power. The currently used “Revenue Maximization (RM)” privatization scheme maximizes the government revenue from privatization but does not provide sufficient incentives for the privatized SOE eiher to charge a price lower than the monopoly price or to improve production efficiency until competition arises. We propose a new scheme to privatize such SOEs. We term this new scheme the “Welfare Maximization (WM)” scheme. The WM scheme practically yields no revenue to the government from the privatization of any such SOE; however, it induces the privatized SOE to charge a competitive price in the absence of any regulation. It also turns out that the WM scheme provides greater incentives for post-privatization process invention (i.e., for post-privatization cost reduction) than RM scheme. (emphasis added)
This is a very specific situation but it helps make the point that just worrying about the price received for an asset is not a good idea. In the above example welfare is maximised (and isn't welfare what we should be concerned with?) while revenue is basically zero.

The point I wish to argue here is that there is problem with thinking about privatisation in terms of the money raised. The reasons for privatisation can hold even if you get nothing from the privatisation programme. Talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that's unlikely to do much for efficiency and welfare.

The point to note is that the advantage of privatisation is that it will depoliticise the firm. The aim is to have the greatest possible "distance" between the government and the firm. Government interference in the running of a firm is impossible to eliminate completely but a good privatisation plan will result in a situation where any government interference is as obvious and politically costly as possible.

For successful privatisation it is more important to get the regulatory environment right so that competition can breakout in the industry than it is to maximise the price for which the asset is sold. Basically I'm arguing we should have lexicographic preferences, with price low on the list. Worrying about whether or not the ‘family silver’ was sold too cheaply misses the point, the price received can only be see as too high or low relative to the market structure the firm finds itself it. Just arguing that a higher price could be obtained with a different market structure is only useful if the new market structure improves welfare.

So let there be a debate about privatisation in terms of efficiency not price.

1 comment:

Matt Nolan said...

I do not disagree on the efficiency issue at all.

However, if you can manage to argue that the "price is fair" in some way then you do not need the efficiency argument in order to justify the sale (at the current margin in New Zealand). As a result, the gains in efficiency are icing on the cake!