Thursday, 6 October 2011

Public = Bad, Private = Good

Donal Palcic: I couldn’t let this one go. Marie O’Halloran in the Irish Times reports on Michael Noonan’s defence of the planned sale of state assets in the Dail yesterday. The opening quote in the article caught my eye:

The Minister said the European authorities believed and were backed by “any economic theory you’d like to read” that “assets in private hands will be used more efficiently for the public good than assets in public hands in general terms”.

It is a major concern that someone as important as the Minister for Finance, who is likely to make crucial decisions in relation to privatisation, makes blatantly incorrect assertions such as this. Even a cursory glance at the theoretical literature on the impact of privatisation on performance would show that the grounds for making such a claim are extremely shaky. No less than Nobel Laureate Joseph Stiglitz has stated that “the theoretical case for privatization is, at best, weak or non-existent. It is strongest in areas in which there is by now a broad consensus – areas like steel or textiles, conventional commodities in which market failures may be more limited. But by the same token, these are precisely the sectors in which abuses can most easily be controlled, appropriate incentives can best be designed, and benchmarks can most easily be set.”

In other words, privatisation can lead to improved performance when firms that are sold operate in competitive markets. Where firms operate in imperfectly competitive markets, the case for privatisation is weak at best. The regulatory structure in place and the degree of competition faced by firms in such markets are far more important determinants of performance. Numerous empirical studies on the effects of privatisation on the financial and operating performance of divested firms have been carried out in recent years. My colleague Eoin Reeves and I review a large number of these studies in our recent book and argue that, overall, the empirical evidence with regard to the impact of privatisation on enterprise performance mirrors the thrust of relevant economic theories and is inconclusive. In general, the empirical literature can be divided into two main groups: broad-based international studies which by and large find that privatisation leads to improved performance, and more in-depth country-specific studies that find more ambiguous results, and suggest that privatisation does not automatically lead to an improvement in company performance. The general conclusion we can draw from the empirical (and theoretical) evidence is that privatisation leads to improved enterprise performance in some, but not all, cases.

The Minister therefore needs to be far more careful when making wild claims that any economic theory you’d like to read shows that assets in private hands will be used more efficiently for the public good than assets in public hands. It is interesting (and worrying) that the Minister makes such comments at a time when Fine Gael’s NewERA plan which was launched last week places public enterprise at the heart of efforts to lay the foundations for economic recovery.


Paul Hunt said...


The focus, most likely, will be on the energy semi-states, because, as the State Asset Review Group's report shows, that's where the money is.

It's particularly unfortunate that the more specific focus is on privatisation, rather than on the restructuring and reform of regulation that would generate sustainable benefits for all consumers and the economy.

And what's even worse is that these policy objectives conflict in terms of their own specific critera for success. A successful privatisation maximises the proceeds of the sale - and, in the energy sector, this generally involves the sale of some or all of an integrated utility. A successful restructuring and reform of regulation will generate sustainable benefits for consumers and the economy. A subsequent sale of the restructured businesses may or may not match the proceeds generated by the sale of the integrated business.

Politicians and policy-makers, under pressure to generate privatisation proceeds, rarely, if ever, put in the time and effort to think through fully what is required. Despite successive governments having ample time to address these issues in the past, it appears the current Government, under pressure from the Troika, has gotten itself into a position where it has seems to have no option but to make some really stupid policy decisions.

It will find it impossible to reveal that the two main energy semi-states have been ripping off consumers and the economy right, left and centre as a result of the policies of, and fully authorised by, succesive governments. It would be bad enough if this rip-off were to continue, but it would be almost criminal to allow private sector investors to share in the proceeds of this rip-off.

And it appears that this is what is likely to happen. I had hoped that the detailed 9-month assessment of the electricity and gas sectors set out in the EU/IMF MoU would be kicked off last month. It may be that the IMF could be persuaded to hold off and ensure this assessment is performed before there is any consideration of privatisation, but the pressure to advance privatisation to put pressure on Greece may be too strong. It is also possible that the Commission and the ECB are not too keen on such a detailed assessment of the Irish energy sector as it might reveal fundamental flaws in the EU model of energy sector liberalisation.

If this assessment isn't performed fully and properly, all of this will end upin one unholy mess and that do even more damage to the interests of all Irish energy consumers and to the economy.

Donal Palcic said...


I'd agree that it is unfortunate that the government appear to be focusing on privatisation rather than on more important issues such as the restructuring of our energy companies and the reform of the regulatory structure. The decision not to restructure the ESB prior to any partial sale is bizarre to say the least, particularly in the context of the original NewERA plans for a "Smart Grid" that Fine Gael published prior to the election.

It looks like the government is opting to take the easier (but wrong) policy route of pushing ahead with a partial sale of the ESB without first having taken the more difficult (but better) route of restructuring and reform prior to any decision to sell.

Paul Hunt said...


The idea has been floated in some quarters that the Government could get itself off this 'partial privatisation of the ESB as an integrated utility' hook on which it has impaled itself by selling some non-core, non-essential bit of the ESB. There has also been some coded language suggesting that the IMF would be quite open to the notion of postponing privatisation until there had been a detailed examination of the electricity and gas sectors.

There is no doubt that there are a lot of manoeuvrings going on behind the scenes. The only thing we can be sure of that some decision or other will be made and it will be delivered as a fait accompli. The requirement to conduct this detailed assessment of electricity and gas was clear in the first version of the EU/IMF MoU. The orginal intention was to kick this off by end Q1 of this year. A requirement to dovetail this with the State Asset Review Group's report (plus a hold off to allow the incoming government to form a view) pushed the kick-off out to end Q2 of this year. A further revision of the EU/IMF MoU pushed this out to end Q3 of this year (i.e., last month). There has been talk that a team from the IEA (conducting one of its periodic national energy policy reviews) has been charged to conduct this assessment. Even people whom one would expect to have some insight have been excluded from the tightly sealed policy-making circle - or else they're keeping shtum. It's all redolent of the Bertie Era 'smoke and daggers'. Given the kinds of things that have been cooked up in the past by this type of closed policy-making circle, people would be entitled to be very worried.

There's also a lot of background noise about structural and regulatory reform - we've had some here, but nobody ever goes into anything specific. It's possible that many people don't know what they're talking about, but it sounds good and it may be used to delay or postpone any consideration of privatisation. It's also possible that others have some insight, but, once they give it some consideration, are unwilling to reveal what it might entail for fear of 'frightening the horses'. It would be useful if you - or other contributors on this board - were prepared to present some ideas on the energy semi-state restructuring options. I'm sure people have some. Why not put them out there?

The energy industry, probably more than most, is characterised by investments in long-lived, specific assets. And this is probably even more the case for electricity and gas. Providers of finance - whether debt or equity - require pretty rock-solid assurance of full investment recovery at an appropriate risk-related rate of return. Previously, vertically integrated monopoly suppliers - whether in public or private hands - were able to provide this assurance of investment recovery.

Paul Hunt said...


The EU's model for electricity and gas market 'liberalisation' has demolished the basis for this assurance. Full retail competition has destroyed the ability to convert the long-term, almost indefinite, commitment of final consumers to consumer and pay for energy into the long-term contracts required to provide the assurance of investment recovery. But the wholesale markets with the depth and liquidity required to replace these contracts have not emerged. Vitally necessary investment is not taking place unless there are solid commitments from regulators or sovereigns and excessive costs are being imposed on final consumers either in the form of being required to pay for an excessively high cost of capital or to pay up-front to part-finance investment or to pay indirectly for shortfalls in investment. And the climate change agenda is imposing additional costs to recover some gloriously inefficient investments.

It is, quite simply, a total mess and governments, in the current economic circumstances, are only very slowly beginning to realise the total costly mess they've created.

And it is even worse in Ireland because consumers have been locked into a particularly virulent form of this nonsense over the last decade. Ive lost track of the billions the ESB has spent on investment, but the networks have more than trebled in book value over the last 10 years. But rather than injecting equity to part-finance this massive investment successive governments have extracted dividends - to the tune of over €700 million over the last 7 years. Consumers have been required not only to pay to finance these dividends, but to pay up-front to part-finance the investment.

But, of course, the Government can't reveal this massive rip-off of consumers and the dereliction of shareholder duty by previous governments because the regulator has been the statutory body sanctioning this rip-off.

This is becoming a very deep hole, but the Government continues to dig - as well as doing the usual ducking and diving. Bright ideas to find a way out of this wanted.

Paul Hunt said...

Front end of previous comment just disappeared. I'm damned if I'm going to try to reproduce it. Two main points. First, it would be good to see some ideas from you - or other contributors here - on energy semi-state restructuring options.

Second, as a preface to the previous comment. Providers of finance for investment in the specific, long-lived assets that characterise the electricity and gas industries require a rock-solid assurance of investment at an appropriate risk related rate of return. Previously vertically integrated monopoly suppliers provided this assurance.

Donal Palcic said...

Thanks for all the comments. I'm not an energy economist so I don't exactly have any novel ideas for the restructuring of the semi-state energy sector. The original NewERA plan, whereby Eirgrid and ESB Networks would be merged and Gaslink and Bord Gáis Networks would be merged, with both companies then included along with Irish Water and the State's broadband assets etc. seems sensible enough to me. While the plan obviously lacks lots of detail on how exactly everything would work, a national network agency which oversees and coordinates network investment in the energy, water and telecoms sector should at the very least lead to more efficient investment (for example, through lower civil engineering costs as a result of coordinating civil works etc). What are your views on their proposed plan in general? Do you think it makes sense to merge the state's network assets together under one agency so that better coordination of investment can be achieved?

Paul Hunt said...

One doesn't have to be an energy economist to understand or make observations on these proposals; doing what economists do would be more than sufficient.

But I detect a reluctance to get to grips with the issues on the progressive-left; too many vested interests to be upset, perhaps?

In any event, it doesn't matter what any of us says or does. The government has all the 'democratic legitimacy' it requires to do what it likes in these areas - once the FG and Lab High Commands can cobble something together behind the scenes.

Paul Hunt said...

OK, Donal. I finally get it. You're a 'privatisation' economist - or, perhaps, an 'anti-privatisation' economist? Me, I'm just an economist who happens to work in the energy sector. But it doesn't, nor should it, stop me from applying economic analysis to other sectors. At its core economics is about the efficient allocation of resources to maximise people's welfare - both individually and collectively. I'll take on anyone or anything that hinders the achievement of this objective. But most Irish economists seem to be weighed down and silenced by the ideological or vested interest baggage they carry - or both.