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SOE Policy: Dumb and Now Dumber

21 June 2006.

SOE Policy: Dumb and Now Dumber

The government's decision to encourage state-owned enterprises to expand into new areas of business has had a bad reception from commentators.

And rightly so. The government talks about 'evidence-based policy' - making policy on the basis of relevant facts and research. Yet empirical evidence, not ideology, strongly points to the folly of government ownership of commercial enterprises, let alone a policy of diversification.

The decision was taken in the name of 'economic transformation'. This is a meaningless buzzword, but in essence the government is talking about economic growth. Minister Trevor Mallard put the issue in this context: "Economies need to grow. This is the only way that society collectively can generate the output needed to improve services and raise living standards for New Zealanders."

Few issues in economics have been subject to more exhaustive empirical investigation than the relative performance of private and government-owned commercial enterprises in using resources efficiently, generating profits and contributing to economic growth.

Surveys by the OECD and the World Bank reviewing over 50 published empirical studies examining hundreds of privatisations around the world conclude that, on average and over time, private firms out-perform their state-owned counterparts.

The qualifier "on average and over time" is important. Clearly some private firms fail and some SOEs succeed, at least for a time.

Air New Zealand is an example of a privatised company that failed. However, the government had other options than bailing it out. Moreover, even though the board and management have done a creditable job of giving it a chance of survival, the company has been a poor investment from the point of view of taxpayers. The Crown has made a zero return on its investment at a time when the NZX gross index has risen by around 77%. The Air New Zealand case reinforces rather than undermines the case for governments getting out of running businesses.

Because the odds are against successful state enterprise, the government's decision to allow SOEs to expand beyond their core business, in addition to its unique (among OECD countries) stance against privatisation and its renationalisation initiatives (such as accident insurance, Kiwibank, Air New Zealand and the rail track), must be bad for growth.

The reasons for expected poorer performance were spelled out by the government's advisers, none of which supported the decision. The Ministry of Economic Development, the Treasury and the Crown Company Monitoring Advisory Unit (CCMAU) variously pointed out that:

* current arrangements already allow limited forms of diversification;

* the proposal risks diverting the focus of management away from core business (such as ensuring reliable power supplies to Auckland);

* SOEs are not subject to normal market disciplines (such as share price performance and takeovers) and the ability to monitor them is weak.

The last point is important. Taxpayers have no way of knowing whether their investments in SOEs are yielding competitive returns. In Australia the Productivity Commission reports annually on the financial performance of government trading enterprises (and it regularly finds that many do not meet their cost of capital). CCMAU has done a poor job in not providing transparent information on SOE performance.

The cabinet paper acknowledges that at best any benefits of the new policy would be "small". The evidence cited earlier suggests they are likely to be negative. The idea that the policy could contribute meaningfully to "economic transformation" doesn't pass the laugh test.

The SOE model was always an uncomfortable halfway house. Businesses need to change and grow, yet taxpayer risks are increased by diversification. The only solution to the dilemma is privatisation.

'Public ownership of the means of production, ownership and exchange' is a policy that has failed worldwide, yet New Zealand has its head in the sand on the issue. Even the National Party, which was founded in defence of private enterprise, had a weak position on privatisation going into the last election. It ought to have been embarrassed that the government's partner, United Future, which advocates minority private shareholdings in SOEs, had a stronger one.

And the illogical basis of the government's position is illustrated by the sale of Meridian's Australian business and the sensible decision to use the proceeds to invest in Auckland roading. If it makes sense to divest SOE assets in Australia, why doesn't it make sense to divest them in New Zealand?

A 2002 Business Roundtable study concluded on the basis of World Bank estimates that New Zealand could gain over $1 billion a year or around 1% of annual GDP by privatising SOEs. That estimate made no allowance for assets held by local government, which are as large as 'Total Crown' assets.

Such moves would deepen New Zealand's capital markets, promote the 'ownership society' the government talks about, facilitate tax reductions, and reliably contribute to the government's stated goal of faster economic growth.

Roger Kerr is the executive director of the New Zealand Business Roundtable.


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