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John Key Speech: State Sector Under National

Lifting the performance of the state sector under a future National Government

John Key Speech

Good Morning and thank you for the invitation to speak at your breakfast meeting.

They say time flies when you are having fun and maybe that’s why the last 3 years as the MP for Helensville have flashed by so quickly.

It won’t be long before we are back on the campaign trail in what promises to be a most interesting election.

I want to talk today about how we ensure that we get value for money from the considerable investment in assets held within the public sector, and about how a future National Government would approach these issues.

But before I get into that, I want to remind you that while these issues are important, they are not by any means the crucial ones for the future of New Zealand.

Peter Blake, in pursuing the quest of winning and then retaining the America’s Cup, used to say that he was not interested in discussing an idea unless it was directly related to “making the boat go faster”.

Well, the crucial issues to making the NZ boat go faster, and making it a boat worthy of sailing in, are reducing taxes and regulation, and implementing welfare and educational reforms to turn New Zealand once again into an opportunity society. We also must deal with a Treaty industry that has got out of control, and must stand up for the core values of our society with tougher law enforcement.

Those are the crucial issues that will make our communities safer and more prosperous and will make our boat go faster.

And they will be the prime focus of the next National Government.

Let me turn then to the important subsidiary issue which I will focus on today.

How do we ensure that we get value for money from the huge investment taxpayers have in publicly owned assets? How do we ensure they are not a drag on our boat?

First, I think we should remember that we have come a long way from the grossly undisciplined quasi-socialist approach of the middle part of last century.

It’s easy to forget just what New Zealand was like as recently as 20 years ago.

That was a time when the government controlled and ran a huge part of our economy. And it wasn’t a great advertisement for government control and direction of business.

It was a time when government services went far beyond the basics of law and order, health and education, but reached all the way out to renting hotel rooms and running bus services.

In 1985, if you combined all of what are now the SOEs into one portfolio, they were worth around 20 billion dollars. And what sort of return did the taxpayer get for that massive investment?

The answer was astonishing – the taxpayers got worse than nothing. In aggregate these businesses made a loss.

There was no net dividend to the taxpayer. Instead the taxpayer continued to fund the losses – or more accurately, the government was borrowing to fund the losses. Those losses would have to be paid for by future taxpayers – by us.

By 1987 the situation was even worse. While these businesses were responsible for producing 10% of the country’s GDP, and accounted for 20% of all gross investment, every one of them made a loss.

It was simply scandalous.

And it is almost inconceivable today!

Imagine owning around 20 billion dollars in assets and receiving no return whatsoever on the investment. Sounds mad? It was mad!

And then it all changed. And it had to change.

The Labour Government that came to power in the mid-1980s faced some unenviable tasks. And although they failed to address many things, including the inflexibility of the labour markets, they did set in train a programme of both modernisation of the State Sector and widespread asset sales to deal with huge levels of public debt.

The asset sales were controversial, and remain so today.

Through some strange quirk of personal and political psychology, Helen Clark and Michael Cullen like to distance themselves from that period of privatisation, and yet they were both Ministers (and Helen Clark was for a time the deputy Prime Minister) in a Government that engaged in the most intensive privatisation programme this country has ever seen, selling NZ Steel, Petrocorp, Post Office Savings Bank, Air NZ, Rural Bank, State Insurance and Telecom, amongst others.

The asset sales programme pressed ahead with some urgency, despite being dogged by a range of criticisms, most of which it is fair to say lacked substance, and many of which were simply irrational. As in any series of auctions, looking back you can see that in some cases the buyer got a good deal, but in others the seller did.

In many cases foreign investors ended up owning these assets (ie they took an equity claim on our economy). But because the asset sale allowed public debt to be reduced, other foreigners no longer held a debt claim of equal value over taxpayers.

If we wanted to understand the reticence Clark and Cullen have about being so closely associated with this period of privatisation, the analysis would have to be psychological, or perhaps ideological, as there is no adequate economic rationale for it.

And the proof of that is that, apart from the odd political dinosaur - and there are a number scattered through the parliament - there are few who would suggest we should again run up massive debts on behalf of future taxpayers just so that the more ideologically driven amongst us can have the satisfaction of claiming to own public assets.

After all, in principle the privatisations are easily reversible – simply borrow tens of billions offshore, and buy the assets back.

The State-Owned Enterprises Act of 1986 was the first serious step along the path of improving the performance of publicly owned enterprises.

This Act effectively corporatised government trading operations, giving them independent boards and decision-making autonomy and a more transparent self-contained structure.

The worst of the fiscal and debt crisis receded by the mid 1990s, and accordingly the emphasis on a wholesale asset sales programme has faded.

By the mid 90s the National Government was looking at these ownership issues on a much more pragmatic, and cautious, case-by-case basis.

Change had also occurred in the process of selling assets. Foreign trade sales were replaced with domestic floats to ensure that Kiwi investors could participate.

Such a regime was used to conduct the sales of Contact Energy, Auckland Airport and Capital Properties, all of which I think it’s fair to say are considered successful.

So, where does the Labour Party stand on these issues now?

In 1999 the incoming Labour Government decided to give this issue a wide berth, their earlier approach was replaced by a blanket policy banning sales.

Six years on the ban remains and if anything this Government has gone the other way by purchasing assets. Initially ACC were given back their monopoly control of the accident insurance market, while in recent years a bankrupt Air New Zealand was largely renationalised and, more recently, the rail track network was also returned to public ownership.

The first of these decisions, ACC, was a simple case of ideology trumping the knowledge that monopolies, whether public or privately owned, tend to end up providing low quality, high cost services.

The purchase of Air NZ was in a sense the only option left after a novice finance minister failed to capitalise on an offer by Singapore Airlines to increase their existing 25 percent shareholding to 49 percent.

And the rail track network purchase was presumably driven by some concept of an analogy with Transpower as a monopoly national grid.

As I have noted in the past, this exposes the taxpayer to the risk of pork barrel politics determining which tracks are funded and which are not. I am happy to take a pragmatic approach to these things, and believe the changes deserve time to prove themselves, or not, as the case may be. So we would not propose reversing that move.

Apart from these cases, I detect no sense that the Government has any enthusiasm for reviewing any other previous asset sales, because they themselves recognise the significant advantages in having those businesses run by the private sector.

Let’s consider some of those.

First, the taxpayer is not continually having to bail them out. Over time having these businesses in the private sector tends to save the taxpayer money.

Secondly, the performance incentives are more acute and finely tuned in the private sector.

What incentive is there to drive performance where you have no outside benchmarks such as a stock price, when you are protected from sale and your master is a shareholding minister with scores of more important issues to deal with, and when nobody closely involved with the company has their own financial capital at stake?

Third is the issue of corporate governance and the appointment of board members.

Yes, in the early days, some of New Zealand’s finest business people did grace the boards of our newly established SOEs. But sadly, that trend has not continued.

Too often today appointments are made on the basis of political favour rather than commercial savvy. Compare that with private sector companies where – especially post Enron’s spectacular collapse there is an increasingly rigorous focus on corporate governance and the importance of the role played by directors.

Fourth, private sector institutions give greater transparency and accountability.

Limited external scrutiny can undermine performance, as evidenced by the range of dividends paid by the current SOEs, and the wildly fluctuating returns on capital from enterprise to enterprise.

Such a lack of external scrutiny not only results in competing entities operating in the same marketplace under different rules, but it also allows important transactions to take place without sufficient cross evaluation.

Consider this example: the Government’s recent agreement to support energy sector SOE Genesis when it developed a new gas power plant at Huntly.

The Government and Genesis’s refusal to release details of the deal’s structure places its private sector competitor Contact in an impossible position, along with any other private sector energy companies which may be considering entering the market place.

Who would take the tremendous risk of investing large sums of capital in a country where there is one set of rules for the private sector and another for the government?

Accountability is only possible if companies are adequately monitored – by shareholders or by financial markets, or both.

In a public company the stock price acts as a performance indicator.

In an SOE there are no teams of stock market researchers, probing and questioning performance. Instead, it’s left to the government’s auditors and CCMAU, the government’s monitoring arm, to ask questions and report back to a minister or a board that is often too risk averse or simply ill-equipped to know how to react.

So, there are some significant difficulties in running companies with 100% public ownership.

And that leads naturally to the question I am often asked – how would a future National Government approach this issue?

Firstly let me start by saying that New Zealand does not face the balance sheet crisis of 1984, or even of the early 1990s. Far from having dangerously high debt levels, gross debt to GDP is around a modest 25 percent and net debt may well be zero by 2008.

In other words, there is no longer any balance sheet reason to justify an aggressive privatisation programme of the kind associated with the 1980s Labour Government.

In recent years an interesting trend has been the development of “mixed ownership” structures, with developments being partly public and partly private sector.

Some recent New Zealand examples point to success, such as Ports of Auckland and Air New Zealand, and in recent times NZ Post.

Consider Air New Zealand. This is a company that operates in one of the toughest sectors in the world economy, aviation, an industry that when you add up the combined losses and profits of the industry over the last 60 years you won’t find a net profit. Yet Air New Zealand has in the last 3 years gone from strength to strength.

The security of Crown capital, coupled with world-class management and board representation and backed with the discipline demanded by a bevy of external analysts, has paid dividends. This is a company that is both majority publicly owned and a listed company on the sharemarket, and thus attracts all the monitoring and scrutiny that this involves. This is undoubtedly a healthy thing.

We can also even see the beginning of a less backward, ideologically driven approach by this Labour Government. In recent months NZ Post sold half of its courier business to German-based DHL. I was and remain a little critical of the way this deal was completed, a function of the differing rules that are applied to an SOE as opposed to a public listed company, but the underlying outcome, the injection of a world-class partner and private sector capital, should be applauded.

This model of mixed ownership and the introduction of private sector capital has considerable merit.

Of course such an approach would not work for all businesses.

Some might be too small. Others, like Transpower, operate in a monopoly environment, and sale to the private sector would necessitate adding a further layer of complex legislation to protect the consumer.

But over the next decade, where the government will be expanding its asset ownership in some areas, it may well be that its ownership stake could be usefully diluted in others. Freeing up capital to improve New Zealand’s infrastructure may well be the best approach.

Another structure having many advantages is the BOOT structure, whereby a private sector company can tender for the right to Build, Own, and Operate an asset, but at the end of the concession period the asset is Transferred back to the government again, based on pre-agreed conditions.

The BOOT model is a new way of thinking about SOE management and growth. It is not appropriate for everything but does open up a whole new range of options for getting top performance out of public sector investments.

It ensures the long-term public ownership that, by and large, the public desires, but keeps financing and management in the private sector.

And in fact this is a model that is already being used, albeit in a small way, in New Zealand. A recent deal will allow the private sector to effectively own, finance and operate car parks at Auckland Hospital for a given period of time.

What this all shows is that the competing ideologies of never selling anything and maintaining public sector ownership of businesses regardless of performance, on the one hand, or of selling everything that moves on the other, are both representative of attitudes of 20-30 years ago. These are attitudes that entirely miss the point of the much richer menu of options we have these days to get value and performance from public investments.

What should be obvious from these examples is that these decisions have to be made very much on a case-by-case basis.

So what you can expect from National as the public sector builds its asset base over the coming decade is a flexible, transparent and pragmatic approach to asset ownership.

One that balances ownership with performance.

What I do want to stress is that our approach will be cautious and measured. As such I do not expect any significant ownership issues to arise with the electricity generators over the next term of government, as this whole sector needs significant work to ensure the regulatory regime is robust and effective.

The Labour Government has failed to get anywhere near resolving critical issues around future energy supply, and that won’t happen until all involved - public and private companies - understand just what the ground-rules are and can be confident that they will be stable over the long-term horizon of the investments that must be made.

In general, our approach is premised on a strong desire to increase the performance of public sector assets.

While we expect that, in aggregate, public sector investment will increase, not shrink, that does not imply no asset will ever be sold, or that we would never dilute the degree of public ownership by introducing private stakes, in much the same way that Labour has done with NZ Post.

But let me also stress this is an area where any significant changes will be well signalled to the public.

As such I want to make specific mention of some that have attracted some media attention in the past.

The first is Kiwibank.

While it wasn’t our policy to establish the bank and we have a very healthy degree of scepticism about the role of government in providing banking services, we do acknowledge the hundreds and thousands of Kiwis who have in good faith established a relationship with Kiwibank. For an incoming National Government to simply unwind this on the basis of ideology would cause unnecessary disruption.

It is therefore our intention to keep the bank for at least our first term in office so that any final decisions on its future can be made with the benefit of full and complete information.

Nor do I see the need for the next Government to spend time and energy reviewing the ownership of Television New Zealand. My Leader is already on public record with his verdict that selling TVNZ will not make the boat go faster, and, indeed, is more likely to provide a giant distraction for those charged with successfully driving an increasingly complex business in a highly competitive environment.

The same applies, I suggest, to any question of splitting out TV2. Indeed, I envisage that the full first term of the next Government will be employed in dealing with decisions which have been put in the too hard basket by the current administration: dealing with a programme for renewing the frequencies of incumbent broadcasters, including TVNZ, and charting a course for the digital mode in this country, rather than focusing on issues which will add no value.

I could also add that, in respect of Landcorp, we do not see a good case for the government owning an extensive portfolio of farms, so it is likely that individual farms would be gradually sold down over time.

In respect of Solid Energy, if an opportunity arose to introduce a private sector partner, we would consider that seriously.

In conclusion let me make one more point.

The New Zealand economy has, over the past decade, delivered vastly improved levels of economic growth. But we need to improve further if Kiwis are to enjoy increased standards of living and wider opportunities.

The days of blind ideological or emotional approaches to economic issues are gone.

When it comes to the economy our approach is one of being firmly focused on what it is that “ will make the boat go faster”.

Improving the performance of SOEs and related Crown companies and Crown entities is an important issue. We need all parts of our economy, especially a large part like this, to be firing on all cylinders if we are to reach the kind of growth levels that can one day put us back in the top half of the OECD.

But it’s important to stress that times have changed.

The days of wholesale asset sales are gone, replaced by the need to harness skills of balance sheet management, and embrace a wide range of techniques that can marry the public’s desire to retain ownership with the need to maximise performance.

In the months ahead, I will have more to say about our economy and the future of expanded opportunity that a National-led Government can deliver to us all.

Thank You

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