One of the respondents to my earlier post on NSW electricity privatisation accuses me of a possible “ideological bias against privatisation” and proceeds to make sweeping generalisation about the benefits of privatisation.. I thought I might clear the air on this issue.
I have always adopted an agnostic stance on privatisation – i.e. I do not start with a prior presumption for or against. I certainly refuse to start with a belief that it is unsound public finance for our governments to borrow or that government borrowing for infrastructure investment puts upward pressure on inflation and interest rates whereas a comparable private investment does not (an economic nonsense of the very first order).
I then ask myself the question: will the private sector prove a more efficient owner-manager of the proposed infrastructure than government? There is little doubt that the private sector is generally better than the public sector in design, construction and operation of infrastructure. But capturing these benefits does not require private ownership. Governments can and do out-source most operational matters to private companies and consultants.
On the other hand, the efficiency case for private ownership of infrastructure is based on a number of preconditions which may or may not apply in practice.
Firstly, it assumes that the equity risks of the infrastructure project are largely commercial in character. But the equity risks are often more regulatory and political in character and in such cases the private sector is likely to demand an excessive risk premium. In the case of electricity privatisation, I accept that the electricity business requires skills in trading and hedging which the private sector is likely to be better at.
Secondly, the government is not always able to effectively transfer to the private sector the ultimate risk of default. Whatever the formal contracts might say, if a privatized hospital, school, road or railway network fails to perform, the government is held responsible. This is not relevant to electircity.
Thirdly, private ownership is able to deliver benefits to users only if there is sufficient contestability in financial and service markets, thus preventing costly regulation and close monitoring. This condition will largely apply in electricity.
Fourthly, private ownership will often lead to improved managerial incentives. And this is true of electricity. But in other areas it is far from clear. While government agencies are often derided for their lack of modern management expertise, in recent years they have developed ways to auction out community service obligations to avoid opportunistic political interference while also giving managers clear goals and well-structured performance incentives.
Finally, in some cases, assigning infrastructure ownership predominantly to the private sector leads to a misallocation of capital resources. For example it may create a bias in favour of infrastructure investments with good commercial potential and against social infrastructure with high social returns (an issue I return to later). As well, in the case of new roads, privatization can distort patterns of usage (forcing motorists to take less time-saving alternatives).
In short, I have few qualms about privatisation of electricity (the non-natural-monopoly bits) but each privatisation case needs to be assessed on its merit. .
Let me stress again. As an economist, I have nothing against private financing in principle. I just want to see the decision made on grounds of cost-effectiveness not prejudice or preconceptions.