The power of persuasion
That’s the headline for my article in today’s Fin, which follows:
After a messy and unedifying process, the Iemma government has finally reached an agreement with the Opposition to proceed with the privatisation of the New South Wales electricity industry. The price of the deal has been acceptance of the Opposition demand for an inquiry by the Auditor-General, Peter Achterstraat.
In most cases, inquiries into policies on which the government is already determined are little more than rubber-stamps. Whatever the desired result, a suitably distinguished former judge or some other eminent person, with appropriately written terms of reference, can usually be relied on to deliver it.
But Auditors-General are a sturdy breed, among the few groups of public officials who have offered significant resistance to the politicisation of the public service over recent decades.
Back in the 1990s, Tony Harris did sterling work exposing the spurious accounting behind some of the NSW governmentâ€™s early ventures into privately-funded infrastructure, such as the Sydney Harbour Tunnel. (Fifteen years later, Achterstreet is still trying to clean up that mess). And in Victoria, Ches Baragwanath (along with DPP Bernard Bongiorno) stood up to a Kennett government that had cowed almost the entire state into submission, and helped to bring about its demise.
If Achterstraat lives up to the standard set by his predecessors, his report should make uncomfortable reading for the Iemma government, and particularly for Treasurer Michael Costa. The governmentâ€™s case for privatisation is economically nonsensical, a fact acknowledged even by supporters of privatisation like Ross Gittins who argues that this is merely an instance where politicians â€˜choose the arguments the punters are likely to find most persuasive and least offensive, not necessarily those that make sense to economistsâ€™,
The governmentâ€™s case centres on the claim that selling electricity assets will enable it to finance projects such as a new new metro rail system. This is an argument the Auditor-General should reject out of hand.
The economic justification (or otherwise) of the metro rail proposal is entirely independent of whether the government sells or retains its electricity assets. As long experience has shown, hypothecating the proceeds of an asset sale to fund some politically attractive project or another is a recipe for boondoggles on a grand scale.
The Auditor-General should be primarily interested in the implications of the sale for public finances. Here the central issue is straightforward. Will the proceeds from an asset sale (net of expenses and any dissipation in electoral bribes) exceed the present value of the earnings lost to the public through privatisation.
Some privatisations have met this criterion, but many have not. In the electricity sector, Victoria got a very good price for its assets, several of which were subsequently resold at much lower prices. By contrast, the returns from the privatisation of the South Australian industry were well below the value of future earnings. To add to the ill effects, South Australian consumers experienced sharp price increase as a result of the Olsen governmentâ€™s decision to kill off an interconnection project in the hope of boosting the sale price.
As far as the Auditor-General is concerned, the crucial requirement is to ensure that the sale process goes ahead only if the financial benefits outweigh the costs. The generators (Delta, Macquarie and Eraring) made combined earnings of $700 million which suggests that the sale price for these assets should be at least $14 billion (discounted at a real interest rate of 5 per cent) and probably more. Even allowing for the additional cost of emissions permits, it seems likely that the profitability of electricity generation will increase over time.
Whether such a price can be realised depends, of course, on the willingness of buyers to pay premium prices for assets. The Victorian privatisation took place at at a time when newly deregulated US utilities were engaged in a worldwide buying spree.
By contrast, it is hard to imagine a less favorable time for an asset sale than the present. The credit crisis has raised the cost of capital to private investors, while government bond rates remain at low levels by historical standards. And thatâ€™s before taking account of the emerging problems at Babcock and Brown, which seem likely to take one potential buyer out of the market, and perhaps to result in significant asset sales.
The Auditor-General will be under severe pressure to produce a report that places no obstacles in the way of privatisation. But his obligation is to protect the interests of the people of New South Wales, not the political agenda of its government.