A bit more on Queensland asset sales

Updated: Following some criticisms by the Queensland Treasurer, I’ve updated the estimates to exclude gains made by the Port of Brisbane on the sale of its shareholding in Brisbane Airport. Obviously, there are other adjustments that ought to be made to get a proper comparison between the interest savings from privatisation and the income foregone. Treasury has the resources to do this, but instead has chosen to present a totally invalid apples-and-oranges comparison between current year dividends and projected whole of government interest savings

I have a piece in today’s Fin criticising the Bligh government’s case for asset sales. I will probably post it here tomorrow. In the meantime I’ve picked up and confirmed a bit of additional information.
(i) Although the estimated sale price is $15 billion, about $7.5 billion will go to repaying debt held within the Government Business Enterprises themselves. That’s currently being covered out of the revenue of the GBEs, so this debt repayment will make no difference to the fiscal position of the government. The net return to general government is also about $7.5 billion, and it’s only this money that can be used to repay general government debt.[1]
(ii) The estimated interest saving from a AAA rating is $266 million over four years
(iii) The Port of Brisbane and QR[1] produced pretax profits of $553 million in the last reporting year. These state-owned enterprises don’t pay tax to the Commonwealth, but make tax-equivalent payments to the state so it’s pretax income that is relevant.

Port of Brisbane: Pretax 2009 $332 million [3]
QR: Pretax 2008 $221 million

This provides a simple basis for assessing the short-term fiscal impact of privatisation. The gain from privatisation, assuming the sale took place now, the estimated price is realised, the risk-adjusted interest rate is 6.5 per cent and sale costs are ignored would consist of
(a) interest savings from debt repayment, 6.5 per cent of $7.5 billion or $490 million
(b) savings from the AAA rating, $66 million per year
for a total of $551 million per year

So, the short-term effect of privatisation is roughly neutral. In the long term, it seems likely that returns would grow at least in line with inflation, while interest savings would remain fixed in nominal terms. Hence, privatisation would result in a long-term fiscal loss.

Perhaps there is a case for privatisation that would outweigh these fiscal losses, but, if so, the government hasn’t put it forward.

fn1. The alternative would be to do a whole-of-government comparison, taking account of all debt repayments and using Earnings Before Interest and Tax (EBIT) as the comparator.

fn2. Note that this calculation does not include Queensland Motorways or Forestry Queensland. These organisations roughly broke even in the most recent period, but they hold assets that can be expected to grow steadily (and, in the case of forests, literally) in value in future years.

fn3. This excludes a $275 million profit on the sale of shares in Brisbane Airport, but includes other valuation gains, which have been earned consistently in recent years.

33 thoughts on “A bit more on Queensland asset sales

  1. A couple of quick typo corrections:

    $450 billion should be $450 million
    $266 billion should be $266 million.

    On the broader point, sounds quite plausible. There may or may not be a case for flogging off these enterprises. But the financial arguments put up almost always seem to be a nonsense.

    D’oh! Typos fixed now, I hope

  2. Its hard to see how its more efficient to have 5 electricity retailers and 3 electricity generators and another company maintaining the grid. The one head of department on $250,000 and one working computer system is replaced by 9 CEOs on million dollar packages and 9 computer systems which may be written from scratch.

    In Victoria we found that privatised electricity companies do not plan for improvements in technology, increasing customer demand or environmental changes like competing demands for water. Neither do electricity transmission companies headquartered in Singapore (a long way from the consequences) spend money on clearing grass under powerlines in January and February.

  3. “So, the short-term effect of privatisation is to make the public worse off by around $234 million per year”

    We also know that the short-term and long-term effect of privatisation is to make the public worse off by reduced quality of service, higher prices, job losses and Australian money going offshore. Can someone please put a price on that and shove it up where it hurts them the most.

    There must be a fair old stigma attached to the losing of a AAA rating. Could even hurt their chances of re-election. Of course politicians would never stoop so low as to privatise so as to keep the AAA rating to make them look good. Would they? One would think that the act of privatisation would hurt their re-election chances more.

    What other case could be made? Is there something else going on here?

  4. Thanks for this further valuable analysis, John.

    Is this issue for the Government not simply the interest savings via a return to AAA rating, but their apparent/suggested inability to sell any/sufficient Government Bonds until they return to AAA? And, hence, have a significantly reduced capacity to fund all sorts of stuff because they just can’t borrow enough through Bonds? Or, have to replace Bonds borrowings with other, more expensive, borrowings?

    Does that issue affect at all where this discussion goes? Personally, NFI.

  5. John, the profits/interest cost comparison is a bit simplistic, because the interest cost is certain, and the profits are uncertain. You can’t just assume that the profits will grow at a constant rate.

    Of course even taking account of the uncertainty in the future profit numbers, privatisation might still be a bad deal, but to properly conclude this you’d need to discount the future profits by more than the real cost of borrowing, to properly reflect the risk in the earnings. (To forestall an unnecessary discussion of the market failure inherent in the equity risk premium, the discounting need not be at the rate required by private equity investors.)

  6. @Mike Smith (not the radio guy, not the banker)
    As I understand it, with the AAA rating the bonds could easily be placed through private negotiation with no need to put them out to tender. With AA+, the government actually has to go to the market, which doesn’t please Leo Hielscher at QTC, but is scarcely the end of the world. The vast majority of bonds issued in the corporate world are below AAA, and, obviously, they get sold. For the foreseeable future, these bonds will be guaranteed by the Feds.

  7. @Uncle Milton
    Granted, you need to look at a risk-adjusted rate to get a final comparison. But, the equity premium market failure analysis implies that this shouldn’t be much above the bond rate. And I’ve been very conservative in assuming that (mean) returns only grow with inflation.

    More to the point, it’s the government/Treasury who should be putting up a proper analysis, not me in my non-existent spare time.

  8. @jquiggin
    This is true, but the government/Treasury is trying to talk up the businesses to maximise the sale price, which might not be consistent with putting a proper analysis in the public domain.

  9. Professor Quiggin,

    You make an excellent case, but it is against state ownership.

    The owner of the business assets in question, as you show, seems to be incapable of the most basic business decisions, such as buying or selling an asset at a profit using net present value cash flow analysis as their guide.

    This inability to sell an asset for a profit calls into question the ability of governments as owners of business enterprises to make more complicated business management and entrepreneurial judgements that must be undertaken by the owners of any business firm.

    I have put to one side any public choice considerations as to whether the information and knowledge required to be a success as a business owner are at the Queensland Government’s disposal, but it does not have the political incentive to use it.

    Private asset owners have a good incentive to sell assets at a profit as it will hurt their share price and, and if not traded company, their personal wealth.

    Inferior entrepreneurs are punished by losses, unless bailed-out by governments. The assets that these inferior entrepreneurs sell for a bargain price end up in the hands of more alert entrepreneurs.

    There are no similar feedback measures disciplining goverments as business asset owners both in capital management and the day-to-day monitoring of the components of their large business portfolios. Governments who own business assets have an inherent soft budget constraint.

  10. Ha Ha, Jim Rose just pointed out a turd on the dance floor. Who’s is it really, the Markets’ or the Governments’. Ideal government vs ideal market. No such thing in reality and we are left with sh*t markets or, in QLD’s case, even sh*ttier govt.

  11. No, the $7.5 billion has already been counted (converted to a cash flow of interest saved). An alternative way of doing things, which would give a larger loss would be to discount the stream of profits at 5 per cent, giving a capitalised value of $17 billion, against the $7.5 billion net proceeds and the value of the AAA rating.

  12. You have counted the interest saving on the $7.5 billion pay down of debt. And extra savings from the change of credit rating. However what about interest earnings on the further $7.5 billion that can presumably be put in the bank?

  13. @TerjeP (say tay-a)
    Sorry, it’s a bit confusing to have two lots of $7.5 billion. I’ve rewritten the para in a way I hope ic clearer

    Although the estimated sale price is $15 billion, about $7.5 billion will go to repaying debt held within the Government Business Enterprises themselves. That’s currently being covered out of the revenue of the GBEs, so this debt repayment will make no difference to the fiscal position of the government. The net return to general government is also about $7.5 billion, and it’s only this money that can be used to repay general government debt.

  14. I know this sounds really shocking but I agreed with ProfQ on this sale.

    It shouldn’t go through. It does not make any economic sense and it would be better to hold the assets now.

    Wow… I agreed with Alice last week and the Professor this week. Let me check outside to see if there are seven plagues signalling the end of civilisation…

  15. @jquiggin

    John, The $17 billion NPV of the foregone profits should be compared to the gross sale figure of $15 billion plus the AAA value. If you sell the businesses you get the cash but you lose the profits. However you don’t get to keep all the cash because you either have to pay back the debt or you have to keep paying interest on the debt in perpetuity.

    The privatization is a bad deal on your assumptions but it is not $10 billion worth of bad!

  16. The issue is how much the AAA rating is worth. Does anyone have the numbers for the latest auction of Queensland state gov’t debt?

  17. Thanks for that John. I misinterpreted your interest calculations — I thought they were getting from EBIT to NPBT. Confusing because both debt and equity are $7.5bn.

    Still, I think your figures are out.

    You calculate net profit (before tax) for QR at $386m. My reading of their annual report is that this is for their entire business. But only the coal arm of it is being sold off. I couldn’t find separate income accounts for this part of the business, but they do report that QR National Coal had revenues of $1.3bn. Applying reasonable margins on revenue means that there earnings could be no more than $250m (and this is before interest payments).

    On Port of Brisbane, their income statement for this year is dominated by ‘fair value gains on investment property’ ($259m from $548m of NPBT). This hardly seems like recurring income. (I get $548m form their 08-09 annual financial report, p. 8).

    So you seem to be overestimating income by at least $300m, which wipes out the estimated cost of the asset sales.

    Plus, I’m not sure 7.5bn is right either. Port of Brisbane have borrowings of $694m and QR have borrowings of $6.46bn. This gets close to your $7.5bn figure but again this is for QR total, not only QR Coal. I can’t find separate accounts for this.

    I have to say the Queensland Govt seems to have been very opaque about this process. The only public info I could find was a myths website that provided no useful info. Am I missing something? Are the details in the budget papers?

  18. Sorry, it’s a bit confusing to have two lots of $7.5 billion. I’ve rewritten the para in a way I hope ic clearer

    Yes that is much clearer. Thanks.

  19. JQ – If you have the numbers I’d be interested to see a stand alone analysis of the privatisation of Forestry Plantations Queensland.

  20. @Uncle Milton I disagree. If you want to count the entire gross proceeds, including the amount proposed to repay GBE debt, then you should be using EBIT, not pre-tax profit as the income foregone. I think these two changes should cancel out/

    @Matt C Matt, you’re quite right. I would love the government or Treasury to put up an analysis with the correct numbers. As far as I know, there is nothing in the public domain that is any more informative than “The Myths vs the Facts” pamphlet, distributed to all households at public expense. Unfortunately, presumably due to a printing error, quite a few of the statements labelled as “Facts” were myths, and vice versa.

  21. The professor’s cash flow analysis of the Queensland Government asset sales is based on a false premise.

    That false premise is that governments are revenue maximising leviathans.

    Democratic governments are supposed to serve the people and give away plenty of goods and services, and income transfers. The swinging voter puts much of these give-aways into the hands of the middle class and well-to-do.

    If a business stays is government hands, it is subject to Director’s Law.

    Director’s law of public expenditure’s is that public expenditures are made for the primary benefit of the middle classes, and financed with taxes which are borne in considerable part by the poor and the rich.

    Asset sales move state owned enterprises away from political manipulation and into the hands of those who specialise in business and entrepreneurship. That is the welfare gain.

    The cash flow analysis conflated government revenue gains with social welfare gains.

    We want government to provide those goods and services that people in fact want and that, for a variety of reasons, are hard to provide through the market.

    Most people would like to have the poor taken care of by taxes on those better off. Of course, that does not prove that in general people are in favour of the exact quantity transferred or the methods used by the government.

    Public goods are provided by the market in a very inefficient way and will be provided in a better (although far from optimal) way by the government.

    We will just accept as a fact that there are a number of things which are better dealt with by the government.

    We will also accept as a fact that there are other things which are better dealt with by the market. Running businesses is not a function for political processes.

    What happens in a democracy is that if the party in power does not deliver what the voters want, the voters vote for another party at the next election.

    Most voters have neither the time, education, nor the inclination to do more than punish.

    All that most voters know are results and voters will then select political leaders and governing parties on that basis.

    If the Right fails to deliver on its promises, the Left takes over, and visa versa.

    Public ownership of business assets has a democracy deficit.

    Both Left and Right run interference on state ownership, making for a distraction to better democratic control over the quality and quantity of public goods, social services and social insurance that voters cannot get on the market much at all.

    State ownership of businesses overloads the democratic agenda.

    The harried voter has enough challenges in successfully punishing political leaders for their poor performance in providing basic public goods and social insurance without distractions about the relative performance of parties as business managers.

  22. @Jim Rose
    “State ownership of businesses overloads the democratic agenda”.

    “Public ownership of business assets has a democracy deficit”.

    Fallacies.

    Certain types of infrastructure need to be viewed as a common good. Not all state services should be privatised. Privatisation disasters have been accruing. We have already lost many effective state run organisations in the mistaken view of that one sentence above.
    Privatisation failures also overload the cost to the taxpayer, and you cannot make such ideologically blind statements as “public wondership of business assets has a democracy deficit”

    Market failure exists.

    “The harried voter has enough challenges in successfully punishing political leaders for their poor performance in providing basic public goods and social insurance without distractions about the relative performance of parties as business managers.”

    So we think public services should be privatised but then we think we have the right to punish political leaders for not providing services??? Its a contradiction in terms. We have no right after we have privatised everything to blame politicians for failing to provide adequate services.
    If the people didnt want public goods they wouldnt punish politicians – so clearly they want public provision in many areas. (again I refer you to leigh’s “political economy of tax reform” based on polls, and Id like to nail down exactly who isnt listening in the corridors of power).

    When it has all been sold, and the orderly process of socially beneficial infrastructure ends up being dysfunctional and detrimental to the economy, we cannot dare blame politicians… we have only ourselves to blame for blindly accepting those into power who promote dangerous “market ideologies”.

  23. Alice,

    If reform is to have realism and relevance, reforms must start from the here and now and not some other starting state more tractable of analysis and political bargaining.

    The here and now of state ownership is the electorate and their political agents have many conflicting objectives to judge government performance against in a world of costly information, limited knowledge and conflicting incentives.

    It is mistaken to assume that people have no limits of their ability to reshape the world in accordance with their desires. The knowledge and institutional capacity to do so can not be assumed to be available.

    In the here and now, a large size government calls upon democracies to agree on more topics that it may be capable of agreeing upon.

    Democracies can agree on only a certain amount of topics, and once this limit is exceeded, democratic control over political leaders may fail to work as well, if at all.

    State ownership is a distraction. Governments provide a large and diverse portfolio of policies and services on which we vote on an all-or nothing basis every few years.

    Why add a periphery of issues such as asset ownership to election agendas when core government services for which there are no market substitutes are subject to poor democratic control over their quality and quantity. That is the democracy deficit.

  24. @Alice

    Do you accept that there are government failures as well? Failures in demand-side management. Failures in managing public bodies and corporates. Failures in implementing social democratic policies. Do you accept that there are failures?

    The public sector is heavily unionised and rarely seeks to change the status quo. In an era of technological change making organisations more flexible and adaptive, as governments are less likely to also be responsive to change then inefficiencies set in and ultimately strikes and wastage occur.

    Whenever you arbitrarily increase the power of government then you run the risk of failure which hits all taxpayers. Look at the failed state banks while Babcock and Brown was put to a relatively quiet death.

    If you look at Japan – massive government spending and deficits, ideal of life-long employment – you see huge waste and white elephant projects. According to your logic where government does not wrong and that all infrastructure is equally good, then bridges to nowhere that cost taxpayers billions are a worthwhile investment.

  25. Alice,

    You also make mention of market failure.

    This concept has been dead on its feet since the 1960s because the comparison is with unobtainable ideals regarding the workings of markets and governments.

    Market failure arises from government failure regarding the creation and enforcement of property rights.

    Market failures at best are unexploited profit opportunities.

    Entrepreneurs cannot exploit these opportunities to serve consumers better because of an institutional failure of government to adequately assign property rights over the rewards for doing so.

    Public policy making should be based on comparative institutional analysis. This is the comparing the relative merits of the market process and the government, warts and all, for all their failings to see which is better in addressing the problem at hand.

    Disappointment in the market outcome does not automatically create the capacity within government to do any better. This capacity of government to do any better must be proven to be there, not assumed.

    To anticipate a standard objection, the panic of 2008 was the result of government failure from start to finish.

    Monetary policies were far looser than suggested by the policy rules that delivered the great moderation in inflation and the business cycle from the early 1980s.

    U.S. policy interest rates were 1% for several years after any possible justification could be made for that by, for example, the Taylor rule for monetary policy,

    The housing boom was further spiked by anti-deficiency laws in the states were most sub-prime mortgage defaults occurred, such as California, Arizona and Florida.

    Anti-deficiency laws limit or prohibit banks from pursuing defaulting mortgagees if the mortgagee sale comes up short. Anti-deficiency laws turn mortgages into options, especially if there is no deposit. Anti-deficiency laws caused what Americans call jingle mail. Posting the house keys back to the bank because the investment headed south. The defaulting mortgagee faces no further consequences or risk of bankruptcy.

    The housing boom and the sub-prime mortgages in particular were underwritten by government charted enterprises subject to a soft budget constraint.

    These government charted mortgage underwriters were Freddie Mac and Fannie Mae. Their underwriting of mortgages in the trillions meant that neither the issuing banks nor the mortgagees will be held responsible for any deficiency.

    Risk taking by bank staff was encouraged by amendments to the U.S. tax code in the early 1990s that limited tax deductions for salaries to $1 million. Share options were still deductible, so this became the main form of executive compensation.

    To sweeten the housing boom, interest payments on home mortgages and home equity loans are tax deductible in the USA!

  26. Im getting a very ugly picture here.

    The government, having re-educated and re-engineered senior mandarins into accepting and applying the profit incentive wholesale and unquestioningly through every government departments performance criterion, now sadly looks and finds the general government performing below par (oh dear – not making a profit), initiating machine gun fire sell offs of state assets and services.

    They can then apply our taxes, relatively risk free, to fire up government business enterprises (whoopee…think of all that extra profit they can make by charging us fees as well as taxes!!).

    Wow, it must be so wildly intoxicating to set up businesses with other people’s taxes and get rid of those musty old underperforming general government departments, that giddiness has overwhelmed their remaining senses.

    Roads? Ports? Schools? Who needs them anyway?? (in our futile dreams).

    Think of the lunches pollies get to have with those entrepreneurial big wigs…and the kudos… when pollies are out touting to set up a government business or two with our taxes!! And, if the GBE goes kaput in a short time (?Suncorp Metway) and we are down a port or school or ten …well thats not going to be their fault – it was the market of course.

  27. @Jim Rose
    Coase only came up with one solution to market failure Jim Rose. He never had any monopoly on the cause. 1. transaction costs are not small in many cases 2. The parties are not few in many cases 3. Property rights dont apply in many cases and cant be applied. No one owns the air we breathe (subject to pollution).

    But you really are stretching all credibility when you ascribe the GFC to a failure of government Jim Rose (coloured glasses?). Goldman and others of their ilk gambled us up the wall because they had the reigns let loose after intense lobbying by the financial sector and a weak, compliant…sycophantic suit worshipping thieving dishonest…Bush led Govt. I am not even discussing the Freddie and Fannie blame delusion. This govt organisation shouldnt have been privatised in the 1960s to start with. They did a good job before then (for decades). Any rot can be traced to that, but its nothing on the scale of rot inside goldman sachs, ML, AIG and Wall street.

    Anyway its too late to argue with libertarians about the government or the GFC (plus weve heard it all before).This thread is about QLDs privatisations.

  28. Alice:
    “The government having reducated and re-engineered senior Mandarins…”.
    Am sure Sir Humphrey Appleby would render the concept justice, before receding with a last moment purr: “But yes, I’ve come to see it your way, now that you have explained in that cosmopolitan way…”, before receding back to the void from which he had emerged.

  29. Of course, you could always consider a scenario with a reversal, where Hacker is a public servant and Sir Humphrey a politician. Depends how you feel about public servants or/and politicans.

  30. “I’m getting a very ugly picture here.

    The government, having re-educated and re-engineered senior mandarins into accepting and applying the profit incentive wholesale and unquestioningly through every government departments performance criterion, now sadly looks and finds the general government performing below par (oh dear – not making a profit), initiating machine gun fire sell offs of state assets and services. ”

    aAice, take comfort in the fact that your “picture” is based on complete and total ignorance of how the Queensland public service and Queensland government actually operates.

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