Bad for the client, bad for the bottom line

My report on the NSW governments proposal to sell (they prefer to say “lease”, but it’s a sale) assets and then undertake a large-scale infrastructure program notionally funded by the proceeds cited the former Secretaries of the NSW and Victorian Treasuries the point that selling income-generating assets does not create a ‘bucket of money’ that can be used to fund non-income-generating infrastructure. I made the claim that regardless of their attitude to privatisation, economists (at least when writing honestly on the subject) would agree with this.

My point was proved, twice over, a couple of days ago. The main point was proved when global bank UBS released a research note headed headlined “Bad for the budget, good for the state“. Of course, UBS supports privatisation, but the adverse effect on the budget was obvious.

However, it turns out that a different part of UBS is advising the Baird government on privatisation. A quick call from the Premier’s office produced a revised version of the note with the offending phrase removed. This proved, via the contrapositive, the parenthetical aside in my claim.

The episode raises the question: what reliance can be placed on published reports from firms like UBS cited in support of government policy? Of course, the same question is equally applicable to reports like my own, which more commonly oppose government policy? A few thoughts over the fold.

First, you can’t learn much from a summary of the conclusions of such a report . There are plenty of banks and consulting firms, with impressive sounding names, who will say whatever the client wants them to say. But even leaving that aside, most experts have a track record which makes their views fairly predictable. For example, a government with a proposal like Baird’s is unlikely to hire me as an expert, while its opposition might do so (for the record, this report wasn’t funded in any way, but I have done consultancies on this issue in the past).

So, there are a few options in dealing with such reports. One is to read them carefully and form your own views. A second is to make judgements over time as to which experts are reliable and which are not. A third is to ignore such reports altogether. In the case of UBS, the last of these is, I suggest the way to go.

A final aside. Here’s the New York Times on UBS “UBS is in a league of its own given its track record for scandals …The bank’s recidivism seems rivaled only by its ability to escape prosecution”

But none of this seems to have any effect on the bank’s standing. When the Abbott government needed a new Treasury Secretary, they went to (you guessed it) UBS.

21 thoughts on “Bad for the client, bad for the bottom line

  1. When the Abbott government needed a new Treasury Secretary, they went to (you guessed it) UBS

    This is a cheap shot. They went to a former Deputy Secretary of the Treasury (and a former adviser to John Howard when he was Treasurer) who was working for UBS. If he’d been working for, say, Credit Suisse or BNP Paribas, they still would have gone to him.

    the adverse effect on the budget was obvious.

    I thought your argument is that privatisation is budget-neutral, because the state gets paid for the asset an amount equal to the present value of the future profits.

  2. Privatisation is budget neutral. So, using privatisation as the notional source of finance for new expenditure is budget-negative.

    As regards Credit Suisse and BNP Paribas that’s a distinction without a difference. UBS attracted the particular ire of the NY Times, but the global banks are all the same: repeat offenders, immune from serious sanctions.

  3. @John Quiggin

    But UBS said that privatisation would be bad for the budget because of the loss of dividend payments, which is false.

    And if the one-off sales proceeds are spent on a one-off infrastructure project, instead of year by year dividends being spent on year by year salaries for teachers and nurses, that is also budget neutral.

  4. On 1, Privatisation without proceeds spent (on either capital or current outlays) affects the budget by the loss of dividends as UBS said

    On 2, it’s quite true that infrastructure could be paid for by cutting expenditure on salaries for teachers and nurses, but I don’t think this has been proposed. If you “spend” the proceeds of asset sales on infrastructure, but keep the teachers and nurses previously paid for with dividends from the assets then the budget is wrose off.

  5. On 2, it’s quite true that infrastructure could be paid for by cutting expenditure on salaries for teachers and nurses, but I don’t think this has been proposed.

    Imagine if the privatization proposals explicitly stated that they involved cutting the salaries of teachers and nurses. They’d be laughed out of town.

  6. @John Quiggin

    On 1, how is the budget worse off by getting the sales proceeds now, not spending the proceeds, and not getting the dividends later? The government could, in this scenario, invest the proceeds in a listed electricity distribution business, and get the same dividends that it is getting now.

  7. Are you sure about budget neutrality of asset sales?

    I live in Virginia (US) and in 2009 I watched as a newly elected Republican Governor (who is now under sentence for corruption) proposed the sale of the state Alcoholic Beverage Control (ABC) stores to fund highway construction in order to avoid an increase in gas taxes. (As a relic of Prohibition and its repeal the sale of liquor in Virginia is a state monopoly.)

    Even though the Virginia state legislature had and has a significant Republican majority in both houses, the Governor’s plan to sell the ABC stores was quickly picked apart and an increase in state gas taxes and car registration fees was ultimately enacted a couple of years later. As the proposal was evaluated, even the Governor’s supporters could see that the projected proceeds from the sale of the ABC stores were dwarfed by the future profits that would have been lost to the state within just the first decade following the sale.

    The core of the problem was the relatively high capitalization/discount rate that any purchaser of the ABC stores was assumed to require to generate an acceptable return on its investment to fund the purchase. A secondary factor is also that any purchaser would pay a higher interest on its borrowings to fund the purchase than the state pays on its bonds. (Virginia has a top credit rating and in the US interest received on state and local government bonds is exempt from US federal income taxes, so bond purchases accept a correspondingly lower interest rate.)

    Perhaps the proposed asset sales you are talking about in NSW are of more passive and stable assets than a chain of retail liquor stores. If so then the cap rate issue may not arise or may be diminished.

    I enjoy your blog though many of your Oz political references are lost on me.

  8. JQ, it seems to me your analysis is rather straight forward financial economics.

    1) The present value of future profits (= dividends) depends on the cost of capital.
    2) The financing costs of infrastructure projects depends on the borrowing costs of the government.
    3) Infrastructure projects such as roads contain non-cash items under ‘benefits’ (eg travel time saved).
    4. The ‘sale’ of (some) poles and wires (the ‘asset’) to private investors is budget neutral for the entire life of the asset iff the cost of capital of the private investors is equal to the rate of return from the proceeds of the ‘sale’ for the entire life of the ‘project’ and there are no transaction cost (eg UBS is being paid $0)

    Your conclusion rests on the observations (which contradict the conditions in 4) that
    a) The government can finance infrastructure projects at lower costs (borrowing) than the cost of capital used by the private investor to discount future profits of ‘the asset’.
    b) The monetary rate of return on infrastructure projects is less than the cost of capital used by the private investor to discount future profits and transaction costs are strictly positive.

    Question 1: Have I missed anything?

    Question 2: What type of lease is it, an operating or a financial lease?

  9. who cares what the (supposed) budget impact is. The basic economic ssue is are they better run by private or public owners. And the answer to that is not a material difference if government is disciplined enough not to saddle them with public sector employment conditions and is also prepared to provide adequate equity funding.

  10. Btw John Fraser was in John Howard’s office for about four weeks only. He’s a good guy so far as Tory economists go. Very pragmatic.

  11. @wkj

    Hi wkj,

    Slightly off-topic but arising from your comment: WTF??

    Re: the “Alcoholic Beverage Control”, I was just watching ‘Democracy Now’ and saw a story about the vicious bashing of a University of Virginia student by “Alcohol Police”. I thought I must have misheard or misunderstood.

    But now I know you really do have police whose job is to control alcohol. Wow, and I thought Australia was fascist! (Well, it is really).

  12. But now I know you really do have police whose job is to control alcohol. Wow, and I thought Australia was fascist!

    A logical consequence of a state monopoly. There are 18 US States with such a monopoly. So much for free enterprise.

  13. @Historyiintime
    Absolutely correct. It doesn’t matter who owns shares in the company as long as it is run on professional lines. If it is profitable, the shareholder will get the returns and why should a govt. not get good returns on its shareholding? Why should good returns go only to the private sector?

  14. @TerjeP
    I agree that armed ABC cops are a terrible idea, but the concept of ABC stores make sense to me. [Over]consumption of alcohol is a source of significant health and social problems. Outright prohibition obviously did not work, but passively discouraging the purchase and consumption of alcohol by selling it only in grungy state ABC stores that do not advertise seems to me to provide at least a small social benefit in addition to the significant profits that fund other state activities.

  15. @wkj

    Any local insight into the UoV incidents? I mean the bashing of students by the Alcohol Police. In the cases I’m thinking of, the students apparently didn’t even have any alcohol and were not intoxicated.

  16. I assume so far the state budget has been the focus of attention.

    The federal budget may be negatively affected in addition due to tax minimisation (high leverage is the simplest example, profit shifting is another one).

    Michael West (whom I consider an expert journalist in the area of corporate taxation and multinationals) has an interesting article in the smh of 23/03/15:

    http://www.smh.com.au/business/comment-and-analysis/tax-strategies-may-distort-power-sales-20150322-1m4w52.html

  17. @Ernestine Gross

    It would be easy to stop all that nonsense with a few well written laws. The reason our government(s) don’t do it is because they are already bought lock, stock and barrel by the rich. Our government(s) have not the slightest interest in stopping any of this.

  18. Speaking of “consulting firms, with impressive sounding names, who will say whatever the client wants them to say”, last week Michael West also took a look at the Centre for International economics, who managed to write simultaneous reports claiming that expanded coal exports both were and were not plausible in NSW.

  19. Without disputing the general validity of JQ’s case against privatisation, do the bonus dollars on offer from the Commonwealth for “asset recycling” change the cost-benefit analysis for NSW in this case?

  20. I don’t understand your question Nevil Kingston-Br.. .

    The Commonwealth uses taxation revenue, including tax paid by people and companies in NSW to offer what you call ‘bonus dollars’ (which I would call a ‘side payment’ – the game theory term for ………. – Ikonoclast or anybody else may wish to decide which word is most appropriate).

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