I’ve written a couple of posts about Labor’s social housing fund, showing that it’s smaller than it appears, and that hypothecation (linking housing expenditure to the fluctuating proceeds of an investment fund) is bad policy. But is the underlying idea sound? This is a complicated question, and the answer takes us back to the mixed economy of the mid-20th century
To recap, the key idea is to borrow $10 billion at the low rate of interest payable on government debt, invest it in higher-yielding assets and use the profits) to finance social housing.
The fundamental idea is the same as that of a sovereign wealth fund, of which Australia’s Future Fund is an example. Many other national governments have done the same, and even state governments, like that of NSW are getting into the act.
The source of such funds varies – it may be derived from foreign exchange reserves (Singapore) from resource royalties (as with Norway), from the sale of public assets (the privatisation of Telstra was the starting point for the Future Fund) or from new borrowing. In all cases, the creation of a fund of this kind involves a higher level of public debt than would otherwise be the case. This new debt (or the decision not to pay down existing debt) is used to finance public investment in shares or other financial assets.
The crucial question then, is whether the profits earned by a sovereign wealth fund are genuine or whether they are an accounting fiction like this used in a variety of infrastructure funding schemes. The idea that they might be a fiction rests on the observation that investments in shares and other assets are risky, so that the profits earned a sovereign wealth fund in normal years might be offset by big losses in bad years.
This argument would be correct if the observed higher returns to shares (called the ‘equity premium’) could be explained as a market allowance for risk, consistent with reasonable assumptions about the variability of returns and the risk attitudes of investors. But it’s been known for a long time that these factors would imply a small premium, probably less than one percentage point. This is the ‘equity premium puzzle’, first identified by Mehra and Prescott
I’ve been working on the equity premium for many years, and my conclusion is that it is the result of the way financial markets work, or fail to work, rather than a meaningful assessment of the social cost of risk. It follows that governments should treat the rate of interest on public debt (now close to zero) as the true cost of borrowing.
That makes borrowing to invest in the stockmarket an appealing option in the absence of any better investment opportunities for governments. The positive net returns that can be generated in this way are real but not limitless, for two reasons
First, if governments borrow enough and buy enough shares, we can reasonably expected that the rate of interest on bonds will rise and the rate of return to equity capital will fall, reducing the anomalous equity premium. Second, if this strategy is pursued far enough, governments will become major, or even majority, shareholders, effectively becoming owners.
Long experience suggests that governments are quite good at running some kinds of business, such as capital intensive infrastructure business, and not so good at others, such as retail trade. Once we accept the logic of large scale public investment, financed by debt, it makes more sense for governments to have 100 per cent ownership of infrastructure businesses and smaller, or zero, equity in businesses that belong under private sector management.
And that was precisely the way Australia’s economy worked during the brief period of broadly shared prosperity in the mid-20th century. Governments borrowed at low rates of interest and invested in physical and social infrastructure of all kinds. The success of sovereign wealth funds points the way to a return to this model.
6 thoughts on “The case for public ownership of equity and of enterprises”
It seems that there are two issues here. Many infrastructure projects are natural monopolies so there is a case for public ownership because of the well-known difficulties of regulating a monopolist. This is the angle I prefer. The second argument that you stress is based on the existence of a positive “equity premium” that provides an apparent “free lunch” to public borrowers. Maybe but there have been long periods where equity returns have been negative – example after 1987 and 2008. I am a bit nervous of this argument generally since it opens the door to public investments that have very low or even negative rates of social return. The spendathon positions of the current Federal Government and of the State of Victoria can be rationalized in terms of such low hurdles. As you point out the “free lunches” will tend to zero as public borrowing increases (interest rates rise) and yields on stocks are driven down. A key issue remains credit worthiness concerns and budget constraints as well as intertemporal equity in imposing repayment requirements on Joe Citizen. .
In the realm of feasibility (for now) I tend to the view that governments should invest in and own (re-own) natural monopolies and strategic industries. Whenever bailouts occur (as in the airline industry for example under the COVID-19 crisis) the governments should receive equity in the business. This could pave the way for a future government takeovers.
Do governments need to borrow to do this? This is where I would look to a new system, eventually. Governments could borrow from themselves (effectively). Do they necessarily have to borrow from private sources? That is where I simply would say “tax the rich and the corporations harder” or even just tax them… since they often pay no significant tax at all. The “brief period of broadly shared prosperity in the mid-20th century” which actually characterized by extremely high marginal tax rates on the wealthy.
What belongs “under private sector management” is a matter of judgement, but I would agree that distributed systems of small players (retailers) perhaps belong under private ownership. But natural duopolies in a small country, what do we do with them? I would say strongly regulate their behaviors and responsibilities. For example, the disgraceful spectacle of wage theft by these and similar players is becoming tediously common.
And we need to get rid of the massive subsidies to big private businesses and corporations: subsidies which make welfare to the poor look puny by comparison. There are inadequate incentives for honest work and professions. There are far too many incentives for speculators and investors. That’s why my son and many of his professionally credentialed under-30s friends and acquaintances prefer to be self-employed investors rather than use their qualifications in their chosen field. They don’t always necessarily gross more money but they can jig it so their costs and taxes are far lower. It’s a losing proposition for them to go off and do paid (and productive) work for employers or even productive work as self-employed.
Private financial capital is not, strictly speaking, productive. It is merely allocative and then parasitic. It makes dreadful allocation decisions, like more sports stadiums and less hospitals for example, shovels off the negative externalities onto “someones and somethings” else and then parasitizes on the workers by stealing a portion of their real production. It’s as simple as that. Of course, I won’t win this argument. I simply await the inevitable collapse of capitalism. It’s happening now. It’s collapsing now. It can’t make proper allocations to protect people or environment. This is why it is a system decaying and collapsing right now before our very eyes.
To further complicate matters, with our superannuation system we are compelled to invest in private companies which invest in things which probably should be government owned as well as things that shouldn’t.
Given that housing is a necessity, my view is that direct public investment and provision is as important as spending on health and education, if we want to maintain our standard standard of living. Housing, or property, is one of the more reliable asset classes in terms of yield. Spending $40 billion directly on new housing should be a better bet than putting the money in a sovereign wealth fund. Even allowing for the flattening out of house prices due to a fairly rapid increasing in supply (surely a feature, not a bug!) there would be growth in the value of the asset.
As far as I can make out, Labor wants to spend money on an investment to raise money for another investment that is probably a better store of long term wealth and is also a public good. Add to this that a $40 billion investment in public housing provides all the less tangible benefits arising from affordable, adequate and secure housing like better health outcomes, better employment prospects, better education outcomes and, as already mentioned, a stabilising effect on the whole housing market. When we take care of our “human capital” in this way it benefits to the whole economy. And isn’t improving welfare the whole point of the economy?
The return on borrowing this kind of money for one year should be realised in monetary terms in the medium term and in real tangible human benefits almost immediately. The best reason for a sovereign wealth fund would be for large unexpected events like the pandemic. I can’t see the logic of investing in an asset to raise revenue for another asset under any circumstances. A national public housing trust, as proposed by the Greens, would maintain a different housing fund that, after ten or so years of building up a large asset base of land and housing, would pay for land, new builds, repairs, maintenance and subsidised housing from those who need it. On-going revenue for the fund would be raised partly by renting out housing not needed for subsidised tenants at the market rate, the sale of land and housing no longer fit for purpose (wrong type, wrong place), and taxing the excess wealth of those who earn and hold far more from wealth housing and other (and other assets) than they will ever need.
While the Greens policy proposes that ten per cent of the nation’s housing stock be government owned and ongoing support from tax revenue, it was once the case that South Australia had a near revenue neutral public housing system. In the 1930’s, the state government owned thirty per cent of all housing in South Australia. To be sure, the revenue raised by market rents paid by ninety percent of the tenancy was supported employment conditions that no longer exist. Steady employment and income for the bottom third of the workforce lead to the demise of this system. Low to low middle wage paying but stable jobs form mass employment by industry where either been sent over seas, lost to technology, or replaced by less secure contract labour. The trend towards small government and privatisation also contributed to a reduction in the number of tenants able to pay market rent and by the eighties, the Federal Labor government was no longer will to provide the ongoing funding needed. But it is possible that other policies providing higher and more secure income, from ending insecure work arrangements to work and income grantees, could support a public housing system that could mostly fund itself.
For a government to maintain such a large asset base in an industry seen as controlled the private sector, is heterodox to today’s market driven economic philosophy, which perhaps the reason why Labor has chosen such an indirect method of purchasing an insignificant amount of housing. Economic orthodoxy still maintains that if only government got the settings right or got completely out of the way, everyone would be able to afford housing. In reality, a minimum standard of housing is always going to be unaffordable to around a third of all households.
My faith in Public Housing was completely demolished when years ago it was revealed that the NSW government owned hundreds of houses that they had literally forgotten about. Of course most were in a shambles. No private landlord could afford to do that – unless the tax system made it advantageous, which it often does of course.
My faith in the old Housing Commission model is very strong. The Qld. Housing Comission was the backbone of the suburbs I grew up in and of many suburbs around. In the late 1940s and 1950s (at least) newly married couples got Housing Commission houses at very cheap prices and mortgages with long term fixed rates. These working class families thrived and many soon joined the middle class. Their children were well educated in state primary schools, state secondary schools and then as apprentices or in Industrial Techs and Universities with scholarships. It was an enormous success. Dysfunctional families were rare, houses were well maintained, upgraded and extended and community involvement was strong. Socialism with homeowner characteristics! It worked fantastically well. We should never have departed from that model. Maybe we should have added more parts to it.
I bet if you examined the “forgotten houses” history in NSW you would find rampant corruption stemming from private money corrupting state politicians. The pollies were no doubt payed to “forget” and then sell off the stock after it was deliberately ruined. The NSW was corrupt as hell in the 1970s in a conspiracy involving property developers, politicians and their underworld allies. This is well documented.