Brad de Long correctly summarises the argument of my papers with Simon Grant. If you accept that the equity premium (the large and unexplained difference between the rate of return expected by holders of private equity and the rate of interest on low-risk bonds) is explained in large measure by the fact that capital markets do not do a good job in allocating and spreading risk, the the natural solution to all this is the S-World: Socialism: public ownership of the means of production This is because risk can be more effectively through the tax system, and through governments’ capacity to run deficits during economic downturns than through private capital markets. A very robust implication of the observed equity premium is that a dollar of investment returns received during a recession is worth two dollars during a boom – this provides governments with a huge arbitrage opportunity.
But we economists love our ceteris paribus (all other things equal) clauses. At least one commentator noted my qualification that this argument applies “unless there are large differences in operating efficiency between private and public enterprises”. Since, in a wide range of businesses, public enterprises have not performed very well (my own home state of Queensland experimented with state-owned butcher shops in the 1920s) this seems to leave us in the realm of “on the one hand this, on the other hand that”. Fortunately there is a simple empirical test which enables us to balance these considerations, at least in relation to proposed privatisations. If the advantages of privatisation outweigh the difference in the cost of capital, and assets are sold in a competitive market, then the government should come out ahead by selling assets and using the proceeds to repay debt, thereby reducing obligations.
In fact, this is rarely the case. In most cases, the interest savings from selling public assets are less than any reasonable estimate of the earnings foregone. And if you don’t like using estimated earnings you can look at cases where assets were valued for privatisation, but then not sold. Again governments came out ahead from not selling in most cases. It was this empirical observation, rather than theoretical analysis that led me to the conclusion that the equity premium provides a case for public ownership.
On the other hand, the kinds of enterprises where government ownership is common are, in general, those where you would expect the balance of considerations to lean towards public ownership. They are capital intensive, so a lower cost of capital is important and excess labor costs (for example, due to overstaffing) are not. In addition, they are often subject to fairly tight regulation for natural monopoly or essential-service reasons, which reduces the reward to entrepreneurial innovation.
The record of government ownership in other large-scale businesses is mixed (I mean this literally, not as a euphemism for ‘bad’). Brad notes that the US government made a pot of money by rescuing Chrysler in the 1980s, and the British government did the same for Rolls-Royce. But plenty of rescues have turned out badly (from memory, British Leyland didn’t do to well). And in these cases, the cost of acquisition was not great – the case for governments buying profitable enterprises outside the infrastructure sector (broadly defined) is not so strong.
The argument is clear-cut in the case of entrepreneurial businesses that don’t rely on outside equity. For such businesses, the incentive effects of having the residual flow to an owner-manager outweigh any considerations of risk sharing. Hence, as far as the considerations outlined above are concerned, there is no case for public ownership.
So, it turns out that the equity premium provides a case for the mixed economy, rather than for comprehensive socialisation. Given the generally successful performance of mixed economies (most notably between 1945 and 1970), there’s nothing paradoxical or surprising about this.
John Quiggin 
The trouble with the government owning companies, instead of investors, is that there is no incentive to improve,(no competition), and no incentive to hold down costs, thus the employees do less and less, for more and more, while the rest of the population suffers.
Have you heard the term “Feather-bedding”, where an employee had to be hired to do a job which no longer existed, because the job was in the union contract, like the stoker on a Diesel Locomotive.
“less and less, for more and more,” – what, like Telstra and the old PMG and TAA and the railways and the trams and oh, hospitals and government schools.. and CSIRO.. and the Commonwealth Aircraft Factory etc… and the Army and the police. Governments do exert control over their institutions for the common good, even in the absence of competition.
Soon after I joined the public service in 1969 the man in charge of school supplies died about a year before retirement. The public service investigated, decided he’d been a bit overworkd, and replaced him with three people.
That salutary lesson notwithstanding, I spent over a decade later on doing more with less and personally working 60+ hours a week. When I left I had over 240 staff being downsized to about a dozen and was working 80 hours a week.
I assume big al and old ari have heard of “productivity dividends” much beloved by Peter Walsh when he was finance minister. It is a euphemism for the “salami slice” method of downsizing, which research shows is the most destructive of morale. You keep taking thin slices until the target group or unit falls over. Then you reorganise, reduce their function, combine the function with another group and pretend it’s still available, or just kill it.
All the while your reputation for effective service is going down the gurgler and you have to listen to an ignorant mob baying from the sidelines.
Big al’s reasoning seems to run as follows:
(A) There are government enterprises that are inefficient.
(B) There are investor-owned enterprises that are efficient.
THEREFORE:
(C) IF an enterprise is government-owned THEN it is inefficient.
(D) IF an enterprise is investor-owned THEN it is efficient.
So what can we deduce from:
(E) There are government-owned enterprises that are efficient.
(F) There are investor-owned enterprises that are inefficient.
Whether or not there are effective incentives in a particular case is up to the owners and management. Entrenched opposition to change may be found in either type of enterprise.
In addition, they are often subject to fairly tight regulation for natural monopoly or essential-service reasons, which reduces the reward to entrepreneurial innovation.
A nice way of conceding that regulation usually reduces innovation. Surely the big case for privatisation has always revolved around the dynamic gains from unleashing the gales of creative destruction – the sort of gales that government usually try to shield people from. And the point about innovation is that its rate is highly unpredictable, so neither market or government are good at assessing the gains or losses from privatisation ex ante.
But where you can reasonably expect rapid innovation in an industry in the near future (telecoms, anyone?) the case for privatisation must be stronger.
An inefficient private enterprise can and often will fail. An ineffecient public one can go on and on and on and on and…
That’s as good a reason as any for private ownership in my opinion.
“An inefficient private enterprise can and often will fail. An ineffecient public one can go on and on and on and on and…”
Wrong. An inefficient private enterprise can only fail once, if that. An inefficient public enterprise can and often will fail. On and on and on and on and…
But the crucial problem with both kinds of enterprise is hidden. Most private ones fail from inefficiency, and the continual generation of fresh sacrifices is an underlying problem (related to “winner’s curse”, I’d guess); and something similar applies to public enterprises. The fact of singleness of private enterprise failure doesn’t tell you the underlying process, the likely efficiency. You would get the same pattern with a roulette strategy that quit as soon as you lost, with the public enterprise one corresponding to doubling your bets on each loss. What private enterprise success really needs for public benefit is, something that loads its odds. That does usually exist, but you cannot infer it from the simple fact of private enterprise not doubling up in response to failure.
Brad de Long points
Brad de Long points to a piece on the equity premium by Marty Weitzman and says, Marty Weitzman is smarter than I am …This is brilliant. I should have seen this. I should have seen this sixteen years ago. I…
Marty Weitzman on the equity premium
Brad de Long points to a piece on the equity premium by Marty Weitzman and says, Marty Weitzman is smarter than I am …This is brilliant. I should have seen this. I should have seen this sixteen years ago. I…