Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 5 June 2014

Privatisation and government debt

Possibly the worst argument for privatising part of the public sector is a supposed ‘need’ to reduce public sector debt. I think the problem with this argument is obvious to most economists, but as it is repeatedly ignored by politicians, it is worth spelling it out.

As I argued in a previous post, decisions to privatise or contract out should be based on considering the microeconomic pros and cons, which will vary from case to case. This analysis should include political economy considerations, like the extent of public sector corruption, or the ability of firms to extract rents from the public sector.

Suppose that such an analysis left the decision to privatise evenly balanced. Should macroeconomic factors, like the need to reduce public sector debt, ever be used to sway the decision in favour of privatisation? In our recent paper, Jonathan Portes and I argue (here or here) that a government should have some view about what the long run desirable level of public debt relative to GDP should be. Two arguments that could be used to argue for lower long term debt are that paying interest on debt requires raising taxes, which are ‘distortionary’ (they tend to reduce GDP and welfare), or that public debt may crowd out private capital and investment (assuming those are thought to be too low).

If we start out with public debt above its long run target, why not use privatisation to help get us towards that target? To see why that is nonsense, consider the two reasons for reducing debt given above. The first was to reduce the need to raise taxes to pay interest on that debt. While privatisation might reduce debt, it will also reduce future revenues or increase future public sector payments. Privatisation will either mean that the public sector loses the revenue that the privatised activity produced, or the private sector will have to be paid to undertake the outsourced activity. So the net impact on taxes will be zero.

What about the point that public debt may crowd out private investment? Once again privatisation does nothing to encourage additional private sector investment. All that happens is that existing capital and any investment that goes with it are relabelled private rather than public. No additional savings are released to encourage new private sector activity.

Consider an extreme example: Greece. The country is desperate to show that debt can be at least be brought to some sustainable level. So what is wrong with selling off some state asset, like part ownership of a water company for example, to help reduce this debt? Now there may or may not be good microeconomic reasons for doing this, but is there a good macro reason? Selling the asset would allow the Greek government to reduce its debt, but it would also have to raise future taxes, or cut future spending, to make up for the revenue lost from no longer owning that company. If microeconomic efficiency is unchanged, this sale would make no difference to the balance between taxes and spending required to make debt sustainable. Debt interest payments would fall, but so would receipts.

To make the same point another way, if we valued public sector assets and calculated the public sector’s net asset position, privatisation would have no effect on that net number. So why should anyone think that the position of the Greek government had been improved by this asset sale?

Obvious though this point may be, it illustrates a problem with most fiscal policy rules. Most rules need to involve what Jonathan and I call realisable operational targets: goals that politicians can aim for (and be judged by) within the lifetime of administrations and parliaments. Privatisation is one of a number of devices that flatter the short term public finances with no impact (or worse) on the long term position. (Considerably worse if the asset is sold far too cheaply, as in the most recent UK case for example.) Because fiscal rules inevitably focus on the next few years, politicians will always be tempted to use these devices to in effect cheat those rules. This is why it is vital to have effective fiscal councils to work alongside any rules. These independent institutions need to be able to shout when they believe only the letter and not the spirit of these rules is being met. The UK’s fiscal council, the OBR, does not have this kind of mandate, and can therefore only note when policies have this kind of effect (see here, paras 1.8-9).  


  1. Above threshold 60% the ruling envelope is the European Fiscal Compact and no space for such a rationale

  2. I generally am in agreement with your view here, but could you answer one question? Is the assumption here that the sale price of the publicly-owned asset does not capture the discounted net present value of (revenues minus outlays)?

    I think your case could be made with or without that assumption. If the price does reflect those NPVS, then the macro argument is neutral. If the price is consistently below the NPVs, then it would be macro-foolish to privatize. If, by some special alignment of the stars, governments could consistently convince private actors to pay a sum greater than the net present value of the (revenue minus cost), then it could be macro-prudent to privatize.

  3. You will rarely find someone who supports privatisation while thinking that the private company will be as well managed or worst than by the government.
    If you think that by privatisation you increase efficiency then it does make sense. Let's say at current efficiency expected revenue is 100, and that we know that private sector can increase this to 110. When the government sells it, it will be able to sell it at 110 locking an extra expected revenue of 10 potentially reducing debt.
    My point is supporting privatisation necessarily means saying private sector is more efficient.

  4. From a non economist's perspective, the sale of assets and revenue streams associated with them feels like the granting of a medieval tax farm.

  5. I like the example of Chicago parking meters. To reduce a budget deficit Chicago sold off the rights to collect parking fees to a private firm. So the benefit was all taken today and future taxes will need to be raised, so it was basically a bond sale. And not even a particularly good one.

    "like the extent of public sector corruption" This cannot be a good argument. For any sale is itself handled by the public sector, so there will of course be corruption in the sale. One needs to compare the amount lost by selling now due to present corruption, vs the present value of the amounts lost by future corruption should the sale not go through. If you just consider this factor, a sale basically wagers that future corruption is likely to increase. See the Chicago parking meter sale or Russia's experience with privitisation.

  6. It the Warnerisation of 'economics':

    "The bottom line is that you can only really make serious inroads into the size of the state during an economic crisis. This may be pro-cyclical, but there is never any appetite for it in the good times; it can only be done in the bad” (see this blog Monday, 23 September 2013
    'The scandal of the austerity deception').

    This is the same man who said of Krugman in the Telegraph that "he’s a false prophet with satanic intent" (see Krugman blog May 25, 2012 'The Antichrist Cometh').

  7. "So what is wrong with selling off some state asset, like part ownership of a water company for example, to help reduce this debt? Now there may or may not be good microeconomic reasons for doing this, but is there a good macro reason? Selling the asset would allow the Greek government to reduce its debt, but it would also have to raise future taxes, or cut future spending, to make up for the revenue lost from no longer owning that company."

    Most of those state-owned companies are loosing money... So no revenue lost, nor taxes to ve levied to make for it...

    1. If these state-owned companies are losing money, then why would the private sector want to snap them up? To make the sale work, the private sector must expect to make a profit on them in terms of expected net present value.

  8. It is a workable concept if done correctly. Unfortunately it is often times done using the failed axiom of cronyism, and is doomed to fail all involved.

  9. Surely the state funding level is an important variable in this analysis which you are not mentioning. An asset sale is an extreme form of secured borrowing. If the credit spread on a government is very wide, selling asset might be reasonable even when no micro efficiency is expected. It all depends on the market conditions at the time of sale.

    The PostOffice experience is really more an example of how important it is to properly market a share issuance. A different auction mechanism could have achieved a much better result for the government (like the case of spectrum auction has shown). The lack of ability to properly manage the sale, it doesn't fill me with confidence they would have been able to properly manage the business and avoid losing all the expected profits to internal capture...


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