It appears that the principal rationale for any potential privatisation is to raise revenue for the exchequer in order to deal with the country’s acute fiscal crisis. Although privatisation can raise useful revenues for the exchequer in the short- to medium-term it cannot, however, be justified on this basis alone. In a recent article published in Administration, we show that the revenues generated from privatisations, both in Ireland and abroad, are rarely maximised.
In Ireland, ten SOEs have been privatised to date and the exchequer has accrued over €8.3 billion. However, we show that the exchequer has foregone over €2.1 billion as a result of a combination of costs related to the underpricing of shares, debt write-offs, fees to advisors, underwriters etc., and the establishment of employee share ownership plans (ESOPs), which account for approximately half of the foregone revenues.
This is shown in the table below, where direct costs refer to advisory fees etc, and indirect costs refer to the cost of debt write offs and the underpricing of shares. Admittedly, the aggregate costs are dominated by the biggest divestiture to date (Eircom), however, there were questionable decisions in relation to a number of other sales. For example, when the refinery and terminal operations of the Irish National Petroleum Corporation (INPC) were sold in 2001, the sale involved a large debt write-off and other costs which amounted to €76 million. The Whitegate and Bantry assets were sold for €116 million, but six years later the new owners put the Whitegate refinery up for sale for a price of approximately €350 million.
The cost of ESOPs in the table above is calculated as the difference in the revenues received by the exchequer for the 14.9 per cent transferred to employees and the value of that stake based on the sale price of the firm. For example, in the case of the TSB, employees received a 5 per cent stake in return for accepting a transformation agreement, and purchased a further 9.9 per cent stake for €25.15 million. Based on the €430 million price paid by IL&P for the TSB, the 14.9 per cent stake was worth just over €64 million.
In the case of Eircom, employees also received a 5 per cent stake in exchange for the acceptance of a transformation agreement, and purchased a 9.9 per cent stake for €241 million. Based on the proceeds from the flotation of the government’s 50.1 per cent stake in July 1999 (which raised €4.2 billion), the 14.9 per cent stake transferred to the ESOP was worth approximately €1.25 billion. The difference between the amount received by the exchequer for the 14.9 per cent stake and its actual value amounts to over €1.01 billion.
Some degree of privatisation appears inevitable but sales will undoubtedly involve the exchequer incurring big costs in order to bring in some much-needed cash. Can this be justified? Perhaps, if there are compensating gains such as improved enterprise performance and public service delivery. However, the Irish track record is not hugely impressive in this regard.
The question of privatising public enterprises requires careful consideration of all the costs and benefits. Ideally the decision to sell these companies should be made in the context of an overall strategy for the sector, but this doesn’t exist. Instead, the issue of privatisation is under consideration as a revenue raising measure. Past experience shows us that there are reasons to be fearful about the quality of decision making in relation to the disposal of such assets. The firesale approach that appears to be imminent is a worrying development.
20 comments:
Why is 'some degree of privatisation inevitable'?
If it is counter-productive, as is shown it is, it should be argued against.
If carried through, it should be reversed at no increase in price.
In that way, the privatisation would prove temporary, or very unlikely to occur.
Donal and Eoin, you make a very compelling case about the real value of privatisations. I remember being quite alarmed at the cost of the sale in fees to advisors, underwriters, valuers, lawyers, accountancy firms (always the Big 5 or 6 – who dominate their professional bodies and thus the dinner/breakfast circuits of opinion) etc. when I was writing Selling Out (published by TASC & New Island) and yours is a timely reminder of this cost.
When it is added to the low pricing of assets today internationally, it is a very bad time to sell. Then there is the loss of entrepreneurship, revenue, jobs etc. As NTMA has no problems borrowing and total National Debt is €84bn as of today and it had no problems raising all it sought to raise this year (€15bn to date) the only real issue is the increasing amount of interest. And if it is less than the losses on fire sales of state assets (and one must factor in the loss of revenue in dividends) then we borrow, not sell the family silver.
I think the review is timely and a good idea. But we can take the High Road of developing these state owned commercial companies , on there own or in partnership with private firms or we can take the Low Road, of sell-off for immediate cash. The Low Road is advocated powerful interests, some within the soon to be privatised companies, many commentators in newspapers, “professional” advisors and their “independent bodies,” stockbrokers, their economists etc.
Congress has issued a challenge on the fire sale at http://www.ictu.ie/download/pdf/congress_response_to_government_review_of_state_companies.pdf
Though I understand the pessimism, I would agree with Michael. The case you have both made undermines arguments for widescale disposal of state assets. Indeed, we could go further – why shouldn’t public enterprise, in different forms and models, become a strategy for expanding the indigenous enterprise base. As far back as 1960 Dr. Fitzgerald identified the rationale for public enterprises as a ‘desire to initiate an economic activity seemed necessary in the national interest- but one which for one reason or another private enterprise has failed to inaugurate or to operate on a sufficiently extensive scale'. That observation still stands – particularly if we expand the concept of national interest into a wider social and economic interest. Such an expansion of public enterprise need not exclude private capital – indeed, it could facilitate it (all the more important since as Davy Stockbrokers pointed out, private capital tends to be short-termist and non-productive). If we had a local government system fit for purpose, new municipal enterprises could be developed. Public enterprise can be molded and shaped to fit any number of scenarios. That Fine Gael uses an expansion of public enterprise to deliver an infrastructural investment programme (regardless of Michael Noonan’s on-again, off-again agnosticism about job creation numbers) is an example of this. But public enterprise could be expanded into traded and commercial areas, local and regional economies, in partnership with private capital, workers and other stakeholders. If we are looking for a new business model firmly rooted in the logic of the market, public enterprise could be of great assistance. Therefore, the issue is not only ‘we shouldn’t sell them off’ but also, ‘we should be expanding them’. In this respect, ICTU's statement referred to by Paul is most welcome.
In some respects a timely post, but, at this stage we seem to know little about the reported Colm McCarthy-led 'stock-take' of state assets. My understanding is that it hasn't really kicked off yet, no formal terms of reference have been issued, the full membership of the review body hasn't been announced and it could be the end of the year - or even into early next year - before anything emerges. And at that stage there is no guarantee that the Government will make formal policy decisions on foot of its report.
There is a possibility that the review might be a first step in establishing a proper set of government accounts - income statements, funds flow and balance sheets - rather than the 'tennis club' set prepared at the moment. Developing pro forma sets of these accounts on a projection basis under different scenarios is the best way of assessing state assets and other contingent liabilities from a genuinely strategic perspective.
And this strategic perspective must be applied also at the sectoral level where the state has majority ownership stakes - particularly in the energy, water and transport sectors.
In the energy sector, for example, the principal deadweight losses incurred by consumers (almost €5 billion in the last decade) arise from gloriously inefficient financing of huge network investments and the enthusiastic application of a deeply flawed EU-driven model promoting competition and choice in a national (and, subsequently, island) market that is too small to generate sustainable benefits for consumers.
Most household consumers (and probably many small businesses - shops, offices, restaurants, bars, etc.) - just want secure, reliable affordable utility services. Obviously they will be tempted to switch if they are offered a lower price by a competing supplier. But this supplier will be using the same pipes or wires and sourcing supplies from the same source (market, resource or technology) as the existing supplier and will only be able to sustain a competitive advantage if it has an ability to exercise and/or abuse market power somewhere along the supply chain. Somebody, somewhere is experiencing a deadweight loss and society is worse off.
(continues)
(continued)Wrt energy Ireland is triply damned. Not only is the financing of investment highly inefficient, but it is linked (and will be linked even more closely when the East-West interconnector is completed) to Britain whose seriously flawed energy market model is being applied throughout the EU and, by agreeing to sequential EU Directives applying a variant of this model, is locked in legally to apply it. The first is related to ownership and financing, but this is distinctly different from the other two which relate to strategic restructuring of the industries.
It is too late to secure a derogation from this malign EU legislation, but there may be scope to seek to enforce the principle of subsidiarity which allows member-states to draw a line between EU and member-states competencies. In addition, despite its flawed nature, it would make sense to accelerate further integration with the electricity and gas markets in Britain. Further integration would compel DG COMP to treat the integrated market on both islands as the 'relevant' market. In this context, although dominant on the island of Ireland, the ESB and BGE would be closer in size to the participants in the British markets and this would remove competition concerns in the integrated market.
Probably the only valid aspect of the EU’s energy market liberalisation programme is the requirement to separate the network and supply businesses fully in ownership terms. Unfortunately, throughout the EU, this is being pursued at both the transmission (wholesale or bulk supply) and the distribution (retail supply) level. There is considerable evidence (much coming from the US) that most of the efficiencies of market liberalisation arise at the wholesale level. Indeed there is increasing evidence that retail competition imposes costs on consumers that far out-weigh any benefits that might be generated. In this context, it would sense to place the transmission networks of both the ESB and BGE in separate ownership - and possibly merge them in single ownership as in Britain. However, the distribution and retail supply businesses should remain in single ownership with a regulated obligation on these businesses to provide distribution network access to suppliers competing to supply consumers who choose to opt-in to the market. (The current EU legislation treats all consumers as having opted-in, but without securing their consent or, in most cases, without providing appropriate information. It would be far better if consumers were given the choice of opting-in or staying with their existing supplier.)
These integrated supply businesses would be able to capture economies of scale and scope, operate efficiently in the wholesale market and generate benefits for consumers.
(continues)
This brings us to the ownership and financing of these restructured businesses. Since regulation has been applied to these businesses, successive governments have not contributed one cent of direct financing to meet the huge investments in the networks. Instead they have pursued policies and compelled the energy regulator to extract the lion’s share of financing up-front from consumers, leads to excessively high final prices. The current fiscal situation means that they cannot provide any direct finance. The energy regulator is struggling to continue gouging consumers to meet the ESB’s demands for cash-flow – particularly now that it needs to fund its acquisition of the NI networks.
Selling these businesses (restructured as outlined above) to appropriately qualified long-term investors is the only way to remove this burden of excessively high prices from consumers and to generate much needed funds.
However, I suspect such a strategic approach is not on the agenda of a government which is focused on the tactics of electoral survival. It is probably important to recognise that merely indicating the possibility of asset sales sends a signal to the international capital markets which, even if it subsequently does nothing, will buy the government some time. Everything is being assessed purely in the context of buying more time in power. And even if it were to pursue a half-baked privatisation without any restructuring, I suspect any employee resistance would evaporate if the ESOTs were increased to 15%.
@Michael B
Some degree of privatisation is inevitable since fiscal pressure is often one of the main factors underpinning the decision to privatise in most countries.
A recent example of this is Portugal, which has announced a €6 billion programme of privatisation as part of its most recent Stability Programme. This fire-sale of state assets has been justified by the Portuguese government on the grounds that the divestitures will contribute ‘to the promotion of greater efficiency and productivity in the sectors concerned, and the essential reduction of general government debt’. The former objective is often trotted out by politicans as justfication for the privatisation of SOEs, even when the primary (or sole) objective is to raise revenue for the exchequer.
If any sales are eventually announced in Ireland, I am sure we will see a similar line being spun by politicians here.
@Paul S
Thanks for the link to the ICTU response, I hadn't seen it. The holding company approach that yourself and ICTU have been advocating for some time makes sense and it is a pity that there has been no movement from our current dual model of SOE governance towards a more centralised model which has been recommended by the OECD.
I agree that the review of our stock of public enterprise is a good idea. However, I fear that any report that eventually emerges will take the 'low road' rather than taking the 'high road' and pushing for the long-term development of some of these companies as part of a comprehensive strategy for the overall SOE sector.
Any future decision in relation to privatisation needs to be taken in the context of a coherent and clearly articulated strategy for Ireland’s SOE sector. This strategy must consider all aspects in relation to the SOE sector and provide a clear statement of the objectives of each enterprise that highlights both their economic and social functions. Any assessment of the performance of SOEs must then be based on consideration of these objectives.
The formulation of such a strategy needs to address issues in relation to the governance of the sector, as well as issues in relation to the internationalisation of SOE activities, and the regulation of individual SOEs and their relevant sectors.
Just as low-tax, low-spend economic model courts slump and exacerbates it via the reduction of automatic transfer payments, so a privatised, government-lite economy does the same.
Privatising SOEs will exchange a valuable flow of revenue to the public sector (their surpluses or profits) for an undervalued stock via privatisation receipts.
But there will also be structural damage done.
The decline in investment (GFCF) in this economy has been continuous for 12 quarters and fell again in Q1 this year. It is a decline of €32bn, which exceeds both the fall in GDP (€28bn) and GNP (€31bn). This is an investment recession.
It is a private investment strike, abetted by cuts in the government's own investment expenditure.
What is required, both now and in other recessions, is to increase investment and so boost aggregate demand. The SOEs are capable of this through their surpluses, and the investment is required.
Instead, it is proposed that they be sent to swell the ranks of the private sector, where the investment strike continues. The private sector either cannot or will not invest, uncertain that it will make a positive return on investment and hoarding cash.
There is no reason to believe the newly-private former SOEs will not behave in the same way, both in this slump and in future recessions. If you take a company such as Greencore, its 2009 profits were up despite lower sales, because it slashed investment, by around €10bn http://www.greencore.ie/content.asp?topic=2009&page=423 .
SOEs can be part of the solution to the current slump. Privatisation removes that pssibility both now and in the future
It is disappointing, but, perhaps, not surprising that there has been so little engagement on these issues. A comfortable retreat into "Ah this privatisation thing, shure 'tis terrible bad" won't get us very far. It is unfortunate, but very real, that successive governments have added layer upon layer of complexity to the provision of what are very basic infrastructure and utility (I&U) services. Stripping away these layers to reveal the underlying policy drivers and seeking to craft solutions that are in the interests of all citizens and the economy are time-consuming, tedious tasks, but the graft cannot be avoided.
Even if the Government decides to consider some privatisation options it is extremely unlikely to have the time or to be able to secure sufficient popular support to implement any irrevocable changes. Now that Eamon Gilmore appears to have ruled out cohabitation with FF, it looks almost certain that we will see some sort of FG-Lab coalition at the next time of asking.
Wrt the semi-states there appears to be a broad measure of agreement between the proposals advanced by FG and the ICTU. It is not clear to what extent the latter's proposals inform Labour's thinking, but it is probably safe to assume that there is considerable common ground.
However, the devil is in the detail and, imo, none of these sets of proposals tackles the fundamental restructuring of these sectors that is required. Apart from external purchasers of exports, all citizens and residents pay the final prices for all goods and service produced in the economy. The primary goal of economic policy is to ensure these goods and services are produced and delivered as efficiently as possible to promote prosperity and well-being. In the broader commercial context efficiency in the I&U sectors means reducing the costs of doing business and the provision of services that facilitate the start-up and doing of business. Despite having lost much of its fiscal, macroeconomic and monetary sovereignty, Ireland still retains considerable sovereignty over policy in the I&U sectors. Let us focus on those things we can change.
(continues)
(Continued) Restructuring and ownership are frequently conflated, but these are two separate dimensions that may, and should be, separated when examining the I&U sectors. It is perfectly possible to have efficient, restructured, I&U sectors with considerable state ownership. It is equally possible to have seriously inefficient, restructured I&U sectors in private sector ownership – Britain is a good example. Irrespective of the nature of ownership, problems generally arise when the restructuring pursued is inefficient. This manifests itself in unearned profits being captured along the supply chain, in additional costs being imposed on final consumers and in poorer quality or less reliable services. The EU’s programme of electricity and gas market liberalisation (ironically, largely modeled on Britain’s) is a perfect example.
Wrt to electricity and gas Ireland has managed to achieve the worst of both worlds. The deeply flawed EU model has been applied in an entirely inappropriate context (and applied more enthusiastically than the Commission required) and government ownership has proved gloriously inefficient. The EU model is flawed and the Irish market is simply too small to sustain the introduction of the type of competition and choice mandated by the EU; and successive Irish government have failed to invest directly, have authorised a seriously inefficient financial structure and imposed huge costs on consumers.
The water, telecoms, transport and waste sectors reveal different trajectories of failed government policies but all with the same outcome of a combination of excessive cost being imposed on consumers and poor quality of service.
In all these sectors the first task is to identify the appropriate structure that will deliver efficient services. The next step is to assess the ownership and financing implications. In an ideal world one could consider a significant role for the state (even though it might beg the question why would the state commit scarce resources in an area where effectively regulated private sector players would allocate theirs – particularly when there are areas where the state has to commit resources because the private sector is either unwilling or unable to participate – or would operate inefficiently). But this is far from an ideal world. Ireland is facing a steeply sloping supply curve for sovereign debt – and it shifts erratically and might have a vertical region (which we should not wish to discover). There is really no option but to restructure those sectors where there is considerable asset value, sell some of these assets and use the proceeds to part-finance the restructuring of other sectors.
This, in my view, is where the debate should begin.
Restructuring and ownership are frequently conflated, but these are two separate dimensions that may, and should be, separated when examining the I&U sectors. It is perfectly possible to have efficient, restructured, I&U sectors with considerable state ownership. It is equally possible to have seriously inefficient, restructured I&U sectors in private sector ownership – Britain is a good example. Irrespective of the nature of ownership, problems generally arise when the restructuring pursued is inefficient. This manifests itself in unearned profits being captured along the supply chain, in additional costs being imposed on final consumers and in poorer quality or less reliable services. The EU’s programme of electricity and gas market liberalisation (ironically, largely modeled on Britain’s) is a perfect example.
Wrt to electricity and gas Ireland has managed to achieve the worst of both worlds. The deeply flawed EU model has been applied in an entirely inappropriate context (and applied more enthusiastically than the Commission required) and government ownership has proved gloriously inefficient. The EU model is flawed and the Irish market is simply too small to sustain the introduction of the type of competition and choice mandated by the EU; and successive Irish government have failed to invest directly, have authorised a seriously inefficient financial structure and imposed huge costs on consumers.
The water, telecoms, transport and waste sectors reveal different trajectories of failed government policies but all with the same outcome of a combination of excessive cost being imposed on consumers and poor quality of service.
In all these sectors the first task is to identify the appropriate structure that will deliver efficient services. The next step is to assess the ownership and financing implications. In an ideal world one could consider a significant role for the state (even though it might beg the question why would the state commit scarce resources in an area where effectively regulated private sector players would allocate theirs – particularly when there are areas where the state has to commit resources because the private sector is either unwilling or unable to participate – or would operate inefficiently). But this is far from an ideal world. Ireland is facing a steeply sloping supply curve for sovereign debt – and it shifts erratically and might have a vertical region (which we should not wish to discover). There is really no option but to restructure those sectors where there is considerable asset value, sell some of these assets and use the proceeds to part-finance the restructuring of other sectors.
This, in my view, is where the debate should begin.
Apologies for the double post. I'm getting all sorts of warning and error messages.
@Paul
I agree that restructuring of our energy SOEs is required, however, it is unlikely that the government has the time (or the inclination) to carry out restructuring along the lines that you have suggested within the next year or two. Without such restructuring it is hard to see how the full privatisation of our energy companies makes sense.
If the government do not adopt the 'strategic approach' in relation to these companies that you refer to and instead opt for the 'half-baked' privatisation of such assets without appropriate restructuring, would you agree that this would be a mistake? Your argument for privatisation hinges on the government's ability to successfully restructure the companies/sectors prior to any sale, identify an appropriate long-term private investor and ensure a proper regulatory structure is put in place. As you have said yourself, such an approach is unlikely to be high on the agenda for a government focused on electoral survival.
Donal,
Thank you for responding. I note that you have being trying to broaden the debate across the road on irisheconomy. I don't think there's any disagreement between us on the requirement for fundamental restructuring of most SOEs (and I would add in water, waste water and waste generally industry even though there are not in SOE land) before any form of privatisation is considered. (There's always a conflict beween maximising privatisation revenues and getting the structure of the industry right first and then privatising. The former just transfers rents - or the potential to capture rents - from the public to the private sector. This characterises a lot of what happened in the Britain.)
My sense is that this is a job for the next government and not this one. One can only keep the fingers crossed that, while they remain, constitutionally, in power, they don't start making difficult-to-change, half-baked decisions in this area.
Given the likelihood of an FG-Lab combination (and the strains that issues like this are likely to create) I think it is a good time to begin some detailed analysis of the options and the potential. I'm always sceptical of policies that emerge fully formed from the bowels of the party machines (and, in a coalition context, hammered together in the backrooms)and are then whipped through the Oireachtas.
I'm up for any collaboration that might be feasible.
The MoF has established the asset review group and set its ToR:
http://www.finance.gov.ie/viewdoc.asp?DocID=6396
Wrt the four bullet points in the ToR I trust that the members will commence their analysis at the last point and work their way back. A huge amount may be achieved simply by re-organising the corporate and financial structure of many of these SOEs, without any consideration of asset sales.
An opportunity may have been lost by the failure to extend the review to the water, waste water and waste management activities even these are in the LA domain.
The use of the term 'national interest' is a bit worrying. Though it is as nebulous a concept as the 'public interest', the former tends to be defined by the Minister, special advisers and senior Department officials. We should all be aware of where that has gotten us in the last 10 years. In other jurisdictions the latter tends to be associated with an increase in the current and future economic welfare of citizens. This should set the criterion in this case.
It is also noteworthy that Minister Ryan has expressed his unease about any sale of assets in his patch. Obviously the current arrangements, where the ESB and BGE finance his green whizzo schemes at consumers' expense, suits him very well.
One can only hope that a new government will have a solid basis for making some sensible decisions and that the current one won't have the time or opportunity to make stupid ones.
@Paul
Thanks for the response. I saw the terms of reference on the DoF website and I also hope the group work backwards from point 4, rather then start at point 1!
I don't have your email address to hand but if you send me an email I would be happy to explore any feasible colaboration.
Dónal, It is very hard to see much if any net income arising from any of the disposals because of the huge holes existing in the pension funds of many of these companies. Pension funds have been recklessly used to fund staff reductions and there has been consistent failures across the commercial State sector to set appropriate contribution levels into schemes. The ESB has continued to pay dividends, despite having a huge pension problem. Cutting through all of the FRS 17 rules, the core liability of that company is deemed to be €5004M @ 31/12/08 with assets of just €2438M, a funding hole of €2566M. The company intended to contribute just €71M to the scheme in 2009. (All figures are based on 2008 accs.)
The current legal cases around British Telecom should be a clear lesson in relation to sales of State companies and future pension liabilities.
An Saoi,
Thanks for the comment. I hadn't thought of the pension angle and there does seem to be a gaping hole in the pension funds of some of the remaining SOEs.
If I remember correctly, Aer Lingus had a sizeable pension fund deficit (something in the order of €170m) when it was privatised in 2006. The airline had to contribute approximately €100 million from the IPO proceeds to establish two supplemental funds to address the issue.
Any SOE with a significant pension deficit would face similar problems in any potential divestiture and it is an important point to be considered.
If these companies pension funds have huge deficits now, are we liable to be lumbered with an even bigger bill to make up the short fall in the future if the state keeps them?
Dónal, The degree of pension problems in many of these commercial companies will leave the pension trustees in a powerful position, enabling the trustees to possibly block any sales unless the position of the pension fund is protected.
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