A big theme in Australian history has beenhome.swiftdsl.com.au/~daveclark/econ2313lec2state.pdf · Australian development than most Western economies Railways state-built & run because

Copyright David Clark 2006

ECON2313: Australian Economic Development in

the Twentieth CenturyLecture 2 - The Role

of the State

Some views on the public sector"Politics: A strife of interests masquerading as a contestfor principles." Ambrose Bierce, The Devil's Dictionary.

"Government consists of taking as much money as possible from one party of citizens to give to the other." Voltaire.

"Frankly, I'd like to see the government get out of waraltogether and leave the whole field to private industry."Milo Minderbender, Catch 22.

"The government should intervene to stop the laws ofeconomics from working." Student Essay.

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A big theme in Australian history has been:

“The government shouldinterfere to stop the laws of economics from working.” (Student essay)

However, such laws usually defeat the best efforts of governments

ABS

Three main roles of government

Encouraging a stable political and macroeconomic

environment

1.

Ensuring a minimum standard of services in areas that only the whole community can

afford: such as general education, pure (and some applied) research, and some

infrastructure.

Providing a system of rules that set the parameters for business to operate and

which are effectively enforced




of the StateWhen public officers argue about the scope for intervention in an economy they all too often sound like a eunuch explaining the Kama Sutra. (Prof. W. Hogan, University of Sydney, SMH 31 December 1977)

Australia is a sunny land, flowing with milk and honey; the cows get into Parliament and the bees get all the money. (Sir John Northcott, SMH, 1 July 1961)

Two sceptical views of the public bureaucracy &

politicians

Economic functions of the government:

Re-allocation of resources – types of taxes, including direct and indirect, types of outlays ·

Redistribution of income – progressive, regressive and proportional taxes, social welfare payments

Stabilisation of economic activity – via the use of fiscal and monetary policy

Other – including competition and environmental policies.

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Economic functions of the government: Australian storyOne of first economies with income taxes and land taxes - last major one to adopt a VAT/GST

Redistribution of income – through progressive income tax and land taxes

Stabilisation of economic activity – government intervention quickly accepted but external pressures made it difficult

Other – extensive state involvement and regulation in most areas of economy

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of the State

Main influences on government policies in Australia

Policies & ideologies of political partiesThe Australian ConstitutionInterest groups of various kindsBusinessUnionsWelfare agenciesThe media

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Source: OECD 2004 figures

Australia government spending not high by Western standards

Canada Germany Italy UK US Australia0

20

40

60

80expenditure as a % of total

Defence Education HealthSocial security Govt. expendit. (% of GDP)

But State played bigger direct role in Australian development than most Western

economiesRailways state-built & run because unprofitable for private sector.

State or government business enterprises (GBE's) more widespread than any other Western economy - even had State pubs and fish-and-chip shops early in 20th century!

Highly regulated economy - but governments went soft on anti-competitive practices because of small size of market.

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of the State

Arguments for government investment in infrastructure

Public goods argument. ie. there are goods and services for which it is difficult to charge for access. eg. lighthouses.

"Natural monopoly" argument. ie. rests on economies of scale. eg. high initial costs of building power, transport and communications facilities.

"External benefits" argument. ie. there are positive "externalities" which flown from public investment. eg. better public transport to city may increase labour mobility.

But: Non-economic arguments tend to overwhelm economic ones.

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World War II and 1970s saw biggest government spending rises

Data source: RBA

1928/29 1938/39 1948/49 1958/59 1968/69 1978/79 1988/890

10

20

30

40

50

60Public spending as a % of GDP

Note both Whitlam (Labor, 1972-5) & Fraser (Coalition,

1975-83) eras werehigh spending

ones

World War II

Av. 32

Deficits blew out across West in 1970s

Data: OECD

AUSTRALIA

FRANCE

WEST GERMANY

JAPAN

UNITED KINGDOM

UNITED STATES

0 1 2 3 4 5-1-2%

1965-691974-75

Public sector deficit, % of GDP




of the State

Reasons for rise in Budget deficits

Inflation rose, pushing up cost of government provided services. This rise largely a product of cost-push inflation - particularly rise in oil prices & wages.

Consensus among economists that deficits OK, particularly when unemployment was rising - a consensus shared by politicians wishing to win next election.

A demand-side emphasis of Western economic policy, which paid little attention to the effects of government spending on profits, wages, inflation and interest rates.

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Why Western governmentsundertook structural reform in 1990s

High public debt and budget deficit burdens. Realised that taxpayers' money spent on interest payment on debt could be much better spent.

Reduced effectiveness of domestic policies in a rapidly globalising world

The end of the cold war, which encouraged a re-think of industry policies

An increasing general awareness of the limitations on the government’s role in the economy

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Why Australia had so many GBEs

Tyranny of distance and geography - in early days many activities were simply unprofitable.

Belief in the "Nanny State".

A challenge to capitalism by worker controlled enterprises.

Desire to assist private sector with infrastructure and cheap materials.

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of the State

Government ownership in 1990

Source: The Economist0%-25%25%-75%75%-100%

West Germany

Britain

United States

Japan

AustraliaPost AirlinesTelecom.

Railways Electricity

By 1920, Australia had widest range of state enterprise outside USSR

State railways, joineries, quarries, clothing factories etc in most states

And even fisheries and fish-and-chip shops (NSW) and pubs and butcher shops (Qld.)

Commonwealth Bank established in 1910 - as a result of fear of the "money power"

National Shipping Line set up in 1927

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But many closed down in 1920s and 1930s by non-Labor govts

Little interest in accountability and efficiency.

"Brother-in-law problem" ie. much nepotism and religious or political favouritism in appointments and management

Pressure from private sector competitors - particularly from brickmakers.

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of the State

Labor govts in 1940s re-opened some and started new ones

AWA, Aluminium Commission, Commonwealth Engineering, Atomic Energy Commission set by Federal Govt.

State Labor governments re-opened brickworks etc closed down by Nationals

Also brought the Keynesian Revolution"down under"

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Menzies Govt - 1949-1965- talked "free enterprise" but did little to reduce public

sector Country Party "socialists" continued to push for privatising of their profits and socialising of their losses.

Manufacturers demanded high protection, assistance and other handouts

The result: govt. outlays as % of GDP higher at end of Menzies era - 1965 - than after 8 years of Labor rule in 1940s!

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PM Bob Menzies

In late 1980s we acknowledged that GBE efficiency had to be improved

OECD study suggested labour productivity of Aust. GBEs less than half OECD average.

Same study suggested capital productivity just over half OECD average.

But were notable exceptions - eg. former Overseas Telecommunications Commission

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of the State

GBE profitability poorAverage net rate of return on capital invested, %

Source: OECD. 1998 figures

16.1

3.1

Private Public0

5

10

15

20 But:- 1988 a very good year for private sector- Some GBEs performed well

State GBEs were the big losers

1983-84 1985-86 1987-88 1989-90

0

1

2

-1

-2

$Billions

Commonwealth States/Territories

Largely railway losses

Easier for Commonwealth - couldpush up phone & post prices

GBEs had more capital, less product

16.0%

10.0%

74.0%

15.0%

19.0%

66.0%

Gross product Net capital stock

GBEs Other Public Sector Private Sector

1989 estimates for EPAC




of the State

Public sector efficiency crucial(For both traded and non-traded goods sectors)

On average, two-thirds of value of final product ofAust. manufacturers is purchased from other sectors. Mining and agriculture especially vulnerable to cost of inputs of power and transport

Govt. supplied goods and services (g&s) represent about 17% of total value of inputs bought by private sector.

Outlays on such g&s exceed more than 10% ofproduct price of iron and steel, sawmilling, pulpand paper, cement and fertiliser industries.

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ie Cost structure of enterprises partly determined by cost of inputs and efficiency of their suppliers.

Therefore if our GBE-provided inputs more expensive than inputs used by our overseas competitors - then our international competitiveness is lessened

Inefficient intrastructure industries also mean consumers pay higher prices, impacting on poor the hardest.

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of the State

Ways of improvinginfrastructure efficiency

Much more cost/benefit analysis.

More efficient pricing of public services.

Better co-ordination between the states and Federal Government.

Joint ventures with private enterprise. eg. toll roads

Partial and full privatisation of GBEs..

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Privatisation is the full or partial transfer of ownership of public assets to the private sector.

This process refers to the sale of enterprises which are a ‘going concern’ rather than the sale of land or buildings.

NB: Privatisation does not cover activities such as contracting out, leasing and private financing of infrastructure projects.

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What is privatisation?

Reasons for privatisations in Western economies: I

Academic studies, which had suggested that it was the lack of competition and the sectoral concentration of government business enterprises (GBEs) - and not so much the ownership structure which explained the differences in efficiency between private and public owned enterprises - were increasingly discredited.

Most of these studies were based on a comparison of cost between different enterprises in public and private ownership. Studies done outside universities, which have looked at the same enterprise before and after privatisation, have demonstrated the emergence of significant efficiency gains from privatisations.

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of the State

Reasons for privatisations in Western economies: II

Increasing, internationalisation and economic integration of economies made cross-border mergers and acquisitions and strategic alliances all the more important. This encouraged privatisations for two main reasons.

First, relieved from the restraints of government budget financing, privatised GBEs were now more free to target new business areas and to make new investments by tapping directly into the capital market.

Second, private companies were now more willing to undertake joint ventures with enterprises that were not state owned.

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Reasons for privatisations in Western economies: III

An aim to create a "share holder" culture in the population at large - a kind of "peoples' capitalism". This important in both UK and now Australia - eg. Telstra float saw 1.8 million Australians buy shares

This aim part of a bigger goal: the development of further expansion of capital markets.

It was argued that large scale privatisation should lead to increased capitalisation, to more liquid markets, and to closer scrutiny of companies by the capital market.

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Reasons for privatisations in Western economies: IV

Governments came under increasing budgetary pressure . This made the privatisation of GBEs attractive by removing the need to transfer resources to GBEs running deficits.

However, by selling off GBEs, the government gives up the future dividend stream from these assets, leaving the net effect on government wealth difficult to assess.

Also, it is crucial that the proceeds from privatisation are not utilised to simple relieve pressure for taking measures against structural budget deficits.

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of the State

Privatisation: two main methods

A public offering: ie sale of equity in the capital market to investors. Usually used in countries with a developed capital market and where GBE has little need of restructuring

Trade sales : ie. GBE simply sold off to competitors or another company in the private sector. Often preferred when to high a level of public offerings has depressed share market

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Why privatisations attractive to investors: I

Investors usually make an immediate gain. The reason is because companies are ordinarily underpriced, i.e. the equity price in the first days of free trading is higher than the offer price.

Reason for underpricing? Governments underprice in order to signal a political commitment to - and to develop broad support for - the entire privatisation programme.

This has been the case with most Australian privatisations

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In the long run, privatisation shares have tended to outperform the market average.

The above average rise in equity prices of companies following privatisation reflects the fact that efficiency gains appear to have been larger than investors and analysts expected before privatisation.

This has been the case with most Australian privatisations

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Why privatisations attractive to investors: II




of the State

Why privatisations attractive to investors: III

Privatisation offerings are often huge compared to the existing domestic market, meaning that they will constitute an important part of the market index.

Thus, big institutional investors seeking to track the index will be obliged to purchase the equity.

This was the major reason why Telstra shares rose so sharply after their late 1997 float

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For retail investors, privatisation offerings of equity have often come with special attractions which seek to secure a wide distribution of shares among the public and aim to motivate the retail investor not to sell the shares right away.

Thus, the offer price for retail investors is usually set below the price for the institutional tranche.

Other features used in the retail offering have included bonus shares, if the equity is retained for a specific period, and partly paid shares, where full payment is made in several subsequent instalments.

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Why privatisations attractive to investors: IV

Privatisation: impact on capital markets

Increases equity market capitalisation and market liquidity.

When floated companies listed on offshore exchanges, this adds to the internationalisation of equity holdings and to the globalisation of stock markets.

With an unchanged government financing need, a privatisation offering will increase the supply of equity while at the same time reducing the supply of government bonds. This can make monetary policy decision more difficult.

However, with a high level of substitution between these two types of assets, capital markets should, in principle, be able to absorb the equity offerings without major effects on either equity prices or interest rates.

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of the State

To sum up arguments for privatisation

MACROECONOMIC:- reduce public borrowing and debt.

MICROECONOMIC: - improve efficiency, innovation and choice

CAPITAL MARKETS: - widen share ownership and private opportunities

INSTITUTIONAL: - more rational pricing of goods and services

MAIN DANGER - PRIVATISATION MERELY REPLACES PUBLIC SECTOR MONOPOLY WITH PRIVATE SECTOR ONE

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Australian GBE reform: main stepstaken before or instead of privatisation

Set clear objectives

Directly funded Community Service Obligations (CSOs) - rather than relying on subsidies

Required dividends as guide to performance

Same tax regimes and conditions as privatesector enterprises implemented

Uniform and commercial accounting practices introduced

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5. ONBOARD

REFORM

GBE reform: the five main steps

I. Commercialisationbegins

II. Corporatisation beginsie GBS exposed to same tax and other regimes as private sector competitors

III. Sale of State Banks & insurance offices begins - State Banks of Victoria, SA, WA & Commonwealth Bank

1981

1989

1992

iV. Restructure & privatisation of natural monopolies begins

1993

V. National Competition Policy measures begin:·extension of trade practices law·competitive neutrality/·access regimes·legislation reviews·compliance schedule and payments.

1995




of the State

Effects of asset sales

Sale of govt.assets

Receipts reduce Budget deficit

But also reduces govt. revenue

And can worsen CAD if funds borrowed

offshore

Flows pre- privatisation - thinFlows at privatisation - thick

Post privatisation - ++++

STATE GOVERNMENT

FEDERALGOVERNMENT

PRIVATEINVESTORS

GOVERNMENTENTERPRISES

NotionalTax

After taxreturnTax loss

compensation

Proceedsof theprivatisation

Aftertax

return

Corporatetax

Investor tax

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+++++++++

Explanation of chartPre-privatisation position:

- State GBEs not subject to Federal income taxbut many pay "notional" income to their State owners.Rate is usually same as Federal corporate income tax.

Post-privatisation:

- These tax payments now collected by the FederalGovernment- State governments also lose their claims to after-tax returns - ie future dividends and capital gains -of their GBEs. These now owned by private sectorinvestors.

RESULT? - Federal Government collects a no-costwindfall gain. Hence State uproar.




of the State

Australian privatisations big by world standards

RBA Bulletin, December 1997

0.12 0.120.35 0.4

0.75

1.75 1.8

JapanGermany

SwedenFrance

UKAustralia

NZ0

0.5

1

1.5

2

Annual average proceeds, 1990-97, as a % of GDPAccording to the OECD, global privatisations totalled about US$30 billion in 1990 and are expected to reach nearly US$100 billion in 1997.

Privatisation: three main areasFinancial services - e.g.

Commonwealth Bank, State Banks of Victoria, SA, NSW

and WA

Electricity & gas - Victoria the most radical but other states likely to follow suit.

Telecommunications and transport - e.g. Telstra &

Qantas. But state railways unlikely to find buyers.

Australia's major privatisationsTelstra (66%)

Telstra (33 %)Vic Electric

CBA (2nd float)United Energy

Qantas (75 % float)CBA (1st float)

NSW GIOSolaris Power

Bank SATabcorp

Qantas (25 % to BA)

0 10 20 30 40 50Proceeds, billions of dollars

Nov 95Sept 93

Aug 93July 95July 91June 92

Oct 95June 95June 94Dec 93

Nov 97Estimated




of the State

Both Commonwealth & State governments privatised

RBA Bulletin, December 1997

2 1.8 3 1.9 4

20

3 22

13 8

4.5

1991-92 1993-94 1995-96 1997-980

5

10

15

20

25

30

$s, billions

Commonwealth*State

* Includes the full proceeds of $14.3 billion from the sale of Telstra in financial year 1997/98, although payment is in two instalments in 1997/98 and 1998/99.

GBE reform benefits largely went to government owners

Data source: Steering Committee on GBE's Annual Reports

70

23

-3

150

Real labour productivity

Sales margins

Real prices charged

Real payments to govts.

0 20 40 60 80 100 120 140 160 180-20% change, 1989-90 - 1993-94

Rose from $1.4 -$3.5 billion

Asset sales helpBudget bottom lines

Source: 1998 Budget Papers

87/88 89/90 91/92 93/94 95/96 97/98 99/20

0

10

20

30

-10

-20

$ billion

Asset sales Budget balance

ie. Budget deficits wouldhave been bigger and

without them!surpluses much smaller

Treasury projectionsbased on full Telstra sale




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Privatisations cut government trading enterprise debt dramatically

1999 Budget Paper 1, Budget Statement 9

1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-000

10

20

30

40

50

60

70Billions of $s

4

6

8

10

12

14

16

18Debt % of GDP

Govt. trading enterprises debtDebt % of GDP (right axis)

1999 Budget estimates2001-02

Electricity industry productivity rose

ABS 8401.0

-7-6

1

Jobs Wages & salaries bill Value added

0

2

-2

-4

-6

-8

% change, 1996-97

Prices fell sharplyPrice indices, 1989 = 100

Steering Committee on National Performance Monitoring of Government Trading Enterprises (various) Performance Indicators, Industry Commission

1989-90 1991-92 1993-94 1995-9670

80

90

100

110

Electricity Water Australia Post Telstra

Electricity

Water

Post

Telstra




of the State94 89 86 82 81 79 76

1994 1996 1998 20000

20

40

60

80

100

120Telsra's revenue as % of total market

Source: Telstra Annual Reports

Telstra lost market share but still dominates telecoms

Source: Telstra Annual Reports

Federal public service jobs: outflows greater than inflows

Australian Public Service, Statistical Bulletin, Department of Finance (1987-1997)

1985 1990 19950

0.5

1

1.5

2

Ratio of inflows/outflows

0

5

10

15

20Thousands

Ratio of inflows/outflows (left axis) Inflow (right axis)

Public service was a good place to be in recessions

Commonwealth public servant growth

1965 1970 1975 1980 1985 1990 19930

200

400

600

800

1000

1200

1400

1600Index,. 1967=100

All permanent staffSenior Officers

Recession period

Recession period

Recession period




of the State

The argument why more user pays needed

Capital worksprogramme

Prices rises limitedfor political reasons

Under-pricedservices

Over- utilisation &environment degradation

Hoped effects of user paysBetter pricing

signals

More efficientsystem use

Less investment&

greaterenvironmental

awareness

More demandresponsive pricing

Australia has had one of the larger programs among OECD countries – second, by value, to the UK and, relative to GDP, to New Zealand.

Privatisation proceeds are estimated to have been about $61 billion in the 1990s, coming roughly 50:50 from State and Commonwealth privatisations.

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Australian privatisations: a check-list

Governments have sold assets both by offering equity to the public and through trade sales.

Proceeds of sales have been used largely to reduce government debt.

Privatisation has dramatically increased share ownership in Australia.

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Documents

A big theme in Australian history has beenhome.swiftdsl.com.au/~daveclark/econ2313lec2state.pdf · Australian development than most Western economies Railways state-built & run because