Revisiting privatizations

Over the course of last year and this year, I have advocated that European countries facing excessive indebtedness and sub-par growth should consider selling public assets.  In the case of Greece, I noted in 2011 that ex-ECB board member, Juergen Stark, had estimated Greek public assets available for sale at around €300 billion; this was to be compared with a national GDP of €240 billion and an overall sovereign debt of €320 billion.

I also advocated the same course of action for others, such as Italy, Spain and France.  The benefits of such a policy would be to increase overall economic efficiency and to raise funds to reduce national debt.  It could also help develop a large and stable pool of savings for future retirees.

I also noted that the best example of what this policy could yield was the Chilean experience in the 1980s.  This is one in which I was closely involved as a banker and investor.  Back then, Chile received no outside financial help, in stark contrast to the current European situation.  Yet, thanks to well conceived debt-to-equity and debt prepayment programs, it managed to reduce its external commercial debt by one third without alienating international markets.

Therefore I was happy to read an interview of Mexican billionaire Carlos Slim in which he too advocated the sale of public assets as a necessary although not sufficient condition to get European economies back on track.

Countries are often reluctant to part with public assets, for very human reasons:

1.      Bureaucrats will lose a sinecure and a power base while employees may see their benefits cut back and even be terminated;

2.      Selling assets during a crisis is bound to bring less than optimal prices;

3.      Deep pocketed foreigners will take advantage of their momentary weakness to take control of national assets;

4.      Public services, once privatized, will be rationalized, resulting in higher tariffs and smaller geographic coverage.

 Indeed, reducing bureaucracy is one of the benefits of privatization.  In many instances, public employee benefits are far more generous than those accruing in the private sector, and the difference represents a subsidy which is unfairly borne by the latter and should be eliminated.  Privatizations often result in job cuts, but the resulting hardship can be controlled and reduced with compensatory and retraining policies and by the opening of new private job opportunities in a resurgent economy.

It is obvious that, at least in the beginning, public assets will be sold at depressed prices, but getting optimum prices is not the name of the game, putting the economy back on track is.  Besides, the cost of a weak economy with a depressed job market is far higher than the money left on the table, so to speak, by selling assets early.  And experience in Brazil and Chile has shown that, if privatizations are accompanied by sound fiscal and economic policies, markets soon adjust and subsequent asset sales command higher prices.

Rich multinationals or vulture funds are often the bugaboos that discourage countries from privatizing.  The reality is that it all depends on how privatizations are structured.  In Chile, most privatizated companies were bought by local entities, sometimes operators, sometimes financiers, sometimes by consortia which included local pension funds; in the case of the largest privatizations, special financing was made available so that local households could buy into blocks of shares that had been reserved for them (the so called capitalismo popular).  In Mexico, it is worth remembering that the largest privatization was won by a consortium of Mexican, American and French interests led by Mr. Carlos Slim who retained effective control.  I might also add that, in my experience, foreigners who have bought local companies on the cheap in times of great national stress end up paying a fair price over time, as governments find ways to extract more money or consideration from them.   One can only look at the electric utility sector in Brazil where the current government is trying to force through a new tariff regimen.

One large and apolitical source of funds to tap in order privatize public assets would be national pension funds.  These were instrumental in similar projects in Latin America and some Nordic countries.  Unfortunately, countries such as France, Italy and Spain largely rely on pay-as-you-go pension schemes, and their pension funds control very small pools of funds (0.2%, 4.6% and 7.9% of GDP respectively).   By contrast, pension funds in countries such as Chile (67%), Finland (82%) and the Netherlands (135%) are much larger and offer far more strategic flexibility.  It would be highly controversial in France in particular, but just imagine if it had a pension pool of 1 trillion euros!  If Italy had €900 billions and Spain €600 billion!  Such funds would dwarf the much maligned hedge funds and vulture investors; they would also match their long term investment horizons with the government desire to find stable institutional investors.

Finally, there is the fear that privatized public services will no longer serve the public, or that tariffs will be raised too high.  With sound regulations, the former concern can be allayed.  The real question is whether essential services should be subsidized, and if so how, or not.  If a country decides that the provider of such services should subsidize them, then privatization may not be appropriate.  Witness the continuing frictions between Telmex and the Mexican government on this issue, or worse, the case of the energy sector in Argentina or even EDF in France.  Countries can’t have it both ways: they can’t privatize and then control prices.  Ultimately though, tariffs may initially increase and then gradually decrease as most of the efficiency gains are passed on to customers.

The current debate in Europe has little chance of bringing about a workable solution to the prevailing financial and fiscal problems:  drastic austerity, be it via spending cuts or tax increases, cannot work because it is socially and politically unacceptable; fast growth is unrealistic because, in the absence of other measures, it is equivalent to Northern member countries subsidizing their Southern fellow members and cosigning their debts.

Austerity is necessary, but its focus should be a combination of shrinking the public sector and making the economy more efficient.  Privatizing public enterprises should be the key driver of this effort.

Growth based on EU subsidies and wealth transfers is a non starter; but growth based on a leaner, more flexible private sector is possible and sustainable.  Indeed, examples of this are easy to find in recent history.  Part of the privatizations proceeds should be earmarked to retrain downsized employees and to help them bridge a conversion period leading to new jobs in the private sector.

Finally, privatizations are essential to reduce sovereign debts in a manner which doesn’t disrupt markets, encourages new investments and keeps financing costs affordable.

At the end of the day, return to fundamental financial equilibrium and economic growth is possible but no single silver bullet exists that will do it all.  Rather, European democracies will need to find a workable balance of some austerity, some tax increases, gains in efficiency and delayed but better quality growth.  To that end, a broad privatization program is essential to help achieve many of these goals in a sustainable and socially acceptable way.  It would also provide the opportunity to establish a modern and potent retirement pension fund industry.

The Yellow Brick Road

It is too soon yet to guess who will be the next president, but not too soon to detect a change in the dynamics of the country.  And that is good news.  Perhaps unexpectedly, the American voters seem to take a greater interest in the substance of the debate and to realize that any solution will have to be negotiated in the political middle.

I think that it all began with the first presidential debate.  The Republican candidate, Mitt Romney, surprised almost everybody: he won, did so on substance and was much more moderate than the press had painted him to be (in fairness, he moved back to the center after having won the nomination on the right).  By contrast, the President demonstrated that eloquence needed a base in facts, in experience and in a successful track record to be effective, at least if you are the incumbent.  Though it had lapped screaming TV talk shows and the vacuity of The Wives of … reality programs for some years now, the public gave Romney a decisive victory in post debate polls because he had presented sounder arguments.

To my mind, the vice-presidential debate reinforced this trend towards problem-solving.  Vice-president Joe Biden was very aggressive as expected but was also very rude and at times contemptuous of his opponent.  His arguments often lacked substance and his tone was generally populist in the extreme.  By contrast, Paul Ryan was composed and displayed greater command of facts and numbers; he was also surprisingly at ease debating foreign policy.

Democratic pundits were delighted: Joe Biden has come out with all guns blazing.  Yet I think that this strategy was flawed.  For one, he made his boss, President Obama, look weaker.  For another, his demeanor seemed to have turned off the Independents and undecided voters who were less interested in televised combat and wanted to hear solutions to their and the nation’s problems.  Paul Ryan may have taken a lot of verbal abuse but he seemed to have won on points so to speak.

The next presidential debate will be interesting and likely will determine the outcome of the elections.  By temperament, President Obama is more collected than his vice president; he also will be faced by Mitt Romney, some 20 years his senior and a person with a strong track record in private and public life.  As is clear to most already, winning over the American Middle is the key to winning the presidency and there is ample evidence that the winner will need to win on substance: that is what people want, besides, while Obama is generally viewed as likable, Romney is no longer viewed as a cold hearted money-maker.

Whoever becomes president in November, it looks to me that the American people are realizing that the solution to the country’s problems will cause pain to everybody rather than a few thousand plutocrats: effective tax rates will have to rise (sorry Republicans) and public spending will have to be cut (sorry Democrats).  Failed experiments in Japan and Western Europe have brought this country back to reality and none too soon.  Welcome back to the Center!