Public assets and the public interest - an interview with Donal Palcic

Donal Palcic is a lecturer in economics at the University of Limerick, and co-author, with Eoin Reeves, of the book Privatisation in Ireland: Lessons from a European Economy. With the Government determined to push ahead with the part-privatisation of the ESB, Politico spoke to him about the logic behind public ownership of assets and utilities, and the case for and against privatisation.

Very broadly, can you explain why states tend to retain control over certain key utilities and services, rather than farming them out to the private sector?

Generally speaking, governments in Europe tend to retain a degree of control over key utilities such as electricity and gas due to the natural monopoly power associated with ownership of national utility networks. Prior to the 1980s, it was generally accepted in Europe that the efficient operation of utility industries such as telecommunications, electricity and gas could only be achieved under state ownership. It was believed that private ownership of such natural monopolies would only lead to abuse of market power and, consequently, most countries in Europe created national telecommunications, electricity and gas operators during the twentieth century.

During the 1990s, the EC began to pursue a liberalisation agenda in both the telecoms and energy sectors primarily concerned with the introduction of competition in order to improve the efficiency of formerly monopoly incumbents. In the case of telecoms, the liberalisation process initiated and coordinated by the EC from the late 1980s onwards was a major factor underpinning the decision by every member state to partially or fully privatise their national telecommunications operators. This resulted in the creation of partially or fully market-driven telecommunications industries where firms pursued their own private interests.

While liberalisation has generally led to most of the former telecoms monopoly incumbents becoming more efficient, in many countries this was driven by more innovation using the same capital asset base. Lack of investment in upgrading aging capital asset bases (particularly in rural areas) resulted in market failures in the provision of high-speed broadband infrastructure and has led to public policymakers in EU member states shifting their policy focus from increasing efficiency towards stimulating infrastructure investment in a liberalised environment. The EU has recognised this by changing its state aid rules to facilitate joint public-private investment in broadband infrastructure in both rural and urban areas. Many countries have recognised the strategic importance of high-speed broadband and are taking steps to ensure their countries do not fall behind through various public funding initiatives.

With regard to the electricity and gas sectors, the issues are largely the same as above. While private ownership of energy network assets might lead to greater static efficiency gains, the long-term investment that is required in these assets may not occur at the desired pace (or at all). This is best illustrated by Dieter Helm’s excellent assessment of the evolution of infrastructure and utility ownership in the UK over the past number of decades. Helm shows how the privatisation of infrastructure utilities led to substantial financial engineering and the balance sheets of many companies being geared up towards exhaustion, with major implications for financing future investment. It is precisely this worry that has led many European countries to retain majority/minority stakes in their former national incumbents and ensure they continue to have some control over strategically important network assets.

What are the downsides to public ownership? Are publicly owned companies more inefficient than privately held companies? Is political interference a problem (either historically or contemporarily; in Ireland or in Europe)?

Political interference in the running of Irish state owned enterprises (SOEs) was a problem in Ireland in the past. However, this must be viewed in the context of SOEs being used as major tools of public policy, with companies such as Bord na Móna and Irish Sugar contributing significantly to employment generation and regional development in rural areas over many decades. However, poor financial performance in many SOEs from the 1970s onwards became a matter of significant concern as the public finances deteriorated in the early 1980s. This was highlighted in a number of official reports and policy documents in the early 1980s, all of which advocated commercialisation, with primary emphasis to be placed on commercial viability and profits.

The increased focus on commercialisation obviously conflicted with the other social goals SOEs had fulfilled in the past and the government was slow in some cases to allow SOEs become more profit focused when it meant sacrificing employment or regional development goals. A good example of this is Irish Sugar’s attempts at rationalisation in the 1980s. In September 1981, the Board of Irish Sugar recommended the closure of the smallest of the company’s four sugar plants (in Tuam), as maintaining operations at the plant would lead to annual losses of over €3 million. The government, however, refused to accept the Board’s recommendation following strong local opposition to the closure and consequent job losses. This decision imposed a considerable cost on Irish Sugar for which it received no compensation. An effective stand-off between government and enterprise management ensued, with little invested in the plant over the following years. In December 1986, the government finally relented to its closure. The cost of keeping the Tuam plant open since 1983 had amounted to over €16 million.

Since the late 1980s successive Irish governments have generally allowed commercial SOEs to operate independently with little interference and almost all were profitable by the mid to late 1990s.

With regard to the question of comparative performance, there have been a large number of international studies comparing the performance of public and private sector firms and most recognise that assessing organisational performance is not without problems, especially when conducted in a comparative context. One set of problems concerns the choice of performance indicator. Purely financial measures (for example, turnover, profitability, return on capital employed etc.) are often inadequate insofar as they do not account for the non-profit-based objectives of SOEs.

Whereas profit maximisation exists as a dominant objective of private enterprise, SOEs in the past faced a host of sometimes conflicting objectives. These included efficiency, equity and a variety of other macroeconomic objectives. The use of SOEs as instruments of government policy with regard to these objectives limits the validity of single performance indicators, and undermines public-private sector comparisons. Many comparative studies have been criticised insofar as they fail to control for all variables affecting performance, other than ownership. These include factors such as regulatory environment, size, market structure and incentive structure, which theory suggests are important determinants of performance.

In competitive markets, most empirical studies have shown that private ownership is generally superior to public sector ownership. However, in markets that are imperfectly competitive or that suffer from other market failures, ownership has been shown to be largely a secondary concern with factors such as regulation and product market competition far more important determinants of performance.

Do you agree with Mary-Lou McDonald’s assessment that the Government’s plan to privatise part of the ESB is “wrong-headed and short termist”? If so, why? If not, why?

I would agree that the plan to privatise is short termist in that the decision to privatise the ESB as a fully integrated utility (thereby raising the value of any stake sold) appears to be driven by a desire to keep the Troika happy and avoid the difficulties that would arise if the government moved to restructure the ESB prior to any sale. Fine Gael’s pre-election NewERA plan had envisaged establishing a new SOE – SmartGrid – from the merger of Eirgrid and ESB Networks and retaining this key network infrastructure in full public ownership. The report of the Review Group on State Assets and Liabilities also recommended the separation of the transmission assets from the ESB prior to any privatisation. In addition, the Memorandum of Understanding with the Troika recommended that a detailed independent assessment of the electricity and gas sectors should be carried out. When viewed in this context, the government’s decision to partially privatise the ESB as a fully integrated company is bizarre to say the least.

Why do you advocate for the establishment of a new State-owned telecoms network utility to provide for a next-generation broadband network? Why can’t the private sector do this?

A useful summary of my argument for a national next-generation broadband network can be found in this blog post from January of last year. Little has changed since then. While UPC has continued to invest in upgrading its network and providing faster download speeds, these services are only available in more densely populated urban areas. Eircom (despite its almost bankrupt position) is also investing in the rollout of fibre to the cabinet/home as part of a pilot project in Sandycove (Dublin) and Wexford. Imagine has also invested heavily in the rollout of WiMax technologies at different locations across Ireland. While all of this private sector investment is to be welcomed, the State could be doing far more to deal with the digital divide that has developed between the quality of broadband services in urban versus rural areas. The State owns a large amount of fibre infrastructure that could be amalgamated and developed as part of a next generation national broadband network. Fine Gael’s original NewERA plan advocates exactly this. The plan envisages the amalgamation of existing telecoms network assets held by Bord Gáis, CIE, ESB and the Metropolitan Area Networks to create a national open access next generation broadband network. The amalgamation of existing State telecoms assets was proposed years ago, however, progress on this front was almost non-existent, with the previous Government only getting as far as establishing an “Implementation Taskforce” to examine the issue. Under the current government a “Next Generation Broadband Taskforce” is examining how best to progress the delivery of high speed broadband and it will be interesting to see what the Taskforce recommends in its report due at the end of the year.

Notwithstanding the difficulty associated with amalgamating existing state telecoms assets, the question of how best to upgrade the critical “last mile” infrastructure is even more difficult to resolve. The bulk of the proposed NewERA investment in broadband is to be directed towards investment in the roll out of fibre in the ‘last mile’. However, the vast majority of the last mile infrastructure in the State is owned by Eircom. While the NewERA plan envisages co-investment in infrastructure with the private sector, it is impossible to see how the almost bankrupt Eircom will be able to invest significantly in the upgrading of its last mile infrastructure (much depends on whether Eircom is able to agree a restructuring of its debt burden with bondholders over the coming months). It is therefore likely that significant public funds will be required if this critical infrastructure is to be upgraded in the near future. Unfortunately for Ireland, the longer we delay in facilitating the rollout of this critical infrastructure, the further behind our counterparts we fall and the more we hinder our long run potential growth.

Do you think that the Review Group on State Assets and Liabilities, and the Government, are cognisant enough of the lessons from Europe, where, as you write in the Irish Times: “governments maintain control of two-thirds of privatised firms in the EU by a variety of means”? Or do you find worrying Michael Noonan’s assertion that “The movement towards the private sector holding infrastructural assets, such as those about which we are talking, rather than the public sector has been a part of economic management in all modern economies for the past 30 years, of which I am sure the Deputy is well aware. The European authorities are of the view - it is supported by any economic theory one would like to read - that assets in private hands will be used more efficiently for the public good than assets in public hands in general terms.”

The Review Group on State Assets and Liabilities does recognise some of the lessons from Europe in that it recommends the separation of key network assets from the likes of the ESB and Bord Gáis prior to any sale of the remaining non-strategic assets. However, as we explain in the article linked to in the question, the report does not distinguish between full privatisation and partial privatisation and does not pay sufficient attention to the possibility of privatising but retaining a degree of State control. Such an approach offers the possibility of reaping the benefits of private ownership while retaining State control over what might be regarded as strategic assets.

The lessons learned from the Eircom privatisation are salutary. The full privatisation of a strategically important industry in the context of a weak regulatory framework resulted in failure, mainly manifested in considerable underinvestment (particularly in broadband) by the newly privatised monopoly. This, coupled with the stifling of competition by the incumbent in the fixed-line market, led to a situation where Ireland was perennially ranked close to the bottom of most EU broadband performance indicators. Just one page of the 179-page report on State assets is devoted to examining the lessons arising from Ireland’s largest privatisation to date. The review group suggests the problems that emerged with Eircom were not a result of privatisation and point to regulatory failure. This misses the point completely. The key lesson from the Eircom privatisation is that governments should never opt to fully privatise strategically important network SOEs, particularly when there is limited competition and the potential exists for the newly privatised public enterprise to abuse its dominant position.

In relation to the Minister’s statement on the superiority of private ownership, I commented on this on the blog a few weeks back and stated that it is a major concern that someone as important as the Minister for Finance, who is likely to make crucial decisions in relation to privatisation, makes blatantly incorrect assertions such as this. Even a cursory glance at the theoretical literature on the impact of privatisation on performance would show that the grounds for making such a claim are extremely shaky. No less than Nobel Laureate Joseph Stiglitz has stated that “the theoretical case for privatization is, at best, weak or non-existent. It is strongest in areas in which there is by now a broad consensus – areas like steel or textiles, conventional commodities in which market failures may be more limited. But by the same token, these are precisely the sectors in which abuses can most easily be controlled, appropriate incentives can best be designed, and benchmarks can most easily be set.”

In other words, privatisation can lead to improved performance when firms that are sold operate in competitive markets. Where firms operate in imperfectly competitive markets, the case for privatisation is weak at best. The regulatory structure in place and the degree of competition faced by firms in such markets are far more important determinants of performance. Numerous empirical studies on the effects of privatisation on the financial and operating performance of divested firms have been carried out in recent years. My colleague Eoin Reeves and I review a large number of these studies in our recent book and argue that, overall, the empirical evidence with regard to the impact of privatisation on enterprise performance mirrors the thrust of relevant economic theories and is inconclusive.

In general, the empirical literature can be divided into two main groups: broad-based international studies which by and large find that privatisation leads to improved performance, and more in-depth country-specific studies that find more ambiguous results, and suggest that privatisation does not automatically lead to an improvement in company performance. The general conclusion we can draw from the empirical (and theoretical) evidence is that privatisation leads to improved enterprise performance in some, but not all, cases.

The Minister therefore needs to be far more careful when making wild claims that any economic theory you’d like to read shows that assets in private hands will be used more efficiently for the public good than assets in public hands. It is interesting (and worrying) that the Minister makes such comments at a time when Fine Gael’s NewERA plan, which was launched recently, places public enterprise at the heart of efforts to lay the foundations for economic recovery.


Image top: Kevin Allen.