The privatization drive: Appeasing animal spirits

The privatization drive: Appeasing animal spirits

Edward Mariyani-Squire, Associate Lecturer, School of Economics
and Finance, College of Law and Business, University of Western
Sydney, Sydney

The government's deliberation over the privatization of
publicly owned businesses is an interesting case of
microeconomics meeting macroeconomics.

As the Senior Deputy Governor of the Bank of Indonesia Anwar
Nasution wrote in this daily on Dec. 13, the government may face
a fiscal crisis due to the large interest payments it must make
on foreign borrowings. One way in which the government is trying
to stave off this problem is by debt and interest payment
rescheduling.

It is felt that this is not enough; thus the drive to
privatize, so the government will be able to secure a substantial
sum of money to pay off some of the public component of the
foreign debt. This, all other things remaining equal, will
reduce the government's interest payments to foreign lenders.
Further, where those businesses are currently subsidized, this
would represent further "savings" to the government. The
reduction in both interest payments and subsidies would reduce
budgetary constraints in the future.

But the main game is getting the economy back on its feet.
Despite the recent talk about consumption expenditure, recovery
hangs on the growth of private investment expenditure.

Alas, as John Maynard Keynes pointed out long ago, the "animal
spirits" of private investment are fickle. One might suppose
that thanks to the relatively low value of the rupiah, investors
(and especially foreign investors) would have a strong incentive
to set-up and/or expand highly competitive export and import-
replacement industries. But this is clearly not enough.

After all, if the U.S. economy continues to slide, the returns
on such investments would not be as high as they would otherwise
have been. Some economists argue that if the government's debt
rescheduling plan goes ahead, this will cause (predominantly
foreign) investors to classify everything Indonesian as "Third-
World" -- i.e., a high-risk low-return option. Hence the much-
needed injection of foreign direct investment will not come and
the economy will be worse off than if, say, government
expenditure were drastically cut instead.

Clearly something more is needed -- a sacrifice to the animal
spirits! Here's where the second aspect of the rationale for
privatization comes in. Perhaps if the government sells off its
businesses -- profitable or not -- to foreign investors, stands
up to the managers and unions of these businesses, ignores the
bleeding-heart NGOs who oppose privatization, and raves on like a
cold-war warrior about "the freedom to choose", then investor
confidence in the government as a good economic manager will be
bolstered.

The investment expenditure tap will turn itself on again,
unemployment will fall, and thanks to the massive excess capacity
of the economy, an appreciation of the rupiah and high interest
rates, inflation will remain relatively stable (if a little
high).

It is a gamble, however, firstly because the final outcome is
uncertain and secondly because if things don't go as planned,
there are losses to be faced. Why is the final outcome uncertain?
Because the animal spirits are unpredictable. No one knows
whether privatization is either necessary or sufficient to
contribute to a change in investor attitudes toward the
Indonesian economy. At this time, not even investors themselves
know! This is because investment behavior tends to be "herd-
like". If some high-profile private investments go ahead due to
privatization this might lead at an optimistic mood on the part
of other investors, which could lead to a stampede to invest and
consequently, economic growth.

Ironically, if most investors become optimistic, this itself
justifies their optimism. Alas, the opposite is also true. It
depends on which way the herd turns. Maybe the herd will take
the current farcical stumblings toward privatization as a sign of
a desperately inept regime. Who knows? It is a game of chance
in which literally no-one knows the probabilities. (One should
thus be very suspicious of free-marketeers who state
unequivocally that privatization will undoubtedly fuel an
economic recovery.)

If things don't go as planned (the herd does not become
optimistic about prospects in Indonesia), why are there losses to
be faced? Because by privatizing its assets, the government will
have lost control of vital aspects of the economy with no genuine
guarantee that the privatized businesses will act in the interest
of consumers. At the microeconomic level, privatization only
tends to produce beneficial outcomes if there is substantial
competition in the market and strict regulation of that
competition. Unfortunately, many of the businesses mooted for
privatization are either virtual monopolies or operate in
oligopolistic environments.

By selling them, the government will be establishing
essentially unregulated privately owned monopolies and
oligopolies; and there are few things worse, economically
speaking, than such beasts. Privately owned monopolies are
inevitably allocatively inefficient -- restricting supply and
increasing prices above the cost of production to maximize
returns. And oligopolies tend to collude in various ways and so
end up behaving like monopolies. So if things don't go according
to plan, the losses will be borne by citizen-consumers.

Instead of privatizing businesses, the government could seek
to reform them. Some would dismiss this suggestion, claiming,
"the private sector can manage ... productive assets more
efficiently [read: less inefficiently] than the state", as
written by the above Senior Deputy Governor of the Bank of
Indonesia. But if one looks at independent international studies
of privatization themselves (rather than the IMF's selective
interpretations of them), one finds, generally speaking, that
public firms can be either as efficient as private firms, or
cannot be compared with them because they have social rather than
commercial objectives. Ownership isn't a relevant variable.

Reform would involve a radical change in public-corporate
culture. Ideally, the government would aim for professional,
corruption-free, accountable management that is legislatively
directed to meet socially responsible goals with respect to
pricing and output. Achieving this would be something of a
macroeconomic coup -- certainly more so than a bungling
government-sponsored garage sale; and thus a brilliant
demonstration to investors of the government's skills as a
microeconomic manager. Maybe this would have the same desired
affect on investor confidence as privatization.

Of course, no-one can say for sure whether this would turn the
animal spirits in favor of Indonesia, but no-one knows whether
privatization will either. It is relatively certain, however,
that efficiently reformed government owned businesses would
provide more scope for protection against consumer exploitation
that would unregulated privately owned monopolies and
oligopolies.

Undesirable effects of privatization could indeed be mitigated
by substantial government regulation of the privatized companies.
These companies might have to meet, say, certain community
service obligations and have to conform to anti-trust type
legislation. Perhaps the government could also seek to support
and encourage new competitors into the respective markets of
privatised companies.

No doubt ideologues and consultants would argue against such
measures, evoking the rhetoric of "the free market", but
independent economists would be more likely to support such
measures insofar as they make for a competitive market.

The paradox of such measures, however, is that although they
are good for the micro-economy, they tend to make public assets
less attractive to buyers and so decrease their potential sale
price even further below that of their "true" value as public
assets.

The up-shot of all this is that the government is taking a
gamble with privatization. It is selling public assets on the
off-chance that this will have a positive effect on investor
confidence and so help drag the economy out of the doldrums. In
the process it is willing to sacrifice the possibility of genuine
microeconomic reform that would, if handled correctly, definitely
benefit citizens in the long run. Then again, can we seriously
expect to see the government do something as ambitious as fix up
its own businesses?