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?