27 January 2009

Australian Economists on Bank Public Ownership

It seems the premium the banks pay as private enterprise units comes at the cost of systemic risk.....

It turns out that there is economic research on this issue. Interestingly, the main contributions have come from Australian economists who did this research a decade ago only to be told by international journals that as privatisation had occurred everywhere by then, no one was interested in the conditions under which government ownership would be preferable. Well, I guess that view is wrong.

So what are the contributions? Well, the first stream comes from Simon Grant and John Quiggin. Their argument was simple. The equity premium in financial markets (that is, that stock owners seem to require a higher rate of return than debt holders) comes from an inability to insure against systematic risk. Governments, through their power to tax, can, in fact, provide that insurance and so face a lower cost of capital. End conclusion: so long as there aren’t too many other inefficiencies from pubic ownership, it is preferable to private ownership.

Grant and Quiggin had to dress this up as a paper on social security privatisation to get it in as a shorter paper in the American Economic Review. But this Economica paper deals with the main idea. And it is this line of argument that has driven John Quiggin’s contributions to the recent debate.

But there is a sense that this falls short as a rationale for nationalisation. To be sure, the issue of systematic risk lies at the heart of all this (see Ricardo Cabellero) but there is a difference between the ability to raise capital at a lower cost and ownership per se. After all, if the government can get capital from foreign or domestic borrowers more cheaply than the companies themselves, they should just get that capital and provide cheaper finance. No need to manage assets on a day-to-day or strategic basis if that is the problem you are trying to solve. Indeed, this is arguably precisely what the Australian government is doing with its property fund.

We need to go to the other stream of research to understand why government’s should actually own some assets. Core Economics’ own Stephen King and Rohan Pitchford, in a series of papers, analysed that issue (here and here; the last one isn’t publicly available — apparently these two authors aren’t into open dissemination!). The research is grounded in the property rights theory of the firm. That theory says that it is optimal to grant ownership to agents who are either essential or who undertake important, and not easily contracted on, actions. So, for instance, if you believe that government managers do not have enough incentives to contain costs, you want privatisation. On the other hand, if you believe that there are some big externalities associated with some investments, you might want government ownership. And as examples of the latter consider the disposal of toxic waste and the ownership of the last mile copper Telstra network. In each case, private owners will undertake actions on those assets missing some big externalities (negative and positive) whereas a government might more easily internalise them.


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