February 15, 1988
Stuart M. Butler is Director of Domestic Policy Studies at The Heritage Foundation. He testified before the President's Commission on Privatization on January 22, 1988. ISSN 0272-1155. 01988 by The Heritage Foundation.1) Well-structured asset sales do lead to economic benerits to the nation and to a real improvement in the condition of federal finances. Thus asset sales would be good policy even if the federal government were enjoying a healthy budget surplus. 2) Certain creatively designed asset sales can help the public interest by enabling government to reach public policy goals more effectively than is possible by retaining full control of the asset. Thus asset sales actually could be the best way to help those whom society wants to assist. 3) Asse t sales can be a highly successful vehicle for widening the base of free enterprise in the United States and abroad, and privatization therefore should be a central feature of U.S. policy for encouraging economic development and political stability in les s developed countries. Thus the strategy of asset sales could further U.S. economic development policy abroad and help the quest for democracy.
THE ECONOMIC BENEFITS OF ASSET SALES
The buying and selling of assets is a basic feature of American capitalis m, from Wall Street to Main Street. These sales take place - in the vast majority of cases - not to accomplish a mere bookkeeping purpose, but because there are economic advantages to both the buyer and seller. For the seller, the cash raised and the flex ibility it gives him are more advantageous than actually holding the asset. For the buyer, the value he places on the purchased asset is greater than the value he gives to the cash.
How Sales Improve Efficiency
In the case of strictly income-producing ass ets, such as businesses, transactions occur because the buyer estimates that under his management the business will yield greater income than under current management, while the seller is offered a price that is greater than the present value of future re t urns he expects under his own management. This potential for improvement in income under different management is why it often makes sense for the owner of a profitable business to sell, and it is why even a chronically money-losing business can sell for a good price.
Moreover, in the aggregate, such sales in the private sector lead to a net general economic gain. The reason for this is that the change in management leads to an improvement in the use of the assets; that is, an improvement in productivity. T his is good for the general health of the economy. Only in those cases where the buyer misjudges the potential of the asset under his control might there be a net general economic loss, because the asset passes into the hands of a less competent manager. But buyers who make such mistakes do not last long in the market, while shrewd buyers prosper. Good managers d.rive out bad, to the benefit of the whole economy.2
This process is exactly the same in the case of government-held assets, although many crit ics of such sales seem to misunderstand that. When a government asset, such as Conrail or part of the federal loan portfolio, is put up for sale, potential bidders estimate the potential returns that could be derived Erom. the asset under their control. W i th rival buyers in competition, the market price for the asset will reach the point at which the bidder (or group of investors in the case of a public offering) with the greatest degree of confidence offers a price reflecting the best likely future return .
Why should the government accept such a bid in the public interest? Because unless the federal government is a more efficient manager than all the rival bidders, the bid price for the asset will be greater than the current value of the future income unde r federal control. In other words, the cash that the government can raise, and use to reduce debt or pay for federal outlays, is greater than the discounted value of future earnings from continuing to hold the asset.
Why Public Ownership Is Less Efficient
In the case of chronic money-losing assets, this benefit to government is obvious. Selling uncollectible loans for even a few cents on the dollar means the government receives something. But it holds true even when the asset is earning money, assuming th e government is not the most efficient possible manager.
There are good reasons to suppose that government will not be the most efficient manager - indeed there are reasons to believe that it will be one of the least efficient. For one thing, federal owne rship usually means some degree of monopoly status or at least some protection from competition. This is true in the case of the Postal Service, for instance. Whether in the private or the public sector, freedom from competition means freedom from the nee d to be efficient. For another thing, even the best federal managers have to labor under constraints that do not occur so strongly in the private sector. Federal managers generally face more bureaucratic red tape than managers of similar operations in the p rivate sector. And they have to factor in the political reality of powerful congressional chairman who often demand that local constituency benefits be provided, even when this reduces efficiency. A manager of Amtrak who ignores politics when considering t he closure of an unprofitable line or station will soon find himself out of a job. These constraints in the public sector force good managers to make bad decisions knowingly, leading to inefficiency. Not surprisingly, when many frustrated public sector ma nagers move to the private sector, they are far more effective.
Thus the sale of a federal asset is not merely a convenient bookkeeping exchange to make the deficit look better. It is instead an important economic transaction, benefiting both buyer and sel ler and thus improving net national economic efficiency. The value of that net improvement efficiency is reflected in the difference between the bid price and the (lower) discounted value of future earnings in government hands. It is shared between the bu yer and seller according to political and market conditions and to the comparative bargaining skills of government and private negotiators.3
Does a Sale Help the Long-run Deficit Picture?
Clearly any asset sale helps the immediate deficit picture throu gh an infusion of cash, just as selling a subsidiary may raise cash for an ailing company. This can be beneficial in itself. If it gives the federal government breathing space to carry out more orderly restructuring and reductions in costly programs, as a n alternative to the savage and inefficient across-the-board cuts that might otherwise be required, it will help the long-term picture by permitting a better process of reorganization. In the same way, selling that subsidiary can give a company time to res t ructure itself and weather the storm. But clearly, if government simply uses asset sales to delay necessary action, it has squandered the opportunity presented by asset sales - although, it should be recognized, the economic benefits of the asset sale, as discussed above, will still occur even if the opportunity to improve public finances is lost.
The potential advantages of the sale are not confined to breathing room, however. When an asset is sold, it reduces either the existing debt of the government or its future borrowing requirement. By reducing this debt or borrowing requirement, the government simultaneously cuts the interest payments it needs to make in the future. Thus the effect of the sale lasts well beyond the immediate infusion of cash.
This effect is very similar to selling a private house. When the homeowner sells, his indebtedness declines and he raises cash. But in addition to that, he no longer has to make monthly mortgage payments. So not only does he obtain the immediate "one-shot" ben efit of the sale, but his annual outlays are cut. Exactly the same thing happens when the government sells an asset.
This long-term benefit is obvious in selling a loss-making asset, where the government reduces its interest costs and also cuts future outl ays to subsidize annual losses. But even selling an income-generating asset (like Conrail in 1987) makes good public finance sense. The market valuation of the asset embodied in the purchase price is higher than the discounted value of the asset in govern m ent hands, reflecting the greater flexibility and efficiency of private sector managers. Thus the interest payments the government can avoid with the cash it raises will be greater than the interest charges it can defray with the income it will generate b y holding on to the asset. Avoiding interest charges altogether by selling Conrail, for example, meant more savings for the taxpayer than simply holding on to the railroad and using its income to offset future interest charges.WHAT ABOUT THE PUBLIC INTEREST? Critics of asset sales point out, correctly, that government does not own assets merely because it wants to be in business. It does so for the most part because it believes that owning the asset provides the government its best way of reaching a publ ic interest goal. Thus the government owns financial assets because it wants to make it possible for certain students to enter college; it continues to own Amtrak because Congress believes that providing rail transportation to those who travel on Amtrak s erves some public purpose; it
4owns forests and wilde mess areas because it wants to protect the environnient; it operates public housing with the aim of providing shelter to the poor. These critics maintain, again correctly, that if such assets were simply handed over to the private s ector, in all likelihood many aspects of these services would be discontinued as unprofitable. Thus, it is said, government ownership is needed, even if it is'much less efficient, to guarantee continued provision of these services. Alternatives to Direct Government Ownership Leaving aside the issue of whether or not such services should be provided, the fact is that ownership of an asset is rarely the most efficient or effective way to secure any service. Careful use of privatization can serve the benefici aries far more efficiently, and in certain instances the creative use of asset sales can lead to public policy benefits well beyond those already being provided under government ownership. Covenants. For instance, adding covenants (requirements that the p urchaser perform a service even if it is uneconomic) to an asset sale agreement can ensure that the purchaser continues serving specific groups, while also introducing private sector efficiency into the provision of the service. Thus the public objective c an be realized while efficiency is improved and the cost to the taxpayer reduced. Covenants attached to the 1987 Conrail sale agreement, for instance, required the new owners to continue certain operations for an agreed period. Covenants attached to the s ale of British Telecom by the Thatcher government in 1984 included such provisions as the requirement to serve even unprofitable customers and to maintain a series of emergency payphones across Britain. It should be remembered that, by requiring such coven ants, the attractiveness of the asset to a private buyer is reduced and the bid price thus will be lower. In addition, as in the case of the Conrail sale, powerful politicians often will use covenants to provide special-interest protections and benefits b y forcing the buyer to maintain services that reward constituents rather than pursuing the public interest. But although these reduce the gains from the sale, all they do is make explicit the social costs currently carried under public ownership. Efficienc y gains are still obtained, and public finances are still improved - just not as much as they would be without the special-interest covenants. Regulation. An asset sold to the private sector also can be regulated, bearing in mind the long debate about the effectiveness of regulation versus competition as a form of consumer protection. The British are currently wrestling with this issue. Several large government commercial assets, including British Telecom, were sold as regulated monopolies rather than firs t being broken up to promote competition. The government is now reviewing this strategy with an eye to future privatizations and considering steps to encourage greater competition in existing cases. Vouchers. Some mixture of asset sales and other forms of privatization also may be more effective than public ownership. Take the case of housing. By shifting from government ownership or subsidized construction of housing to a policy of housing vouchers, the government can gain the benefits of a more efficient market mechanism for supplying housing, while ensuring that the families that the government intends to assist have the
5means to obtain housing in the market in spite of their low income, which otherwise would keep them out of the housing market. An d incidentally, such a voucher system means that only those families are assisted, and not the developers, construction firms, and public housing managers who prosper so much under government ownership. Wider Public Policy Goals Asset sales combined with such other devices as covenants or vouchers can do far more than just reach existing goals more efficiently. In some cases the change of ownership, of itself, can fundamentally change the social and economic dynamics of a situation, such that unexpected positive effects occur. Housing. Again, take the case of housing. In their program to sell public housing to tenants, the British have discovered not only that the approach improves the finances of government-assisted housing programs, but also that the ownership change itself h a s led to a transformation of the projects involved. Homeownership leads residents to assume a very different attitude toward their neighborhood and their housing. A walk through such a project shows the effects of this change very clearly. New homeowners have been improving their homes and gardens, and they have been taking action to protect the value of their investment by cleaning up common areas and tackling such social problems as vandalism. The experience in the United States suggests that there will be similar results when the privatization provisions of the recent housing legislation take effect. The new law allows successful tenant-managed public housing projects to move to homeownership. Just with management control, tenants in such projects alrea d y have achieved quite dramatic social as well as economic improvements, as this Commission learned during its hearings on the subject. Tenants and other advocates of full privatization agree that the homeowner incentive will spur greater improvements. At last, privatization may enable these projects to become ladders out of welfare and decay, as they were intended to be, rather than sinkholes for the hopeless, as public housing has become under public sector control. Public Lands. Similar arguments have be en advanced in the case of public lands. Environmentalists of the New Resource Economics school point out that public ownership of forests, rangeland, and wilderness areas is actually ownership by nobody, and that the lands therefore are operated accordin g to bureaifcratic and political incentives, not primarily in the interests of the environment. They note that many environmental organizations, such as the Audubon Society and the Nature Conservancy, own some wilderness tracts privately and that these are managed far better than those operated by the government. As direct owners, these groups have the incentive to consider the long run and not just this year's federal budget allocation. They are interested in preservation, not creating Forest Service or Na t ional Parks Service jobs. And they are prepared to allow carefully screened energy and mineral exploration to raise revenues for the purchase and protection of additional land. As do good museum trustees, these private owners use carefully screened commer cial activities to raise money for additional land purchases, and trade lands to improve their "collection" and thus pursue their overall goals. The New Resource Economists argue that control of wilderness lands should be transferred to a
6Wilderness Board, consisting of respected environmental organizations, so that the objectives of public ownership can be pursued more effectively than is possible by keeping these lands under the bureaucratic control of the federal government.
WIDENING THE BASE OF PRIVATE OWNERSHIP
The third key aspect of asset sales concerns the way they can be used to further the objective of wider capital ownership. While this is an important policy goal in the United States, it is even more important for U.S. policy abroad.
In Britain, France, and Japan, and in some less developed countries such as Jamaica, asset sales have been combined with a strategy of wider share ownership and more extensive employee ownership. By aiming large privatization public offerings at the small i n vestor, for instance, Britain has increased the number of households owning shares of any kind by a factor of three and the number of blue-collar stockholders by a factor of five. Commentators generally agree that this wider ownership has helped to reduce the deep class divisions between "them" (owners) and "us" (workers) which for decades have held back British industry.
Britain has also experimented with outright employee ownership. The National Freight Corporation, Britain's largest trucking firm, a los s-making, government-owned operation, was sold to its employees in 1982. At its last annual stockholders' meeting, worker-directors announced that a unit of stock purchased in 1982 is now worth forty times its original value, thanks to the dramatic improv e ments in productivity and profitability achieved by the new owners. The worker-stockholders made it clear to the media that there was nothing magical about the transformation; when you own the company you work for, they said, you work harder and you elimi nate restrictive work practices rather than expanding them.
The United States has had long experience with employee-owned enterprises, and worker takeovers have managed to save a number of firms seemingly destined for bankruptcy, such as the Weirton Steel Company of West Virginia. Employee-ownership models should be considered aggressively within the context of privatization in the United States and in the less developed countries.
AmtraL Amtrak's northeast corridor and parts of the Postal Service would se em to be candidates for serious consideration. If Britain's National Freight Corporation experience is any guide to the potential, transferring the Washington-Boston corridor to Amtrak workers at an attractive price could have dramatic effects on producti v ity and the financial bottom line. Instead of privatization posing a threat to Amtrak workers, it would then become an opportunity for workers as owners to gain directly from improvements in productivity. And instead of Amtrak being a money-losing albatro ss that cannot be sold because of worker and rider opposition, it could become an efficient alternative service without draining the Treasury.7
The Postal Service. Similarly, transferring, say, the Postal Service's bulk mail system to its employees at a suitable price would allow the worker-owners to compete head-to-head with private competitors without having one hand tied behind their backs wit h federal red tape. The result would be better service for customers and a better deal for workers.
Promoting Economic Democracy Abroad
Employee ownership also should be a central feature of U.S. development policy abroad. Treasury Secretary James Baker, together with the Agency for International Development, has already made the transfer of commercial assets to the private sector a condition for certain assistance. This is a welcome step - but only a first step. If such privatization took the form simply of transferring control from government bureaucrats to their cronies in the private sector, or even to large international private firms, it very likely still would be opposed by some moderate and most leftist governments, and it would maintain the popula r image of capitalism as control by a powerful oligarchy. If, instead, privatization took the form of spreading ownership through wide stock ownership (where that were feasible) or though worker ownership, the resulting "democratization" of capitalism coul d be a powerful force for free enterprise. By associating capitalism with worker control, this form of privatization would be more palatable to unions and to socialist leaders. And by introducing incentives for productivity improvements, it would help spur the economy - an attractive benefit for employees and for political leaders of all persuasions.
Thus worker-ownership as a form of privatization should be an important dimension of U.S. development policy overseas. In Central America, in particular, there is a tradition of employee ownership through such organizations as the Solidarista labor movement. As Ambassador William Middendorf argued in his report on economic development in the region, the High Road to Economic Justice, presented to President Reag an last year, U.S. policy should build on this tradition by linking privatization to employee ownership. This, said the Ambassador, would mean a policy of fostering economic democracy alongside the current strategy of encouraging political democracy.
Good Public Policy. Asset sales are an important form of privatization. Unfortunately, though perhaps understandably, the discussion of such sales has focused almost exclusively on their impact on the deficit, and even that discussion has been marred by a misu n derstanding of the true effect of sales on public finances. The fact is that asset sales are good public policy whether or not the government is in deficit, because they can achieve more important objectives than simply making the deficit books look bette r . Asset sales can lead to genuine improvements in the economy, because of the efficiency gained through ownership changes. They can be used to achieve public policy objectives more effectively. They can help ordinary Americans obtain better services. And they can give employees an opportunity to obtain rewards for enhanced productivity8