Economics & asset sales: Why governments get consistently ripped off

Governments are bad negotiators, because democracy demands they tip their hand before going to the bargaining table. That means governments get the short end of asset sale deals

A common claim in favour of asset sales is that the sale price is usually the “net present value of future profits”, which means that the sale price plus the interest you save on your lower debt is about the same, over the long term, as the dividends you would have made from keeping the asset. Where does this claim come from?

It comes from basic microeconomics, where if these two things weren’t more or less the same then one of the parties would not rationally want to make the deal. The idea is that asset sales are a way for the government to make all the money they would have made owning the asset, without the hassle and risk and inefficiency of being in the power / telephone / airline business.

The problem with that way of thinking is that governments are not rational profit-maximizing economic actors.

The thing politicians care about most of all is votes, not money. Sometimes being prudent with public money brings in votes (e.g. promising to scrap hip-hop tours), and sometimes it does not (e.g. Labour’s debt-reducing surpluses). Asset sales are a case where the government has strong political incentives to make a sale, even when the sale price represents a poor financial return.

Here is how it works in the two most common forms of state asset sale:

Sales to “Mums and Dads”

When governments sell assets to everyday folk by way of a share float, their incentives are convoluted. They have an obvious financial incentive to reap as much from the sale as possible, but they also have strong political incentives to make sure the float is oversubscribed (so that the asset sales policy appears popular) and also to avoid the impression of pricing Mums and Dads out of the market (so as to avoid their ire at the ballot box).

Both of these political incentives serve to lower the price the government is willing to charge for its assets. An over-subscribed float is a sign of a lowball float price, because the government could have increased its sale revenue by raising the share price so that a few potential investors no longer register for shares. A share price that increases immediately post-float is another sign of a government ripping itself off. Yet these are also two things that governments work **towards**, as they politically signal a popular policy and bring quick gains for the lucky "Mums and Dads."

Sales to firms

The other way to sell assets is directly to large firms. New Zealand’s government says it isn't doing that this time (at least directly), but it is worth considering the dynamic anyway. Firms, simply put, care only about delivering financial value to their shareholders. Governments, on the other hand, care about much more – especially perceptions of political competence and ideological coherence. This provides a massive negotiating advantage to the kinds of firms that purchase state assets such as utilities.

Firms know that asset-selling governments have large amounts of political capital tied to the act of making a sale, and that the government has some wiggle room with the public (who are not all utilities analysts) in terms of spinning what a fair price would be. Governments are the classic “motivated seller,” a position that invariably brings in a low sale price.

Some may think that this problem does not arise if there are multiple firms bidding on the asset, because they will competitively bid it up to its fair price. Not quite.

If there are multiple firms bidding on a government asset, they will indeed bid it up – but the end point to the competitive bidding is not fair market value for the asset, it is the cost of the next best opportunity for the firm. If there are even a smattering of opportunities around to purchase some government’s assets without paying full market value, then that will bring down the sale price on all the other asset sales. Do those few opportunities for monopoly buyer profits exist?

Yes. The number of firms prepared to place large investments in heavily regulated sectors in the far south west Pacific is sometimes disturbingly small (especially in the current context of an overvalued currency). Exhibit A: The Great New Zealand Radio Frequency Debacle, where a firm was willing to pay $100,000 for a frequency, but the government only charged them $6 for it. Yes, $6.

Think about selling a home. When you sell your house, everyone knows that you should posture as a reluctant seller, because that it how you induce higher bids. Buyers who smell a desperate seller make low offers.

Asset-selling governments publicly showcase their almost giddy excitement at the prospect of selling up, portraying themselves as overly eager sellers. That brings unfairly low prices for governments and, through them, for everyone.