Massimo Florio, Department of Economics, Business and Statistics, University of Milan

1
Massimo Florio, Department of Economics, Business
and Statistics, University of Milan

• THE WELFARE EFFECTS
• OF PRIVATIZATION
• AND UTILITY REFORM
• Inter-American Development Bank,
• Washington DC
• April 25, 2005
• Presentation based on
• Carrera J., Checchi D., Florio M. (2005),
  Privatization discontent and its determinants
  evidence from Latin America
• Florio M. (2004), The Great Divestiture.
  Evaluating the welfare impact of British
  privatizations 1979-1997, Cambridge (MA), Mit
  Press
• Brau R., Florio M. (2004), Privatisations as
  price reforms Evaluating consumers welfare
  changes in the UK, Annales déconmie et de
  statistique, n.75-76, 109-133
• Florio M. (2003), A State without ownership the
  welfare impact of British Privatizations
  1979-1997

2

RESEARCH MOTIVATION

• Privatization has been a major policy reform in
  the last 20-30 years. Chile and UK paved the
  way to a worldwide trend, then the transition
  economies followed. Denationalization is still
  important in many EU countries and elsewhere,
  including Latin America.
• Utilities (electricity, gas, telecom, water, etc)
  are often the key industries for a privatization
  policy. Changes in economic welfare potentially
  affect millions of users. There are concerns
  about redistribution impacts, and increasing
  popular opposition in some countries
  (particularly in LA, but in the UK and elsewhere
  as well)
• We need to evaluate welfare changes caused by
  utility reforms in order to offer feasible policy
  advice.
• If possible, we need to disentangle the welfare
  effects of privatization from regulation and
  liberalization. These in principle are different
  policies we can observe and evaluate different
  combinations (across countries, over time)

3
EARLIER RESEARCH

• There is a huge empirical literature on
  privatization (Megginson and Netter, JEL, 2001)
  1717 books in Amazon 1516 books at the LSE
  Library, thousands papers in REPEC and SSRN, etc.
• This literature however typically focuses on
  efficiency in a narrow sense. Most of the
  research takes a business economics, or financial
  perspective. Limited evidence on allocative
  efficiency, very few studies on welfare effects.
• Most of the literature concludes that
  privatization raises profitability . This is
  true, but not very relevant for economic welfare
  (monopoly profit argument) 
• Many productivity studies in the EU, Latin
  America, and elsewhere typically consider
  company accounts or crude productivity
  indicators some years before and some years
  after divestiture and find that labor
  productivity increases after divestitures
  (less strong evidence for TFP) . However, with
  this approach, you very often would get the same
  for nationalization in the 50s and 60 in
  Western Europe. We need long time series, and
  control for exogenous shocks. Florio (2003) and
  Florio and Puglisi (2005) study 40 years of
  British Telecom data, and find no statistically
  significant impact of ownership change.

4
EARLIER RESEARCH (2)

• Galal et al (1994), Newbery and Pollitt (1997),
  Newbery (2000), Pollitt (several papers), and
  others use social cost benefit analysis to study
  specific companies or industries. Florio (2004,
  The Great Divestiture. Evaluating the welfare
  impact of British Privatisations 1979-1997,
  Cambridge (MA), the Mit Press) uses CBA to
  evaluate the whole UK programme (1979-1997).  
• Waddams Price and Ugaz (2003) study
  redistribution effects in LA. See also Chong and
  Lopez de Silanes (2003), Estache (2003, Several
  country studies Galiani et al (2003), Anuatti,
  Neto et al (2003) on Brazil Aspiazu ans Schorr
  (2003), Chisari et al (1995), Galiani et al
  (2003) on Argentina, Barja et al (2002) on
  Bolivia, Paredes (2001) on Chile, Torero and
  Pasco-Font on Peru (2001).
• Example Delfino and Casarin (2003)

5
EARLIER RESEARCH (3)
6
Privatization discontent in Latin America

• Carrera, Checchi and Florio (2005) analyse
  privatization discontent in Latin America.
  Evidence of wide dissatisfaction Latinobarometro
  (2002), 18522 respondents in 17 countries to the
  question
• The privatization of state companies has been
  beneficial to the country?
• AROUND TWO THIRDS DISAGREE.
• (Similar evidence for several polls in the UK,
  MORI and other surveys)

7
Research question does perceived privatization
failure reflect distributional issues?

• We use
• the full demographic information on the
  individual respondents (including age, sex,
  education, employment, if they access to drinking
  water, sewage, telephone, if they own a
  refrigerator, pc, washing machine, car, etc)
• a privatization dataset including 430 events in
  the LA countries, with several information
  including the share of utilities (gas, water,
  electricity and sanitation) in total proceedings
• macroeconomic controls GDP growth, Gini index,
  government spending, measure of deprivation.

8
FINDINGS

• We find statistically significant evidence that
  privatization discontent in LA increases with
• large and quick divestitures programmes
• a high proportion of utilities
• income inequality in the country
• and when
• there are macroeconomic adverse shocks
• the respondent is poor
• the respondent is relatively better educated.
• Several of these features could be observed in
  the archetypal privatization story Great Britain

9
Fig. 1 -Estimates of the impact of education and
socio-economic level on support to privatization
Latin America 2002
10
Fig. 2 -Estimates of the impact of education and
ownership of durables on support to
privatization Latin America 2002
11
Research objectives
An evaluation of the long-term welfare impact of
divestitures of public enterprises in the UK
Motivation
British privatisations are an ideal case study in
economic-policy evaluation
Five reasons
1) The UK case study is a large scale one and in
principle major welfare impacts should be
observable in the long run 2) An assessment of
the British experience is relevant for an
international debate on the economic role of the
state. 3) We have long time series for several
industries, and we can study two quite different
policy environments (before and after 1979) 4) We
can capitalize on a wealth of high quality
empirical analysis (more than 300 papers and
books) 5) No previous evaluation on the overall
impact (on individual industries Galal et al
1994, Newbery and Pollitt, 1997, Waddams-Price,
Hancock 1998, Newbery 2000).
12

The CBA framework
Different approaches 1) microdata -
partial equilibrium - general equilibrium
2) inter-temporal public budget at shadow
prices 3) macroeconomic welfare function
13
STEP 1 CONSUMERS

• gross welfare change for consumers through
  observed prices change
• (indirect effects on other industries and then
  other consumer prices)
• less counterfactual welfare change under
  continued public ownership
• less correction for distributional welfare
  weights
• (or less additional extra-profitsoutput valued
  at marginal cost)
• (and less excess burden of additional
  extra-profits)
• CONSUMERS NET SOCIAL WELFARE CHANGE

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STEP 2 SHAREHOLDERS

• net present value of gross (extra) profits
• less price paid to by the privatized assets
• less NPV of corporate taxes
• (less windfall tax)
• distributive correction for high incomes
•  
• SHAREHOLDERS NET SOCIAL WELFARE CHANGE

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STEP 3 TAXPAYERS

• privatization proceeds
• corporate taxes (and windfall tax)
• less foregone extra-profits
• correction for the shadow pricing of public funds
• SHAREHOLDERS NET SOCIAL WELFARE CHANGE

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STEP 4 EMPLOYEES

• change in wages under private ownership
• less counterfactual change under public ownership
• correction for shadow wages
•  
• EMPLOYEES NET SOCIAL WELFARE CHANGE

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STEP 5 OVERALL BALANCE

• CUNSUMERS NSWC
• SHAREHOLDERS NSWC
• WORKERS NSWC
• TAXPAYERS NSWC
•  
• WELFARE IMPACT OF PRIVATIZATIONS

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CONSUMERS

• Price trends
• Comparison between the trends in nominal prices
  before and after privatizations
• Electricity
• Gas
• Water
• Bus
• Railways
• Telecom
• Scarce evidence of structural breaks following
  privatization, and different shocks
• regulatory impact (price controls)
• liberalization (monopoly, duopoly, regional
  oligopoly, collusion, open competition)
• exogenous/endogenous change in costs
• side-impact of other policy changes (eg.
  environment laws)
• changes in quality, information, contractual
  arrangement

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Fig.3 Water. Retail prices (relative to RPI)
1995 1
20
Fig.4 Electricity. Retail prices (relative to
RPI) 1975 1
21
Fig.5 Gas. Retail prices (relative to RPI).
1975 1
22
Fig.6 Coal. Retail prices (relative to RPI)
1975 1
23
Fig.7 Rail. Retail prices (relative to RPI)
1975 1
24
Fig.8 Bus. Retail prices (relative to RPI) 1975
1
25
Fig. 9 - Household expenditures on privatized
utilities services, 1974-1998. Percentage share
of total consumptionSource our processing of
ONS data
26
Fig. 10 Welfare changes by privatised industry.
Millions 1994 costant Lst 1984-1999, at median
years expenditure
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SHAREHOLDERS TAXPAYERS

• Social dimensions
•  
• popular capitalism
• share owners from 2,5 millions 80s to 11end
  90s, but
• 54 of individual shareholders own shares in only
  one company
• 83 of individuals own portfolios of no more than
  3 shares (unefficient, marginal, shareholding)
• and only 17 in four or more.
• In 1957 almost two-thirds of shares were owned by
  individuals. In 1997 16,5
• Foreign sector the biggest owner 24
• Then unit trusts, pension funds, etc.

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Underpricing

• -BT recorded a price difference of 33 after the
  first trading day (subsequent tranches were less
  underpriced).
• -tender offers (ABP, BAA, BP, Britoil, CW,
  Enterprise Oil) underpricing was nil
• -a multiple of the value of the offering e.g. 32
  times for BA, 35 times for ABP, typically 7-8
  times greater than supply.
•  
• Cawthron (1999) the IRR of 38 placements up to
  1997, based on the return for the holder of a
  share at May 31st, 1997 assuming that the share
  was purchased at the issue price or on the
  secondary market 24 hours later. The difference
  between the two rates gives us an idea of the
  underpricing. The absolute difference in the real
  IRR varies from a minimum of 3-4 points to over
  10 (on average 5.7 points) (25 difference).
•  
• Levis (1993) examines 712 IPOs in the UK over the
  period 1980-88, roughly the same period as that
  studied by Vickers and Yarrow (1988) and finds
  that the average abnormal adjusted return after
  24 hours is 14.3.

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Abnormal returns in the long term

• International empirical literature shows that
  with ordinary IPOs, subsequent negative abnormal
  returns correct the excessive reaction of the
  market.
• Levis (1993) finds that for a period of 36 months
  there is evidence of underperformance also in the
  case of the UK the cumulated abnormal return of
  the IPOs as a whole was 55.72, that of the
  privatised firms was almost double 96.91.
• Florio, Manzoni (2002) sample of privatised
  firms (55 cases), extending the analysis to
  different periods of time 1 year, 5 years, 10
  years (for the latter the sample was reduced to
  14 cases). We excluded the first month, so the
  initial underpricing is not included.
• We confirm that there is clear evidence of
  abnormal returns in the long run (using the FTA
  index as a benchmark).
• The cumulative abnormal returns are 21 at one
  year 30 at two years 57 at five years and
  down to 38 at 10 years (for a smaller sample).
• We decompose the results by subsamples,
  particularly by industry, and by the time of the
  public offering and other variables.

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Fig. 11 - Electricity industry performance
31
Fig. 12 - Telecommunications industry performance
32
Fig. 13 - Energy industry performance
33
Fig. 14 - Transport industry performance
34
Fig. 15 - Public sector net worth - net debt (
of GDP)
Source HM Treasury, 1999
35

• HM Treasury (1998) admits that
• privatizations may have had an effect on net
  wealth insofar as the balance sheet valuation of
  the underlying asset was different from the
  privatization proceeds received in some cases
  the differences seem to have been significant and
  we think that this would mainly reflect
  inaccurate valuation in the balance sheet data
  (or perhaps valuation on a different basis).

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WORKERSFig. 16 - Employment Thousand units
37
Fig. 17 - Employment Thousand units
38
Fig. 18 - Employment Thousand units
39
Fig. 19 - Relative Average Hourly Wages of Males
Full-Time Manual (Source ONS, NES data)
40
Fig. 20 - Relative Average Hourly Wages of Males
Full-Time Non-Manual
41
Fig. 21 - Relative Average Hourly Base-Wages of
Males Full-Time Manual
42
Fig. 22 - Relative Average Hourly Base-Wages of
Males Full-Time Non-Manual
43
Conclusion a conjecture on the overall welfare
balance

• The assumptions
• - we focus on 4 agents
• consumers,
• workers,
• shareholders,
• taxpayers.
•  -We guess the actual welfare change for each
  group, then we sum the values the balance is the
  gross welfare change for the society.
• - The net welfare change is defined as the actual
  gross value, less a virtual value for a
  counterfactual scenario of continued public
  ownership
• - All values are expressed in constant 1995
  sterling
• - the social discount rate we use is real 5
• - end of the period 1979-1997 and then stay
  unchanged with an infinite time horizon we
  convert all yearly values in their NPV perpetuity

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RESULTS

• a) Consumers
• Without any shadow pricing and with a prudent
  benchmark counterfactual (nationalized industry
  would have been able to offer only 50 price
  decrease), the observed consumers net welfare
  change at 1997 was around Lst 2 bn.
• With shadow pricing and correcting for
  redistributive impacts, there is probably a small
  net welfare loss as compared with optimal
  regulation or continued public ownership at
  marginal costs.
• b) Shareholders
• 1) pay to buy shares,
• 2) enjoy capital gains by underpricing and
  ouperformance
• 3) pay corporate taxes.
• Suppose extraprofits (gross of taxes) were 7
  billion per year. Taking the Corporate Tax rate,
  which is around 30, as a reference point we
  would have 2.1 billion yearly as a tax burden
  for the shareholders. Taking the higher estimate
  supplied by HM Treasury (1995), or data by NERA
  (1996), we would have 2.8 billion, whose
  perpetual value at 5 is 56 billion.
• Thus the Treasury receives around 126 billion of
  discounted sterling, 70 billion from
  privatisation proceeds 56 billion from
  corporate taxes. Buyers pay 70 billion and they
  appropriate excess profits, net of taxes, of 4.2
  billion a year, whose perpetual value is 84
  billion.
• The result is a net benefit to shareholders of
  14 billion, or 20 of underpricing.

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• c) Taxpayers
•  
• Conversely the loss suffered by taxpayers is
  equal to all of the underpricing. The above
  reasoning can be easily repeated. The Treasury,
  on behalf of the taxpayers sold at 70 billion
  assets worth 84 billion to the buyers, thus it
  was unable or unwilling to extract by them all
  the potential rents.
• Correction for the shadow price of public funds.
• Because public funds have a shadow price due to
  distortionary taxation, with a 0.30 correction,
  the net loss to the taxpayer is around 18
  billion.
•  
• d) Workers
•  
• We did not find clear evidence that employment
  and pay under the counterfactual would have
  differed much from the actual trend under private
  ownership.
• Blue-collars suffered a welfare loss and top
  managers and part of the white-collars enjoyed
  increased rents. But the evidence so far is not
  enough to guess a figure for the average workers
  welfare change. Presumably there was a regressive
  redistribution of income, but we are unable to
  quantify it. Thus we suggest no change.

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CONCLUSION

• Overall balance without shadow prices
• Our overall result, without the use of any shadow
  price, would be that
•  taxpayers suffered a loss of 14 billion,
• but this was cancelled out by the equivalent
  transfer to shareholders (privatization price
  doesnt matter here),
• workers welfare was probably slightly negatively
  affected, but overall this impact was negligible,
  
• consumers enjoyed a perpetual net discount on
  prices worth around 35 per capita during the
  privatisation years 1979-97, or a perpetuity of
  700 per capita. With indirect effects and the
  most generous assumptions, no more than 1000 per
  capita. This is also the overall perpetual
  welfare change for the UK.

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• Overall balance with shadow prices
• If we consider monopoly profits as costly rents,
• we introduce a shadow price for public funds of
  0.30,
• welfare weights in order to account for
  regressive redistribution of the income,
• then there is a per capita perpetual welfare net
  loss of less than 400, or 20 pounds during the
  privatisation years.
•  
• This offers us a conjecture on a range of values.
  
•  

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• Concluding remarks and further research
• Industry by industry evaluation
• Sensitivity analysis for the values of the
  various parameters involved in the calculation,
  including shadow prices and welfare weights.
• Microdata on impact on consumers
•  
• The measurable net social benefit of British
  privatisations was low. The highest value we may
  conjecture is around Lst 50 per capita (at 1997).
  (The lowest is a loss of around Lst 30 per
  capita). This is on yearly basis, 0,004 of
  private consumption (or 0,06 of the utilities
  bill).