In a number of countries, privatization has been mentioned in the context of general measures intended to secure a reduction in the government or public sector deficit. The fiscal impact of privatization is, however, less obvious than the act of selling an enterprise or eliminating the need to subsidize loss-making enterprises would seem to suggest.
Asset Sales in Government Accounts
Recommended Fund practice, as described in its Manual on Government Finance Statistics, is to treat the proceeds from asset sales to the private sector as either capital revenue or a loan repayment in government accounts. If the government sells fixed assets previously held for its own use, land, or intangible assets such as mineral rights, the sale proceeds are recorded as capital revenue. If the government sells part or all of its interest in a public enterprise, the transaction is treated as a sale of equity and the proceeds are recorded as a loan repayment. These conventions apply when considering both the government accounts (either central government or general government) and the public sector accounts (which reflect the consolidation of general government and the public enterprise sector).
As in the earlier discussion, asset sales will be equated with sales of public enterprises. In an accounting sense, the immediate fiscal impact of an asset sale is straightforward: if there are no other budgetary changes, the overall deficit—that is the difference between total expenditure and total revenue—will be reduced by an amount equal to the sale proceeds. To the extent that the timing of an enterprise sale implies that revenue in the form of profit normally remitted to the government by an enterprise is forgone in the year of sale, the reduction in the government overall deficit will be lower by the amount of this unremitted profit.
This means that in general asset sales would tend to lead to a once-and-for-all reduction in the overall deficit unless the sale price was less than income that would have accrued to the government. In practice such an outcome would be possible if a firm had sufficiently large liabilities that future discounted earnings were negative while current earnings were positive, but such an enterprise would probably be a candidate for liquidation rather than privatization.
The overall deficit provides a guide to a number of aspects of the relationship between government activities and the economy as a whole. Most importantly, since the deficit measures the difference between government expenditure and government revenue, changes in the overall deficit, after suitable adjustments, are often regarded as indicating changes in the government’s fiscal stance, and especially whether demand management policy has become more expansionary or contractionary.19 In addition, since the government must borrow to finance the overall deficit, its size has monetary and associated financial policy implications. The size of the overall deficit, and the way in which it is financed, also has balance of payments consequences. This section focusses on the overall deficit as an indicator of fiscal stance in the context of asset sales, and discusses briefly their financial implications and their impact on the balance of payments.
Asset Sales and Fiscal Stance
Assume that a public enterprise is sold to a private buyer at a fair market price. Such a price is defined as being equal to the present value of the discounted stream of after-tax net earnings of the enterprise, assuming that tax liabilities are the same both in the public and private sectors. Further assume that this stream is positive in all future years. As indicated above, all other things being equal, the overall deficit would be smaller at the time of the sale. But the counterpart to this initially smaller deficit will be larger deficits in all future years, reflecting the loss of revenue in the form of remitted profit. However, if the discount rate embodied in the sale price correctly reflects financial opportunity costs, these larger future deficits would be exactly offset if the government used the sale proceeds to purchase other financial assets or to retire an equivalent amount of outstanding debt. In such circumstances, the government and the private sector are simply exchanging financial assets and liabilities, and this should not affect the demand for real resources at the time of sale, or in the future. Fiscal stance is therefore permanently unaffected by the asset sale.
If the government uses the sale proceeds to finance a temporary increase in current expenditure or a temporary reduction in taxation (or both), the deficit in the year of the sale would be unaffected while future deficits will be larger. Whichever combination of tax cuts and expenditure increases is chosen, there will have to be a corresponding contraction in the future. If the expenditure increase and tax reduction are intended to be permanent, there will be both an immediate increase in expenditure or reduction in taxation (or both) and a reduction in the deficit, and the impact of these changes will fall between the outcomes just described. The same will also be true in future years. Clearly, whatever the use made of the sale proceeds, the resulting change in the current overall deficit fails to reflect the macroeconomic consequences of the sale in the medium term.
The above argument holds in the case of both profit-making and loss-making enterprises. If an enterprise requires a subsidy on a transitory basis, but the present value of its net profit stream is positive, the only difference is that in some future years the deficit will be smaller rather than larger. The more interesting case, since it is one where privatization is widely advocated, is when an enterprise not only makes losses but also the present value of its net profit stream is negative. In such cases the first part of the above argument applies symmetrically (there is no possibility of financing an increase in current expenditure or a reduction in taxation in such cases). If the enterprise is sold at a competitive market price, this too will be negative, and a buyer will have to be paid an up-front lump sum subsidy equal to the negative present value of the enterprise’s future net profit stream, or a stream of marginal subsidies will have to be guaranteed.
The precise pattern of subsidies will determine the resulting time profile of deficits, but unless the transaction is extremely artificial—with a positive sale price and correspondingly larger future subsidies—the most likely outcome is a larger initial deficit and smaller deficits in future years. But since the government will have to finance the larger initial deficit, the need to service the additional debt will return future deficits to their higher original levels. Again, the public and private sectors have simply exchanged financial assets and liabilities, and fiscal stance will not be affected. The notion that privatization without changes in performance—as opposed to liquidation which in many cases may be more logical—offers permanent financial dividends to the budget where enterprises are heavily subsidized, is misleading. This would only be the case if enterprises can be run more efficiently in the private sector.
Given that in most frequently encountered circumstances the change in the overall deficit is taken as a reliable preliminary guide to fiscal stance, a question naturally arises as to why this is not the case where asset sales are concerned. According to Ashworth, Hills, and Morris (1984), the source of the problem is that by focusing exclusively on cash flows, standard budgetary accounts fail to reflect what is happening to government or public sector net worth. Thus, when reference is made to the government’s balance sheet, it is clear that if an asset sale involves a change in the composition of assets but net worth is unaffected, then despite resulting changes in deficits such a transaction has no fiscal impact. Similarly, when the sale proceeds are used to finance current expenditure or reduced taxation, and there is no change in the deficit, the resulting reduction in net worth indicates the initial expansionary impact of the transaction, and the consequential need for subsequent contraction, to compensate for the income that would have been generated by the lost wealth.
In suggesting that attention should be paid to the net worth of government in assessing the fiscal impact of asset sales, any implication that it is necessary to construct a full balance sheet where future impact of all government activities is represented in present value terms is not intended. Such an exercise raises methodological and practical problems that would make it an enormous, and in many cases fruitless, undertaking. Nevertheless, an exercise of this sort has been advocated, and partially completed, by others, for example Buiter (1983a, 1983b), and Ashworth, Hills, and Morris (1984), with a view to determining, amongst other things, whether government consumption is consistent with estimated net worth. The requirements of the aforementioned exercise are more modest. There is no suggestion that the overall deficit be attached any less significance than is the current practice. Rather, the suggestion is that in certain circumstances additional information is needed in order to assess the fiscal implications of budgetary changes. In the case of asset sales, and a wide variety of other cases, this additional information relates to the underlying changes in government net worth, or the extent to which the government is saving or dissaving.
Financial Implications of Asset Sales
If an asset sale is used to reduce the overall deficit, while other revenues and expenditures are held constant, there will be no financial impact in the medium term, provided the asset is sold at market value. As indicated above, selling an asset is equivalent to borrowing against its future income stream. However, if the government sells a bond, it is also borrowing against future income. In both cases, the government is accepting an obligation to raise taxes in the future, in the first case to replace a forgone income stream, and, in the second case, to service debt repayments. The division of financial flows between the public and private sectors is not significantly affected by the form of borrowing (Buiter (1983a)). When the sale proceeds are used to increase current expenditure or reduce taxation, bond financing and asset sales are also equivalent, and in this case future resources have to be diverted from the private to the public sector to pay for current expenditure increases or tax reductions.20
Asset Sales and the Balance of Payments
The sale of a public sector asset to the private sector cannot, of itself, affect the current account of the balance of payments. As indicated above, the public and private sectors have simply exchanged assets, and this alone cannot influence economic activity. But if privatization raises the overall productivity of the economy, net exports should increase. Also, if the savings and investment behavior of the private sector is adjusted in response to privatization, then the real economy will be affected. However, unless privatization programs are large, the impact of asset sales on the current account is likely to be only marginal.
Qualifications
The above conclusions clearly require modification to the extent that the explicit and implicit assumptions underlying them are inappropriate. Mansoor (1987) explores a range of qualifications in detail. These relate to: the different tax regimes that may confront private and public enterprises; the implications of uncertainty and imperfect markets; discounts implicit in sale prices; and the impact of second-order effects arising from, inter alia, the effect of asset sales on private sector liquidity, on the riskiness of private sector portfolios, and on the capital structure of privatized enterprises. It is shown that the fiscal (and financial) impact of asset sales is potentially quite sensitive to the above considerations, but that few general results emerge. While their precise impact has to be assessed on a case-by-case basis, the analysis does serve to emphasize the basic point that the initial effects on the overall deficit can be misleading in evaluating the impact of asset sales.
A key assumption not mentioned above, but one that requires more extensive discussion, relates to the impact of the sale of an enterprise on its expected income stream. One of the strongest arguments used to support privatization is that an enterprise’s income stream will improve if ownership is transferred to the private sector because of increases in efficiency. Morever, one of the reasons why governments tend to underprice assets may be that the private sector sees opportunities to improve efficiency that the public sector ignores. These potential improvements in efficiency should, however, be viewed cautiously. They do not arise simply from a transfer in ownership but from concrete actions that raise the productivity of the enterprise or reduce unit costs. Such actions can in principle be taken in either the public or the private sector, and when they occur in the public sector they will directly benefit government and public sector finances. When efficiency gains are judged to be feasible only under private ownership, government and public sector finances will benefit to the extent that the government can share in these gains by setting asset prices to reflect at least part of the improvement in performance and by taxing the higher profits that result. Indeed, in budgetary terms, this should be the whole point of the privatization exercise.
Such adjustments reflect factors such as the phase of the business cycle, the treatment of unemployment compensation, and inflation (see Heller, Haas, and Mansur (1986)).
In the argument that asset sales are akin to bond issues, all the problems associated with Ricardian equivalence—that is, whether taxation and debt should be treated symmetrically—arise. Barro (1974) contains one of the strongest statements of the Ricardian position. See Atkinson and Stiglitz (1980) for further discussion.