The mathematical logic of privatisation

It is a testament to how much of Pakistan’s political discourse is still shaped by the socialist vocabulary of Zulfikar Ali Bhutto that even today, economic liberals hesitate to forcefully make the case for privatisation for fear of the inevitable, visceral populist backlash. And it is a testament to how pathetically low our investment in education has been that the criticism levelled at the idea of privatisation is usually devoid of even the most rudimentary understanding of mathematics, let alone economics and finance.

But the case for privatisation is relatively simple: it works. It improves productivity, reduces government spending, increases tax collection and improves service quality, to name just a few benefits. And it does all of this not in some economics textbook or in an advanced economy whose conditions are very different from ours, but right here, in Pakistan, with all of the flaws and inefficiencies of our market.

The Nawaz Administration’s announcement that it will be selling stakes in 31 state-owned enterprises is likely to be met with the usual parade of populist bromides against capitalism. There will be the usual complaints that ‘national assets’ are being sold at ‘throwaway prices’ or that the people who buy them will ‘suck the blood’ out of their customers. All of these are wrong. Horribly, absurdly wrong.

For starters, most of the critics who pretend to become instant investment bankers have no idea about financial valuation methods or what constitutes a fair value of a company. But even without explaining the theoretical underpinning of discounted cash flows or the capital asset pricing model, one can make the argument — purely mathematically — that the government rarely ever gets a bad deal on privatisation.

The government, it must be understood, is not an ordinary investor whose returns are determined purely by the difference between the buying and selling price and any dividends received in between. The government, through its power of taxation, is in a position to continue reaping revenues from companies long after it has sold every single share in them.

Take the banking sector, for example. In 1994, when most of it was nationalised, it cost the government nearly Rs46 billion in bailouts (about Rs235 billion in today’s money). In 2012, however, the banking sector nearly Rs62 billion in just corporate income taxes. Over the past five years, the Pakistani banking sector has paid Rs202 billion in income taxes, an amount that is only likely to keep growing over time.

An inflow of taxes is certainly much better for the public than an outflow of bailout money. The finance ministry states that the cost of bailouts of state-owned companies to the taxpayer is in the range of Rs500 billion a year. Just eliminating that amount is worthwhile for the government, even if the price it receives for all of those companies combined is zero. Doing so would reduce the budget deficit by one-third, thus bringing down interest costs and slowing the rise in the national debt.

But privatisation offers much more than just a reduction in the fiscal bleeding. It contributes to the solution by providing a steady stream of increasing tax revenues from newly-profitable companies. Hence, not only would the budget deficit go down, but the tax-to-GDP ratio would go up. Lower budget deficits, would, in turn, translate into lower inflation.

My reasons for supporting privatisation are ideological. I am an economic liberal who believes that the government should not be in the business of running companies. But even those who do not share my ideological beliefs cannot deny the sheer mathematics of it: privatisation works.

Published in The Express Tribune, October 12^th, 2013.

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