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It’s not obvious from the past that government can better run utilities

Date: 02 October 2017
Publisher: The IFS

John McDonnell, the shadow chancellor, has just reaffirmed the commitments in the party’s manifesto to bring rail, water and at least some of the energy sector into public ownership. He also has proposed to look at the range of public finance initiative deals and bring at least some of those back in house.

This raises a lot of questions.

The first is how much it will all cost. That is actually by far the least interesting issue, though that hasn’t prevented it being the focus of most of the media speculation. From the point of view of the headline public finances, borrowing would be increased by the amount spent on nationalisation in the year in which the nationalisation takes place. Government debt would rise by a similar amount. Given that these companies, and PFI contracts, are worth many tens of billions of pounds, that might sound like a very big problem. It shouldn’t be. To the extent that the government pays what the asset is worth, then overall the public sector would be no better off and no worse off. If I borrow £200,000 to buy a house worth £200,000, I do not become £200,000 worse off at the moment of purchase.

Of course, the same was true at the point at which many of these assets were privatised. Unfortunately, the privatisation receipts tended to be treated as revenues to be spent immediately rather than being used to pay off debt or invest elsewhere. The public sector balance sheet suffered as a result. Governments past have played games with the public finances, but that should not in itself be a reason not to renationalise.

The second question, then, is how much to pay for these assets. In the case of quoted companies like the water companies, the obvious answer would seem to be the market price. In many PFI contracts, the terms on which private providers can be bought out will be set out in the contracts. There are legal mechanisms for setting the price.

But is that what Mr McDonnell intends? Part of his explanation for wanting to bring PFI contracts back in-house is that they were bad value for the taxpayer. Some, though not all, were. But if the government is going to pay what they are worth to their owners, then it can’t easily get better value. The cost of buying them out would be high. And remember the owners are often you and I via pension funds and other savings instruments.

Forcibly buying assets for less than they are worth is a very different thing from abiding by legal contracts and paying what they are presently worth. Indeed, at first sight it looks like expropriation, an undermining of the rule of law that keeps the economic system going. Actually, the issues are not quite as black and white as that. Remember 1997? Back then, the Labour government didn’t renationalise anything, but it did impose a substantial “windfall tax” on the privatised utilities. That also penalised the current owners of the shares, generally not those who had made windfall gains, and was arguably a retrospective and somewhat arbitrary tax.

Earlier, in 1981, the Conservatives implemented a windfall tax on certain bank deposits. In neither case did the world fall in. Even so, it will be crucial to the future stability of the British economy that any compensation payment is seen to be reasonable. What is for sure is that if investors believe they are at risk of being expropriated in the future, they not going to invest. The UK does not want to have that reputation. That would be a disaster.

The third and most important question is what benefit we might expect to gain from spending an enormous amount of time, effort and disruption renationalising these industries and contracts.

Here it is important to be clear that we are talking about sectors of the economy, like energy and water, that are already highly regulated. The prices that water companies can charge and the amount of investment they are expected to do are set by the regulator, Ofwat. It is arms’ length from government. It sets prices and investment levels by balancing consumers’ interests with the ability of the companies to finance service delivery. The regulation won’t be perfect, but broadly speaking the regulatory framework is trying to ensure that these companies act in the public interest while their profit motive pushes them to be as efficient as possible.

It may well be possible to replicate these structures and to improve upon outcomes in the public sector. But there is no necessary reason why the public sector should be able to run these utilities better than the private sector. Nor, by the way, is it obvious that the private sector does best. The market fails and needs regulating, a fact too often ignored by those on the ideological right. But the public sector can, and does, fail, too. Those on the left tend too often assume that this is not a problem.

Just as private firms can be inefficient and private owners greedy for profits at the expense of long-term investment, so public firms and governments can be guilty of mismanagement and under-investment. They certainly have been in the past. If we are to return these companies to public ownership, we need to learn the lessons of that not-so-glorious past. Whether in the private or the public sector, clear frameworks of rules, freedoms and accountabilities are needed, with decisions made well away from the political process. Ministers should not be allowed a free hand to run water and energy companies any more than should private shareholders. It’s not obvious from history that they are either more competent or more trustworthy.

Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist.

This article was first published by The Times and is reproduced here in full with permission.