24 October 2014

Richard Prebble on Finding Balance: "I am New Zealand’s last Postmaster General."

Speech by the Hon Richard Prebble at the launch in PNG of Finding Balance 2014: Benchmarking the Performance of State-Owned Enterprises in Island CountriesThe Port Moresby Chamber of Commerce & Industry, 24 October 2014

I am New Zealand’s last Postmaster General.

I got the job because the cost of sending a letter was increasing faster than inflation but the mail delivery was so bad that the claim that your cheque was in the mail could be true. You met your obligation to pay tax in New Zealand by posting a cheque on the due date People had taken to mailing tax cheques from rural letterboxes knowing it might be some time before Inland Revenue could cash the cheque. The government had made an emergency multi-million dollar bailout of the Post Office but the losses continued.

One advantage about being a Minister is you can ask questions about things you have always wanted to know. My first question to the manager of New Zealand Post was: “Why is it that every parcel I get looks as if it has been dropped out a four storey window?”

“Minister, that is because it has,” said the Manager. “We sort parcels on the fourth floor of the CPO and then drop them down shoots to the ground for delivery.”

“But that just smashes the parcels to bits,” I said.

“Minister we have signs in every Post Office telling the public to wrap parcels securely”.

“Do you think,” I said, “that dropping every parcel four floors is the reason Post has lost 90 percent of its parcel business to the couriers?”

It was clear from the manager’s reaction that this idea had never occurred to him.

I got to be Post master General and to be in charge of 20 other government trading departments because together they were losing a billion dollars a year. Service standards were awful. Not one government business was profitable. No government business had paid a dividend, ever. The managers said that to restore efficiency they needed a capital injection equal to the government’s total budget. It did not seem likely to me that cabinet would let me have the total budget so we had to find another way to run government businesses.

In the case of the Post no post office had ever been closed. There were places where mining had been abandoned a hundred years ago where the only building was the Post Office. No town, no customers, just a post office.

Every MP knew Post had a list of Post Offices it wanted to close. The previous Minister denied all knowledge of the existence of the list by instructing the Post Office never show him the list.

After I had solved the riddle of my smashed parcels I said to the manager: “What about the mysterious list of uneconomic Post Offices?”

“I thought you might ask me, Minister. Here is the list of 527 surplus post offices. We need an annual subsidy of 20 million dollars to keep them open.”

I examined the list. “Is this first page typical?”

“Yes Minister”

“How is it that the first 17 Post Offices are all in my electorate?

“Are they Minister?”

Are they Minister? In America it is called closing the Washington Monument. Whenever the civil service is asked to recommend cuts they propose closing the Washington Monument which would be like a New Zealand Government closing the National War Memorial. I was being tested. I wrote over the list. ”

“Approved for closure”. My critics claimed that I closed more Post Offices on one day than Hitler.

We actually opened more postal outlets. We removed the rule that said only Post Offices could sell stamps and do postal transactions. 800 shops began selling stamps.

We made the Post Office and the other 20 government businesses companies under the Companies Act with businessmen as directors. We required all the enterprises to operate as efficient businesses. To publish their plans and held them to account. We removed any preferential treatment. We invented what has become known as the State Owned Enterprise model.

In the case of Post I was told they had to have a monopoly so they could cross subsidize rural delivery. Rural delivery was done by private contractors and these concessions had never been reviewed. People would inherit deliver routes and would sell a route. We decided to auction the rural delivery routes and were surprised by how much was bid. One unsuccessful tender set up in opposition. The Post Manager said to me that I must invoke the Postal monopoly and close him down.

“But you have been telling me the rural post is uneconomic," I said. “If we do nothing he will do bankrupt”.

The rogue rural operator did so well he cut the price of his stamps.

I decided to remove the postal monopoly. You can go to New Zealand today and set up your own postal service. There is a number of them. The lawyers operate their own document delivery.

The results of the changes were dramatic. In three years all 21 SOEs were profitable. Service levels went from awful to world leading. In the case of New Zealand Post they were making so much money that the price of stamps was reduced by 25 percent.

The New Zealand State Owned Enterprise model has been copied around the world transforming government trading departments into businesses with their own boards of directors. The results have been a massive improvement on the government departments but no one has duplicated New Zealand’s early success.

In 2002 the Prime Ministers of six Pacific countries including Papua New Guinea asked the Asian Development Bank to do a benchmark study of the six Pacific nations SOEs to discover what was and was not working.

Like many truly brilliant ideas this was very simple. If there was a Nobel Prize for the most cost effective aid program ever the ADB benchmark study would have to be a contender. We are talking big money. If Samoa could just get its SOEs to earn their capital needs the saving to the taxpayer would be equal to half that country’s health budget. Here in PNG since the last study over K$400m of SOE debt has had to be written off.

The first report exploded a number of excuses for poor SOE performance such as Pacific Island nations were too small or too poor or lacked enough experienced business people to be able to run efficient State businesses.

One of the poorest and smallest island nations Tonga turned out to have the most efficient SOEs.
The study was an eye opener especially to hard pressed finance ministers. They saw that Tonga was able to spend taxpayers money on health and education that they were being forced to spend propping up their inefficient State Enterprises.

The Pacific Prime Ministers also noticed and have got the Asian Development Bank to do regular follow up reports. We are launching here today the fourth benchmark study.

First the good news.

Buried in the last paragraph of Appendix 1 is this statement
“Thirty years of SOE reform proves the principles driving good, and poor, SOE performance are universal. Sustained political commitment to achieve commercial outcomes – supported through legal, governance, and monitoring frameworks – will result in improved SOE performance. This has proved to be true, regardless of the size of the SOEs or the economies in which they operate. The complexity of the issues may vary, but the core drivers are the same”.
That means any country can have efficient profitable SOEs. It is just a matter of political commitment. That is where this Chamber as a leader of business opinion has a vital role to play.
I have a couple of personal observations about this study.

As one of the inventors of the SOE model I was invited to the launch of the first study and have been a commentator on each benchmark exercise.

This study has attracted worldwide interest. Three countries not in the Pacific asked to join this study, Jamaica, Cape Verde and Mauritius. Their State Owned Enterprises performances are truly awful. Pacific Island nations are doing well in comparison. Air Jamaica for example has lost US $1.5 billion. Jamaica would love to have Air Niugini’s results.

Never underestimate the power of example. I have no doubt these ADB benchmark studies are part of the reason for the improvement in SOE performance in most of the Pacific countries.

In the first study the nation with the worst results was the Solomon Islands that has just come out of a civil war. The Solomon Island government’s SOEs are the biggest improvers and in some ways the Solomons now has the best SOEs.

So how is Papua New Guinea doing? Overall PNG’s SOEs make a positive return on assets. Looking deeper the return on equity has slipped since the last study. The quality of service needs improving.
PNGs SOEs provide essential services such as the water, power, ports and airports that impact on every business. They consist of 10 percent of PNGs assets but produce just 2.5 percent of GDP. That hides the human reality. PNG has a high infant mortality. Clean water and good sewage does more for health than any doctor. Good SOEs literally save lives.

Your government is well aware of the need to do better.

The benchmark studies provide a blue print of the steps to be taken to good SOE performance. SOE performance rests on the foundation of good corporate governance and a sound legal framework.

SOEs need to have the objective of being run as commercial businesses. SOEs must as a minimum generate enough income to pay for investment and growth.

Boards of directors should be selected solely on the basis of their commercial experience. A SOE board is no place for either political appointees or civil servants. SOEs should publish their statements of corporate intent and publish their annual reports. SOEs should receive no subsidies or regulatory advantage and pay the full cost of any funding. Any social service obligation should be identified, be transparent and be publicly tendered. If the private sector can provide the service cheaper then the private sector should be the provider.

After four benchmark studies there is no doubt about the need for each one of these measures. Counties that have implemented them have improved and those who have not have suffered poor performance.

So what does that mean in PNG? Let me give the example of PNG Power. Can I add I have spent nine years as a director of one of New Zealand’s largest and most efficient power line companies. It is an industry I know a bit about.

PNG Power cannot generate its cost of capital because it is not allowed to increase prices. It is required to cross subsidize customers.

It maybe that low cost power is a social priority. I am not questioning government priorities. But if it is a priority it should be transparent.

The cost of the subsidy needs to be calculated and put in front of parliament. Politics is all about priorities. MPs need to decide whether they wish to spend taxpayers’ money on power subsidies as against say health.

Just because the cost of holding down power prices is not visible does not mean it does not exist. It manifests itself in PNG Power not being able to expand its network and the power cut I experienced when reviewing this presentation. It results in energy users not locating close to the cheapest source of energy. It removes the incentive to invest in new efficient distributive energy.

The longer the price signals are hidden the greater the cost to the country.

PNG has huge supplies of natural gas. In a freely operating electricity market one would expect gas fired electricity generation.

My advice is to split the grid, which is a monopoly, from the generation and regulate it. Then allow anyone to generate electricity and in a competitive market it is likely power prices will fall. But if government will not allow investors to at least earn a reasonable return then power will continue to be in short supply.

The importance of identifying social service obligations is a key finding of these benchmark studies and has resulted in spectacular service improvements.

In 2002 many Pacific Island nations were running loss making government shipping services. Many countries in this survey have identified providing shipping services as a social service obligation. The Island Nations have put the provision of shipping service out to tender. Private shipping companies have won the routes. The private providers have been so efficient the numbers travelling has gone up, the fares have gone down and so has the cost of the subsidies. A win win win.

In 2002 most SOE directors in most of the countries benchmarked were either ministers, civil servants or political appointees with no business experience.

Today only the Marshall Islands which as perhaps the worst performing SOEs still has elected officials as directors. The quality of director appointments in most of the nations surveyed has gone up. This has cost not one cent more but the savings are multi millions of dollars.

I think appendix 3 is essential reading.

The appendix lists a summary of factors that have proved necessary for good SOE performance and not one country in the benchmark study has implemented every factor. But then there is not one country in the survey where the SOEs performance equals what a private sector investor would regard as satisfactory.

The authors ask a question “Is the SOE model flawed?” The authors point out that in New Zealand where the model was invented SOE performance has declined.

It seems that as long as government owns the business then politics will trump commercial objects. The political cycle and the commercial do not coincide. What government owned Power Company is going to increase power prices before an election and if you think about it, it is always before an election.

If it’s a choice between SOE profits and votes then votes wins every time.

Is privatization a better option?

The report notes that over the last thirty years privatizations of over a trillion dollars have been made, enough to be statistically significant. Privatized businesses have, with some spectacular exceptions, out performed State Owned Enterprises.

Privatisations in the Pacific benchmarked by this study out preform SOEs. There are examples of State Enterprises that were effectively bankrupt that are now after privatization, thriving businesses.
I visited the government owned slipway in Talagi in the Solomons with the then then Prime Minister. It was in such a state of disrepair that it just had workers and no work. He wanted to know what I thought the government should do

“Sell it” I said.

Some years later some other advisor was more persuasive and the government did sell. The shipyard is now a thriving business.

There is also evidence that partial privatizations are superior to SOEs but not as good as a total sell down. Politicians are more likely to interfere in a company the government has shares in than a totally privately owned company.

So plans to sell even a minority shareholding are likely to result in better SOE performance.
I give some cautions.

The partial sale of SOEs in New Zealand did not bring in the price the government expected. Frankly institutions and mom and dad investors did not rate the government as a good majority owner. As most SOEs in this benchmark study do not earn their cost of capital why would minority shareholders not significantly discount value unless they can see a way to better manage the asset? So both government and managers are likely to be disappointed at the amount of money minority shareholding will bring. Forcing the superannuation fund to invest in SOEs as has been done in one Island country is a short sighted policy. That is just robbing the future value of pensions to subsidize today’s poor performance.

As Minister of SOEs I was not in favour of partial privatization for two reasons: My experience from the partial privatization of Petrocorp. Government made the mistake of selling a stake in the government owned petroleum company before we had settled on an energy policy. The minority shareholders thought they were buying into a company that has a privileged position so when the government determined to have a level playing field the shareholders sued.

My second reason was when I discovered how much investors would pay for control. It exceeded even our advisors expectations. Investors paid hundreds of millions for companies that under government ownership had never paid a dividend because they believed they could make the business efficient and profitable.

But I still favour even partial privatization over total government ownership. Minority shareholders are likely to bring pressure to bear on management to perform. Across the Pacific there are many examples of government businesses who despite legal requirements to produce audited annual reports fail to do so.

Failure to do so by listed companies brings real consequences. But be warned, questions, like the regulatory framework need to be thought through before sale, not afterwards. Selling an unregulated government monopoly is selling a license to print money.

You need to have thought through what the goal is. In New Zealand I wanted to attract the world’s best management so we made it a worldwide sale. We attracted Atlantic Bell one of the world’s leading telecommunication companies and Wisconsin Railroad, the world’s leading railway. Even more valuable than their money was their management expertise.

PNG is a nation that needs capital investment and privatization is a way to attract high quality investment. Foreign investors cannot take the assets away.

There is a lot of nonsense talked about foreign investment. Here are two examples to think about a hundred years apart. The United States became a world economic power when railways opened up America. The British owned many of those railway companies. America was the winner. China has just become the world’s biggest economy. When China opened to the world foreign investment funded and owned seventy percent of those Chinese exports. Today, the Chinese firms own 70 percent of those exports. Who benefited the most from the foreign investment?

There is another alternative to State Owned Enterprises and that is PPPs. Public, private partnerships.
This is a movement that is sweeping the world. A wide range of projects from road building, to schools to the management of maintenance to major new infrastructure is being conducted by PPPs as an alternative to SOEs.

The evidence is in this benchmark study is that well-constructed PPPs are a far better option than asking an SOE to make a major infrastructure expenditure.

If I can make the observation that there is not a single example of an inner city rail project built by community owned companies that have been built to budget or that met the promised patronage.
In contrast there are now numerous example of successful PPPs in transport.

The advantage of a PPP is the risk is transferred to private sector.

The New Zealand government is moving to build schools using PPPs. The previous model was to build by tender using the cheapest architect and the lowest cost builder. The result is schools that leak and will cost billions of dollars to fix. In contrast in the PPP the builder has to maintain the building. I am a director of Hawkins Construction, some of our team are here today, and we built the first PPP schools. We turned the government model on its head. We picked the best architects, the best materials and the best subcontractors. We are responsible for the maintenance. The most cost effective maintenance program is to have such a high quality building that it is never going to leak.
The benchmarking report strongly recommends as an alternative to State Owned Enterprises government use well designed PPPs.

But let me say this in conclusion. Neither PPPs nor privatization are ever going to replace all state owned enterprises. Even in countries like Britain where they have had massive privatisation and extensive use of PPPs there are significant SOEs.

The PNG government is always going to own significant SOEs.

To achieve the level of economic performance and the living standards PNG desires it is necessary to continue to improve SOEs.

That needs political commitment.

Politicians need support. I would never have been able to put through our reforms without the strong support of New Zealand’s business community. When I was being attacked for closing post offices the Chambers of Commerce came out and supported me. When a power price is approved come out in favour and say why. Now the Chamber being in favour of a price increase that will be reported.
Busy business leaders did not want to be appointed to businesses like the New Zealand Post Office. They gave hugely of their time. I never turned around any SOE. It was the businessmen I appointed.
I think your chamber should read this report. There is a wonderful chart on page 50 that sets out the 15 things you need for efficient SOEs. PNG has done five and is making good progress on two more, some on another and has yet to tackle six factors for successful SOE performance. Here is one that is crying out for action, “Skills based director selection”. The Chamber should nominate people with the skills to be first class directors. One day the government will surprise you and appoint your nominee.

Set up a subcommittee on SOEs and monitored performance. Lobby for SOE reform. You can make a difference.

Since I started with a Post Office story let me finish with another one.

The directors I appointed discovered the Post Office did not even have an asset register. The Post Office did not know what it owned. The directors got in some consultants who went around recording the assets. In a massive warehouse in Wellington where half a million black dial phones were stored just in case they made a comeback, the consultant found a huge packing case the size of a room.

“What is in here” he said.

“No idea” said the Forman. “It is always been here”

“Who is the oldest employee” asked the consultant.

Old Joe was summoned who said the packing case was there when he had started work.

To the horror of the employees the consultant attacked Post Office property with a crow bar and opened the packing case and revealed a brand new 1936 petrol driven Bedford truck. They put fuel in it, turned the crank handle and the engine started. If the tires were not flat they could have driven it back to the dealer and asked for a refund. A brand new vintage 1936 Bedford truck with no miles in the gauge turned out to be rather valuable. So my final advice to SOEs is to have a good search of the back of the warehouse.

You never know what you might find.