by Harsh Vardhan.
What would you say if someone was borrowing money at 8% and investing it to earn around 3%? “Uninformed!”, “financially illiterate!” or even outright “foolish”! And yet this is what our government has been doing with trillions of rupees over the last many years and has committed to continue to do so in the future. The process by which this is done is called capitalisation of public sector (PS) banks. Such capitalization is not only a bad idea economically as it puts enormous stress on the government resources, but also one which affects that behavior of banks and hence the robustness of the whole banking sector.
Commercial banks need capital to grow. Capital adequacy requirements ask all banks to keep a minimum amount of shareholder capital in proportion to their balance sheet size. Currently, in India this requirement is 9% of “risk weighted assets” of banks. Roughly, it means that banks are expected to have equity capital which is 9% of their commercial loans.
As banks grow their business, their risk weighted assets also grow. This means that banks has to increase their capital base in line with the growth of their loan book. Such increase in capital can come from exactly two sources – retained profits that are added to the capital base, or fresh infusion of capital from shareholders (old or new). In India, given the overall profitability of the banks (~1.1% return on assets) and the amount of dividend that they pay (~20%) of post-tax profits, banks do not have enough retained profits to support their business growth. Therefore, every now and then, they go to shareholders to raise fresh capital.
PS banks pose a peculiar challenge for the government. Being the majority owner of these banks and having committed to stay the majority owner, government has to infuse capital into these banks proportional to its ownership stake. Since the government wants to maintain its ownership at 51%, it has to supply atleast 51% of the fresh capital that PS banks need. RBI governor Dr. Subbarao, in a recent speech, said that the capital infusion by government into PS banks over the next decade will be of the order of Rs.0.9 trillion. I have read estimates of other analysts where this number is as high as Rs.2.50 trillion. These estimates depend on the assumptions one makes about a number of factors – the rate of growth of banks (which in turn depends on the growth of the overall economy), the profitability of banks, their dividend policy, their ability to raise other forms of capital (especially tier II capital), regulatory requirements on capital, etc. No matter how you estimate it, the number is very large. In other words, the government will be compelled to invest a very large amount of capital into PS banks over coming years.
Why is this a problem? Let’s look at the some simple public finance issues. India is in a deep fiscal crisis, and it is not easy to find trillions of rupees to put into PS banks. If such resources were injected into PS banks, it is not conducive to healthy public finance, since these injections are not a good deal for the government. The Indian government currently borrows long term money at over 8%. The dividend yield on PS banks shares has been between 2% and 3% over the last decade. This means that the government earns between 2% and 3% on its investments in PS banks. There is a 5% “negative carry” or loss that government bears on these investments.
A private investor also earns a low dividend yield from investing in PS banks, but can benefit from capital gains – a potential increase in the value of shares which the investor can obtain when she sells the shares. Government has never sold shares of PS banks (except when it initially listed some banks) and will not do so if it has to maintain majority ownership which is its stated policy. Hence, for the government, the financial analysis of a proposal to put money into PS banks should hinge on a comparison between the flow of dividends versus the cost of borrowing.
Capitalisation of PS banks is, thus, bad for government finances. It’s a double whammy! On the one had government has to raise vast resources to be invested into banks and then carries a loss of around ~5% on these investments year after year.
Ownership and behavior of banks
Government capitalisation of PS banks is not just a fiscal challenge. It also impacts the competitive dynamics of the banking industry. Most privately owned banks are under constant scrutiny of investors and analysts. When they go to external investors for raising capital, they have to satisfy these investors on number of critical aspects of the business – profitability and its sustainability, efficiency of capital use, quality of management team, cost efficiency, etc. In other words, private banks face a market test; they do not get capital for free. Only well run private banks get equity capital that is required for growth.
None of these questions get asked when government puts capital into a PS bank. One has never heard a senior government official commenting on the Return on Asset (RoA) or Return on Equity( RoE) of PS banks. The decision to put capital into PS banks is treated as a mechanical and administrative decision. This absence of a market test has systemic consequences. PS banks have ~70% share of the Indian market. When the majority owner is asking no or very few questions on performance, and is assuring an almost unlimited supply of capital, these banks have little incentive to improve financial metrics such RoA and RoE. This hurts the overall banking industry. For example, PS banks can underprice loans compared to their private sector peers. Such behavior would migrate the whole business to lower returns. It is hard for a private bank to be profitable when facing rivals that are not concerned about return on capital.
Misplaced obsession with majority ownership
The source of this whole capitalization issue is the government’s obsession with retaining majority (over 51%) ownership of PS banks. This is often explained in terms of the need to maintain the “public sector character” of these banks. While there may be a separate debate on whether we need to maintain public sector character for all the 25 plus PS banks, the fact is that the government does not need majority ownership to achieve this objective.
All PS banks are not companies under the Companies Act. The notion of 51% giving majority control is enshrined in the Companies Act. PS banks were created under the Nationalisation Act (SBI has its own SBI Act). The Nationalisation Act provides the government untrammeled control over these bank. While it does prescribe 51% government ownership in the PS banks, the control of government is independent of the level of its ownership. Furthermore, there is a limit of a 5% (10% with prior approval of the RBI) stake owned by any single shareholder in all banks. There is no chance, therefore, of any external shareholder acquiring control in these banks. Even relatively minor changes to the functioning of PS banks require approval of the parliament. Where is then the question of diluting the public sector character if the government ownership were to drop to, let’s say 26%, which is the threshold for “significant” minority stake in a company?
In the long run, therefore, it makes no sense for the government to commit itself to the capitalisation of PS banks. Precious government resources can be better deployed in critical areas (such as power transmission and distribution) where private capital on large scale is hard to come by. In the medium term, it can use tactical measures such as merging banks where it has significantly high ownership with those where the ownership is already down to 51%. But these tactics will not solve the issue structurally. The only long term solution is to give up the majority obsession, explain to all the stakeholders the fallacy of this obsession and the resulting pressure on public finance, build a political consensus to enact necessary legislative changes and then dilute down to a reasonable level.
Alex Tabarrok, at Marginal Revolution, has a post about firefighters and their work. In it, he notes that the number of career firefighters has doubled over the last 25 years while the number of fires has halved. To put it another way, it’s highly probable that the market has reached its saturation point for firefighters.
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Thus, now may also be a good time for privatizing firefighting since the risk of fires is declining while the cost of fighting them is increasing. To put it another way, the need for firefighters (and presumably the direct demand) is declining while the practical cost is increasing. We have an inefficient market since the government serves as the middle man, and payments are indirect and cannot be opted out of. Thus, privatizing firefighting should help to significantly reduce costs without significantly reducing the amount of actual firefighting service provided.
To address the practical objections, I imagine that the most probable way of handling privatization would be to handle it through insurance companies. For example, home insurers would likely make subscribing to a firefighting service a requirement for a policy. Alternatively, home insurers might offer discounts to people who subscribe to a firefighting service because that indicates conscientiousness, which in turns indicates a lower risk of having the fire in the first place (for if one takes some pains to address fires, will he not also take others?). Or insurers could sell subscriptions as a form of insurance (if your house starts to burn, you’ll be guaranteed that some company will come put out the fire). This line of reasoning also extends to landlords as well. Furthermore, the continued presence of volunteer firefighters suggests that even those who are too poor to subscribe to a firefighting can still be reasonably assured of help, much in the same way that poor people used to be assured of charity health care.
In any event, privatizing firefighting is very feasible. Not only that, the risk and transitory pains are, at this point in time, likely the lowest they will ever be. Maybe it’s time for a change.
When the UPA came to power, the word privatisation was buried, partly out of deference for the communist parties which were
supporting the UPA. The sale of shares did revive after the UPA-2 commenced [history].
On a global scale, the experience with firms like British Airways and AlItalia has done a lot to persuade people that government is a
terrible owner of firms. As a consequence, even though governments worldwide took up ownership of many financial firms during the global crisis of 2008 and 2009, there was never any question that this `nationalisation’ would be more than temporary. In OECD countries, there is full clarity that even if government gets into a firm when the firm is in trouble (for certain public policy reasons), this ownership must only be temporary and government must get out of this unpleasant state as soon as possible.
Given the lack of commitment to economic reform in the UPA, expectations in India on the question of privatisation have been
low. But the problems of public sector firms are glaringly large and the issue does not go away.
We are all used to Air India being a phenomenally bad use of public money. But as T. N. Ninan points out in the Business Standard today, there are quite a few other such breathtakingly large sinks for public resources. As he says:
…it takes a special kind of government company to lose Rs 8 crore a day, while earning just Rs 10 crore as revenue — and that in the booming field of telecommunications. That’s Mahanagar Telephone Nigam Ltd (MTNL) for you. Its big sister, the Bharat Sanchar Nigam Ltd (BSNL), also loses Rs 8 crore a day, though it earns much more revenue — about Rs 90 crore daily. BSNL blames the jailed former minister A Raja for its troubles, but there must be more to the story. Now the two companies propose to merge; expect an Air India kind of situation, with staff from the two companies battling over pay and seniority many years into the future.
Air India, meanwhile, provides more proof that the government is a lousy shareholder. One minister destroyed the airline. Another now watches while the airline cuts flights because it has exhausted its credit and credibility, and therefore has to pay for fuel in cash. The staff, meanwhile, is not paid incentives that are equal to something like half their monthly salary in most cases — and the government expects this de-motivated staff to fight and regain lost marketshare, to offer service with a smile to passengers.
And what about Prasar Bharati, the once supposedly autonomous broadcaster which is now once again little more than a government department? It employs 38,000 people, and loses Rs 2.5 crore a day, to earn about as much revenue. Someone should ask the obvious question: Why is the government in the business of running phone companies, airlines and news broadcasting when it is losing large dollops of money, when private providers are doing a reasonable job, and when there is no shortage of competition? For that matter, does the government need to make watches (at HMT), cement (at Cement Corporation of India), tyres (at Tyre Corporation of India), or shoes (at Bharat Leather)?
The UPA-2 made a big break with the pessimism by moving forward on selling off Scooters India. The long spell of zero privatisation may come to an end, with the UPA-2 selling off Scooters India.
But how might one view the prospect of government selling off some of the other public sector firms? I think a sound approach to this
question involves three elements.
1. Removing entry barriers
The first piece of the story is that it is essential to remove entry barriers in various fields, which were once dominated by the
public sector. Our poster child in this regard is telecom. Private and foreign firms came into Indian telecom; Indian users of telecom
services were huge beneficiaries. Whether MTNL / BSNL were privatised, as VSNL was, was of second order importance. The most important thing that is required for India to make progress is for government to not get in the way of the private sector.
As an example, Indian banking is a place where there are steep anti-competitive restrictions against private and foreign banks. While
I believe we should have strong rules about ownership and governance for banks (just as we should in critical financial infrastructure), we should not be blocking the rise of suitable private and foreign banks. We should not be blocking the long-term decline in importance of PSU banks. Getting out of the way of private and foreign banks is as important, if not more important, as the task of selling PSU banks.
2. Dispersed shareholding corporations rather than strategic sales
If all PSUs were sold off, the top 500 families of India would likely endup controlling all of them. This prospect makes one worry,
about the increased concentration of economic and thus political power. It would be far better if India move towards privatisation by creating dispersed shareholding (e.g. ICICI or HDFC) instead of privatisation through strategic sales (e.g. VSNL).
This issue also links nicely to the problem of corruption. A country where spectrum auctions can take place while requiring bids to
be placed in 45 minutes is a country where auctions that sell off PSUs could be rigged. It is, hence, far better to setup a steady drip
whereby 0.1% of the shares of a PSU are sold every day into the pre-opening call auction at NSE and BSE, so that 25% is sold every year. Such a procedure comprehensively eliminates the problems of government process in the sale of shares. The government would merely put out an advertisement, before the story began, saying that over the next 250 days, it will sell 0.1% of this firm on every single day into the NSE and BSE call auctions.
Alongside this sale of shares, government would need to take interest in establishing good quality corporate governance structures
for these companies, which are transiting out of government control into becoming dispersed shareholding corporations.
Even in the case of Scooters India, suppose government decided to sell off its ownership of 95.38% within 100 days. It is better to do
this without bringing any investment banker into the picture, by selling 0.9538% into the call auction for every day in the coming 100 days, after making a public announcement to this effect. Alongside this, government would need to setup a good quality board and then allow ordinary corporate governance procedures to work.
3. GDP growth, not proceeds
Every now and then, these discussions get stuck on the issue of how government can maximise the proceeds from selling off (say) Scooters India. This is the wrong end of the puzzle. The really important story is about how the labour and capital that’s blocked inside Scooters India can turn into greater output. Once that’s done, government collects the NPV of future taxation that this productive enterprise will generate.
The focus should be on getting assets out of public control, while avoiding the corruption or political complexity of strategic sales. As
long as these are achieved, the magnitude of the proceeds is not of great importance.
As Vijay Kelkar has long emphasised, India’s privatisation question should be viewed as a question about the portfolio of the State. For each Rs.10,000 crore of shares of Air India that the government owns, it is forgoing 2,000 kilometres of highways. The State needs to ask itself whether it is better to own 2,000 kilometres of highways as opposed to owning the same shares of Air India. On this subject, also see Section 4.3 of this paper.
The second key dimension that should shape the discussion on privatisation is that of improving GDP growth. When assets are moved from public control to private control, the translation of capital stock and labour into GDP growth generally becomes more effective. Through this, India would reap GDP growth by better utilisation of existing resources.
Both these issues have, so far, been largely seen questions about the control of public sector undertakings (PSUs). But both issues are broader: they are about asset ownership by the government more broadly. Given India’s socialist background, government has frequently and wantonly grabbed assets, far beyond those required for the production of public goods. Hence, the problem of selling off assets is much bigger than just PSUs.
As an example, this article says:
The defence ministry is the largest state landowner, holding 80 percent of the 7,000 square kilometres of government land, much of it now prime real estate, according to the CAG report released Friday.
Here is the CAG report referenced there.
There are two interesting dimensions to the problems of defence land. First, while the Ministry of Defence undoubtedly needs large tracts of land on which it can run exercises, training, experiments, etc., it certainly does not require prime land in cities. There may be a role for one big HQ in New Delhi, but I don’t see why the DRDO or dozens or other defence installations are required to be in Delhi. The governments stands to raise trillions of rupees by selling this land and shifting these organisations to locations in the boondocks, where land is roughly free. And there is a further kicker: When defence holdings in places like New Delhi or Poona are moved off into private ownership, India’s GDP will go up. So this is a win-win at two levels: First, India’s fiscal problem is eased by selling defence land and writing down debt, and India’s GDP is increased because the land gets put to productive use.
Similarly, I don’t see why anything connected with the Indian Navy needs to be in Bombay. It’s perfectly feasible to create naval bases at boondocks locations on the coast and thus free up the space used in high marginal product land.
The second interesting dimension is that of the Ministry of Defence as a creator of new cities. If you start off with land in the boondocks, on day one, nobody wants to go there. The Ministry of Defence has the ability to solve the coordination problem. It can engineer the synchronised movement of a large number of distinct pieces that are required to create a new cantonment town. Once this has been put into motion, within 20 years or so after starting up, it would be wise for the government to sell this off and start over. For MoD, there is little difference between being in a mature cantonment town versus a brand-new one. But for the exchequer, enormous value is created through this process. And for India, this works well because new cities can be steadily created in this fashion.
I had a big long rambling post on general parking/pension issues, but it just isn’t in me to post. Reading about the latest round of rumblings on the fifth floor had be wondering how we wound up in this state. Council-mayor relations have occasionally been bad in the past. Intra-council relations have sometimes gone off the deep end with members swearing at each other in session. So maybe things today were sedate in comparison.
Two things really need commenting on though. Bram tweets that the administration presented some idea that if a bond was issued against future parking revenues, that there was a potential for the parking authority to default with a result of the bond holders taking possession of city parking assets. If Bram passed that on accurately, then folks should know that that is basically false. Default on a revenue bond really can’t result in foreclosure against public assets like that. Skipping legal wonkery, it just isn’t the way things work. Purchasers of a revenue bond have claims against future revenue streams, not the underlying assets. It would be extraordinary, and certainly not required for the bonds to have a mortgage pledge in their prospectus. The concept of wall street types winding up as owners of the garages is just not an option.
Beyond that.. like I said I don’t have it in me. We are again down the rabbit hole Downtown and who knows where we will emerge when all is said and done.
OK, I can’t resist one really fundamental comment. Seems to me that the whole presentation today by the mayor was that this bond issue plan wouldn’t work and it was based on some math saying a bond would be issued at 5.5% if tax-exempt and 7.5% if not tax-exempt. Are those rates for real? I don’t think any muni bond rates are that high these days are they? Would make for some very different math if those rates are incorrect. I really need my Bloomberg box back.
Speaking of bond rates… us 3 public finance wonks may have noticed that bond insurer Assured Guarantee had its bond rating dropped today… Methinks a few big public bonds locally have bond insurance issued by Assured Guarantee. Oh, nevermind.
Yeah… my original post was still longer than all of that.
Jack has taught me about lots of things, probably including this little thing in economics called opportunity cost. I shudder to ask what the whole parking endeavor has cost the city. Beyond fees and sheer time and effort there is the investment made by the Parking Authority and I really wonder whether there are contingency fees Morgan Stanley (and others?) is going to claim in the event the city does not go through with a lease. Those $$ amounts may all pale in comparison to what I really worry about.
That headline was from August 27th specifically. In a remarkable and frightening coincidence August 27th just happened to be the day the Dow closed at it’s lowest levels since July. The Dow closed that day at 9,982 and would climb by approx 10% over the 6 weeks since then. Even with a big market loss today, the Dow’s close was 10,978 Even bond prices have generally gone up since then. Get where I am going?
- Vikas Bajaj in the New York Times on privatisation in India.
- I had recently written a blog post on India’s foolishness on visa rules for people coming into conferences. Siddharth Varadarajan has a great opinion piece on this in the Hindu. In sensible countries, there is no such thing as a `visa for the purpose of attending a conference’. It’s just called a tourist visa.
- An editorial in the Wall Street Journal on India’s success on establishing a private sector with competition in mobile phones.
- Swaminathan S. Anklesaria Aiyar in the Economic Times on what the budget speech should say. Also see Ila Patnaik in Indian Express on the roadmap, and in Financial Express on expenditure. Writing in the Business Standard, Sanjaya Baru is also optimistic about what Pranab Mukherjee will be able to pull off.
- An extremely insightful conversation on charges of ETFs (in the comments to this post). This is the sort of thing one hopes for in blogs.
- Give financial sector a Financial Stability Board, in the Times of India.
- Bibek Debroy in Indian Express on India’s license-permit raj of exchange controls.
- I was at IFMR recently: did a talk on distribution of financial products, and looked at the `KGFS’ idea on increasing outreach of financial products.
- Sanjeev Sanyal in Business Standard on the outlook for Bombay.
- Andrew Jacobs in the New York Times on new developments in the Chinese end of India’s tiger extinction problem.
- John Gravois on remittances.
- We in India can look at the brainpower in the Chilean cabinet with wonder and envy.
- Catherine Rampall in the New York Times, reviewing Capitalism and the Jews by Jerry Z. Muller, which made me think about the different story of business-oriented ethnic groups of India.
- Robert Litan on financial innovation.
- Tarun Ramadorai in the Financial Express on hedge fund regulation.
- Alessandro Beber and Marco Pagano, on voxEU, analyse the global evidence on bans on short selling in the crisis. Hopefully we will learn the lesson for the next crisis.
- One of the great achievements of monetary policy reform in recent decades has been the establishment of executive Monetary Policy Committees (MPCs) which use formal voting mechanisms through which the policy rate is modified in order to achieve an inflation target, on a regular meeting cycle, with full transparency about how each person voted and why.
Writing on voxEU, Tim Besley and Andrew Scott emphasise the role of `fiscal councils’ where some (but not all) of these ideas are deployed into fiscal policy.
- I find it interesting to look at how the army of a great power works. See Elizabeth Rubin in Time magazine on Robert Gates (the US defence minister), and Chris Wilson in Slate on some remarkable soldiers. I suppose journalists like Elizabeth Rubin and Chris Wilson are also integral to being a great power.
- Interesting new things in the world of trading and exchanges, all from the Financial Times: Size of share orders cut in half on global markets and Small orders breed dark pools and higher costs by Jeremy Grant, Markets: Ghosts in the machine by Jeremy Grant and Michael Mackenzie, and lastly New US options exchange battles for market space by Hal Weitzman.
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- Read this interview in the Times of India with Steve Coll, and this Congressional testimony of his. If you haven’t yet read Ghost Wars, you should.
- Vijay Kelkar’s recent speech on privatisation.
- The comments on this blog post are worth reading.
- Sanjeev Sanyal, in Business Standard, summarises our public policy problem: we need to build a strong (i.e. capable) State with a limited mission.
- Joe Leahy, in the Financial Times, has an article titled India: A nation develops about global quality R&D taking place in India. I’m pleased that researchers are being paid salaries large enough to make it easy to relocate to India. Also see David Brooks in the New York Times on Israel’s achievements in this.
- Tamal Bandyopadhyay in Mint on the woes of foreign banks in India.
- Pratip Kar in Business Standard on competition between stock exchanges in India.
- Parth Shah debates Vinod Raina in the Business Standard on private schools.
- Nitin Pai has a response to Barbara Crossette’s diatribe.
- Vikas Bajaj in the New York Times on the literature festival in Jaipur. How civilised. I have long felt that a genuine life of the mind in India is 25 years or more into the future. Maybe that’s being too pessimistic.
- Olivier Coibion and Yuriy Gorodnichenko remind us that we are in the Great Moderation.
- Shai Bernstein, Josh Lerner, Morten Sorensen and Per Stroemberg have an NBER working paper titled Private Equity and Industry Performance . They find that industries where PE funds have invested in the past five years have grown more quickly in productivity and employment.
- Michael Slackman in the New York Times, taking stock of Dubai.
- One of the best blogs that I know of, from India, is `Wanderer’s Eye’, by Aniruddha Dhamorikar. E.g. see his latest post, on a mother wasp. Also see: a great collection of pictures on India.
- In the Hall of Shame of the 25 dirtiest cities of the world, by Forbes magazine, Bombay is at rank 7 and Delhi is at rank 24.
- Watch me talk about the recent RBI credit policy announcement — part 1, part 2.
- Raghuram Rajan has a careful response to the Obama’s proposals, which illuminates my recent writings on this.
- Scott McNealy has a beautiful goodbye note to Sun.
- Chris Anderson has an amazing story in Wired magazine about the new world of `small batch’ manufacturing.
- Miles Corwin has an inspiring story for everyone who wants to be a writer or a journalist. And, for anyone engaged in deep thinking about the media, do not miss this lecture by Alan Rusbridger.
Air India has got itself into serious trouble, and private airlines are also doing badly. The CMIE report on air transport for August 2009 shows a bad picture for the airline industry: from the quarter ended June 2007 onwards, in each quarter, the PAT margin was negative.
There are three interesting aspects to the present situation. The first is about the role of the State. Flying by plane is a private good and not a public good. Seats in a plane are rival and excludable. I fly in a plane, I benefit. There is, hence, no role for government to be in this area. Governments in good countries do not run airlines. The right thing to do is to privatise Air India as soon as possible, without trying to engage in a government-led restructuring. In an auction, if the highest bid is a negative number, government should pay this to get the company out of public ownership.
The next point is the cost of a bailout. NHAI highways cost roughly Rs.5 crore per kilometre. Hence, if government puts Rs.5,000 crore into Air India, this comes at the opportunity cost of 1000 km of four-lane highways.
The most interesting dimension, and one that has not been widely noticed in India, is the impact of Air India upon the woes of the aviation industry. Air India today is a `zombie airline’: a firm which should be dead but isn’t only because it is artificially propped up by the government. (The phrase `zombie firms’ or `zombie banks’ originates in the experience of Japan in the late 1980s).
If market forces were allowed to work, then Air India would go into liquidation. This would lead to somewhat higher prices for air travel since competition would be reduced. In addition, it would lead to somewhat lower prices for staff (since erstwhile Air India staff would be looking for jobs) and somewhat lower prices for planes (since erstwhile Air India aircraft would be available for purchase or lease).
Other firms in the industry would thus obtain somewhat higher revenues and face somewhat lower costs.
Conversely, when a government steps in to create a zombie firm in an industry, it damages profitability and investment amongst the healthy firms of that industry. If this process goes on for a while, then otherwise healthy firms in an industry will become sick. This was the experience in Japan, when the `zombie firms’ supported by the government led to sickness spreading amongst other firms and led to a extended period of reduced private corporate investment.
In summary, one reason why the private airline industry as a whole is in the doldrums is that Air India is being artificially kept alive.
Death, taxes and government ownership of roads: all inevitabilities, right? Well, not according to Dr. Walter Block, professor of economics at Loyola University in New Orleans and senior fellow at the free-market Mises Institute. Dr. Block, whose most famous work, Defending the Undefendable, not only made a case for drug legalization but also argued that black-market drug dealers are “heroic,” will be publishing a new book later this year dedicated entirely to the privatization of streets and roads.
Milton Friedman: “Road Socialist”
Block was converted from socialism to laissez-faire capitalism by a personal acquaintance with none other than Ayn Rand. Later, he met the “anarcho-capitalist” libertarian philosopher and Austrian economist extraordinaire Murray Rothbard, who converted Block from Rand’s preference for an ultra-limited government to “Rothbardian” hard-line individualist anarchism. But this conversion to an unpopular faith didn’t stop Block from becoming widely recognized as a great free-market economist. To the contrary, Block’s prolific work won the respect of his peers, and in fact, the forward to Defending the Undefendable was written by Nobel Laureate Friedrich von Hayek.
Roads have long been a pet issue for Block. Years ago, in a debate with the legendary Milton Friedman, Block called Friedman a “road socialist.” Friedman, who like Hayek was a Nobel prize winner in economics, resented the remark at first—and then he admitted it was true—he was a road socialist.
When even Milton Friedman, a heralded defender of the free market, considers socialization of a good or service to be wise, then that must be the case, right? Other supposed laissez-faire capitalists, such as George Mason University professor of Law and Economics Gordon Tullock and Cato Institute adjunct scholar Richard Epstein, also oppose the privatization of roads. But Block stands by his support for a free market in transportation because, in his view, it’s a matter of life and death.
1.2 Million: The Thirty-Year Government-Road Death Toll
Walter Block says that 40,000 people die each year on U.S. government roads, and that death rate has remained relatively stable since the 1970s. If roads were privately owned and operated, Block estimates that the annual death toll would be more like 10,000. Over a thirty year period, as many as 900,000 lives could be saved.
But why would privately owned roads be so much safer? There are a variety of reasons. For one, the government’s monopoly on roads leaves consumers with few alternatives. If roads were privately owned and operated by numerous road entrepreneurs, consumers would choose the safest ones. What’s more, private road owners could be held legally accountable for deaths on their watch—the government is immune from such liability.
“Pass the Socialist Salt”
The needless deaths caused by government roads are the strongest moral argument for road privatization but by no means the only one. Lew Rockwell—proprietor of the Internet’s most widely read libertarian Web site, LewRockwell.com, and founder of the Mises Institute—says that salt poured on roads to deal with ice causes millions of dollars in damages to cars. In extremely rare instances, according to Rockwell, government salt spreading has even killed people when the bottoms of their cars gave out due to corrosion caused by the “socialist salt.”
Walter Block points out that salt might in fact be the best way to deal with ice. Or maybe sand is better. A third and more costly—but not necessarily less cost-effective—method for dealing with ice is burying underground heating elements to melt it away. Block says he’s not a road entrepreneur, so he doesn’t know the best way of dealing with ice. But as an economist, Block says he does know that “competition brings about a better product.” Various private road companies competing for business would discover the best solution.
Answering the Objections
Walter Block presents answers for every possible argument against privatizing roads. Private roads would have to be built without eminent domain (government land seizure for public use), which to Block, an ardent defender of private-property rights, is not an obstacle but yet another element of their appeal. Still, he says this presents no real problem.
“What if a person or company owns ‘all’ of the land between here and Boston?”
That could never realistically happen. And even if it did, why would they not want to make money by leasing or selling some of their land to the road company, perhaps for a share of the profit?
“What if a crazy hold-out just won’t sell?”
No problem. Private roads can go around any hold outs. Or, if necessary, they could go over or under. And besides—there are plenty of roads that have already been built. There’s no sound argument against privatizing existing roads.
Walter Block knows a thing or two about government inefficiency—and he would even if he weren’t one of the foremost scholars of Austrian economics. After all, he is a resident of New Orleans, and like everyone from the Big Easy, he saw government mismanagement firsthand with Hurricane Katrina.
The proponents of “road socialism” should consider the following: the same people who run FEMA are also in charge of America’s roads. Is it a surprise that 40,000 people a year die on those roads? Would the free market really do worse? It seems unlikely.