The Economics of the Royal Mail Privatisation

royal mailThe privatisation of Royal Mail will begin tomorrow when the final launch price of the shares and their allocation will be announced. How are these shares likely to perform? Well, if history is any guide, they will perform fabulously well.

Have a look at this graph that was run in the Financial Times on Tuesday. It shows the amount by which the share price on the privatised British companies under Thatcher rose.

IMG_20110101_123736

As we can see, most of these companies did rather well. After only a year British Telecom’s share price was up over 80%, British Airways’ was up over 20% and British Gas’ was also up over 20%. The only one that didn’t do so well was British Steel. But this was a moribund industry that had to compete on the worldwide market, while the other three companies were domestic; as is Royal Mail.

What’s more, from what we currently know the markets are valuing Royal Mail far higher than any of the companies privatised under Thatcher. The Guardian reports:

The frenzy for the shares – fuelled by expectations of an immediate paper profit of 20% to 30% when trading begins on Friday – is more intense than demand for British Gas or British Telecom was at the height of the privatisation drive in the 1980s and 1990s.

The likelihood that these shares will thus result in windfall returns for private investors is very high.

Why then are the UK government privatising the company? Two main reasons, I think. (1) Ideology. (2) Because the UK government are engaged in austerity and so they don’t want to pony up the money that would be needed to modernise Royal Mail, instead they’re going to leave it to private investors. What will the results of this be? Higher prices for consumers, obviously.

Here’s an interesting question though: if we abstract away from ideology and the UK government’s obviously absurd austerity politics, what are the real economics behind the privatisation? Well, let’s try a counter-factual first. Let’s imagine that the government were to modernise Royal Mail by engaging in increased deficit spending. What would happen?

First of all, the interest rates on government debt would not budge given the current ZIRP environment. Secondly, there would be an immediate boost in demand for real goods and services as the investment drive began. The UK economy today is nowhere near full employment or full capacity, so this would not lead to inflation; rather it would just increase output and employment. (Probably not by very much, but still). The new capacity that is brought online by the investment drive will then increase productivity. Finally, prices for postage would remain stable; they may even fall if the modernisation produces extremely good productivity gains.

Now, let’s lay out the economics of the privatisation.

Let us imagine that after the shares are sold in the market private investors undertake an investment drive. Let us further imagine that most of the money for this investment is borrowed by the company. Again, interest rates will not rise in the ZIRP environment; so, no difference there. Likewise, there will be no inflationary pressure due to this increased investment; it will all contribute to increased employment and output. Again, the investment drive will increase productivity. Prices on postage, however, will likely rise.

So, what are the net effects? Simple. In the case of privatisation postage prices will increase and this will feed into the CPI — i.e. it will contribute to inflation. Whereas, if the government had done the investment themselves there would be no price increases and the CPI would remain as it would otherwise be; indeed, in time the modernisation may even contribute to a fall in postage prices.  In addition to this the price increases will accrue as profits to investors, so there will be a redistribution from consumers to investors. That’s it really.

Now, doesn’t it seem like the privatisation is an eminently stupid thing to do? Of course. But that’s what austerity politics and budget deficit taboos are all about: stupidity. Good news for those who buy up the shares though.

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About pilkingtonphil

Philip Pilkington is a London-based economist and member of the Political Economy Research Group (PERG) at Kingston University. You can follow him on Twitter at @pilkingtonphil.
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