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June 29, 2015

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Risks, benefits of public-private partnerships

Chinese authorities have placed a priority on reforming the way large infrastructure works are financed and the way state-owned enterprises are run.

To get an outsider’s view on those issues, Shanghai Daily recently sat down with William L. Megginson, a University of Oklahoma finance professor specializing in privatization of state-owned companies and sovereign fund investment. He was at Fudan University’s School of Management as a guest speaker.

Q: A lot of people in China think the United States has no state-owned companies. Is that true?

A: In the US, we do not have a tradition of the government itself owning companies. It has never owned the banks, and it has never owned the railroads — well, it did briefly own a railroad — but it has never owned airlines, steel mills or telecoms. One exception is airports. Airports in the US are all owned by the government because of a quirk of financing. But the majority of American companies have always been privately owned, though regulated by the government. In most of the rest of the world, at one time or another, companies were actually owned directly by governments.

Q: China is now promoting a model of public-private partnerships in the financing and operation of large infrastructure projects. What do you think of that?

A: It is a kind of intermediate model. The idea is to bring in private market discipline and financing.

But it is hard to get it right: private investors don't have full ownership but they are asked to bear all the responsibilities, while the government makes the key decisions.

Q: So it would be difficult to implement successfully in China?

A: It’s difficult everywhere! The public-private partnership is very hard. It can work, but there needs to be a lot of negotiation going into it. It tends to be very legal intensive. You have to write detailed contracts, and you have to make sure about their implementation, including how to exit.

For example, a private investor builds a public road and then is allowed to charge a certain level of user fee. If there is not enough demand, the company does not make enough money. So what happens next? The company goes to the government asking for more money or decides to raise the road toll. You can't perfectly predict what will happen. There’s also the chance that the project ends up being very profitable, which makes the government feel it has done a bad deal for itself.

Q: And if it backfires?

A: Take the Eurotunnel connecting London and Paris, the world’s largest public-private partnership project. The governments were involved, and the project was all privately financed. So that is the ultimate example of funding a huge infrastructure project. Albeit an industrial success, the original shareholders were not happy because all of them were wiped out in the later stages of the project. They got creamed.

The public-private model is a way to finance only specific types of assets. You don't do technology ventures with private funds because there are too many risks. Usually, it is about infrastructure because there is no delivery risk and there’s a high payoff.

Q: In China, we use public-private partnerships as a kind of management innovation to address the problem of local government debt.

A: Well, China is unique. It has a savings rate of 50 percent and an investment rate of 48 percent. Unlike the US, where it is very hard to get capital projects off the ground, China can just act when it decides to do something like building a port or an airport.

Public-private partnerships allocate the risks to those best able to bear it, and the government is ultimately involved to ensure fairness and compliance and that the country isn’t being ripped off. Governments everywhere have severe financial constraints. China has constraints, too. Some say people are a bit worried about public-private partnerships in China. But I think it is essentially controlled. Companies have a choice. They can choose not to do it, unless they are a state-owned company.

Q: Speaking of state-owned enterprises, China is now trying to promote mixed ownership, allowing private and foreign investors as shareholders. What do you think about that?

A: China is different in privatization because the Chinese government is never going to let go of companies such as PetroChina.

Also, China does privatization differently. Everywhere else in the world, what happens is that governments sell stock. For example, with the British Telecom privatization, the government sold 25 percent of its shares. That is called a pure secondary offering.

But in China, it is the state-owned enterprises that sell stock. So the government doesn't sell its stock at all. In China, privatization is a capital-raising event. That is a fundamental difference. I'm not a big fan of that, by the way. I don't think that's the way they should go, but that's the way it has been done.

Q: So in foreign countries, it is the companies at the center of privatization. But in China, it is the government?

A: Well, in every other country, the government is selling the stock that it owns. So it is deliberately reducing its stock, probably down to zero. The company itself does not get any of the money. All of the money from the privatization of British Telecom went to the British government. So, if there is any performance improvement after the privatization, it's not because the company got all the money. In China, it is a primary share offering. The company is selling stock and raising money. The percentage of the government's share goes down, but it doesn’t sell any stock. It's very, very different.

There has been some ambiguous empirical evidence on privatization, but once you do it correctly and analyze it correctly, you have the same performance improvement in China for privatizations. Firms become profitable and more efficient. The same thing happens here as it does in other countries, although it occurs differently. It is because China has this primary share offering and because China is growing so fast anyway.

Q: Do you have any suggestions on how China should reform its state-owned companies?

A: Oh, I do. The government should sell its stock. They won’t listen to me, of course. I admire many things in China, but that's not one of them. If a company is really stuck, the government can’t do anything with all these non-tradable shares they own. So it is a very perverse loop that they are in. A terrible dilemma. Every country has an ideology and the binding ideology of China is simply that the government must retain control over certain sectors, which I don't agree with.

Q: Given the framework as it is, how can China make state-owned companies more efficient?

A: Allow as many market forces as you can, particularly over management. What most standard Chinese state-owned enterprises do is put bureaucrats in charge. That is not what they should do. It should be professional managers. Also, companies in non-sensitive sectors should be privatized. Why does the Chinese state need to control steel companies? They are already globally competitive. They have the latest technology that can produce the newest and the best steel. So there is no reason why the Chinese government should fear allowing them to be fully private.


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