Manufacturing the market we want

30/03/2013 § 3 Comments

A lot of economic theory is about markets. We then add government in as something that moves the market away from equilibrium. Subsidies, taxes, quotas, regulations, etc. — these are all ways in which government moves the market away from our assumption of what have happened otherwise. We never observe the counterfactual. We end up working backward from what we observe to what we think might have been.

And then we get situations like the affair with Rio Tinto/Meridian/Mighty River. The basic story is:

  • the Government is trying to sell part of Mighty River as the first of its State Owned Enterprises sell-offs
  • the sagging market for aluminium and high New Zealand dollar has led Rio Tinto to put pressure on Meridian to sweeten the deal around electricity prices
  • Meridian doesn’t want to give the shop away, and is resisting Rio Tinto’s negotiating tactics
  • the Government is concerned that lack of a deal will drop electricity prices, which would affect the market value of Mighty River shares.

I think I’ve got the story right, although I might not, so please feel free to set me straight in the comments.

The core problem for an economic analysis is that there isn’t really a market operating. The Government intervenes on the supply side of the electricity market through the SOEs. The Rio Tinto smelter as well as all the country’s households and other businesses make up the demand side. Now, the Government wants to step into the demand side to prop up demand from the smelter, rather than letting the two companies negotiate an agreement.

The intervention will be artificially inflating electricity demand above the level expected, given world prices and the exchange rate. This extra demand will boost consumer prices (and will cause more use of coal- and gas-fired plants, leading to more GHG emissions). That is, consumers will be paying a hidden transfer to Rio Tinto via power prices.

On the other hand, inflated demand will allow the Government to receive higher prices for the Mighty River share float, and then also for the planned Meridian float. That’s good for taxpayers and the public finances, but it’s bad for investors (and electricity consumers). Of course, an individual might be a taxpayer, investor and consumer all at once — are they better off?

The other worrying thing is that the Government intervention looks very much like ‘channel stuffing’. This is a business practice of artificially (and temporarily) increasing the sales figures in order to make the business look better than it really is. In this case (follow the bouncing ball), the Government would borrow money to raise Meridian’s sales figures to inflate the value of Mighty River to raise the value of the share float to pay off the borrowing.

This doesn’t require a market analysis; it needs a Rube Goldberg diagram.

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§ 3 Responses to Manufacturing the market we want

  • JC says:

    The situation has changed:

    http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10874850

    Key looks to have done one of those moves that satisfies the politics and the economics at the same time:

    “”We have put our best foot forward, put our only card on the table,” Key told TV3’s Firstline. “We have no interest in a long term subsidy. If it can’t stand on its own two feet, it shouldn’t be there.”

    JC

    • Bill says:

      A fascinating development. That does change things. Let’s see what happens next.

      Also, what does this mean for Ryall? His initiative seems to have been shut down by his boss.

      Now I’m starting to sound like a soap opera….

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