Net Present Value, Indeed

Michael Burke writes:

There are now 403 million reasons why Royal Mail should not be privatised. Financial results for Royal Mail just announced show that operating profits in the latest 52 weeks jumped to £403m, from £105m in the previous year. The government has signalled it intends to press ahead with a deeply unpopular privatisation even though Royal Mail achieved this return to profitability while remaining in the public sector.

All sides are agreed that the company will need to invest. Royal Mail faces the threat of a declining market as various forms of electronic messaging replace old-fashioned letters. But it also faces an opportunity in the form of a fast-growing parcels business, driven by the rise in internet retailing and home delivery. Investment is needed to manage the efficient decline of the letters business while using its unrivalled network to offer a market-leading parcels business.

Against all logic, the government insists that the capital required for investment must come from the private sector, and that this means Royal Mail must be sold off. But economists, from Adam Smith onwards, have recognised that the government can borrow more cheaply than private companies. The same is true today. Interest rates charged to government are about half of those charged even on highly rated company debt. Of course, in the private sector Royal Mail would also have to pay out dividends to shareholders. This has the effect of both increasing the costs of funds for and reducing the amount available for investment.

Royal Mail could also borrow on its own account at very low interest rates because it is implicitly guaranteed by the state, something which would not be available after privatisation. State sector companies all across Europe are allowed to borrow very cheaply because of their links to government, including banks, railways, health care providers and, yes, postal services.

The government argument that privatisation is necessary because its borrowing is needed to fund spending on services such as the NHS is false. Royal Mail could borrow more cheaply, more efficiently, on its own account if it remains in the public sector. Far from being a drain on scarce resources, Royal Mail could make a contribution to boosting growth and improving government finances.

Any company producing operating profits of over £400m can easily generate its own funds for investment and borrow for expansion. Not a penny of government borrowing would be required. It is the fall in investment which accounts for the slump in the British economy and Royal Mail could make its own contribution to rectifying that. In addition, although the government tries very hard to disguise this fact, investment by the public sector can also generate returns, just as it can in the private sector.

Ministers talk about selling it off – for £2bn to £3bn. In reality, a business generating profits on this scale is worth vastly more to government than that. Taxpayers, who supported Royal Mail through difficult times with subsidies, would be doubly ripped off.

Financial market operators can calculate the real value of Royal Mail using net present value. NPV is the current value of all future cashflows. For a publicly owned body, the calculation is straightforward. At current long-term interest rates, how much would the government have to borrow to yield £400m a year? With interest rates at 2% to 2.5% the answer is between £16bn and £20bn.

The proposed sell-off of Royal Mail has nothing to do with greater efficiency or boosting investment. Privatisation would crimp investment and the higher costs of borrowing would be extremely inefficient. Instead, it offers the opportunity to make a killing by the private sector that motivates this government, along with George Osborne's fiddles and schemes to pretend the deficit is falling.

Royal Mail is growing and investing while it remains in the public sector. Let it stay that way.