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Privatization and changes in welfare costs of inflation the case of ENTel Argentina
JOURNALOF
PUBLIC
ECONOMICS
ELSEVIER
Privatization
Journal
of Public
Economics
55 (1994)
465-493
and changes in welfare costs of inflation The case of ENTel Argentina Manuel San Lorenzo Received
April
Angel
Abdala* .’
366 3A, _5UUOCordoba, 1992, final version
Argenfina
received
June
1993
Abstract In a country with permanent deficit-driven inflation problems, the proceeds from privatization may translate into potential reductions of the seigniorage needed to finance a given a level of government expenditure. The changes in welfare costs of inflation brought about by divestiture are quantified in a monetary model. In an Argentine case study, these changes were found to be small, both in terms of GDP and as a percentage of seigniorage revenue. Within the model, this is mainly explained by the low values encountered for the elasticities of money demand with respect to expected inflation, and by the exclusion of considerations about unanticipated inflation.
1. Overview
Apart from considerations concerning the potential efficiency changes within the industry, governments have been tempted to use privatization (especially in countries where the state sector is large) as a tool for macroeconomic policy. Among such uses, it has been frequently said that privatization may have the additional advantage of reducing the burden on * Current address: Expectativa. Argentina. ? I wish to thank the Public Enterprise Program of Boston University for indirect financing of this work; SIGEP (Sindicatura General de Empresas Publicas) for releasing ENTel’s accounting and Pankaj Tandon for constructive reports; Ingo Vogelsang, Leroy Jones, Paul Beaudry, insights and suggestions; Clemencia Torres and Santiago Cuneo for gilt-edged observations; and Marcel0 Schoeters for researcher assistance from Expectativa (in Argentina). Tel: (54-51) 69-7751; Fax: (54-51) 69-7751. 0047.2727/94/$07.00 0 1994 Elsevier SSDI 0047-2727(93)01404-X
Science
B.V. All rights
reserved
466
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the government’s budget. In a country with permanent deficit-driven inflation problems, this translates into potential reductions of the seigniorage needed to finance a given level of government expenditure. The changes in welfare costs of inflation brought about by the privatization venture will be calculated by looking at seigniorage as another form of taxation for government finance. The study focuses on the links between the fiscal flows prompted by privatization with changes in welfare costs of inflation. The exercise is applied to the leading case of the telecommunications company (ENTel) in Argentina. Even though the decision hurdle about divesting important public enterprises (PEs) seemed to have been overcome by governments of dissimilar countries all over the world, in most cases rhetoric - rather than action - has been the common denominator. Argentina’s latest bold move towards integral ‘rush privatization’ constitutes a peculiar case study that astonishes even the most radical advocates on the subject.’ To understand the importance placed on the fiscal aspect of divestiture, we need to examine the motives that prompted sudden privatization in Argentina. The government’s explicit initial objective stressed the fact that privatization was needed in the light of the negative past performance of most enterprises managed by the state. The disguised motives, however, may have been diverse: internal efficiency of the firm, degree of competition in the market, fiscal stringency, political reasons, distributional concerns, labor conflicts, etc., to name just a few. As the process of privatization went on, the government revealed that the fiscal motive was of crucial concern.’ It should not be surprising to find that in a country with permanent monetary inflation problems the fiscal consideration captures critical attention. By focusing on the fiscal impact of privatization in a high-inflation economy I address the main question, which is the following: Had ENTel not been divested, by how much would Argentine citizens be better or worse off in terms of bearing differential costs of inflation?3 This paper is organized as follows. First, I introduce the theoretical
’ A more comprehensive study on ENTel’n privatization is found in Abdala (1992). ’ This is clearly revealed in the stand-by agreement that the government signed with the IMF in mid-1991. Proceeds from privatization are stated to be vital in meeting targeted primary budget surpluses during 1991-92. ’ To our knowledge the explicit connection between privatization and inflationary finance has not been formally treated in the literature. Notwithstanding. numerous references have been made with respect to the fiscal argument of privatization as one of the major motives for selling public enterprises.
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approach are then
/ Journal of Public Economics
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367
to be used in the analysis. The empirical results on the ENTel case presented and discussed, followed by some concluding remarks.
2. Divestiture 2.1.
Ahdala
and welfare costs of inflation
Inflation effects
Inflation is customarily known in the macroeconomic literature as the major trade-off for reducing unemployment. Besides that, within the public finance literature inflation has been explained as the result of rational government decisions about seigniorage collection.” More recently, some economists have contended that extreme inflation processes are best described by chaos rather than by optimal government choices.’ Regardless of whether the government is making rational decisions or not, in our approach inflation is considered to be a form of government finance that imposes a tax on real balances held by the public. As with other forms of taxation, there are welfare losses (or excess burden) associated with the collection of this levy. By treating inflation as an excise tax on cash balances we can measure welfare losses due to increased inflation and interpret them as losses associated with transaction costs. These costs arise due to changes in payment procedures imposed by high inflation periods, including the adoption of barter, the rush for consumption or acquisition of foreign exchange, queuing or searching to find stores that are still open, as well as other time-consuming practices, all of them at the expense of leisure time. Estimating welfare costs of inflation in the same fashion as any other form of taxation is thought to be rather conservative. Since a partial equilibrium analysis is used, some shortcomings are involved in this approach. In particular, the approach excludes considerations about sudden redistributions of wealth and income due to unanticipated inflationP assumes real interest rates to remain unchanged, ignores the so-called Tanzi effect,’ and
‘See. for instance, Friedman (1053. 1971) and Bailey (1956). ‘See Dornbusch et al. (1990). ’ Anticipated inflation occurs when agents’ expectations about the rate of price increase are correct and individuals are not locked into contracts which were signed before inflation became anticipated. Unanticipated inflation is therefore inflation in which either of these two conditions are not met. ‘The Tanzi effect addresses the issue of how inflationary finance would affect tax revenue whenever there are collection lags. See Tanzi (1978).
468
omits
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considerations
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about
relative
55 (1994) 465-493
price variability
and inflation
uncertain-
ty. In the Argentine case, however, these cross-effects of inflation can be considered to be of second-order magnitude. The widespread use of an indexation mechanism has minimized the risks of unanticipated inflation and neutralized the Tanzi effect, and the other considerations are not relevant to the main aim and characterization of the paper. 2.2.
Our main problem
The objective is to measure the change in welfare costs of inflation associated with privatization. We need to establish the links between the net fiscal flows generated within the telecom industry and changes in welfare costs of inflation. Compare the actual case of the privatized ENTel with a counter-factual scenario of continued public operation. In the counter-factual projections we follow the evolution of the telecommunications sector had ENTel not been divested. These projections are primarily based on ENTel’s past behavior and on the different known forms of state influence over public enterprises to predict as accurately as possible what the evolution of the sector would have been. The macroeconomic environment remains the same under both scenarios, except of course for those changes that are induced by the counter-factual experience. For a given level of government expenditure, privatization has prompted changes in fiscal flows which will alter the need for government finance. Under the characterization of an administration that is unable to borrow or to alter taxation in the short run, the alternative relies on changing the level the government resorts to of seigniorage collection PI To adjust seigniorage, money creation affecting the rate of money growth, which in turn changes people’s expectations about future inflation. Changes in expected inflation lead people to modify their real money balances. Keeping real variables constant, we should then be able to assess the changes in welfare costs of inflation by finding the counter-factual level of money growth prompted by the differential fiscal flows. 2.3.
The model
unravelled
At each point in time we calculate the differential in fiscal flows (DF,) between the two cases of private (FFB) and public operation (FF:). Fiscal flows basically comprise proceeds and obligations originated by the sale * Later in the paper means of government
we support finance.
this characterization
by studying
the feasibility
of alternative
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I Journal of Public Economics
transaction, direct and net indirect and dividends: 9
taxes, interest
469
5.5 (1994) 465-493
paid to state-owned
banks,
DF, = FF; - FF; .
(1)
The target level of counter-factual seigniorage as a ratio to income (SF) will be equal to the actual level of seigniorage (Sr) plus the differential in fiscal flows (DF,): Sf = SF + DF, .
(2)
Welfare costs of inflation can be measured by focusing on the demand for real money balances. For a given level of income, this demand is an inverse function of the nominal interest rate, and the differential welfare costs of inflation as a ratio to income (DW,) can be expressed as DW, = WC; - WC; , where WC: is the welfare cost under continued government operation, WC: is welfare cost under the privatized scenario. Alternatively,
and
G DW, =
I
m”(x) dx + 7T;[md(7T;>- md(Q
- [77; -
7gmd(Q .
The nominal interest rate (i) is defined as the sum of the real interest (r, which is assumed to be constant) plus expected inflation (v’): i=r+7rr.
(3)
rate
(4)
The money demand equation used, (5), is a Cagan-likeI function which implicitly assumes a constant real interest rate. The next equation, (6), represents the equilibrium condition in the money market: Md m”=yy=ae
(--aTiP) ,
(5)
md = ms
(6)
MiPY is real balances per GDP, (Y is the semi-elasticity of money demand with respect to expected inflation, and a is the inverse of velocity when expected inflation equals zero. Expectations about inflation are characterized to be a function of the money growth rate, p, as shown in Eq. (7). The explicit form of the function is the result of a rational expectations process that appears to apply to the recent Argentine case: ” A definition “‘See Cagan
and a numerical (1956).
presentation
of these
Bows will be made
later in the paper.
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?r;= PO+ P,PL,+ P2l-L1 . Seigniorage (as a ratio to income), which from inflationary finance, can be defined as S, = sF,rnF ,
(7) is the government’s
revenue
(8)
where s = M,,/M,. The base for seigniorage collection is best defined by the monetary base (currency + deposits on Central Bank) plus deposits in stateowned banks, M,. ” The need for s comes since M, (currency + demand deposits) is the variable in the demand function (5), whereas government seigniorage comes only from M,,. Using Eqs. (5) and (7) we can rewrite seigniorage as S, = sp,a e -~(P,)+P,~,+B~~,-,)
(9)
which is a function of present and past speed of money creation. Recall from Eq. (2) that counter-factual seigniorage is determined by the exogenous variable, DF, since actual seigniorage (S’) is known. Therefore we want to determine the counter-factual rate of money growth. Equation (9) provides the ground for such calculation. By looking at the inverse function of (9) we can write /4 =f(SP,
Pk-,) .
(10)
Given the functional form of (9), an explicit expression for p cannot be found. However, we can look at Taylor approximations of Eq. (10) around the points we are interested in. A first-order approximation around the actual lagged rate of money growth and seigniorage yields
and the explicit
form for (11) is
” When considering the monetary base we have left out the amount of bank deposits in the Central Bank that are subject to indexation arrangements, since those should be subtracted when calculating the inflation tax base. We acknowledge that the practice of paying interest on these deposits was stopped beginning in 1990. In addition, the figures for the deposits of state-owned banks in the period analyzed were left out in the calculations since they were not available.
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471
Notice that the counter-factual rate of money growth depends on the actual rate, the difference in seigniorage, and the difference in the previous period money growth rates. All these are weighted by the semi-elasticity of md with respect to expected inflation, CY,and by the responses of expected inflation to present and past money growth (p’s). Now that a value for /-L: has been found, we can use Eqs. (5), (7) and (12) to solve for differential costs of inflation in Eq. (3). Using a transformation given by md(rC) = +(/..L), [an abbreviation of the exponential term on the right-hand side of Eq. (9)] we can write DW as
or
to finally
get
Changes in welfare cost of inflation therefore can be calculated by knowing actual and counter-factual rates of money growth, actual real balances, and the parameters a and p. The latter coefficients have been estimated under the formulation of a model in which people’s expectations about inflation are rational and determined by the policy process governing money creation. 2.4.
Government’s
alternative
fiscal choices
Since the differential fiscal flows arising from the counter-factual scenario can be interpreted as a shock to the government budget, it is important to investigate to what extent alternative ways of financing such fiscal shock would have been available. Three basic alternative options to seigniorage revenue are briefly discussed here. These are debt finance, changes in regular taxation, and
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changes in current government expenditure.‘* In a short-run finance can be seen as the most valid alternative of the three, attributes of regular taxation and expenditure.
situation, debt given the rigid
2.4.1. External and internal debt At least up to mid-1991, new debt finance from external sources was not available to Argentina. In fact, since 1979 Argentina has been unable to generate current account surpluses that would enable her to meet contractual interests in her external debt.13 External debt servicing was kept to minimum formal levels from 1989 to 1991.14 Besides, the country had accumulated arrears of U.S.$5,428 million (14.2 percent of total commercial external debt) in 1989. This implicit form of finance (arrears) has been exercised up to its limit during 1990 as well. We rule out external debt finance as the marginal source for government funds. Internal debt was not a reliable alternative either. The limits to this form of finance were reached as far back as 1989. The interest-bearing internal public debt increased from an average of U.S.$4.0 billion in 1985 to a peak of U.S.$12.4 billion in mid-1989, at the time when the Menem administration took office. Rodriquez (1989) pointed out that for the period 1985-87 the marginal cost of domestic borrowing was around 30 percent annually in dollar terms, reaching a peak of 40.3 percent in late 1987.” During 1989, this rate increased to 59 percent.” This form of finance was extremely expensive for the government, and did not significantly differ from inflationary finance in the sense that it failed to shift the burden of taxation further into the future. With such high cost of borrowing faced by the government the possibilities for new issues were basically nil. As Dornbusch et al. (1990) would point out, ‘in a situation of extreme inflation, neither external nor internal debt financing of the government is available’. 2.4.2. Regular taxation and expenditure When faced with a fiscal shock, the government cannot rapidly implement changes in the level of public expenditure or in regular taxation. In both
” The selection of these choices is in line with the alternatives presented in a basic general macroeconomic framework. This can be corroborated in Artana et al. (1991). ” See Rodriguez (1989, p. 2). ” During the second half of 1990 and in 1991, Argentina paid U.S.$60 million per month to its commercial creditors [McCormick (1991)]. ” For the same period, Artana et al. (1991, p. 58) give an average annual real interest rate on internal public debt of 21.7 percent. When including 1988, the average for the period drops slightly to 19.8 percent. ” Source: FIEL (1989).
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55 (1994) 465-493
cases, major changes require the approval of Congress, a process that may well be lengthy. Figure 1 presents information about current expenses incurred by the Treasury and regular tax revenue taken in by Customs and the DGI (the tax collector body), in the three years 1988-91. Notice that a moderate increase in the real revenue from taxation can be observed during the second quarter of 1991. A tax reform was introduced in April of that year. The reform aimed to simplify the tax system in general, with particular attention to the income tax. It also attempted to fight evasion and attract Argentine capital held abroad.” A more comprehensive look at the structure of DGI revenue in 1991 (see Table 1) reveals that the tax component that grew the most was the value added tax, which is directly related to the increased level of activity observed since the second quarter of 1991. Moreover, the overall level achieved in this period was still lower than the revenue collected during some months in the previous two years. This quick look at the evidence suggests the following: on the one hand, expenditure levels seemed to be quite inflexible to changes prompted by fiscal shocks. On the other hand, a real increase in tax revenue is observed beginning in April 1991. Such an upward trend can be attributed both to the tax reform and the stabilization and recovery of the economy. However, in spite of the reform, the overall level was still too low to allow us to consider regular taxation as the marginal source for government funds at the time.
2.5.
Seigniorage
revenue as the government’s
source of marginal funds
Argentina’s high-inflation history, together with the antecedent discussion about fiscal choices, suggests that seigniorage collection has been the financial instrument of first resort among government administrations during the last 15 years. The two hyperinflation peaks suffered in 1989 and 1990 were crude reflections of the government’s inability to finance a certain level of expenditure without resorting to money creation. The magnitudes for seigniorage revenue in Argentina have been calculated by several authors. While not an exhaustive illustration, Fig. 2 displays measures for this form of finance as a percentage of GDP for various years of recent Argentine economic history, together with inflation levels during the same period of time. During the early 197Os, seigniorage collection variations from 3 to 8 percent of GDP were sustainable with relatively lower inflation rates than in the first half of the 1980s. The reason has to be found in the reduction of the tax base in the latter period, due to the adoption of
“For
a summary
of the nature
of the tax reform
see Fundacibn
Mediterrinea
(1991)
100
200
300
400
500
600
1988
0
Fig. 1. Argentina, australes). Source:
1988-91. IEERAL
Government + FIEL.
1989
current
expenses
and
1990
revenue
(in
1985 constant
1991
M.A. Table 1 1991 Argentine
Abdala
public
sector
I Journal of Public Economics
revenue
(in billions
May
June
July
9564 3477 6087
14015 4925 9090
14169 5106 9063
13411 5153 8258
14840 5641 9199
1129
958
1277
1184
1352
1145
7443
5132
4727
5986
6146
6208
6872
20634
14723
15249
21278
21498
20970
22857
February
March
11868 3853 8015
8461 3243 5218
Customs
1323
Others Total Source:
of July 1991 australes) April
January DC1 Value added Rest
475
55 (1994) 465-493
FIEL.
financial innovations and indexation measures aiming to reduce the risk of exposure to inflation. Finally, Fig. 3 shows monthly seigniorage collection, inflation rates and money growth rates for the period 1988-91. Notice that the seigniorage revenue rates are annual equivalent figures for monthly data. It follows that the interpretation of the seigniorage magnitudes for the high-inflation peaks must be made carefully.‘* 2.6.
Econometric
model for the money demand estimation
The relevant parameter needed to calculate Eq. (13) in our model is given by the semi-elasticity of money demand with respect to expected inflation, (Y. Several authors have estimated money demand equations for Argentina in the past. Unfortunately, their estimates correspond to models and/or periods of time that are not suited to our analysis. Consequently, in this section we develop our own econometric model. It is worth noting that there are alternative approaches to deriving a money demand function for the calculation of differential welfare costs of inflation. The most traditional approach takes an ad hoc Cagan-like money demand function, widely utilized in the literature to explain hyperinflationary periods. Alternatively, the New Classical Economy approach would derive a money demand function by maximizing an infinitely-lived agent’s
” For example, it is not proper to think that the government would be able to permanently collect more than 30 percent of GDP (as in the peak months of the 1989 and 1990 hyperinflation periods) in the form of seigniorage! For a particular month, though, both seigniorage and the associated welfare losses can be very important, as studies of the European hyperinflation in the 1920s revealed. See Barro (1972) and Cagan (1956).
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55 (1994) 465-493
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477
478
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utility function that includes both money and consumption as arguments.r9 Although some variations can be found within this latter approach, in practice an ad hoc utility function for the representative consumer has to be adopted, usually ending up in a derived quasi-Cagan money demand which has analogous implications as the directly presumed Cagan’s demand.” Our approach follows the spirit of Sargent and Wallage (1973) in which the dynamics of hyperinllation are consistent with rational expectations. Sargent (1977) noted that a simple direct estimation of a Cagan money demand function under the implicit assumption of perfect foresight (in which expected inflation is set to equal actual inflation) creates a simultaneous-equation bias in the estimator. Doing such estimation is equivalent to taking inflation as the exogenous variable that ‘causes’ money creation (in Granger’s sense) with no reverse feedback in the other direction. Instead, we use a model in which people’s rational expectations about inflation are a function of the policy process governing money creation. We use monthly data for the period 1988-91. A Cagan-like demand function for real balances is used [see Eq. (5)], under the assumption that real income is constant, either because its variations are negligible or because they are too small relative to changes in inflation. Taking logs and differentiating Eq. (5) yields 7r, = /.Lt+ (Y[?TY- 7i-:+,]. Rational
expectations
m; = E,(n,+,
(4
are introduced
by
10,) >
03)
where the last expression is the mathematical expectation of T~+~ conditional on 0, the information set available to agents at time t. Using the method of undetermined coefficients2r we conjecture that there is a relationship such as
Taking
expectations
E,_,q = i
i=0
in Eq. (C) at time t - 1 and forwarding
4E,-,P(+,
3
one period:
CD)
I9 For some empirical work involving the New Classical Economy approach see Eckstein and Leiderman (1989), De Gregorio (1990), and Janada (1991). “’ As another alternative, Tobin (1956) obtained a money demand from a model based on optimal accumulation of inventories and portfolio decisions. ‘I The use of this method can be seen, for instance, in Sargent (1987), Shessrin (1983, ch. 2), Blanchard and Fischer (1989, appendix to ch. 5) and McCallum (1989, pp. 155-157).
M.A.
Err,+, Combining
Taking
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I Journal of Public Economics
479
55 (1994) 465-493
=iS,EtPt+l+i. the last three
equations
in (A) we get
at t - 1 and rearranging
expectations
terms,
(F) can be expressed
as
We can now solve for 6, such that 1 &I= 1+(Y Using
these
and
solutions
4=
1 a’ (I+(y)‘(l+(Y).
together
with Eqs.
(A), (D),
and (E),
where current inflation is a function of present and expected future money growth. Considering only one lead for Eq. (G) we have
rates of
Notice that there still are unobservables in the last equation. To complete the model we need to specify a rule for the process governing money supply. In order to do so, it is important to determine the nature of the relationship between money growth and inflation. If inflation is affecting the process of money creation, money growth becomes endogenous to the model. Otherwise, money growth can be treated as exogenous with respect to inflation. A Sims22 test has been performed to determine whether or not money growth was exogenous during the period analyzed. The process has been found to be exogenous. We therefore propose the following policy rule: t4 = flo + ‘TIP,-1 + @,Pt+, + 6, >
0)
where .s is the unsystematic component affecting money creation, assumed to be a serially uncorrelated term with zero mean and finite variance. The u’s are constants. Taking expectations for the expression in (I) yields:
” See Sims (1972)
M.A.
480
E t-l&
Abdala
= go +
ml
I Journal of Public Economics
w-1
+
02t-k2
E r-1&+1 = a,(1 + a,) + (6 To simplify notation, sions in (H) we obtain ?Tr= -z2[ao(l
w
)
+ 4/-G1
+
let us call z = a/(1+ CV). Replacing the last expresthe reduced form of the model, given by
Z”l)lk2
can be expressed
WI
7
+
(N)
c3E*.I-2.
The last expression is now a function estimated with Eq. (I), with the following
c1= [l
+
+ C2>]/JPl
as
“r = cO + cl& + $.,-&I
co = -z2[%(1
CL)
‘Tl~2I-L2
+ Cl)] + [l + za,]/-$ + z[a2 - ui - z(a:
-43(1+ which
55 (1994) 465493
of observables cross-restrictions
and it is jointly applying:
c,)l 7
+ ZW,] )
c, = z[q
- c1 - z(vf
c3 = -z[f12(1
+ a,>] ,
+ ZFi)] .
Uniqueness for the value of z has been imposed. Thus, an estimate for the value of CY,the semi-elasticity of expected inflation can be found.23 The econometric results are presented in Table 2. Lastly, recall that Eq. (7) has been derived by taking expectations in (N), so that
or
23 At this stage a Wald test has been performed to evaluate the feasibility of the crossequation restrictions. The explicit forms of the restrictions in the system are given by CO= -[c, - l)ia,12[a,(l + a,)] , c2= (c, - l)[C*//a, ~ 1 - (c, - l)(l + C&)] c, = -cc, - t)[u2clia,)l.
,
M.A.
Table 2 Econometric System with Equation 1: Equation 2: Equation (t-statistic
Abdala
I Journal of Public Economics
results cross-equations restrictions: U, = 00 + crl u,_, + (T~u,_~ n, = cU + cru, + c~u,_, + c~u,-~
1: ut = cr0 + ulu,_, in parenthesis)
+ ‘T~u,_~
Coefficients
Ordinary
Weighted
LS
LS
0.088 (2.48) 0.906 (6.02) -0.264
(TO Ul a2
_....
0.086 (2.49) 0.922 (6.33) -0.277
.!.???
R’ R’ Adj D-W Observations Equation (f-statistic
.!:.!:93!.
0.58 0.55 1.87 42
0.58 0.55 1.90 42
Ordinary LS
Weighted LS
-0.012 1.245 (8.53) -0.357 c2 c,.:................................................ 0.089 0.71 R’ R’ Adj 0.68 D-W 1.54 42 Observations
-0.011 1.243 (8.92) -0.356 0.091
2: r, = cr, + c,u, + czul_, + c,u,_> in parenthesis)” Coefficients
CO cl
Estimate
481
55 (1994) 465-493
of semi-elasticity
of expected
a
a The value cross-restrictions
of the coefficients of the system.
with
0.71 0.68 1.54 42
inflation Ordinary LS
Weighted LS
-0.370
-0.358
unreported
t-statistics
has
been
calculated
using
the
+Direct taxes +Indirect taxes +Dividends +Net. financ. transfers Total ‘core’ FFp
Public operation
57 486 0 0 543
1990
115
Discmmted
FFp
674
-New paid-in-capital +Ext. debt service reduction -Debt take-over obligations Total FFp (undis)
1990
fiscal flows in (U.S.$
118 556 0 0 674
Projected
+Dmxt taxes +Indirect taxes i-Dividends +Net. financ. transfers Total ‘core’ FFp
ENTel Argentina: Private oaerution
Table 3
121 647 0 -20 748
1991
944
0 162 -254 944
325 397 31s 0 1036
1991
million)
72 667 0 31 770
1992
672
0 156 -245 783
353 419 101 0 872
1992
47 718 0 1X 783
1993
652
0 166 -256 885
369 484 122 0 97s
1993
62 773 0 18 854
1994
514
0 182 -274 812
388 516 0 0 904
1994
80 833 0 19 932
1995
451
0 187 -277 831
394 521 0 0 922
1995
96 899 0 20 1015
1996
408
0 I82 -268 876
416 546 0 0 962
1996
115 970 0 21 1106
1997
388
0 179 -262 Y69
464 588 0 0 1052
1997
140 1048 0 22 1210
1998
351
0 183 -263 1022
489 614 0 0 1102
1998
1651 1132 0 23 132.5
1999
317
0 186 -263 1076
512 641 0 0 1153
1999
203 1224 0 25 1452
2000
286
0 18Y -263 1132
536 670 0 0 1206
2Ow
93
543
214
Ext. debt reduction Debt take-over obligations Total DF
Source: own based on Abdula (1992).
214
0
0
131
0 131 14 -21 ~27
-19
-21 2
I
61 70
1991 12
661
0 0 0 770
102 13
1992
10
11
288 196
1991
748
0 0 0 748
1990
131 131
1990
Monthly differential fiscal flows
fiscal flows (annual)
Direct taxes Indirect taxes Financial transfers Dividends Total core DF
lY90-91
Core DF Total DF
Differmud
Discounted FFg
-New paid-in-capital +Ext. debt service reduction -Debt take -over obligations =Total FFp (undis)
14 -21 -27
-19
-21 2
2
3
14 -21 24
-21 2
192 102
1993
577
0 0 0 783
14 -21 -27
-19
-21 2
4
50 -42
1994
540
0 0 0 854
14 -21 ~27
-19
-21 2
5
-10 -100
1995
506
0 0 0 932
14 -21 181
-21 2 157 189
6
7
14 -21 -27
-19
-21 2
-53 -139
1996
473
0 0 0 1015
14 -21 ~27
-lY
-21 2
8
-55 -137
1997
443
0 0 0 1106
14 -21 24
32
-21 2
9
~108 -188
1998
415
0 0 0 1210
14 -21 -27
-19
-21 2
10
-172 -249
11
14 -21 -27
-19
-21 2
1999
390
0 0 0 1325
14 -21 181
-21 2 157 189
12
-245 -319
2Ooo
367
0 0 0 1452
M.A.
484
Abdala
3. Costs of inflation 3.1,
ENTel’s
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55 (1994) 465-493
aftermath
fiscal flows
Before turning to the results concerning differential welfare costs of inflation, we briefly show how the fiscal flows between ENTel and the government have been quantified. These flows are mainly the result of the taxation rules and the firm’s behavior at the industry level.” In the case of ENTel, the identification of ‘core’, or direct flows between the public enterprise and the government, can be summarized as follows:‘5 (a) As a recipient of funds the government collects direct and indirect taxes from the firm and could also receive other distributions, either in the form of dividends or in the form of interests paid to state-owned banks, the Central Bank, and official agencies. The distribution of dividends is not a common practice in PEs.‘~ (b) As a source of funds to the firm, the government can arrange various kinds of subsidies and it can directly or indirectly (through its own banks) provide capital for investment purposes and loans at negative or low real interest rates.” Other fiscal flows are only particular to the transaction itself, and in the case of ENTel we identify the following: (c) Net sale proceeds: (i) cash received from buyers, net of transaction costs; (ii) debt swap mechanisms involved in the transfer that reduces future obligations with government creditors. (d) Debt take-over at the time of divestiture that generated government obligations previously held by ENTel. At any point in time, the main concern is centered on the difference between fiscal flows, as shown by Eq. (1). Table 3 contains the information on fiscal flows between the telecom industry and the government for the whole period 1990-2000. Interestingly, the net fiscal contribution due to ENTel’s divestiture is only positive in the first years, becoming progressively negative towards the end of the decade. As a consequence of substantial increased profitability under private operation the government will be able to collect more in corporate and value-added taxes. However, transfer of ownership brought along changes in the structure of taxation, and the former ‘telecommunication tax’ launched in 1988 (which represented 31.58
I4 See Abdala (1992, ch. II). ” Here we only cite the flows that are relevant to this empirical case study. For a more comprehensive specification see Premchand (1979) and Gray (1984). ” The government never collected dividends from ENTel during the period 1980-88. ” Under the privatized scenario, however, there were no sources of funds from government to the firm.
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485
percent of revenue) was given up as part of the privatization deal. This foregone excise tax accounts for most of the ‘core’ fiscal differentials against the government.*’ In a monthly analysis for 1990-91 we observe that following the date of the cash sale proceeds (October 1990) there are some months in which the negative fiscal impact may imply lower seigniorage collection costs under continued public operation. 3.2.
Core results
To best interpret the results of this research, the period under study has been divided in two parts: monthly data from October 1990 to December 1991, and annual data from 1992 to the year 2000. The reason for this segmentation is quite straightforward. For the monthly period we possess actual data until August 1991 and reasonable projections for the main monetary variables for the rest of the year. From 1992 onwards, our calculations would be more questionable given the high degree of uncertainty about the behavior of most macroeconomic variables. The main attention should be centered on the 1990-91 span. In the ‘core’ run, only the cash component of the sale and the fundamental fiscal flows emerging from differential behavior are used, resorting to the debt transactions (debt swap and debt take-over) as an option course. The reason for adopting the latter criterion is twofold: first, we miss information on how ENTel’s former debt was re-scheduled; and second, despite being able to reconstruct a maturity structure for the re-purchased external debt, the actual Argentine implicit strategy for determining the amount of interest to be serviced was given by goals and considerations that were relatively invariable to ENTel’s swap transaction. Figures 4 and 5 present the differences between actual and counter-factual rates of money growth and the related welfare costs for 1990-91. The major fiscal impact in a single month is given by the cash proceeds from the sale, in October 1990. At the end of 1991 there is also a noticeable difference that is explained by dividends paid out to the government as the owner of the unsold 40 percent shares in the actual scenario. The results show that had the government needed to collect U.S.$214
” In the calculation of the financial transactions under public operation we include interest plus repayments paid to government (in the broad sense), net of new liquidity finance. Liquidity here is not to be considered an interest-free loan since there were various forms of indexation and penalty fees whenever the firm failed to meet its obligation deadlines. ENTel used to accumulate tax arrears that were automatically escalated by the ongoing indexation mechanisms.
486
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-_
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(’ (
/’ \
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-7
/
\
/------
-------
--L
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million in seigniorage (cash proceeds), the money growth rate for October 1990 would have been 12.1 percent instead of 8.2 percent, and the incremental welfare costs would have totalled 0.078 percent of the GDP (annual equivalent). Within our model, it can also be predicted that had ENTel’s revenue not been available, an incremental 5.6 percent rise on October’s inflation would have had to be borne by citizens. During the span from 1990 to 1991, the present value of welfare cost changes amounted to U.S.$16.3 million in the core scenario (see Table 4). Anything that can be said about welfare cost changes from 1992 onwards depends on the Argentine macroeconomic conditions in that period (especially monetary variables). Recall that an institutional change relevant to the monetary policy was introduced in April 1991, the so-called Convertibility Plan. In terms of inflationary finance, the April monetary reforms seriously undermined the government’s future ability to collect large amounts of revenue in the form of seigniorage, as it has done customarily in the past. Although citizens still use local currency as the most efficient mean of exchange, attempts by the government to permanently finance expenditure with seigniorage revenue would provoke an immediate switch from local to foreign currency, thus abruptly decreasing the tax base and, with it, the government’s ability of inflationary financing. Yet this statement does not imply that seigniorage as a source of revenue will completely disappear. Thus, from 1992 onwards, a base scenario calls for projecting relative monetary stability, if one is to believe that the current program will be sustained. A different picture is also plausible, though it will require the replacement of existing legislation. For the present work we will not attempt to measure any changes in welfare costs in an unstable scenario, as it would be a hopeless and preposterous task. The best we can aim for is to project a scenario in which relative monetary stability is achieved, with some constant ratios to be maintained over time. It will be assumed that velocity is constant, its level given by the values observed after the Plan; that GDP grows at a constant average rate of 3.5 percent per year;‘” and that growth in money supply will on average equal income growth plus inflation. Resorting to this characterization, it will not be surprising to expect small welfare costs of inflation, since the government’s ability to collect seigniorage has been substantially limited. The differential welfare costs are also small, despite the fact that differential fiscal flows become progressively negative through time. Within the core scenario, the net present value of welfare costs of inflation changes has been estimated at U.S.$-8.5 million for the period 1992-2000 (see Table 4).
” For this kind of macroeconomic McCarthy (1987).
projections
on Argentina
we have based
our estimates
on
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3.3. Option scenario with debt transactions How would the core results vary when the option route of including the totality of fiscal flows is considered? As can be seen in Table 3, the fiscal effects become negative for the government as early as 1994. In this optional estimation of fiscal flows we include the debt taken over by the government and the relief from the debt buy-back operation.“’ Debt obligations arising from privatization would bear net unfavorable fiscal implications for the government. Spreading out the annual amount of debt take-over obligations (net of external debt relief) during 1990-91 shows that the counter-factual money growth level and associated welfare costs are lower than actual levels, with the exceptions of a few months including October 1990 (sale proceeds), and December 1991 (when dividends are paid out). The overall results are presented in Table 4. 3.4.
Taxation changes
To what extent were changes in taxation within the telecommunications industry introduced as a result of privatization? Would the government have been forced to eliminate the so-called ‘telecommunication excise tax’ regardless of the divestiture decision? The answer seems to lie in the domain of pure conjectures, although the possibility that the government would have removed this distortionary form of taxation anyhow is not all all negligible.”
Table 4 Differential welfare costs of inflation value, U.S.$ million)
results
(in 1991 present
Scenario
1990-91
1992-2000
Core Option
16.32 14.22
- 8.47 - 16.36
“‘Since at the time of divestiture the bulk of ENTel’s debt was external, the obligations taken over by the government at that time are assumed to have a similar maturity schedule as the public external commercial debt. This is quite a general approximation since we ignore how debt repayments were renegotiated with former ENTel’s providers and creditors. The debt service relief from cancellation of Argentine IOUs was estimated using the same maturity scheduled as that of the external commercial debt, and using the government’s implicit probability of debt service (p), as explained in Abdala (1992, ch. I). ‘I In fact, in February 1991, when the new economic minister (Mr. Cavallo) took office, several tax changes intended to simplify the Argentine tax system were prospectively studied for rapid implementation. The tax reform came through in April of that year.
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Table 5 Sensitivity on taxation: Removal of telecom operation in April 1991. Differential welfare (in 1991 present value, U.S.$ million)
55 (1994) 465-493
tax under public costs of inflation
Scenario
1990-91
1992-00
Core Option
21.13 19.32
22.70 13.22
If this were to be the case, there is no reason to think that the decision to remove this excise tax would have come within the same time frame as ENTel’s divestiture. Therefore, we will argue that in a very optimistic perspective the soonest date in which the government would have been able to eliminate this tax (assuming its profound willingness to do this) would have been April 1991, when the major tax reform approved by Congress became effective, shortly after the new economic cabinet took office. This alternative scenario changes the whole fiscal picture, making differential fiscal flows become positive for all periods after the conjectured date of April 1991, for both the core and the option scenario. Changes in welfare costs of inflation will be positive for both sub-periods analyzed. Results are presented in Table 5.
6. Concluding 6.1.
remarks
Changes in welfare costs of inflation
At the macroeconomic level, differential costs of inflation were found to be relatively small, both in terms of GDP and as a percentage of seigniorage revenue. How do we interpret these findings? Explanations can rest on costs of seigniorage collection, on the magnitude of differential fiscal flows, or on the interaction of both. Overall, the marginal cost of collection was 2.5 cents per dollar.32 In principle, this does not strike one as an expensive means of government finance, compared with the welfare losses associated with other forms of taxation. Other economists have also found these costs to be low for the
32 This is the net present value of changes in welfare costs of inflation over the net present value of differential seigniorage revenue. At the time of divestiture, the marginal cost of seigniorage collection was about 4 cents per dollar, in a month in which seigniorage revenue represented 4 percent of DGP (annual equivalent).
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491
same type of model.“’ Why are welfare costs of inflation so low? In this case, the main reason has to do with the shape of the demand curve, given by the semi-elasticity of money demand with respect to expected inflation. Welfare costs follow a non-linear pattern. When inflation is below 20-25 percent (monthly), the demand for money is remarkably inelastic - probably due to the very low degree of monetization of the economy - therefore reducing the scope for welfare losses of anticipated inflation. Only when inflation becomes more extreme (higher than 25-30 percent per month), the costs of marginal collection start to grow exponentially within this model. In addition, it should not be surprising to find small costs of anticipated inflation in a country with such a tiresome history of price increases. The true costs of inflation in the Argentine scenario are probably given by the potential disruption of the monetary system, the redistributional and net welfare effects of unanticipated inflation, and by what we may call the ‘instability hangover’ of inflation, meaning the disincentives to investment due to persistent monetary nuisances. Differential welfare costs of inflation could also be small if the changes in fiscal flows are negligible. During 1990-91 there were at least four months in which these differentials cannot be termed as being negligible. It is true, however, that for several months the diversion was minor. An interesting quantification can be explored by combining ENTel’s proceeds with those coming from other privatization transactions occurring at about the same time as ENTel’s. Since welfare effects will grow exponentially with changes in fiscal flows, the consolidated impact of all privatizations can possibly have a more sizeable effect than that of ENTel alone. 6.2.
Further
suggestions
Some other macroeconomic consequences have been left out in this study. In particular, business investment decisions (including repatriation of flown capital) may have changed through the fact that for the first time the government had accomplished an important divestiture transaction that was so frequently deterred in the past. Additionally, we have not considered how the privatization proceeds may have helped the Argentine government bridge access to a Brady agreement. Were this to be the case with ENTel’s
” For example, Bailey (19.56) found that for a seigniorage level of 6 percent of GDP the marginal cost of seigniorage collection was 7 cents per dollar. rising to IS cents when seigniorage reaches 10 percent of GDP. He suggests that the figure of 7 cents may not be unreasonable for countries with poor tax administrations and tax morality. Aghevli (1977) found that the marginal cost of seigniorage collection was 3 cents per dollar for LY= 0.5 and seigniorage revenue around 4 percent of GDP.
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flows, an evaluation of the potential gains from reinsertion to international capital markets would have to be made. Finally, ENTel’s pilot case may also have relevant effects concerning the size and growth of the Argentine capital market once the remaining shares are publicly floated.
References Abdala, M.A., 1992. Distributional impact evaluation of divestiture in a high-inflation economy: The case of ENTel Argentina Ph.D. dissertation. Boston University. Aghevli, B., 1977, Inflationary finance and growth. Journal of Political Economy 6, 1295-1307. Artana, D., 0. Libonatti and C. Rivas, 1991, Algunas Consideraciones sobre el Endeudamiento y la Solvencia del Sector Public0 Argentino, Boletin Informativo Techint 266, 53-71. Bailey. M., 1956. The welfare cost of inflationary finance, Journal of Political Economy 64, 93-110. Barro, R.J., 1972. InHationary finance and the welfare costs of inflation. Journal of Political Economy X0,978-1001. Blanchard 0. and I. Fischer. 1989, Lectures on macroeconomic (MIT Press, Cambridge, MA). Bruno, M. and S. Fischer, lY87, Seigniorage. operating rules and the high inflation trap, NBER Working Paper 2413. Cagan, P., 1956, The monetary dynamics of hyperinflation, in: M. Friedman, ed., Studies in the quantity theory of money (University of Chicago Press, Chicago, IL). De Gregorio, J., 1990, Costs of seigniorage and welfare, Ph.D. dissertation, MIT, Cambridge. Dornbusch. R., F. Sturzenegger and H. Wolf, 1990, Extreme inflation: Dynamics and stabilization, Brookings Papers on Economic Activity 2, l-81. Eckstain, 2. and L. Leiderman, 1989, Estimating an intertemporal model of consumption, money demand and seigniorage, Foerder Institute for Economic Research, Working Paper 89. Fanelli, J.M. and R. Frenkel, 1990. Politicas de Estabilizacion e Hiperinflacion en Argentina (CEDES. Buenos Aires). FIEL, 1989, lndicadores de Coyuntura 274. Fischer, S., 1986, Indexing, inflation and economic policy (MIT Press, Cambridge, MA). Friedman. M.. 1953, Discussion of the inflationary gap, in: M. Friedman. Essays in positive economics (University of Chicago Press, Chicago. IL). Friedman, M.. 1971, Government revenue from inflation. Journal of Political Economy 79, 846-856. Fundacion Mediterranea, 1991, Newsletter 6, l-15. Gray, C.. 1984, Evaluation of public enterprise performance, in: R. Floyd et al., Public enterprise in mixed economies (Washington. DC). Janada, C., 19Y1, Foreign currency deposits. technological innovation and welfare, Ph.D. dissertation, Boston University. McCallum. B.. lY89, Monetary economics (Macmillan, New York). McCarthy, D.. lY87. Argentina: Towards the year 2000, World Bank Internal Discussion Paper 0013. McCormick, J.. 1991, The secondary market quarterly update. World Bank CFS Informal Notes 35 and 39. Melnick. R. and M. Sokoler. 1984, The government’s revenue from money creation and the inflationary effects of a decline in the rate of growth of GNP, Journal of Monetary Economics 13. 225-236.
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Premchand, A., 197Y, Government and public enterprises-the budget link, Finance and Development 16, 27-30. Rodriguez, C., 1989, Managing Argentina’s external debt: The contribution of debt swaps. World Bank Internal Discussion Papers 24, I-60. Sargent. T.. 1977, The demand for money during hyperinflations under rational expectations, International Economic Review 18, No. 1. Sargent, T., 1987, Dynamic macroeconomic theory (Harvard University Press, Cambridge, MA). Sargent. 7‘. and N. Wallace, 1973. Rational expectations and the dynamics of hyperinflation. International Economic Review 14, 328-350. Shessrin. S.. 1983, Rational expectations (Cambridge University Press, Cambridge). Sims, C.. 1972. Money, income. and causality, American Economic Review 42, 3877403. Tanzi, V.. 1978, Inflation. real tax revenue, and the case for inflationary finance: Theory with an application to Argentina, IMF Staff Papers 24. 154-167. Tobin, J., 1955. A dynamic aggregative model, Journal of Political Economy 23, 103-l IS. Tobin. J.. 1956, The interest elasticity of the transactions demand for cash, Review of Economics and Statistics 38, 241-247. Tobin, J., 1965. Money and economic growth. Econometrica 33, 671-684. Vinning. D.R. and T.C. Elwertowski, 1Y76, The relationship between relative prices and the general price level. American Economic Review 66. 699-708.
PUBLIC
ECONOMICS
ELSEVIER
Privatization
Journal
of Public
Economics
55 (1994)
465-493
and changes in welfare costs of inflation The case of ENTel Argentina Manuel San Lorenzo Received
April
Angel
Abdala* .’
366 3A, _5UUOCordoba, 1992, final version
Argenfina
received
June
1993
Abstract In a country with permanent deficit-driven inflation problems, the proceeds from privatization may translate into potential reductions of the seigniorage needed to finance a given a level of government expenditure. The changes in welfare costs of inflation brought about by divestiture are quantified in a monetary model. In an Argentine case study, these changes were found to be small, both in terms of GDP and as a percentage of seigniorage revenue. Within the model, this is mainly explained by the low values encountered for the elasticities of money demand with respect to expected inflation, and by the exclusion of considerations about unanticipated inflation.
1. Overview
Apart from considerations concerning the potential efficiency changes within the industry, governments have been tempted to use privatization (especially in countries where the state sector is large) as a tool for macroeconomic policy. Among such uses, it has been frequently said that privatization may have the additional advantage of reducing the burden on * Current address: Expectativa. Argentina. ? I wish to thank the Public Enterprise Program of Boston University for indirect financing of this work; SIGEP (Sindicatura General de Empresas Publicas) for releasing ENTel’s accounting and Pankaj Tandon for constructive reports; Ingo Vogelsang, Leroy Jones, Paul Beaudry, insights and suggestions; Clemencia Torres and Santiago Cuneo for gilt-edged observations; and Marcel0 Schoeters for researcher assistance from Expectativa (in Argentina). Tel: (54-51) 69-7751; Fax: (54-51) 69-7751. 0047.2727/94/$07.00 0 1994 Elsevier SSDI 0047-2727(93)01404-X
Science
B.V. All rights
reserved
466
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the government’s budget. In a country with permanent deficit-driven inflation problems, this translates into potential reductions of the seigniorage needed to finance a given level of government expenditure. The changes in welfare costs of inflation brought about by the privatization venture will be calculated by looking at seigniorage as another form of taxation for government finance. The study focuses on the links between the fiscal flows prompted by privatization with changes in welfare costs of inflation. The exercise is applied to the leading case of the telecommunications company (ENTel) in Argentina. Even though the decision hurdle about divesting important public enterprises (PEs) seemed to have been overcome by governments of dissimilar countries all over the world, in most cases rhetoric - rather than action - has been the common denominator. Argentina’s latest bold move towards integral ‘rush privatization’ constitutes a peculiar case study that astonishes even the most radical advocates on the subject.’ To understand the importance placed on the fiscal aspect of divestiture, we need to examine the motives that prompted sudden privatization in Argentina. The government’s explicit initial objective stressed the fact that privatization was needed in the light of the negative past performance of most enterprises managed by the state. The disguised motives, however, may have been diverse: internal efficiency of the firm, degree of competition in the market, fiscal stringency, political reasons, distributional concerns, labor conflicts, etc., to name just a few. As the process of privatization went on, the government revealed that the fiscal motive was of crucial concern.’ It should not be surprising to find that in a country with permanent monetary inflation problems the fiscal consideration captures critical attention. By focusing on the fiscal impact of privatization in a high-inflation economy I address the main question, which is the following: Had ENTel not been divested, by how much would Argentine citizens be better or worse off in terms of bearing differential costs of inflation?3 This paper is organized as follows. First, I introduce the theoretical
’ A more comprehensive study on ENTel’n privatization is found in Abdala (1992). ’ This is clearly revealed in the stand-by agreement that the government signed with the IMF in mid-1991. Proceeds from privatization are stated to be vital in meeting targeted primary budget surpluses during 1991-92. ’ To our knowledge the explicit connection between privatization and inflationary finance has not been formally treated in the literature. Notwithstanding. numerous references have been made with respect to the fiscal argument of privatization as one of the major motives for selling public enterprises.
M.A.
approach are then
/ Journal of Public Economics
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367
to be used in the analysis. The empirical results on the ENTel case presented and discussed, followed by some concluding remarks.
2. Divestiture 2.1.
Ahdala
and welfare costs of inflation
Inflation effects
Inflation is customarily known in the macroeconomic literature as the major trade-off for reducing unemployment. Besides that, within the public finance literature inflation has been explained as the result of rational government decisions about seigniorage collection.” More recently, some economists have contended that extreme inflation processes are best described by chaos rather than by optimal government choices.’ Regardless of whether the government is making rational decisions or not, in our approach inflation is considered to be a form of government finance that imposes a tax on real balances held by the public. As with other forms of taxation, there are welfare losses (or excess burden) associated with the collection of this levy. By treating inflation as an excise tax on cash balances we can measure welfare losses due to increased inflation and interpret them as losses associated with transaction costs. These costs arise due to changes in payment procedures imposed by high inflation periods, including the adoption of barter, the rush for consumption or acquisition of foreign exchange, queuing or searching to find stores that are still open, as well as other time-consuming practices, all of them at the expense of leisure time. Estimating welfare costs of inflation in the same fashion as any other form of taxation is thought to be rather conservative. Since a partial equilibrium analysis is used, some shortcomings are involved in this approach. In particular, the approach excludes considerations about sudden redistributions of wealth and income due to unanticipated inflationP assumes real interest rates to remain unchanged, ignores the so-called Tanzi effect,’ and
‘See. for instance, Friedman (1053. 1971) and Bailey (1956). ‘See Dornbusch et al. (1990). ’ Anticipated inflation occurs when agents’ expectations about the rate of price increase are correct and individuals are not locked into contracts which were signed before inflation became anticipated. Unanticipated inflation is therefore inflation in which either of these two conditions are not met. ‘The Tanzi effect addresses the issue of how inflationary finance would affect tax revenue whenever there are collection lags. See Tanzi (1978).
468
omits
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relative
55 (1994) 465-493
price variability
and inflation
uncertain-
ty. In the Argentine case, however, these cross-effects of inflation can be considered to be of second-order magnitude. The widespread use of an indexation mechanism has minimized the risks of unanticipated inflation and neutralized the Tanzi effect, and the other considerations are not relevant to the main aim and characterization of the paper. 2.2.
Our main problem
The objective is to measure the change in welfare costs of inflation associated with privatization. We need to establish the links between the net fiscal flows generated within the telecom industry and changes in welfare costs of inflation. Compare the actual case of the privatized ENTel with a counter-factual scenario of continued public operation. In the counter-factual projections we follow the evolution of the telecommunications sector had ENTel not been divested. These projections are primarily based on ENTel’s past behavior and on the different known forms of state influence over public enterprises to predict as accurately as possible what the evolution of the sector would have been. The macroeconomic environment remains the same under both scenarios, except of course for those changes that are induced by the counter-factual experience. For a given level of government expenditure, privatization has prompted changes in fiscal flows which will alter the need for government finance. Under the characterization of an administration that is unable to borrow or to alter taxation in the short run, the alternative relies on changing the level the government resorts to of seigniorage collection PI To adjust seigniorage, money creation affecting the rate of money growth, which in turn changes people’s expectations about future inflation. Changes in expected inflation lead people to modify their real money balances. Keeping real variables constant, we should then be able to assess the changes in welfare costs of inflation by finding the counter-factual level of money growth prompted by the differential fiscal flows. 2.3.
The model
unravelled
At each point in time we calculate the differential in fiscal flows (DF,) between the two cases of private (FFB) and public operation (FF:). Fiscal flows basically comprise proceeds and obligations originated by the sale * Later in the paper means of government
we support finance.
this characterization
by studying
the feasibility
of alternative
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taxes, interest
469
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paid to state-owned
banks,
DF, = FF; - FF; .
(1)
The target level of counter-factual seigniorage as a ratio to income (SF) will be equal to the actual level of seigniorage (Sr) plus the differential in fiscal flows (DF,): Sf = SF + DF, .
(2)
Welfare costs of inflation can be measured by focusing on the demand for real money balances. For a given level of income, this demand is an inverse function of the nominal interest rate, and the differential welfare costs of inflation as a ratio to income (DW,) can be expressed as DW, = WC; - WC; , where WC: is the welfare cost under continued government operation, WC: is welfare cost under the privatized scenario. Alternatively,
and
G DW, =
I
m”(x) dx + 7T;[md(7T;>- md(Q
- [77; -
7gmd(Q .
The nominal interest rate (i) is defined as the sum of the real interest (r, which is assumed to be constant) plus expected inflation (v’): i=r+7rr.
(3)
rate
(4)
The money demand equation used, (5), is a Cagan-likeI function which implicitly assumes a constant real interest rate. The next equation, (6), represents the equilibrium condition in the money market: Md m”=yy=ae
(--aTiP) ,
(5)
md = ms
(6)
MiPY is real balances per GDP, (Y is the semi-elasticity of money demand with respect to expected inflation, and a is the inverse of velocity when expected inflation equals zero. Expectations about inflation are characterized to be a function of the money growth rate, p, as shown in Eq. (7). The explicit form of the function is the result of a rational expectations process that appears to apply to the recent Argentine case: ” A definition “‘See Cagan
and a numerical (1956).
presentation
of these
Bows will be made
later in the paper.
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?r;= PO+ P,PL,+ P2l-L1 . Seigniorage (as a ratio to income), which from inflationary finance, can be defined as S, = sF,rnF ,
(7) is the government’s
revenue
(8)
where s = M,,/M,. The base for seigniorage collection is best defined by the monetary base (currency + deposits on Central Bank) plus deposits in stateowned banks, M,. ” The need for s comes since M, (currency + demand deposits) is the variable in the demand function (5), whereas government seigniorage comes only from M,,. Using Eqs. (5) and (7) we can rewrite seigniorage as S, = sp,a e -~(P,)+P,~,+B~~,-,)
(9)
which is a function of present and past speed of money creation. Recall from Eq. (2) that counter-factual seigniorage is determined by the exogenous variable, DF, since actual seigniorage (S’) is known. Therefore we want to determine the counter-factual rate of money growth. Equation (9) provides the ground for such calculation. By looking at the inverse function of (9) we can write /4 =f(SP,
Pk-,) .
(10)
Given the functional form of (9), an explicit expression for p cannot be found. However, we can look at Taylor approximations of Eq. (10) around the points we are interested in. A first-order approximation around the actual lagged rate of money growth and seigniorage yields
and the explicit
form for (11) is
” When considering the monetary base we have left out the amount of bank deposits in the Central Bank that are subject to indexation arrangements, since those should be subtracted when calculating the inflation tax base. We acknowledge that the practice of paying interest on these deposits was stopped beginning in 1990. In addition, the figures for the deposits of state-owned banks in the period analyzed were left out in the calculations since they were not available.
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471
Notice that the counter-factual rate of money growth depends on the actual rate, the difference in seigniorage, and the difference in the previous period money growth rates. All these are weighted by the semi-elasticity of md with respect to expected inflation, CY,and by the responses of expected inflation to present and past money growth (p’s). Now that a value for /-L: has been found, we can use Eqs. (5), (7) and (12) to solve for differential costs of inflation in Eq. (3). Using a transformation given by md(rC) = +(/..L), [an abbreviation of the exponential term on the right-hand side of Eq. (9)] we can write DW as
or
to finally
get
Changes in welfare cost of inflation therefore can be calculated by knowing actual and counter-factual rates of money growth, actual real balances, and the parameters a and p. The latter coefficients have been estimated under the formulation of a model in which people’s expectations about inflation are rational and determined by the policy process governing money creation. 2.4.
Government’s
alternative
fiscal choices
Since the differential fiscal flows arising from the counter-factual scenario can be interpreted as a shock to the government budget, it is important to investigate to what extent alternative ways of financing such fiscal shock would have been available. Three basic alternative options to seigniorage revenue are briefly discussed here. These are debt finance, changes in regular taxation, and
412
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changes in current government expenditure.‘* In a short-run finance can be seen as the most valid alternative of the three, attributes of regular taxation and expenditure.
situation, debt given the rigid
2.4.1. External and internal debt At least up to mid-1991, new debt finance from external sources was not available to Argentina. In fact, since 1979 Argentina has been unable to generate current account surpluses that would enable her to meet contractual interests in her external debt.13 External debt servicing was kept to minimum formal levels from 1989 to 1991.14 Besides, the country had accumulated arrears of U.S.$5,428 million (14.2 percent of total commercial external debt) in 1989. This implicit form of finance (arrears) has been exercised up to its limit during 1990 as well. We rule out external debt finance as the marginal source for government funds. Internal debt was not a reliable alternative either. The limits to this form of finance were reached as far back as 1989. The interest-bearing internal public debt increased from an average of U.S.$4.0 billion in 1985 to a peak of U.S.$12.4 billion in mid-1989, at the time when the Menem administration took office. Rodriquez (1989) pointed out that for the period 1985-87 the marginal cost of domestic borrowing was around 30 percent annually in dollar terms, reaching a peak of 40.3 percent in late 1987.” During 1989, this rate increased to 59 percent.” This form of finance was extremely expensive for the government, and did not significantly differ from inflationary finance in the sense that it failed to shift the burden of taxation further into the future. With such high cost of borrowing faced by the government the possibilities for new issues were basically nil. As Dornbusch et al. (1990) would point out, ‘in a situation of extreme inflation, neither external nor internal debt financing of the government is available’. 2.4.2. Regular taxation and expenditure When faced with a fiscal shock, the government cannot rapidly implement changes in the level of public expenditure or in regular taxation. In both
” The selection of these choices is in line with the alternatives presented in a basic general macroeconomic framework. This can be corroborated in Artana et al. (1991). ” See Rodriguez (1989, p. 2). ” During the second half of 1990 and in 1991, Argentina paid U.S.$60 million per month to its commercial creditors [McCormick (1991)]. ” For the same period, Artana et al. (1991, p. 58) give an average annual real interest rate on internal public debt of 21.7 percent. When including 1988, the average for the period drops slightly to 19.8 percent. ” Source: FIEL (1989).
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cases, major changes require the approval of Congress, a process that may well be lengthy. Figure 1 presents information about current expenses incurred by the Treasury and regular tax revenue taken in by Customs and the DGI (the tax collector body), in the three years 1988-91. Notice that a moderate increase in the real revenue from taxation can be observed during the second quarter of 1991. A tax reform was introduced in April of that year. The reform aimed to simplify the tax system in general, with particular attention to the income tax. It also attempted to fight evasion and attract Argentine capital held abroad.” A more comprehensive look at the structure of DGI revenue in 1991 (see Table 1) reveals that the tax component that grew the most was the value added tax, which is directly related to the increased level of activity observed since the second quarter of 1991. Moreover, the overall level achieved in this period was still lower than the revenue collected during some months in the previous two years. This quick look at the evidence suggests the following: on the one hand, expenditure levels seemed to be quite inflexible to changes prompted by fiscal shocks. On the other hand, a real increase in tax revenue is observed beginning in April 1991. Such an upward trend can be attributed both to the tax reform and the stabilization and recovery of the economy. However, in spite of the reform, the overall level was still too low to allow us to consider regular taxation as the marginal source for government funds at the time.
2.5.
Seigniorage
revenue as the government’s
source of marginal funds
Argentina’s high-inflation history, together with the antecedent discussion about fiscal choices, suggests that seigniorage collection has been the financial instrument of first resort among government administrations during the last 15 years. The two hyperinflation peaks suffered in 1989 and 1990 were crude reflections of the government’s inability to finance a certain level of expenditure without resorting to money creation. The magnitudes for seigniorage revenue in Argentina have been calculated by several authors. While not an exhaustive illustration, Fig. 2 displays measures for this form of finance as a percentage of GDP for various years of recent Argentine economic history, together with inflation levels during the same period of time. During the early 197Os, seigniorage collection variations from 3 to 8 percent of GDP were sustainable with relatively lower inflation rates than in the first half of the 1980s. The reason has to be found in the reduction of the tax base in the latter period, due to the adoption of
“For
a summary
of the nature
of the tax reform
see Fundacibn
Mediterrinea
(1991)
100
200
300
400
500
600
1988
0
Fig. 1. Argentina, australes). Source:
1988-91. IEERAL
Government + FIEL.
1989
current
expenses
and
1990
revenue
(in
1985 constant
1991
M.A. Table 1 1991 Argentine
Abdala
public
sector
I Journal of Public Economics
revenue
(in billions
May
June
July
9564 3477 6087
14015 4925 9090
14169 5106 9063
13411 5153 8258
14840 5641 9199
1129
958
1277
1184
1352
1145
7443
5132
4727
5986
6146
6208
6872
20634
14723
15249
21278
21498
20970
22857
February
March
11868 3853 8015
8461 3243 5218
Customs
1323
Others Total Source:
of July 1991 australes) April
January DC1 Value added Rest
475
55 (1994) 465-493
FIEL.
financial innovations and indexation measures aiming to reduce the risk of exposure to inflation. Finally, Fig. 3 shows monthly seigniorage collection, inflation rates and money growth rates for the period 1988-91. Notice that the seigniorage revenue rates are annual equivalent figures for monthly data. It follows that the interpretation of the seigniorage magnitudes for the high-inflation peaks must be made carefully.‘* 2.6.
Econometric
model for the money demand estimation
The relevant parameter needed to calculate Eq. (13) in our model is given by the semi-elasticity of money demand with respect to expected inflation, (Y. Several authors have estimated money demand equations for Argentina in the past. Unfortunately, their estimates correspond to models and/or periods of time that are not suited to our analysis. Consequently, in this section we develop our own econometric model. It is worth noting that there are alternative approaches to deriving a money demand function for the calculation of differential welfare costs of inflation. The most traditional approach takes an ad hoc Cagan-like money demand function, widely utilized in the literature to explain hyperinflationary periods. Alternatively, the New Classical Economy approach would derive a money demand function by maximizing an infinitely-lived agent’s
” For example, it is not proper to think that the government would be able to permanently collect more than 30 percent of GDP (as in the peak months of the 1989 and 1990 hyperinflation periods) in the form of seigniorage! For a particular month, though, both seigniorage and the associated welfare losses can be very important, as studies of the European hyperinflation in the 1920s revealed. See Barro (1972) and Cagan (1956).
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477
478
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utility function that includes both money and consumption as arguments.r9 Although some variations can be found within this latter approach, in practice an ad hoc utility function for the representative consumer has to be adopted, usually ending up in a derived quasi-Cagan money demand which has analogous implications as the directly presumed Cagan’s demand.” Our approach follows the spirit of Sargent and Wallage (1973) in which the dynamics of hyperinllation are consistent with rational expectations. Sargent (1977) noted that a simple direct estimation of a Cagan money demand function under the implicit assumption of perfect foresight (in which expected inflation is set to equal actual inflation) creates a simultaneous-equation bias in the estimator. Doing such estimation is equivalent to taking inflation as the exogenous variable that ‘causes’ money creation (in Granger’s sense) with no reverse feedback in the other direction. Instead, we use a model in which people’s rational expectations about inflation are a function of the policy process governing money creation. We use monthly data for the period 1988-91. A Cagan-like demand function for real balances is used [see Eq. (5)], under the assumption that real income is constant, either because its variations are negligible or because they are too small relative to changes in inflation. Taking logs and differentiating Eq. (5) yields 7r, = /.Lt+ (Y[?TY- 7i-:+,]. Rational
expectations
m; = E,(n,+,
(4
are introduced
by
10,) >
03)
where the last expression is the mathematical expectation of T~+~ conditional on 0, the information set available to agents at time t. Using the method of undetermined coefficients2r we conjecture that there is a relationship such as
Taking
expectations
E,_,q = i
i=0
in Eq. (C) at time t - 1 and forwarding
4E,-,P(+,
3
one period:
CD)
I9 For some empirical work involving the New Classical Economy approach see Eckstein and Leiderman (1989), De Gregorio (1990), and Janada (1991). “’ As another alternative, Tobin (1956) obtained a money demand from a model based on optimal accumulation of inventories and portfolio decisions. ‘I The use of this method can be seen, for instance, in Sargent (1987), Shessrin (1983, ch. 2), Blanchard and Fischer (1989, appendix to ch. 5) and McCallum (1989, pp. 155-157).
M.A.
Err,+, Combining
Taking
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=iS,EtPt+l+i. the last three
equations
in (A) we get
at t - 1 and rearranging
expectations
terms,
(F) can be expressed
as
We can now solve for 6, such that 1 &I= 1+(Y Using
these
and
solutions
4=
1 a’ (I+(y)‘(l+(Y).
together
with Eqs.
(A), (D),
and (E),
where current inflation is a function of present and expected future money growth. Considering only one lead for Eq. (G) we have
rates of
Notice that there still are unobservables in the last equation. To complete the model we need to specify a rule for the process governing money supply. In order to do so, it is important to determine the nature of the relationship between money growth and inflation. If inflation is affecting the process of money creation, money growth becomes endogenous to the model. Otherwise, money growth can be treated as exogenous with respect to inflation. A Sims22 test has been performed to determine whether or not money growth was exogenous during the period analyzed. The process has been found to be exogenous. We therefore propose the following policy rule: t4 = flo + ‘TIP,-1 + @,Pt+, + 6, >
0)
where .s is the unsystematic component affecting money creation, assumed to be a serially uncorrelated term with zero mean and finite variance. The u’s are constants. Taking expectations for the expression in (I) yields:
” See Sims (1972)
M.A.
480
E t-l&
Abdala
= go +
ml
I Journal of Public Economics
w-1
+
02t-k2
E r-1&+1 = a,(1 + a,) + (6 To simplify notation, sions in (H) we obtain ?Tr= -z2[ao(l
w
)
+ 4/-G1
+
let us call z = a/(1+ CV). Replacing the last expresthe reduced form of the model, given by
Z”l)lk2
can be expressed
WI
7
+
(N)
c3E*.I-2.
The last expression is now a function estimated with Eq. (I), with the following
c1= [l
+
+ C2>]/JPl
as
“r = cO + cl& + $.,-&I
co = -z2[%(1
CL)
‘Tl~2I-L2
+ Cl)] + [l + za,]/-$ + z[a2 - ui - z(a:
-43(1+ which
55 (1994) 465493
of observables cross-restrictions
and it is jointly applying:
c,)l 7
+ ZW,] )
c, = z[q
- c1 - z(vf
c3 = -z[f12(1
+ a,>] ,
+ ZFi)] .
Uniqueness for the value of z has been imposed. Thus, an estimate for the value of CY,the semi-elasticity of expected inflation can be found.23 The econometric results are presented in Table 2. Lastly, recall that Eq. (7) has been derived by taking expectations in (N), so that
or
23 At this stage a Wald test has been performed to evaluate the feasibility of the crossequation restrictions. The explicit forms of the restrictions in the system are given by CO= -[c, - l)ia,12[a,(l + a,)] , c2= (c, - l)[C*//a, ~ 1 - (c, - l)(l + C&)] c, = -cc, - t)[u2clia,)l.
,
M.A.
Table 2 Econometric System with Equation 1: Equation 2: Equation (t-statistic
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results cross-equations restrictions: U, = 00 + crl u,_, + (T~u,_~ n, = cU + cru, + c~u,_, + c~u,-~
1: ut = cr0 + ulu,_, in parenthesis)
+ ‘T~u,_~
Coefficients
Ordinary
Weighted
LS
LS
0.088 (2.48) 0.906 (6.02) -0.264
(TO Ul a2
_....
0.086 (2.49) 0.922 (6.33) -0.277
.!.???
R’ R’ Adj D-W Observations Equation (f-statistic
.!:.!:93!.
0.58 0.55 1.87 42
0.58 0.55 1.90 42
Ordinary LS
Weighted LS
-0.012 1.245 (8.53) -0.357 c2 c,.:................................................ 0.089 0.71 R’ R’ Adj 0.68 D-W 1.54 42 Observations
-0.011 1.243 (8.92) -0.356 0.091
2: r, = cr, + c,u, + czul_, + c,u,_> in parenthesis)” Coefficients
CO cl
Estimate
481
55 (1994) 465-493
of semi-elasticity
of expected
a
a The value cross-restrictions
of the coefficients of the system.
with
0.71 0.68 1.54 42
inflation Ordinary LS
Weighted LS
-0.370
-0.358
unreported
t-statistics
has
been
calculated
using
the
+Direct taxes +Indirect taxes +Dividends +Net. financ. transfers Total ‘core’ FFp
Public operation
57 486 0 0 543
1990
115
Discmmted
FFp
674
-New paid-in-capital +Ext. debt service reduction -Debt take-over obligations Total FFp (undis)
1990
fiscal flows in (U.S.$
118 556 0 0 674
Projected
+Dmxt taxes +Indirect taxes i-Dividends +Net. financ. transfers Total ‘core’ FFp
ENTel Argentina: Private oaerution
Table 3
121 647 0 -20 748
1991
944
0 162 -254 944
325 397 31s 0 1036
1991
million)
72 667 0 31 770
1992
672
0 156 -245 783
353 419 101 0 872
1992
47 718 0 1X 783
1993
652
0 166 -256 885
369 484 122 0 97s
1993
62 773 0 18 854
1994
514
0 182 -274 812
388 516 0 0 904
1994
80 833 0 19 932
1995
451
0 187 -277 831
394 521 0 0 922
1995
96 899 0 20 1015
1996
408
0 I82 -268 876
416 546 0 0 962
1996
115 970 0 21 1106
1997
388
0 179 -262 Y69
464 588 0 0 1052
1997
140 1048 0 22 1210
1998
351
0 183 -263 1022
489 614 0 0 1102
1998
1651 1132 0 23 132.5
1999
317
0 186 -263 1076
512 641 0 0 1153
1999
203 1224 0 25 1452
2000
286
0 18Y -263 1132
536 670 0 0 1206
2Ow
93
543
214
Ext. debt reduction Debt take-over obligations Total DF
Source: own based on Abdula (1992).
214
0
0
131
0 131 14 -21 ~27
-19
-21 2
I
61 70
1991 12
661
0 0 0 770
102 13
1992
10
11
288 196
1991
748
0 0 0 748
1990
131 131
1990
Monthly differential fiscal flows
fiscal flows (annual)
Direct taxes Indirect taxes Financial transfers Dividends Total core DF
lY90-91
Core DF Total DF
Differmud
Discounted FFg
-New paid-in-capital +Ext. debt service reduction -Debt take -over obligations =Total FFp (undis)
14 -21 -27
-19
-21 2
2
3
14 -21 24
-21 2
192 102
1993
577
0 0 0 783
14 -21 -27
-19
-21 2
4
50 -42
1994
540
0 0 0 854
14 -21 ~27
-19
-21 2
5
-10 -100
1995
506
0 0 0 932
14 -21 181
-21 2 157 189
6
7
14 -21 -27
-19
-21 2
-53 -139
1996
473
0 0 0 1015
14 -21 ~27
-lY
-21 2
8
-55 -137
1997
443
0 0 0 1106
14 -21 24
32
-21 2
9
~108 -188
1998
415
0 0 0 1210
14 -21 -27
-19
-21 2
10
-172 -249
11
14 -21 -27
-19
-21 2
1999
390
0 0 0 1325
14 -21 181
-21 2 157 189
12
-245 -319
2Ooo
367
0 0 0 1452
M.A.
484
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3. Costs of inflation 3.1,
ENTel’s
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55 (1994) 465-493
aftermath
fiscal flows
Before turning to the results concerning differential welfare costs of inflation, we briefly show how the fiscal flows between ENTel and the government have been quantified. These flows are mainly the result of the taxation rules and the firm’s behavior at the industry level.” In the case of ENTel, the identification of ‘core’, or direct flows between the public enterprise and the government, can be summarized as follows:‘5 (a) As a recipient of funds the government collects direct and indirect taxes from the firm and could also receive other distributions, either in the form of dividends or in the form of interests paid to state-owned banks, the Central Bank, and official agencies. The distribution of dividends is not a common practice in PEs.‘~ (b) As a source of funds to the firm, the government can arrange various kinds of subsidies and it can directly or indirectly (through its own banks) provide capital for investment purposes and loans at negative or low real interest rates.” Other fiscal flows are only particular to the transaction itself, and in the case of ENTel we identify the following: (c) Net sale proceeds: (i) cash received from buyers, net of transaction costs; (ii) debt swap mechanisms involved in the transfer that reduces future obligations with government creditors. (d) Debt take-over at the time of divestiture that generated government obligations previously held by ENTel. At any point in time, the main concern is centered on the difference between fiscal flows, as shown by Eq. (1). Table 3 contains the information on fiscal flows between the telecom industry and the government for the whole period 1990-2000. Interestingly, the net fiscal contribution due to ENTel’s divestiture is only positive in the first years, becoming progressively negative towards the end of the decade. As a consequence of substantial increased profitability under private operation the government will be able to collect more in corporate and value-added taxes. However, transfer of ownership brought along changes in the structure of taxation, and the former ‘telecommunication tax’ launched in 1988 (which represented 31.58
I4 See Abdala (1992, ch. II). ” Here we only cite the flows that are relevant to this empirical case study. For a more comprehensive specification see Premchand (1979) and Gray (1984). ” The government never collected dividends from ENTel during the period 1980-88. ” Under the privatized scenario, however, there were no sources of funds from government to the firm.
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485
percent of revenue) was given up as part of the privatization deal. This foregone excise tax accounts for most of the ‘core’ fiscal differentials against the government.*’ In a monthly analysis for 1990-91 we observe that following the date of the cash sale proceeds (October 1990) there are some months in which the negative fiscal impact may imply lower seigniorage collection costs under continued public operation. 3.2.
Core results
To best interpret the results of this research, the period under study has been divided in two parts: monthly data from October 1990 to December 1991, and annual data from 1992 to the year 2000. The reason for this segmentation is quite straightforward. For the monthly period we possess actual data until August 1991 and reasonable projections for the main monetary variables for the rest of the year. From 1992 onwards, our calculations would be more questionable given the high degree of uncertainty about the behavior of most macroeconomic variables. The main attention should be centered on the 1990-91 span. In the ‘core’ run, only the cash component of the sale and the fundamental fiscal flows emerging from differential behavior are used, resorting to the debt transactions (debt swap and debt take-over) as an option course. The reason for adopting the latter criterion is twofold: first, we miss information on how ENTel’s former debt was re-scheduled; and second, despite being able to reconstruct a maturity structure for the re-purchased external debt, the actual Argentine implicit strategy for determining the amount of interest to be serviced was given by goals and considerations that were relatively invariable to ENTel’s swap transaction. Figures 4 and 5 present the differences between actual and counter-factual rates of money growth and the related welfare costs for 1990-91. The major fiscal impact in a single month is given by the cash proceeds from the sale, in October 1990. At the end of 1991 there is also a noticeable difference that is explained by dividends paid out to the government as the owner of the unsold 40 percent shares in the actual scenario. The results show that had the government needed to collect U.S.$214
” In the calculation of the financial transactions under public operation we include interest plus repayments paid to government (in the broad sense), net of new liquidity finance. Liquidity here is not to be considered an interest-free loan since there were various forms of indexation and penalty fees whenever the firm failed to meet its obligation deadlines. ENTel used to accumulate tax arrears that were automatically escalated by the ongoing indexation mechanisms.
486
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-_
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(’ (
/’ \
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-7
/
\
/------
-------
--L
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487
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million in seigniorage (cash proceeds), the money growth rate for October 1990 would have been 12.1 percent instead of 8.2 percent, and the incremental welfare costs would have totalled 0.078 percent of the GDP (annual equivalent). Within our model, it can also be predicted that had ENTel’s revenue not been available, an incremental 5.6 percent rise on October’s inflation would have had to be borne by citizens. During the span from 1990 to 1991, the present value of welfare cost changes amounted to U.S.$16.3 million in the core scenario (see Table 4). Anything that can be said about welfare cost changes from 1992 onwards depends on the Argentine macroeconomic conditions in that period (especially monetary variables). Recall that an institutional change relevant to the monetary policy was introduced in April 1991, the so-called Convertibility Plan. In terms of inflationary finance, the April monetary reforms seriously undermined the government’s future ability to collect large amounts of revenue in the form of seigniorage, as it has done customarily in the past. Although citizens still use local currency as the most efficient mean of exchange, attempts by the government to permanently finance expenditure with seigniorage revenue would provoke an immediate switch from local to foreign currency, thus abruptly decreasing the tax base and, with it, the government’s ability of inflationary financing. Yet this statement does not imply that seigniorage as a source of revenue will completely disappear. Thus, from 1992 onwards, a base scenario calls for projecting relative monetary stability, if one is to believe that the current program will be sustained. A different picture is also plausible, though it will require the replacement of existing legislation. For the present work we will not attempt to measure any changes in welfare costs in an unstable scenario, as it would be a hopeless and preposterous task. The best we can aim for is to project a scenario in which relative monetary stability is achieved, with some constant ratios to be maintained over time. It will be assumed that velocity is constant, its level given by the values observed after the Plan; that GDP grows at a constant average rate of 3.5 percent per year;‘” and that growth in money supply will on average equal income growth plus inflation. Resorting to this characterization, it will not be surprising to expect small welfare costs of inflation, since the government’s ability to collect seigniorage has been substantially limited. The differential welfare costs are also small, despite the fact that differential fiscal flows become progressively negative through time. Within the core scenario, the net present value of welfare costs of inflation changes has been estimated at U.S.$-8.5 million for the period 1992-2000 (see Table 4).
” For this kind of macroeconomic McCarthy (1987).
projections
on Argentina
we have based
our estimates
on
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489
3.3. Option scenario with debt transactions How would the core results vary when the option route of including the totality of fiscal flows is considered? As can be seen in Table 3, the fiscal effects become negative for the government as early as 1994. In this optional estimation of fiscal flows we include the debt taken over by the government and the relief from the debt buy-back operation.“’ Debt obligations arising from privatization would bear net unfavorable fiscal implications for the government. Spreading out the annual amount of debt take-over obligations (net of external debt relief) during 1990-91 shows that the counter-factual money growth level and associated welfare costs are lower than actual levels, with the exceptions of a few months including October 1990 (sale proceeds), and December 1991 (when dividends are paid out). The overall results are presented in Table 4. 3.4.
Taxation changes
To what extent were changes in taxation within the telecommunications industry introduced as a result of privatization? Would the government have been forced to eliminate the so-called ‘telecommunication excise tax’ regardless of the divestiture decision? The answer seems to lie in the domain of pure conjectures, although the possibility that the government would have removed this distortionary form of taxation anyhow is not all all negligible.”
Table 4 Differential welfare costs of inflation value, U.S.$ million)
results
(in 1991 present
Scenario
1990-91
1992-2000
Core Option
16.32 14.22
- 8.47 - 16.36
“‘Since at the time of divestiture the bulk of ENTel’s debt was external, the obligations taken over by the government at that time are assumed to have a similar maturity schedule as the public external commercial debt. This is quite a general approximation since we ignore how debt repayments were renegotiated with former ENTel’s providers and creditors. The debt service relief from cancellation of Argentine IOUs was estimated using the same maturity scheduled as that of the external commercial debt, and using the government’s implicit probability of debt service (p), as explained in Abdala (1992, ch. I). ‘I In fact, in February 1991, when the new economic minister (Mr. Cavallo) took office, several tax changes intended to simplify the Argentine tax system were prospectively studied for rapid implementation. The tax reform came through in April of that year.
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Table 5 Sensitivity on taxation: Removal of telecom operation in April 1991. Differential welfare (in 1991 present value, U.S.$ million)
55 (1994) 465-493
tax under public costs of inflation
Scenario
1990-91
1992-00
Core Option
21.13 19.32
22.70 13.22
If this were to be the case, there is no reason to think that the decision to remove this excise tax would have come within the same time frame as ENTel’s divestiture. Therefore, we will argue that in a very optimistic perspective the soonest date in which the government would have been able to eliminate this tax (assuming its profound willingness to do this) would have been April 1991, when the major tax reform approved by Congress became effective, shortly after the new economic cabinet took office. This alternative scenario changes the whole fiscal picture, making differential fiscal flows become positive for all periods after the conjectured date of April 1991, for both the core and the option scenario. Changes in welfare costs of inflation will be positive for both sub-periods analyzed. Results are presented in Table 5.
6. Concluding 6.1.
remarks
Changes in welfare costs of inflation
At the macroeconomic level, differential costs of inflation were found to be relatively small, both in terms of GDP and as a percentage of seigniorage revenue. How do we interpret these findings? Explanations can rest on costs of seigniorage collection, on the magnitude of differential fiscal flows, or on the interaction of both. Overall, the marginal cost of collection was 2.5 cents per dollar.32 In principle, this does not strike one as an expensive means of government finance, compared with the welfare losses associated with other forms of taxation. Other economists have also found these costs to be low for the
32 This is the net present value of changes in welfare costs of inflation over the net present value of differential seigniorage revenue. At the time of divestiture, the marginal cost of seigniorage collection was about 4 cents per dollar, in a month in which seigniorage revenue represented 4 percent of DGP (annual equivalent).
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same type of model.“’ Why are welfare costs of inflation so low? In this case, the main reason has to do with the shape of the demand curve, given by the semi-elasticity of money demand with respect to expected inflation. Welfare costs follow a non-linear pattern. When inflation is below 20-25 percent (monthly), the demand for money is remarkably inelastic - probably due to the very low degree of monetization of the economy - therefore reducing the scope for welfare losses of anticipated inflation. Only when inflation becomes more extreme (higher than 25-30 percent per month), the costs of marginal collection start to grow exponentially within this model. In addition, it should not be surprising to find small costs of anticipated inflation in a country with such a tiresome history of price increases. The true costs of inflation in the Argentine scenario are probably given by the potential disruption of the monetary system, the redistributional and net welfare effects of unanticipated inflation, and by what we may call the ‘instability hangover’ of inflation, meaning the disincentives to investment due to persistent monetary nuisances. Differential welfare costs of inflation could also be small if the changes in fiscal flows are negligible. During 1990-91 there were at least four months in which these differentials cannot be termed as being negligible. It is true, however, that for several months the diversion was minor. An interesting quantification can be explored by combining ENTel’s proceeds with those coming from other privatization transactions occurring at about the same time as ENTel’s. Since welfare effects will grow exponentially with changes in fiscal flows, the consolidated impact of all privatizations can possibly have a more sizeable effect than that of ENTel alone. 6.2.
Further
suggestions
Some other macroeconomic consequences have been left out in this study. In particular, business investment decisions (including repatriation of flown capital) may have changed through the fact that for the first time the government had accomplished an important divestiture transaction that was so frequently deterred in the past. Additionally, we have not considered how the privatization proceeds may have helped the Argentine government bridge access to a Brady agreement. Were this to be the case with ENTel’s
” For example, Bailey (19.56) found that for a seigniorage level of 6 percent of GDP the marginal cost of seigniorage collection was 7 cents per dollar. rising to IS cents when seigniorage reaches 10 percent of GDP. He suggests that the figure of 7 cents may not be unreasonable for countries with poor tax administrations and tax morality. Aghevli (1977) found that the marginal cost of seigniorage collection was 3 cents per dollar for LY= 0.5 and seigniorage revenue around 4 percent of GDP.
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flows, an evaluation of the potential gains from reinsertion to international capital markets would have to be made. Finally, ENTel’s pilot case may also have relevant effects concerning the size and growth of the Argentine capital market once the remaining shares are publicly floated.
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