CHAIR —Welcome, and thank you for appearing. We have your submission before us. It has already been published. Do you wish to make any alterations, corrections or additions to that written submission?

Prof. Quiggin —I would just like to make a brief opening statement. I thank the committee for inviting me to appear. To set this submission in context, in a mixed economy such as ours there are some activities and enterprises that are of more value in public ownership and others that are of more value in private ownership. In this submission I have tried to draw that balance with respect to the various activities that Telstra undertakes. I endorse the government's position that a partially privatised Telstra is an untenable mess, a camel, and all the various things that have been said about it, and that we need to attempt to decide once and for all which bits should be restored to full public ownership and which bits should be fully privatised. I also endorse the government's judgment that, at the current share price, privatising the whole of Telstra would not be justified.

I have been analysing this issue for a number of years and I think it is clear that, taking the organisation as a whole, the value of the earnings in continued public ownership exceeds the returns that could be achieved by selling the entire business and using the proceeds to pay debt. That said, there are significant parts of Telstra that I think should be sold off, most notably the BigPond telecommunications business and the Foxtel deal. As well as the economic justification for that, I think there are important regulatory reasons that it is undesirable for a monopoly or near monopoly carrier to also be a major provider of content. I have added to that list the various overseas ventures. I do not think there are many of those left after the closure in Indonesia.

I have been advocating this position fairly consistently for the last few years. Had we taken this decision three years ago, when the assets that I have suggested selling were much more highly valued, Australian taxpayers would be better off by many billions of dollars than they have been holding on to those assets. Similarly, had we not sold a third of Telstra in 1996, Australian taxpayers would again be a good deal better off. I think it is a matter of making that distinction and getting the division right.

Senator CHERRY —The treatment of dividend imputation credits is something I have been mulling over. I asked some questions of Professor Walker and others on this issue, and I will ask questions of DOFA. Do you know what the government does with the dividend imputation credits that come through from its share now?

Prof. Quiggin —I do not know what the accounting treatment is. I believe that they are not counted at all. That is my understanding.

Senator CHERRY —So they cannot really claim that they will do anything with them. But if they were released that would be a further negative cash flow, wouldn't it?

Prof. Quiggin —That is right. For the portion of Telstra that has been sold, the dividend imputation credits are a direct loss to the government just as they are an increase in the value of the earnings flowing to private shareholders.

Senator CHERRY —So, essentially, when we are trying to do a cash flow analysis of the cost to the taxpayer, we should not just look at the loss of dividend; we should also look at the loss of imputation credits as a further cost to taxpayers.

Prof. Quiggin —We should certainly look at the loss of dividend imputation credits. It is also important to take account of retained earnings and the fact that those retained earnings, to the extent that they are reinvested, imply growth in earnings over time, assuming Telstra's investments are sound. By contrast, if you use sale proceeds to pay debt, you get a fixed nominal stream which does not increase over time. So, even if the comparison were favourable in the very short term, you would need to take account of those retained earnings as well.

Senator CHERRY —How do you respond to the argument that any sort of structural separation of Telstra would significantly affect its market value, to the extent that two Telstras are worth considerably less combined than one big Telstra?

Prof. Quiggin —My view would be that, taking the whole of Telstra or the most ambitious version of Telstra, including, for example, media assets—potentially Channel 9 and so forth—it certainly would be exceptionally valuable because as a fully privatised entity it would be an incredibly powerful monopoly. It would be adding the power of somebody like Kerry Packer to the power of Telstra; it would be something that would be exceptionally valuable. But it would be valuable not for good economic reasons but because you have tied together a bunch of assets with a great deal of monopoly power.

If the asset were to be appropriately regulated, I do not think that the possession of things like an ISP, an Internet service provider, or a pay-TV network would add economic value to Telstra; they may add market value but I do not believe that they would add economic value. I certainly do not support the kind of more radical structural separation that has been proposed of separating service provision from retail. I think that that is clearly not what the market wants. So my version of separation would be to keep pretty much what people would have known as the old Telecom Australia and to sell off the various assets that have been acquired as part of the commercial ambitions of the current management.

Senator MACKAY —What is the major contention that is being put by government? You describe it in your paper, but I wonder if for the purposes of the Hansard you could describe it in a fairly simple way for us. The simplistic version goes: you sell Telstra, you get $30 billion, you retire debt and you save $2.3 billion worth of interest—bingo, that frees up $2.3 billion to be spent elsewhere. Could you comment on that scenario? It is a bit of mantra.

Prof. Quiggin —You have to compare that to the earnings that you lose by selling Telstra. My analysis has shown repeatedly that the amount that is lost over any reasonable time frame is going to exceed the amount that is saved by selling the asset and retiring debt.

Senator MACKAY —Could you expand on that a little bit?

Prof. Quiggin —It is a simple matter of looking at the amount of debt that the asset would service. So we can look at the total earnings of Telstra—which are ultimately what will be forgone, whether they are paid out as dividends or reinvested in the enterprise for future growth. Typical earnings have been around $4 billion a year, leaving aside the extraordinary losses from the sale of the overseas ventures. That corresponds to the interest flow on the amount of debt that is around $6 per share. When you take into account even very modest estimates of likely growth in Telstra earnings, even just keeping them going along in constant and real terms, you are looking at a price of $8 or $10 a share before you would get a return from retiring debt that is sufficient to offset the loss of those earnings.

Senator MACKAY —In fact, you are saying that the critical issue is not necessarily the dividend itself; it is actually the profit of the company.

Prof. Quiggin —That is right; the dividend can be set at any level the company chooses. In many instances in the case of public enterprises, we have had special dividends that actually exceed the profits. So it is clear that looking at dividends alone, given that the dividend is a variable that can be set from anything from zero to more than the total profit, is not an appropriate guide. In fact, many of the world's most profitable companies have a policy of not paying any dividends. Until recently, Microsoft did not pay dividends. That obviously did not make the enterprise worthless. It was simply a judgment that there were sufficient investment opportunities within Microsoft to justify reinvesting the earnings rather than paying them out as dividends.

Senator MACKAY —One of the things that we have been talking about fairly frequently is this issue of using the mechanism of hybrid securities for the sale, if it were to go down that track. I found out only recently about hybrid securities. Essentially it is a debt-equity model. It has been put to us that it is a good way to do it because, firstly, you can appeal to overseas markets which are used to hybrid securities with the divestment of things like Deutsche Telekom et cetera. Secondly, even though you retain a substantial level of debt, the merchant bankers, for example, say that it is cheaper debt and therefore a better way to go about it, rather than a straight share sale. They say that if you sell all these shares the market would be flooded, we would have cannibalisation and it would fall apart. Do you have any comment on that?

Prof. Quiggin —The first time I appeared before a committee on this topic I mentioned the classic theorem of economics, the Modigliani-Miller theorem. The department of finance witness who followed me said that he had never heard of it, which worried me a bit. The point of that theorem is that, leaving aside tax issues and assuming the same population of owners, the capital structure makes no difference to the value of the firm. So, up to a first approximation, it does not matter what sort of mix of debt and equity you use to finance the asset. The more debt you add in, the riskier is the equity and the higher the premium you pay on the equity. So, typically, the extent that these things are beneficial is due to some form of tax arbitrage, either exploiting the tax laws of a foreign country or exploiting Australian tax laws to get more favourable tax treatment of the debt. It is a standard proposition in finance that capital structure of the kind represented by hybrid securities makes no difference to the value of an enterprise in a properly functioning market without tax distortions.

Senator MACKAY —I am interested in the notion that you put forward that in fact retaining Telstra in its over 50 per cent government ownership is almost a safety mechanism in cushioning it from the exigencies of, for example, what happened with the dotcom boom and then bust et cetera. Do you want to expand on that a little bit?

Prof. Quiggin —It is clear that, as a result of public ownership, Telstra pursued better policies than most of the fully privatised enterprises. On the other hand, as a result of partial privatisation, the Australian public was exposed to losses that we should not have been.

Senator MACKAY —Like Reach.

Prof. Quiggin —The billion dollars lost in Reach, for example, would never have been undertaken by a fully public enterprise, and that is why partial privatisation is a poor policy. I argued this in 1996 when the government was saying that it was a good policy. I am pleased to see that the government agrees with me that it is a bad policy. Therefore we should—and Mr Costello agrees—bite the bullet and decide which bits we want fully publicly owned and which bits we want fully privatised.

CHAIR —You opposed the privatisation proposal, but one of the key advantages the government sees is the wider investment and equity opportunities that would flow from privatisation—that as a private company Telstra would, it is said, be more attractive to investors and that the share value would improve for a private company. You do not agree with those proposals.

Prof. Quiggin —Maybe you could clarify them for me. Clearly, if it were fully publicly owned, there would not be a share market so it would not be selling to private investors. Are you suggesting that we should do this as a subsidy to Australian shareholding?

CHAIR —No, that we should sell it off and make it fully privatised. With its hybrid character at the moment, being half publicly owned plus 0.1 per cent, the argument goes that there are limitations in the range of investments that Telstra can engage in, that it is difficult for it to raise capital and that its share price would probably be higher if it were privatised.

Prof. Quiggin —Yes. As I have just said to Senator Mackay, in fact that majority public ownership protected Telstra from disastrously bad investments made by many companies that had been privatised—not completely; we had a billion dollars lost in Reach and the Indonesian investments written off. Those are precisely the kind of examples that people have in mind when they talk of other investments that Telstra might have made. Telstra certainly made far fewer of those investments than, say, WorldCom or other fully privatised enterprises. Those investments are there and if private individuals or companies want to invest in those things, why shouldn't they? They don't need Telstra. Telstra is not needed in order to make those investments. If they are attractive, let them make the investments.

Senator MACKAY —They could do it now.

Prof. Quiggin —Those investments could be made without Telstra.

CHAIR —That is interesting, because one of the arguments was that other telcos such as France Telecom have got into a lot of financial trouble because they overestimated GSM and so on and spent a lot of money in the IT boom which did not deliver results. Telstra's protection is not necessarily a function of being partly publicly owned. Big companies make investments—good and bad; sometimes they work, sometimes they don't—so can you really argue that it is the public ownership that has protected Telstra, as some people do, from making bad investment decisions at managerial level? They did make a mistake in Hong Kong but big companies do make mistakes. BHP and AMP have both made bad investment decisions, so isn't it just the way of the world and the public ownership component is not necessarily a protection?

Prof. Quiggin —I am merely making the point that, as a matter of fact, in this particular period the kinds of investments that were being advocated—using this argument—were almost invariably bad ones. This argument was being made three or four years ago and the investments that people had in mind were investments like Reach. The argument was precisely that these investments were not to be made. Of course I am not saying that the public is inherently wiser than private investors; I am merely saying: why should we sell an enterprise which has greater value in public ownership in order to facilitate these investments? What is the necessity for tying these investments to Telstra? Telstra's core business does not have any particular economies of scope—or synergies, if you prefer—with the kinds of ventures we are talking about, such as Foxtel, Reach and so forth. These things do not add value to the core mission of Telstra; they simply serve the interests of the managers of Telstra.

CHAIR —Okay. Sometimes businesses diversify, though, and again that is the nature of business. Sometimes they come back to their core business but often they take on other businesses.

Prof. Quiggin —I think with the nature of infrastructure monopoly or near monopoly, which is what Telstra is, the general trend in policy have been very much against precisely the kind of thing you are talking about. It has been to ring-fence off those enterprises from secondary investments where the main benefit is likely to be leveraging market power rather than technical efficiency. That applies very strongly to BigPond and Foxtel. I simply observe the core point that we should focus on the core business of Telstra and work out whether it is of more value in public or private hands. I think the analysis shows very clearly that it is of more value in public hands.

CHAIR —That is fine. I was just trying out your views. I am not necessarily being critical of your views. The other thing that interests me is structural separation as a concept—the concept of the public retaining ownership of the network. How would that structural separation work in practice? You would have a telecommunications network owner and everybody else would pay connect charges to access it, including Telstra. Would that be the case? Would you see that as a means of enhancing competition and leading to a reduction in market share, perhaps, and dominance by Telstra of the market and to the growth of the other companies' percentage of the market.

Prof. Quiggin —Structural separation can mean a great many things and obviously I have tried to argue for a particular form of structural separation. In my view the notion of a physical network with retail being ring-fenced is not the appropriate form of separation for Telstra. It is clearly not what the Australian market has shown that it wants. I would draw the line rather differently. As I have said, what I would do is focus on the distinction between content and carriage. I would try to not have a third party access type network where Telstra was providing content in competition with other parties, as it is at present—acting as an Internet service provider, a web entrepreneur, a pay TV provider and so forth. I would push Telstra completely out of that business but I would keep a full telecommunications service including local telephony, mobile telephony and so forth, and for that part I would favour a third party access regime which is pretty much what we have at present. My main focus would be on getting Telstra out of the content business.

CHAIR —I am still quite interested in that model. It is a bit like British Rail these days, where British Rail owns the rail and you find Virgin trains pulling into stations and various other companies running trains on a railway system owned by British Rail.

Prof. Quiggin —British Rail does not exist anymore. Railtrack is not a very happy example of that process.

CHAIR —That is what I want to hear about.

Prof. Quiggin —It is a matter of horses for courses. The British Rail privatisation and restructuring was a very bodgie job done very badly. I do not think that that means we should never have a model of that kind. I think, for example, the separation between generation and distribution in electricity has a lot to be said for it. Again, one of the problems with all these things is where retail fits in. My preference, which I have argued in detail in the paper, is one where Telstra continues to provide a more or less full suite of the basic telecommunications services but, rather than competing with third party providers in areas like content, it pulls completely out of those businesses. For those areas that is a more robust competitive model and it will give better regulation.

In terms of public policy we have big problems. For example, there is a possibility, which appears to be entirely open under current regulation, that Telstra could own a TV network. That would raise huge questions for public policy. Effectively, the minister for communications of the day would have 50.1 per cent control of that with none of the safeguards that go with the ABC and SBS. With the best will in the world, it would be problematic. With anything less than the best will in the world, it would be incredibly dangerous. We are already seeing policy being distorted by the existence of government owned media players. I think we have reached a reasonable accommodation with the ABC but we are venturing into areas where I certainly do not think we should be going.

CHAIR —One of the ideas that floats around is a publicly owned distribution network to which all telcos have access and that that would negate the Telstra dominance of the market.

Prof. Quiggin —Although I support the idea that other parties should be able to connect to the market, and we obviously have that, my judgment is that the economies of scale are so great that Telstra will remain the dominant player. I think that has proved to be the case worldwide. The position of the local telcos, the so-called incumbent local exchange carriers, in the US has proved much stronger than had been supposed by a lot of people analysing the issue, largely from a position of wishful thinking. The advantages of having a complete package of services provided by a single entity are pretty great and therefore, while I welcome competition in terms of keeping pressure on Telstra, I do not see the likelihood that we will move away from a situation where Telstra is dominant and is going to require regulation. Of course, it is largely that regulatory risk that has continued that is one of the important reasons why Telstra is worth less privatised than it is in public ownership. Reasonably enough, private investors do not want to be exposed to that regulatory risk.

Senator MOORE —In some of the evidence we have received, some people have said that one of the things that concerns them is that this legislation has been put before the houses of parliament without a full cost-benefit analysis and that when you are looking at such a major monetary exercise for a government the least you could expect would be to have a cost-benefit analysis. You may or may not agree with it but at least it would be spelt out. In the accompanying documentation to this legislation it says that they are unable to give figures at this stage, so there is a major piece of legislation without any figures to it. From your point of view, is that acceptable and is there any alternative?

Prof. Quiggin —I have tried to provide at least the basics of a cost-benefit analysis right here. Of course the department of finance has taken a consistent viewpoint that its job is not to protect the interests of the Australian public. It has said this in response to a very closely related issue when it was criticised by the Auditor-General: its job is to implement government policy. So for reasons of ideology the department of finance appears to be unwilling to provide a cost-benefit analysis which would discharge the function of protecting the Australian public.

Senator MOORE —Is there any reason that a cost-benefit analysis could not be provided, apart from the philosophical one? Purely from an economic point of view, is there any reason that there could not be a publicly accessible cost-benefit analysis on this process?

Prof. Quiggin —Only the reason that it would show the results that I have derived in my estimate, which is that the proposal would not pass the test.

CHAIR —Professor, thank you very much for appearing. It is has been very good to have you here.

[3.29 p.m.]