Should Merpati be Privatised? August 13, 2008
Posted by Ross McLeod in : Essays and Comments , trackbackIt was reported last week that the government intended to continue to maintain ownership of Merpati Nusantara Airlines, even though the airline is losing over US$2.2 million a month on average. Indonesia’s airline industry has been growing at a remarkably rapid rate of around 16% annually during the last several years, and yet Merpati has seen its fleet shrink from 90 planes to just 19, suggesting clearly an inability to compete with new private sector entrants.
This is a good example of the true rationale for privatisation: the desire to increase efficiency in the use of productive resources. State-owned airlines such as Garuda and Merpati were able to survive in the past because the private sector was not permitted to compete with them on an equal footing. Since the airline industry was deregulated several years ago, many new firms have been established, and there has been an explosion of domestic passenger traffic—to the extent that flying has become an attractive alternative to traveling by rail or bus. Indonesia’s taxpayers have every reason to question the logic of keeping companies like Merpati in government hands when it is blindingly obvious that the private sector can do a better job.
But politicians can always come up with a justification for even the most outrageously wasteful policies. In the present case, the rationale is that Merpati is still needed in order to serve routes between Indonesia’s smaller cities. In other words, the implication is that if Merpati were to be privatised, it would no longer be interested in serving these routes.
Supposing that is true, however, the appropriate solution to this problem is quite simple. If the political decision has been made that Indonesia should have at least one airline serving routes that would not normally be profitable, then all that is required is to open a tender in which airlines are invited to bid for the right to provide this service—just as construction companies bid for the right to build roads, dams, office blocks and so on for the government. Provided such tenders are conducted transparently, the government will then be able to provide these subsidised services at minimum cost, which will be less than the cost of keeping an inefficient airlines such as Merpati in business.
Bottom line: there is no justification for Indonesia’s government to be in the domestic airline business.
Comments»
There are at least two main aspects of the comments by Ross McLeod on Merpati that I wonder about. The first relates to objectives, and the second relates to regulatory arrangements for the Indonesian airline industry.
First, on the issue of objectives, Ross chooses to define the main objective of policy as promotion of efficiency in the sector. Certainly the promotion of efficiency across the Indonesian economy is extremely important so I am very sympathetic to this goal. However, I wonder whether the true goals of policy in the sector do not include a range of other objectives? Government policies often (perhaps nearly always) include multiple goals. I am not sufficiently familiar with objectives set for Merpati by the company’s owners to know what is required of the firm but I can imagine that there might be (either explicitly, or implicitly) a range of other objectives. I would want to know what these objectives are in order to discuss policy in detail.
Ross mentions a second possible objective: fufilling the particular CSO (community service obligation) of providing an airline service to certain smaller cities. Ross suggests that tenders be called to provide this service. Well, perhaps. This is certainly a possibility. However whether it is the best way to proceed depends on various unknown factors. What are the chances that a workable competitive bidding process could be arranged? Could the services agreed to be effectively monitored? That is (and this is a key test of any government policy), “Will it work?” The answers to these questions do not seem to be clear at this stage. The awarding and monitoring of contracts anywhere is often messy. Nasty contract disputes are not uncommon. The government would need to be willing to bear all of these (unknown?) risks.
Second, regulatory policy is surely part of the story. Competition and regulation go together. Ross argues that privatisation is the way to go. I am inclined to agree. However improved regulation needs to be discussed as well. Private airline companies don’t always play by the rules. The performance of Adam Air, for example, doesn’t exactly encourage confidence in the idea of reliable and efficient competition. In fact, good regulation is often difficult to arrange. Sometimes acceptable regulatory arrangements operate more effectively through state-owned companies than through ineffective regulatory boards. This possibility, as well as the need to fulfil other objectives, makes it a tough call to agree with Ross McLeod’s firm call that there is no justification for the Indonesian government to be in the domestic airline business. I’d be inclined to argue, rather, that there is a clear role for government in the domestic airlines business but that exactly what that role is needs to be discussed.
Merpati was on the privatisation list for 2003-2005 (up to 49 %, by strategic sale). Its management was quite serious about the plan, and it reported that it had begun to find strategic investors interested in acquiring such a stake. However, the change in the government regime in 2005 brought a change in this plan.
Regarding services for remote areas, such as the eastern part of Indonesia, recently some local governments and firms have begun to become involved in the airline industry. This fact strengthens the view that the airline industry is competitive. Hence, the central government does not need to waste its money to provide a subsidy for Merpati. Supposing the government needs to open new pioneer routes then it can provide the service by contracting the route out to private firms via a transparent tender (as you has suggested).
let’s consider about timing.
sell merpati to private now with cheap price or
create another strategy, more investment now, then get better, sell later and you get more value.
just a view from a business student.
Mus’s suggestion in relation to privatisation is very often heard in such discussions. More investment now would clearly lead to a higher selling price (providing management doesn’t make a total mess of things). But the cost of this investment has to be offset against the prospective gain. Since the same investment possibility would presumably be available to the hypothetical new private sector owner also, this comes down to the question of who is likely to be able to get the larger return from this investment: the new owner/managers, or the existing ones? Merpati’s past performance, so clearly inferior to that of the private sector airlines, suggests the former.