C.L. Brown and J. Valentine
Christopher L Brown is a senior economist in the Policy Group of the Ministry of Forestry, Wellington, New Zealand.
John Valentine is chief executive of the Ministry of Forestry.
Experiences and lessons from a pioneering effort to privatize national forest assets.
Pinus radiata logs awaiting processing
Over the past 15 years, privatization has become one of the fashionable directions for government policy. New Zealand, along with the United Kingdom, Chile and a handful of other countries, helped to pioneer the privatization process and has gone further down the path than many of its contemporaries. In the forestry sector, the New Zealand experience has virtually led the world and, as such, has generated considerable international interest in terms of both the process and the impacts of comprehensive forestry privatization.
New Zealand forestry has several unique features that differentiate it from forestry as practiced in most other countries. New Zealand has around 1.3 million ha of planted forests, mainly radiate pine, from which the vast majority of commercial wood production is derived. New Zealand also has 6 million ha of (generally protected) natural forest. Prior to 1987, the New Zealand Government was the dominant commercial forest owner in New Zealand, controlling just over half (52 percent in 1984) of the planted resource.
From 1919 to April 1987, the New Zealand Government's forestry operations were conducted by a single agency, the New Zealand Forest Service. The primary objective of the Forest Service was to produce and market profitably forestry products. However, in attaining this objective, other factors had to be taken into consideration, for example policies and directives to undertake afforestation in regions requiring economic development, to provide employment, to utilize low-productivity land and to plant and manage trees to achieve environmental ends.
The New Zealand Government recognized in the early 1980s that a mandate with such multiple objectives was economically suboptimal; that is, where conflicts arose between objectives, the need to find a balance was compromising the organizational efficiency of the Forest Service. The 1987 Report of the Director General of Forests noted: "The major reasons which led to the restructuring of the New Zealand Forest Service were an inability to provide transparent accountability for the mix of functions performed by the department and perceived conflicts of interest between those functions."
In 1987 the New Zealand Forest Service was disestablished with a view to enhancing the transparency and accountability of government forestry operations. The major objective in the restructuring process was to isolate the Forest Service's commercial activities and confine these to a newly established state-owned enterprise, the New Zealand Forestry Corporation. A clear, uncluttered commercial focus was regarded as a prerequisite for the Forestry Corporation to compete effectively with the private sector. The non-commercial functions of the Forest Service were transferred to two new government departments; the Ministry of Forestry, which assumed responsibility for research, training, advisory and regulatory functions; and the Department of Conservation, which was assigned protection responsibilities for the natural forests.
Landing of logging operation, Kaingaroa Forest
From its inception, the Forestry Corporation was regarded as a halfway house between being a government department and a private company. Government ministers, as representative shareholders in the corporation, were assigned powers of intervention and access to all information relating to its affairs. The corporation was limited in its ability to raise capital and was not permitted to diversify into non-forestry operations. Any intraforestry diversification required government approval. Furthermore, because the corporation was state-owned, competitors could potentially access information regarding its affairs under New Zealand's Official information Act of 1982. Given these major commercial liabilities, and the distortionary impacts inherent in such a structure, it seems apparent that corporatization was merely an interim step in the privatization process.
The intention of actual privatization of public assets was announced in December 1987 as part of a government fiscal strategy statement. Government businesses were able to be sold with the primary aim of reducing public debt. More philosophical reasons for state asset sales were also given, namely: to respond to assertions that ministers are not good owners of businesses; to avoid the potential for future calls from the businesses for government cash; to minimize the government's risk exposure in the business sector of the economy; and to enable ministers to concentrate on matters of economic and social policy. The criteria for asset sales were that taxpayers must receive more from the sale of a business than they would from continued state ownership; and the sale of a business must make a positive contribution to the government's economic and social policies.
The primary rationale for forest asset sales was probably ideological, namely the question of whether it is appropriate for the state to own commercial forests. The two sides to the argument can be broadly summarized as a trade-off between the market distortions created by having an active participant (the government) with the potential to manipulate trading conditions to meet objectives other than pure profit maximization, versus the abrogation of a powerful state regulatory instrument in a market. For a government committed to market-led disciplines, continued direct operation in the sector was probably untenable, although the creation of the Forestry Corporation could have provided a compromise position.
A second major question was whether a rationalization of state forest assets would result in a more efficient, internationally competitive sector. The government's forestry assets were dispersed throughout the country and had been established - and under state direction would continue to be established - to meet objectives other than the purely commercial aim of profit maximization. The 1988 Forestry Working Group noted: "It is generally recognized that the New Zealand forestry resources would benefit from rationalization. Ownership of forests does not often reflect sensible economic packaging." A particular concern was the need to provide security of supplies to processors in order to attract new investment into forestry value-adding industries. The sale of forests to enable processors to integrate supplier functions into their current operations was seen as a long-term optimal mechanism to achieve this end.
In the Government Budget of July 1988, the sale of 11 groups of assets, including the state's commercial forestry assets, was announced.
The first major step in the privatization process was the establishment of a Forestry Working Group by the Minister of Finance and the Minister for State - owned Enterprises, to recommend the most appropriate form in which the Crown's forestry asset could be sold. Specifically, the Working Group was asked to make recommendations on whether state forestry assets should be transferred to the Forestry Corporation and the corporation itself be sold, or whether the assets should be sold directly as individual forests, blocks of forest, or some combination; and whether the land itself, or merely use rights to the forests, should be sold with the land being retained in state ownership.
In its October 1988 report, the group concluded that revenues would be maximized by selling more than one package rather than one single forestry estate, and that, given an expressed government desire to retain ownership of the land to protect Maori (indigenous) claimants' land rights, the forests should be sold in the form of transferable management rights. The Forestry Working Group felt that, with the sale of more than one package, there would be a greater number of bidders and hence more competition with less potential for collusion. The increased flexibility of a multipackage sale would also enable the government to tailor packages better to the requirements of individual bidders and. therefore, allow the state to capture the gains from industry restructuring that would otherwise be appropriated by the purchaser in a "second round" of rationalization.
Corporate structure: New Zealand Forestry Corporation
The views of the Forestry Working Group provided, in essence, the principles for conducting the initial sales round. In October 1989 the Crown Forest Assets Act 1989 gave legal embodiment to these principles and the Forestry Corporation was appointed as the government's agent for the sales process.
The first round of forest sales was in the form of a sealed bid tender which closed in July 1990. Bids were to be made for the outright purchase of trees and fixed assets but with the forest land being leased under a tradable Crown Forestry Licence. This initial sales round was relatively unsuccessful in teens of actual forest divestment. Only two bids, for 72600 ha of forest, were accepted while all other bids were rejected as being too low. However, on the basis of these bids, the government entered into a negotiated sales process that resulted in the sale of an additional 174000 ha of forest. The buyers included private New Zealand forestry enterprises and several Asian - based companies.
The unsold state forests were grouped into three separate state-owned enterprises under the umbrella ownership of the New Zealand Forestry Corporation. The major forests of the central North Island (not offered for sale in the first round) were placed in the ownership of the Forestry Corporation of New Zealand. This entity continues to operate today as a state owned enterprise. A second entity, Timberlands West Coast, was given control of a select regional group of forests on the west coast of the country's South Island. The remaining forests, residual to the sales process and dispersed through out the country, were grouped together as New Zealand Timberlands.
The motivations behind the specific groupings of forests into these three state-owned corporations were quite complicated. However, the basic reasoning was that the Forestry Corporation of New Zealand's forests are located in the Bay of Plenty in the North Island and represent the largest concentrated planted forest resource in the country. The scale of the forest industry in this region dwarfs that of most other regions and, for this reason, there was a good argument for these forests to be sold as an individual package. However, these forests are at present tied to a long-term supply contract to a private forestry company and this contract is the subject of an ongoing dispute. Therefore, until the issue is resolved, these forests could be subject to a substantial price discount if sold. The Timberlands West Coast forests are the subject of an environmental commercial accord and comprise both planted and natural forests. It is unlikely they will be sold in the near future. It was therefore logical that these be held separate from the other forests. The forests residual to these two groupings were consolidated as New Zealand Timberlands.
The third stage in the privatization of New Zealand's forests was the sale of New Zealand Timberlands. The sale intention was announced in the July 1991 Government Budget. The sale process was again a sealed bid tender process but the information memorandum covering the sale of New Zealand Timberlands noted that the government's preferred option was that it be sold as a unit, although bids for individual forests would be accepted and the government would consider retaining a portion of equity in New Zealand Timberlands (as a joint venture partner).
The approach to the sale of New Zealand Timberlands appears very different from that of the initial sales and from the principles espoused by the Forestry Working Group. However, the rationale, namely sales revenue maximization, remained the same. A new. government, taking a less theoretical approach, was prepared to compromise its objective of reduced involvement in the forestry sector (by offering joint venture involvement) to obtain a better price. The preference for the sale of New Zealand Timberlands as a whole entity appears to be based on the belief that its forests were too scattered to allow them, individually, to attract processing investment, along with a pragmatic desire to avoid the costs of government being left to manage a large number of small, commercially unattractive forests and prolonged sales rounds. The sale document particularly noted that an additional criterion under which bids would be assessed was the likelihood of particular bids leading to additional downstream investment.
Details of government forest asset sales
|
Date |
Purchaser |
Area (ha) |
Price |
|
|
($NZ million) |
(US$ million) |
|||
|
Forests sold by tender |
||||
|
25/7/90 |
Earnslaw One |
23801 |
102 |
57 |
|
27/7/90 |
Fletcher Challenge |
48852 |
262 |
147 |
|
Forests sold by negotiation |
||||
|
30/8/90 |
Carter Holt Harvey |
100208 |
410 |
230 |
|
9/90 |
Juken Nissho |
43531 |
126 |
71 |
|
19/9/90 |
Wenita Forestry |
20521 |
115 |
64 |
|
10/90 |
Other |
9793 |
13 |
9 |
|
Forests transferred to new state-owned enterprises |
||||
|
1/12/90 |
Forestry Corporation |
165300 |
|
|
|
1/12/90 |
Timberlands West Coast |
21400 |
|
|
|
1/12/90 |
New Zealand Timberlands |
116900 |
|
|
|
Forests sold by New Zealand Timberlands |
||||
|
114/92 |
ITT Rayonier |
97453 |
366 |
205 |
In April 1992, New Zealand Timberlands was sold to ITT Rayonier, a company based in the United States. To date, Rayonier has operated as a log supplier with no indication of undertaking new processing investment. This suggests revenue maximization remained the overriding objective for the government.
In terms of the functions of government in the country's forestry sector, the disestablishment of the New Zealand Forest Service in 1987 saw a fundamental restructuring of responsibilities within the state sphere. For the first time there was a formal recognition of, and a definitive shear between, the separate roles of planted and natural forests in New Zealand.
The establishment of two government agencies, the Ministry of Forestry and the Department of Conservation, with their administrative responsibilities predominantly relating to planted and natural forests, respectively, formalized the generally commercial raison d'être for planted forests and the predominant conservationist values attached to the natural forests. The planted forests took on a "cropping" aspect, in that they were grown to be harvested, and became the primary focus of a Ministry of Forestry charged with promoting sustainable development and economic growth. The Department of Conservation's concerns related more to the protection and preservation of New Zealand's natural resource heritage. This formal separation helped to establish a general acceptance that commercial utilization of planted forests, by substituting for natural forest exploitation, is a method of conservation. There remains, of course, a role for planted forests in terms of conservation goals, particularly watershed management and land stabilization. Where government has subsequently wished to support these objectives, it has done so by providing funds, administered by the Ministry of Forestry, to the private sector. Equally, natural forests continue to supply small volumes of timber to commercial processing operations. However, in the main, the two types of forest are fundamentally differentiated in purpose, and the institutional goals of the two government agencies reflect this. It is noteworthy that the Ministry of Forestry does not own or manage forests. It has responsibilities consistent with the general government objective of ceasing its training and operational activities and establishing core policy agencies. Conversely, because of the specific nonprofit nature of protected forests, the Department Conservation retains forest management responsibilities.
As regards the actual institutional structures resulting from the process, an obvious change was in terms of staff complements. In 1985, when the government announced its intention to reorganize forestry administration, the Forest Service employed about 7000 staff. A non-replacement policy was implemented to reduce the number of staff who would require redeployment. The 1987 Report of the Director-General of Forests stated that 3762 staff had taken a voluntary severance option and a further 90 staff had taken early retirement. The government paid out $NZ 65.7 million (US$ 36.8 million) in redundancy settlements to former Forest Service employees.
The New Zealand Forestry Corporation had a complement of 550 salaried staff, 467 workers paid on an hourly basis and a further 1337 workers on logging and silvicultural contracts. At its inception, the Ministry of Forestry employed 728 salaried staff and 101 hourly workers; in March 1988, the Department of Conservation employed 1103 salaried staff and 991 wage workers.
The new organizations faced a number of challenges in their formative stages. For example, the new Ministry of Forestry identified primary internal weaknesses in terms of dramatic changes in emphasis of roles, rules and culture; an uneven distribution of, and lack of, certain critical skills; new management systems and an initial lack of cohesion between major functional groups; inflexibility associated with public service systems; conflict between national interest and ministerial commercial consultancy functions and profitability objectives; and difficulty in maintaining and developing forestry skills without in-house forests and processing facilities. The other two new agencies also faced problems in their spheres of operation.
Seedling quality inspection in Pinus radiata nursery
Many of the difficulties confronting the new organizations were resolvable, in the medium term, through training and retraining staff, both in specialized courses and as part of basic operations as the organizations became attuned to their new operating environments. Management commitment to staff retraining was vital to the organizations, rapidly becoming effective in their new roles. Several of these issues, particularly public service inflexibility, were able to be more effectively addressed following the enactment of the Public Finance Act and the State Sector Act which changed and clarified the responsibilities of government departments and their chief executives.
One of the major objectives of the restructuring was to enhance the transparency of government forestry operations. Although the primary purpose of this was to isolate the commercial activities, there were also major administrative and financial changes inherent in the new structures. Where, previously, government forestry expenditures and revenues were administered by the Forest Service, almost all revenues were now collected by the Forestry Corporation. The Ministry of Forestry and the Department of Conservation became largely dependent on taxpayer funding. Particularly for the Department of Conservation, with management responsibilities for the large tracts of protected natural forests, the complete curtailment of access to commercial planted forest revenues placed a strong fiscal discipline on its operations.
The privatization process has had major impacts on forest industry in New Zealand and its institutional structure. Efficiency has been significantly enhanced by the privatization of forest industry but this enhancement has not been achieved without cost. Furthermore, as a pioneering effort in forestry privatization, and with the benefit of hindsight, some of the decisions taken are open to question. There are valuable lessons to be learned from the New Zealand experience.
Foremost, it should be recognized that patterns of ownership in any industry are of fundamental importance. For example, given a particular market scenario, a monopolist is likely to react differently to a case where there are several firms in a contestable market. An industry with three dominant firms may well act quite differently if a fourth firm enters the market. The advantage for government in maintaining a commercial arm in an industry is that the government retains a degree of certainty in the market and it gains an additional policy instrument to achieve its aims. The disadvantage is that other firms modify their behavior based on an expectation of government behavior. In New Zealand, for instance, the Forest Service acted as a beneficent log supplier to processors, thereby encouraging inefficient practices and particularly discouraging investment in new technology. The result was a processing sector that struggled to compete in international markets and passed costs down to the New Zealand taxpayer through the need for protection and subsidization. Over the past six years, mill closures and supply disputes have borne testament to the realities of exposure to market forces.
One important mechanism that regulated, possibly inappropriately, the post-sale pattern of ownership was the Commerce Act of 1986, New Zealand's principal antitrust regulation. Three of New Zealand's major companies were prevented by the Act from freely bidding for forests in the initial sales round. In forestry, where security of supply is a paramount concern, and where economies of scale are of fundamental importance in terms of international competitiveness, it is questionable whether a regulation concerned with domestic competitive structures was appropriately applied. The impact of these impediments on sales revenues is also likely to have been negative.
The issue of supply security is of particular interest and can be viewed from several perspectives. Obviously, the optimal situation for a company is to have vertically integrated forest supplies and processing industries to ensure security of supply. Of course, this does not necessarily entail ownership of forests. A long-term supply contract with a beneficent state owner might well be a far more attractive option for a company in that it frees up capital for investment elsewhere and the state may well be prevailed on to supply logs at below-market prices. A government sell-off will be particularly unattractive if it is likely to result in a company's present supply source falling into the hands of a competitor.
Supply security essentially demands that dependent forestry companies protect themselves during privatization by actively seeking to purchase their sources of supply. For companies with high levels of debt this can be a major destabilizing factor if the need to raise capital quickly forces adjustment to long-term strategic plans. This is a good reason for having relatively long lead times between the announcement and implementation of privatization processes. For small processors, without the capacity to integrate vertically, privatization will heighten uncertainty and enforce efficiency. In New Zealand five-year wood supply contracts for existing users at indexed market prices were incorporated in the terms of the New Zealand Timberlands sale.
An important question arises as to the scope of the sale and, particularly, whether the sale should be open to foreign investors. In New Zealand the decision was relatively clear-cut. The principal rationale was revenue maximization, and this was most likely to be achieved by placing as few constraints on the process as possible and by maximizing bidding competition. The government recognized that overseas investors had potentially greater access to capital and were consequently more likely to invest in new downstream processing facilities, and this has generally proved to be the case. A side-effect of the forest privatization was that it undoubtedly acted to market investment opportunities effectively in New Zealand forestry. The entry of foreign investors into the New Zealand forestry sector also had benefits in terms of the introduction of new technologies, the improvement of market awareness and opportunities and the promotion of efficiency through enhanced domestic competition. The major downside to opening the sale to foreign bidders was a negative public perception of foreign resource control.
A second negative perception was that New Zealanders' heritage was being sold, the term "selling the family silver" was one quoted ad nauseam. This argument is somewhat lacking in economic rationality. Tangible assets such as forests are often accorded significance beyond their economic worth while the significance of the national debt, equally a part of a country's heritage, is downplayed. In New Zealand this negative perception was enhanced by the failure of asset sales to achieve a significant reduction in the level of national debt. For instance, Bilek and Horgan (1992) noted: "If the goal was to reduce debt then the sale of the state forest assets was part of a larger failure." Such a view is too simplistic. The timing of the measurement of debt is being ignored. The sale of state assets acted to reduce the deficit and consequently acted to reduce potential debt, assuming the government did not adjust its expenditure pattern in response to its increased cash flows. Given the concurrent spending cuts imposed on such areas as social welfare, health and education, it seems quite plausible that the government utilized the vast majority of sale proceeds to reduce the current deficit.
The process of adjustment to the new regime is drawing to a close. Most in the forestry sector are looking forward to the challenges and opportunities of the future rather than dwelling nostalgically in the past. The process of privatization has strengthened the sector, with most industries now able to compete on an even footing in international markets. For New Zealand, one of the primary challenges today is to remove barriers in its key international markets so that it is selling on a level playing field.
For government, the move to privatization presents a new set of challenges, namely to implement its forestry objectives with a reduced - and possibly in the future without a commercial trading arm. A test has already been posed in the form of the 1993 log price boom which constrained supplies to domestic processors and led to strong calls for government restrictions on log exports. For a government committed to the establishment of a strong domestic processing sector, the constraint that privatization placed on its ability to ensure security of supplies created a conflict with its "free market" economic philosophy.
A future test of the success of the privatization strategy will be in ensuring the sustainable management of the planted forest estate. With the government no longer having a physical mechanism to carry out planting, the onus of renewing and expanding New Zealand's planted forest estate now lies with the private sector. If the government retains its noninterventionist stance into the future, the arguments of the pessimists, that the time horizons of forestry investments are too long for private companies to be relied on to maintain a nation's forest estate, will be put to the test. An interesting shift in government policy during the New Zealand Timberlands sale was the inclusion of compulsory replanting covenants in the sale agreement. However, the government concern which led to the introduction of these covenants has to a large extent been allayed by a dramatic increase in new planting over the past two years. While some of this increase in new planting is in response to changes in the forestry taxation structure, a portion is also attributable to the market-oriented, noninterventionist policies being pursued by the government.
A decision on the final major element of the government forestry privatization programme, the potential sale of the Forestry Corporation, has yet to be made. The reelection of a National Party government in November 1993 carried with it an announcement that government has no plans at present to sell the Forestry Corporation. In any event, the corporation is still embroiled in a contractual dispute over log supplies, which limits the potential for sale in the immediate future. With the New Zealand economy now on a strong footing, a programme of substantial economic reforms now being firmly in place, the urgency to continue the privatization process has diminished. A period to assess longer-term results of the process and the desirability of government retaining some active presence in the sector will result in a decision that will conclude a major chapter in the development of New Zealand forestry.
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Bilek, E.M. & Horgan, G.P. 1992. The challenges of privatization: New Zealand's experience with forestry. In Proc. IUFRO Int. Conf. on Integrated Sustainable Multiple-use Forest Management under the Market System, 6-12 September, Pushkino, Russian Federation. Vienna, IUFRO.
Douglas, R.O. 1988 Budget Part I. Speech by New Zealand Minister of Finance. (unpubl.)
Duncan, I. & Bollard, A. 1992. Corporatization and privatization: lessons from New Zealand. Oxford, UK, Oxford University Press.
Forestry Working Group. 1988. Sale of the Crown's commercial forestry assets. Report of the Forestry Working Group to the Minister of Finance and the Minister for State-owned Enterprises. Wellington, Government of New Zealand.
Lee, D. 1989. Privatisation and the Commerce Act. Forestry Forum: The Ministry of Forestry Magazine, 3 (May 1989).
Roche, M. 1990. History of New Zealand Forestry. Wellington, New Zealand Forestry Corporation/GP Books.
Wije-wardana, D. 1989. Privatisation of state commercial forestry assets. Forestry Forum: The Ministry of Forestry Magazine 3 (May 1989).
