Privatisation involves selling state-owned assets to the private sector. It is argued the private sector tends to run a business more efficiently because of the profit motive. However, critics argue private firms can exploit monopoly power and ignore wider social costs. Privatization is often achieved through listing the new private company on the stock market. In the 1980s and 1990s, the UK privatized many previously state-owned industries such as BP, BT, British Airways, electricity companies, gas companies and the rail network.
Potential benefits of privatization
Improved efficiency
The main argument for privatization is that private companies have a profit incentive to cut costs and be more efficient. If you work for a government-run industry managers do not usually share in any profits. However, a private firm is interested in making a profit, and so it is more likely to cut costs and be efficient. Since privatization, companies such as BT, and British Airways have shown degrees of improved efficiency and higher profitability.
Lack of political interference
It is argued governments make poor economic managers. They are motivated by political pressures rather than sound economic and business sense. For example, a state enterprise may employ surplus workers which is inefficient. The government may be reluctant to get rid of the workers because of the negative publicity involved in job losses. Therefore, state-owned enterprises often employ too many workers increasing inefficiency.
Short term view
The government may think only in terms of the next election. Therefore, they may be unwilling to invest in infrastructure improvements which will benefit the firm in the long term because they are more concerned about projects that give a benefit before the election. It is easier to cut public sector investment than frontline services like healthcare.
Shareholders
It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is inefficient then the firm could be subject to a takeover. A state-owned firm doesn’t have this pressure and so it is easier for them to be inefficient.
Increased competition
Often privatization of state-owned monopolies occurs alongside deregulation – i.e. policies to allow more firms to enter the industry and increase the competitiveness of the market. It is this increase in competition that can be the greatest spur to improvements in efficiency. For example, there is now more competition in telecoms and the distribution of gas and electricity.
However, privatization doesn’t necessarily increase competition; it depends on the nature of the market. E.g. There is no competition in tap water because it is a natural monopoly. There is also very little competition within the rail industry.
The government will raise revenue from the sale
Selling state-owned assets to the private sector raised significant sums for the UK government in the 1980s. However, this is a one-off benefit. It also means we lose out on future dividends from the profits of public companies.
Disadvantages of privatization
Natural monopoly
A natural monopoly occurs when the most efficient number of firms in an industry is one. For example, tap water has very significant fixed costs. Therefore there is no scope for competition among several firms. Therefore, in this case, privatization would just create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly which can exploit the consumer.Public interest
There are many industries which perform an important public service, e.g., health care, education and public transport. In these industries, the profit motive shouldn’t be the primary objective of firms and the industry. For example, in the case of health care, it is feared privatizing health care would mean a greater priority is given to profit rather than patient care. Also, in an industry like health care, arguably we don’t need a profit motive to improve standards. When doctors treat patients, they are unlikely to try harder if they get a bonus.
Government loses out on potential dividends
Many of the privatized companies in the UK are quite profitable. This means the government misses out on their dividends, instead going to wealthy shareholders.
The problem of regulating private monopolies
Privatisation creates private monopolies, such as water companies and rail companies. These need regulation to prevent abuse of monopoly power. Therefore, government regulation is still needed, similar to under-state ownership.
Fragmentation of industries
In the UK, rail privatization led to the breaking up of the rail network into infrastructure and train operating companies. This led to areas where it was unclear who had responsibility. For example, the Hatfield rail crash was blamed on no one taking responsibility for safety. Different rail companies have increased the complexity of rail tickets.
Short-termism of firms
As well as the government being motivated by short-term pressures, this is something private firms may do as well. To please shareholders they may seek to increase short-term profits and avoid investing in long-term projects. For example, the UK is suffering from a lack of investment in new energy sources; the privatized companies are trying to make use of existing plants rather than invest in new ones.
Evaluation of privatization
It depends on the industry in question. An industry like telecoms is a typical industry where the profit incentive can help increase efficiency. However, if you apply it to industries like health care or public transport the profit motive is less important.
It depends on the quality of the regulation. Do regulators make privatized firms meet certain standards of service and keep prices low?
Is the market contestable and competitive? Creating a private monopoly may harm consumer interests, but if the market is highly competitive, there is greater scope for efficiency savings.
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