Chapter 5 Theoretical approaches to explaining and understanding privatisation

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Chapter 5 Theoretical approaches to explaining and understanding privatisation
Malcolm Sawyer
5.1 Introduction
The central purpose of this chapter is to review a number of distinct theoretical
perspectives which come from the economics and political economy literatures on issues
of privatisation and liberalisation. The chapter begins by a consideration of the Austrian
approach and the property rights literature and their approaches to markets, private
property and competition. This broad approach is the one which most unambiguously
promotes the roles of private ownership, competition and unfettered markets, and this is
followed by an examination of the neo-classical approach. The neo-classical economics
approach is broadly interpreted here and agency theory is encompassed within that
approach. The manner in which the neo-classical economics approach addresses issues of
competition and privatisation are evaluated. The wide spread shift from public ownership
to privatisation in the past three decades or so (in, for example, public utilities) raises the
question of whether there are convincing explanations based on economic analysis for
that shift. The contribution of the Austrian and neo-classical approaches to possible
explanations are explored. The notion of efficiency involved in discussion of privatisation
is briefly considered particularly since privatisation is often advocated for its claimed
favourable effects on efficiency. The last main section outlines the political economy of
privatisation and liberalisation, with an emphasis on the roles of profits, accumulation
and finance in the promotion of privatisation.
5.2 The Austrian approach and property rights
The Austrian approach amongst others has long stressed the significance of private
property for the pursuit of profits, but within the context of competition and rivalry, and
argued that efficiency of production comes from that pursuit of profits.1 The Austrian
approach views competition as a dynamic process taking place against a background of
1 The Austrian approach dates back to the late-19th century, taking its name from the
nationality of a number of its founders including Carl Menger, Eugen von Böhm-Bawerk
and Friedrich Hayek. A key feature of its approach is adherence to methodological
individualism – analyzing human action from the perspective of individual agents. See
Littlechild (1990) for collection of major papers on Austrian economics and Littlechild
(1986) for application of ideas to the mixed economy.
change and uncertainty. The pursuit of profits by entrepreneurs, it is argued, will lead on
the one side for the entrepreneurs to press for lower costs in their production processes
and on the other side for them to seek out new markets and to provide the consumers with
what they want (or at least are prepared to pay for). Greater revenues and lower costs
would, of course, increase profits. But being able to charge high prices would be constrained by competition. Hence the existence of profits, particularly high profits, is seen as an indicator that the firms concerned are particularly efficient both in terms of
productive efficiency and of producing goods which consumers wish to buy. In particular,
high profits are not seen as associated with market power, though there may be an
association between high market shares and profits. But the link is not from high market
share indicating monopoly to high profits, but rather that above-average efficiency generates a high market share and large profits.
It is the threat of new entry into an industry which keeps the incumbent firms on their
toes. This leads to an emphasis on the importance of entry conditions into an industry,
rather than the number of firms in the industry. One firm in an industry may appear to be
a situation of monopoly, but if there are a number of firms ready to enter that industry if
the existing firm allows its prices to rise above their level of costs then the incumbent
firm is highly constrained in its pricing.
An important element of the Austrian approach is the importance of property rights and
the role of the entrepreneur in exploiting profit opportunities. If the entrepreneur is to seek after profits, then (s)he must have the claim to the profits generated, and hence, it is argued, the property rights to the profits must be assigned to the entrepreneur. The single entrepreneur is seen to be willing to take risks, to strive for lower costs and so on, because (s)he will be the beneficiary of any resulting profits. In an organization with a large number of owners, the link between effort and profits is much diluted. The essential difficulty of nationalised industries, workers’ co-operatives and also of large manager- controlled corporations is seen to be that ownership is dispersed.
The Austrian approach places great emphasis on the role of the entrepreneur in a market
situation seeking out new opportunities and undertaking innovations. The market process
is viewed as one of discovery, as entrepreneurs compete against one another. The outcome of the competitive process cannot be predicted. This raises difficulties for regulation of public utilities. “Many commentators … have asserted that the purpose of
utility regulation, and of price caps in particular, is to mimic the operation of the
competitive market. I myself have never claimed that. I agree with Mises about the
difficulty of predicting what a competitive market price could be, particularly in markets
characterised by heavy capital investments that are location-specific and have long asset
lives” (Littlechild, 2000, p.13).
The Austrian approach would strongly support private ownership over public ownership
on the grounds of the allocation of property rights which leads to owners having
incentives to pursue profit opportunities. It also plays down the need for any regulation of
an apparent monopoly position or industry operating with economies of scale. A leading
exponent of the Austrian view (and one closely involved with UK privatisation and
subsequently regulation) wrote in the following vein: “what are we to make of the
Austrian view of utility regulation? There seems to be a general consensus that monopoly
is not as widespread or permanent or problematic as generally believed; that such
monopoly as does exist is most likely attributable to government restrictions; that
regulation of potentially competitive markets is likely to produce shortages or be counter-
productive; and that a little intervention is likely to breed more. … Government
ownership of utilities is considered to be undesirable because it is likely to be loss-
making or too powerful, and likely to prolong the monopoly.” (Littlechild, 2000, p.15)
The role of competition is stressed, for example : “Competition is the most important
mechanism for maximising consumer benefits, and for limiting monopoly power. Its
essence is rivalry and freedom to enter a market. What counts is the existence of
competitive threats, from potential as well as existing competitors. The aim is not so-
called ‘perfect’ competition; rather, one looks for some practical means to introduce or
increase rivalry.” (Beesley and Littlechild in Beesley, 1997, p. 29) The implication to be
drawn from statements such as this is that the removal of any restraints by government on
competition and on firms entering an industry should be reduced or removed. The link
between privatisation and liberalisation is then made by arguing that competition can be
more readily generated when there is private ownership rather than public ownership. For
example, “some have argued that ownership is largely irrelevant. But could the benefits
of privatization be obtained without the change in ownership ? We have already argued
that ownership does matter because consumers in general will be better served. Also, for
political reasons, privatization may be a necessary accompaniment to competition. ….
Furthermore, competition policy is (or certainly could be) more effective against a private
company than against a nationalized industry” (Beesley and Littlechild in Beesley, 1997,
p. 29).
The general line of argument which comes from the Austrian approach can be linked with
the literature on property rights. The economics of property rights argues for the
importance of well-defined and objectively enforceable property rights to make
contracting possible without which exchange and trade would be difficult. Contracts are
necessarily incomplete because of uncertainty about the future and the inability of
individuals to envisage all possible futures and to process information (‘bounded
rationality’). Actors aim at minimising the risks of post-contractual opportunism and the
theory of property rights then explains that the owner of the rights has control over the
way how the incompleteness is filled in at a later stage. The ways in which property
rights are allocated becomes crucial for the ways in which trade and exchange are
conducted and for the incentives which prevail. The allocation of property rights largely
determines the incentives structure. The owners can have the right to use, to manage, and
to alienate the property. Property rights can be different from decision rights: the owner
can give decisions rights to another party (in the case of leasing, or renting), or the
decision rights can be limited through laws and regulation.
With respect to the issue of privatisation the theory of property rights focuses on the
incentives related to the type of property rights. Private property rights are generally
considered to be efficient because individuals negotiate in contracting processes on the
exchange of property rights and individuals seek to pursue their own interests. In case of
state owned property the theory predicts large bureaucratic inefficiencies as the state
acquires the property rights but those exercising decisions do not have property rights
specifically with regard to benefits and profits generated by their decisions. In case of
common property (the so-called ‘tragedy of the commons’) each individual will
maximise her/his profits by letting more sheep graze on the common, or fishing more fish
out of the sea. By maximising individual profit the ‘common’ is destroyed. So in that case
the theory of property rights explains the necessity of a set of rules that preserve the
It is argued that it is individuals who pursue their own interests in the context of property
rights. In the case of collective property rights, since an individual member of the
collective would receive little if any reward from the pursuit of the profits of the
collective, there is little incentive to pursue those profits. Many of the arguments for
privatisation are based on the theory of property rights on the basis that under
privatisation property rights will be allocated to individuals who will pursue highest
rewards to the property. But under privatisation, the property rights remain collectively
owned, now by numerous shareholders.
The general case for privatisation from this general perspective is well summarised in the
following : “Privatization will generate benefits for consumers because privately owned
companies have a greater incentive to produce goods and services in the quantity and
variety which consumers prefer. Companies which succeed in discovering and meeting
consumer needs make profits and grow; the less successful wither and die. The discipline
of the capital market accentuates the process: access to additional resources for growth
depends on previously demonstrated ability. Selling a nationalized industry substitutes
market discipline for public influence. Resources tend to be used as consumers dictate,
rather than according to the wishes of government, which must necessarily reflect short-
term political pressures and problems of managing the public sector’s overall demand for
capital.” (Beesley and Littlechild in Beesley, 1997, p. 28)
The Austrian approach has always championed private ownership over public ownership
(and more generally any forms of social ownership), and viewed barriers to competition
as arising from government intervention rather than from economies of scale and
activities of incumbent firms. In the Austrian view, private ownership is inherently more
efficient than public ownership : the key argument in their approach is the identification
of a ‘residual claimant’ who has the interest of maximising the residual (that is profits). In
seeking to maximise the residual, costs are minimised, and in that sense efficiency is
pursued. In the Austrian view any firm which does not have a well identified residual
claimant will not operate in an efficient manner. The natural monopoly argument is not
given a great deal of weight as a rationale for government intervention. Even if
economies of scale are strong enough leading to a dominant firm in the industry
concerned, the Austrian approach stresses the competitive pressures which arise from the
possibility of other firms entering the industry if the incumbent becomes inefficient.
Government policy should then be focused on ensuring that no impediments are placed in
the way of new entrants. The public ownership of natural monopolies often includes the
exclusive rights to operate in the industry concerned. The Austrian approach would stress
the change of ownership from public to private and also the removal of any barriers to
entry. The Austrian approach would also stress the difficulties involved in regulation of
utilities arising from problems of ‘agency capture’ (regulator operating in the interests of
the producers), issues of information and ‘government failure’, the subjective nature of
costs and the inherent difficulties of replicating a competitive market. One summary of
this position is given by “when technical conditions make monopoly the natural outcome
of competitive market forces, there are only three alternatives: private monopoly, public
monopoly, or public regulation [of private monopoly]. … All three are bad so we must
choose among evils … I reluctantly conclude that, if tolerable, private monopoly be the
least of the evils” (Friedman, 1962, p. 28).
The Austrian approach would seek to explain the shift to privatisation in the past quarter
of a century in terms of the ‘triumph of ideas’. The advocacy of privatisation by that
approach has been unchanging and not related to the economic, political or material
circumstances. For the form of privatisation, the shift to private ownership would be seen
as the key element with little need for regulation of the private industry (other than
ensuring that there are not limits on entry of firms into the industry concerned). Any
regulation (notably over prices) should be limited in time until the barriers to entry can be
5.3 Neo-classical economics and privatisation2
At one level neo-classical economics could be viewed as taking a neutral stance on the
issue of ownership whether public, social or private. The objectives pursued by a firm
Neo-classical economic analysis is the dominant school in economics though it is
difficult to define with precision. It is often seen to involve a methodological
individualism approach and revolve around utility and profit maximisation and the
interaction of demand and supply. For readings see Ricketts (1989).
would impact on the decisions which it made with regard to price, output, employment,
investment and so on. But the objectives set for say managers of a publicly owned firm
could, if required, mimic those of managers of privately owned firms, leading to
essentially similar outcome. Indeed, neo-classical economic analysis has been used to
devise rules for the operation of utilities owned by the State and operating on a natural
monopoly basis, for example through ideas of marginal cost pricing or investment
decision rules. Within that framework, it is argued that the managers of the public utility
could be instructed to follow those rules which are deemed to lead to beneficial
Neo-classical economic analysis has long pointed to the conclusion that a situation of
monopoly and the pursuit of monopoly profits leads to higher prices and lower output as
compared with a comparable situation under a regime of perfect competition. Public
utilities appeared as a situation of ‘natural monopoly’, that is industries where there were
extensive economies of scale such that low cost production would lead to a single
dominant firm. Hence a situation of perfect competition (or even oligopoly) would
involve more producers, smaller scale of production for each firm and hence much higher
costs (as benefits of economies of scale were lost) and indeed perfect competition would
be unsustainable as larger firms with lower costs drove out smaller firms. From a neo-
classical perspective, public ownership is a possible solution to the ‘natural monopoly’
problem. Under public ownership the managers of the utility could be instructed to avoid
monopoly pricing, and could price according to marginal cost; alternatively if profits
maximisation was pursued the monopoly profits would accrue to the State.
From the neo-classical perspective, the arguments for public ownership of utilities and
other natural monopolies were undermined in a number of ways. First, doubt was cast on
the extent to which there were economies of scale and the degree to which there was an
issue of ‘natural monopoly’ which required solution. This was linked to the second line,
namely that even where part of a production process was subject to economies of scale,
other parts were not, and those which were not could be operated separately from the
other. Hence competition and private ownership could (should) be injected into those
parts of the production process which were not subject to economies of scale. This would
involve vertical disintegration with different firms being responsible for different stages
of the production process. Third, there was perceived to be a strong link between a
guaranteed position of monopoly and public ownership. Public owned companies were
often granted exclusive rights to operate in a particular industry, and hence protected
from entry from other firms. The threat of competition for these public owned companies
would then be removed leading to such companies being in a soft monopoly position and
not needing to pay attention to their cost structures and their productive efficiency.
Neo-classical economics incorporates the notion of ‘market failure’, which is a rather
specific notion of what constitutes failure – in effect a failure of an actual market to
mimic perfect competition. The propositions of (neo-classical) welfare economics
includes the proposition that a situation of overall perfect competition (which would
include price of each product equal to marginal cost) would be Pareto efficient (that is a
situation in which there is no way to rearrange things to make at least one person better
off without making anyone worse off. One implication of that view is that a monopoly (or
more generally oligopoly) situation is one of ‘market failure’, and the proposed remedy is
often along the lines of regulation of the industry’s prices in order to mimic the
competitive outcome. But a limit on this argument comes from the ‘theory of second best’
(Lipsey and Lancaster, 1956) which argued that if the ‘first best’ outcome of price equals
marginal cost cannot be attained in one industry, it is not, in general, optimal to seek that
outcome in another industry. Hence price regulation of an industry faces the difficulty
that following simple rules such as price equal marginal cost may not be desirable in the
face of monopolistic and oligopolistic elements in other industries. The implications of
the second best arguments are further developed in Chapter 8.
Neo-classical economic analysis had been firmly based on the assumption of technical
efficiency, that the technical maximum output was achieved from the factor inputs, and
then focused attention on questions of allocative efficiency, that is the degree to which
resources are allocated between different activities in a socially desirable manner. The
notion that firms did not typically operate with technical efficiency and that the degree of
technical inefficiency varied (Leibenstein, 1966) changed that perspective (though as
always it could be questioned whether incorporating technical inefficiency and its causes
was consistent with neo-classical economics). This chimed with the frequent popular
accusation that publicly owned enterprises were inefficient. Leibenstein did not discuss
technical inefficiency with regard to different forms of ownership but he did with respect
to competition versus monopoly. The possible link between public ownership and
monopoly alluded to above would point towards the relative inefficiency of public
ownership. Indeed a number of neo-classical economists have argued that public
ownership per se does not lead to inefficiency, but a monopoly position does, leading to
the argument that private ownership may be required to enable the break down of a
monopoly situation. But it would also point to competition rather than ownership as being
the relevant consideration.
Neo-classical economics assumes that (perfect) competition in markets will result in
efficient outcomes. When producers are put under competitive pressure they are then
forced to produce at minimum costs (technical efficiency), to produce what consumers
want (allocative efficiency) and to innovate new products and production processes
whenever possible (dynamic efficiency). If not, they will not survive in the market place.
This is the world of fully rational actors who have sufficient information to calculate ex
ante the minimum efficient scale of production. The firm is then a production
function and the insight provided to management is ‘get the scale of production
From this perspective, markets do not spontaneously result in efficient performance when
there are market failures and/or market imperfections. Market failures refer to public
goods (that is goods where one person’s use cannot be prevented (non excludability) and
that person’s use does not come at the expense of others (non rivalry), to natural
monopolies (decreasing marginal costs) and externalities. Imperfection results from abuse
of market power. In both cases the recommendation is that government should intervene
to correct the failures (produce collective goods, nationalize or regulate natural
monopolies and correct externalities that are not corrected by the market itself) and
imperfections (competition policies).
The principal-agent problem or agency dilemma arises whenever there is a situation in
which one person (principal) is contracted to act on behalf of another (agent) under
conditions of incomplete and asymmetric information. The principal wishes the agent to
act and behave in the interests of the principal, but finds it costly to specify how the agent
should act in a range of circumstances and also finds difficulty in monitoring what the
agent does. In the context of private or public ownership, there are many significant
principal-agent relations including those involving government (ministry) and state-
owned enterprise (and its managers), government (in form of regulatory agency) and
private firm, shareholders and managers, managers and employees. Differences in the
operations of firms under public ownership and under private ownership then arise from
differences in the principal (for example, whether a government department or
shareholders) and the objectives of the principal, differences in the relationship between
principal and agents and the ability and willingness of the principal to monitor the agents’
behaviour and performance.
The neo-classical approach has generally seen public ownership as a response to the
‘natural monopoly’ problem. It was always recognised that regulation (of prices, profits)
of private ‘natural monopoly’ was an alternative to public ownership. As indicated above
the neo-classical approach only favours private ownership over public ownership in so far
as the objectives pursued are more conducive to the achievement of allocative efficiency.
The neo-classical approach may be able to explain privatisation through the idea that
technological changes have changed the extent of ‘natural monopoly’
(telecommunications may be an example) and hence the need for public ownership as a
form of regulation. Another route, which may be debatable as to whether it would be a
neo-classical explanation, would involve changing perceptions of the objectives of public
versus private corporations and the effects of those objectives on technical efficiency. The
notion of X-inefficiency permitted the discussion within neo-classical economics of the
factors which may influence the degree of technical inefficiency, and a favoured line was
the role of competition in this regard. The absence of competition in the natural
monopoly setting could then be viewed as a cause of technical inefficiency (and hence
higher costs).
The neo-classical approach can be seen to have influenced the form of privatisation in
two particular respects. First, the structure-conduct-performance paradigm (from
industrial economics which can be associated with a neo-classical approach) postulates
the relevance of industrial structure including barriers to entry and exit for industrial
performance. Second, the nature and form of regulation has been strongly influenced by
the neo-classical perspective. The ‘natural monopoly’ perspective suggested the need for
regulation of prices and profits of privatised utilities, at least with regard to those parts of
the production process where economies of scale prevailed. The neo-classical approach
has generally informed the approach to the precise regulation of prices and costs and the
allocation of costs between activities (in contrast the Austrian approach stresses the
subjective nature of costs which raises some obvious difficulties for regulation). The
focus on regulation of price rather than say investment, research and development, may
also reflect the essentially static nature of neo-classical economics.
The agency theory and transactions costs economics approaches could then explain the
occurrence of privatisation through some combination of changes in perceptions of the
principal-agent issues and changes in the structure of transactions costs. This would
though leave unexplained how and why the perceptions of the role of property rights and
of principal-agent issues changed. It is rather debatable as to whether the principal-agent
issue and transactions costs have had much effect on the nature and forms of
privatisation. Some utilities have been privatised in a vertically dis-integrated form (the
British railway system is a well-known example) and the ways in which principal-agent
matters arise and the transactions costs (in a broad sense) arise in a disintegrated industry
do not appear to have had much impact on the way in which privatisation has been
5.4 Efficiency
Private ownership versus public ownership is often discussed in terms of the relative
efficiency of the different forms of ownership. The Austrian approach most clearly
postulates that private ownership will be more efficient than public ownership and in
effect judges efficiency in terms of profitability. Survival in the market becomes the test
of efficiency. The neo-classical approach has clear notions of efficiency in terms of
allocative and technical efficiency, where the latter refers to the degree to which the
output of a productive process is the maximum which is technically possible given the
inputs, and the former to whether the right balance of inputs is chosen and whether there
is the optimal allocation of resources between different activities. It is relevant to note the
shortcomings of such an approach to efficiency. First, it is well-known that the efficiency
criteria of neo-classical welfare economics pay no attention to issues of distribution.
Privatisation may well lead to a different structure of prices (as compared with public
ownership) which has a differential impact on income groups. It is often seen that the
pricing structure post-privatisation favours the rich rather than the poor. Second, little
attention is paid to wages and conditions of labour. If cost efficiency is increased through
the payment of lower wages and/or the intensification of labour, it would be doubted as to
whether that can be considered as improving social welfare. Third, the neo-classical
approach adopts a rather static approach and does not pay sufficient attention to issues of
investment and technical progress. The impact which privatisation has on the extent of
investment particularly in the public utilities has been little considered but of
considerable importance for the secure supply of essentials such as water and electricity.
Fourth, the nature and ‘quality’ of the product is liable to change under privatisation and
liberalisation. Regulation of privatised utilities has focused on price and has found
difficulty in ensuring quality. Liberalisation in the form of ‘contracting out’ of public
services has faced problems of writing and monitoring the contracts in a way to ensure
good quality services are provided.
This brief discussion points to the conclusion that privatisation cannot be adequately
assessed using the narrow concept of efficiency associated with neo-classical economics.
Social welfare cannot be narrowly aligned with costs of production or profitability. A
broader range of considerations, some of which have been indicated above, have to be
brought into the picture.
5.5 The political economy of privatisation
The big push towards privatisation can be dated as starting in the early 1980s, and
gathering pace from the late 1980s, though there were some previous examples of
privatisation in market economies alongside some extensions of public ownership. This
push towards privatisation has clearly gone alongside the rise and dominance of neo-
liberalism at the national and international levels. Privatisation epitomises neo-liberalism
in terms of the further expansion of markets and competition in economic life, the entry
of capital into new areas and the greater importance of the financial sector and the
‘bottom line’.
In Western European countries private ownership has been the norm, and this leads to
looking for reasons, rationales and pressures for public ownership as exceptions to that
norm. In some cases, the extension of public ownership was seen by those advocating it
as a step on the road to a socialist economy. But in others, especially when undertaken by
right of centre governments, as an unfortunate necessity in order to rescue a failing firm.
Public ownership has also quite often arisen in response to failures of private companies
and the threat of bankruptcy for companies that are deemed ‘too important to fail’.
Inefficiency and bankruptcy per se clearly do not lead to public ownership – after all
many companies are inefficient and some go bankrupt. It is often combined with the
strategic importance of the firm concerned and the employment and other consequences
of its demise. In other cases, nationalization was undertaken to facilitate greater industrial
efficiency (for example through exploitation of economies of scale), rationalization (often
in the face of industrial decline) and modernisation. Public ownership was also used to
foster economic development (for example IRI in Italy).
Opportunities for profits and accumulation
Privatisation shifts assets and productive processes undertaken by the State into the hands
of private companies. The assets are often sold at a price which does not reflect their
profit potential. Clearly privatisation involves enhanced prospects for profits and
accumulation within the private sector. Privatisation offered new markets for private
capital accumulation at a time when there was insufficient aggregate demand and profits
had been squeezed. This was especially the case in European countries after the 1970s
when restrictive macroeconomic policies became predominant. Profitability was restored
by the end of the second half of the 1980s, but without durable recovery of the rate of
accumulation at the macroeconomic level due to the insufficiency of demand, but also,
presumably, to the impact of the financial liberalisation which favoured more financial
accumulation. In this environment large and secure markets, mainly in public utilities and
pensions systems, and to a less extent in the health system, were made accessible for
private capital accumulation thanks to the privatisation process. Profitable activities were
easily privatised while activities with deficits remained in the public sector.
Privatisation in the form of the contracting out of public services to private contractors,
and the gradual incursion of private companies into the provision of public services
which had traditionally been provided by public employees are clearly to be seen as part
of the extension of the market economy. This not only accorded with ideas that all
economic activities should be undertaken through the market, but also enabled activities
which had previously been removed from the pursuit of profits now coming into the orbit
of profits and private accumulation.
Role of the financial sector
The interests of the financial sector in the promotion of privatisation are perhaps self-
evident. There are substantial fees, commission and income generated by the processes of
privatisation. The underwriting fees of the share issues, the income from dealing in the
shares in the privatised companies and so on. come immediately to mind. Public private
partnerships are also lucrative for the financial sector when that is taken to also include
accountancy firms and economic consultants. Deals have to be arranged, finance
provided, consultancy advice provided at a price and so on, and both private companies
and the public sector draw on the consultancy firms for advice with regard to public
private partnerships and the involvement of the private sector in provision of public
services. “Some financial institution can make enormous amounts of money by arranging
the sale of assets including their commissions. Their political advisors also benefit,
specifically in terms of their salary as directors of previously publicly owned companies.”
(Tatahi, 2006, pp. 5-6)
In varying ways, one of the objectives of privatisation reflected in the way in which the
privatisation was undertaken has often been the development of equity markets and the
spread of share ownership. Privatisation has also been promoted on the grounds of
developing the stock exchange (for example in terms of breadth and liquidity) especially
in the context of emerging markets. This argument in turn has rested on the view that
financial development (particularly with regard to the stock market) is a stimulus to
economic growth.
The financialisation, “the increasing role of financial motives, financial markets, financial
actors and financial institutions in the operation of the domestic and international
economies” (Epstein, 2005, p. 3) is a widely observed phenomenon. Privatisation is
clearly making a significant contribution to that process of financialisation. But a much
more significant element comes from the increased role of financial motives and financial
institutions in the operation of large public utilities. Further, privatisation serves to inject
financial motives into the provision of a range of public services.
The sale of shares in the privatised utilities were also undertaken at a significant discount
with small individual shareholders as the target group. These policies not only indicate
the intentions of these privatisation in terms of changing ownership patterns, but also that
the financial benefits of privatisation are concentrated on a relatively small number. In
contrast, the financial and others costs are spread and diffuse. The financial benefits of
privatisation of utilities arose for those who were able to purchase shares, whereas the
losses were spread over the whole community.
Privatisation and the public finances
The pressures on government finance with a perceived need to reduce budget deficits
have frequently been mentioned as significant in the drive towards privatisation. The
budget deficit, that is the balance between revenue and expenditure, has (nearly) always
been the centre of attention in debates over public finances. It is rarely the case that
attention is given to the government’s balance sheet in terms of assets and liabilities, and
where it is a concern over liabilities and not assets. The sale of public assets is generally
recorded as negative expenditure, which not only reduces the budget deficit but also
appears to reduce the scale (for that year) of public expenditure. However, if the sale of
public assets were treated as a transaction on the capital account, it becomes another way
of financing a budget deficit. In effect the sale of public assets goes alongside sale of
bonds as a means of deficit funding. As bonds have a cost in terms of future interest
payments so the sale of public assets has a cost in terms of the financial and other benefits
from the public operation of those assets. If it were the case that the private sector was
unwilling or unable to fund a budget deficit, then the use of an ‘accounting trick’ is
unlikely to make much difference. The funding requirements placed on the private sector
are the same, though the financial instruments used are different.
Public assets can for this purpose be conveniently divided into two. There are firstly those
assets which help to provide public goods and services but which do not directly generate
a financial flow (for example profits). Secondly, there are assets (typically operated by
public corporations) which help to produce goods and services which are sold to the
public and on which profits could be said to be earned.
Privatisation with regard to the first type of asset has essentially involved a leasing back
arrangement whereby the asset is owned and operated by the private sector in exchange
for a leasing and service fees. The private finance initiative (PFI) and public private
partnerships fall in this category. The immediate impact of the use of an PFI (as compared
with a conventional finance capital project by government) is to reduce government
borrowing requirement. However, the longer term effect on budget deficit is likely to be
negative : the future stream of leasing payments under PFI will in general exceed the
stream of interest payments (which would arise under conventional finance).
A similar argument applies in the case of state owned enterprises. In public ownership,
those enterprises would yield a future stream of profits which are now lost to the public
sector following privatisation. It could be argued that state owned enterprises are often
loss-making, but if so that makes them an unattractive proposition for private investors.
The loss to the public sector is amplified by the general underpricing of privatised
companies. There does not seem any doubt that there has been underpricing in general,
though the question can be asked as to how the degree of underpricing compares with that
which occurs with share floatation of private companies.
Privatisation and globalisation
Public ownership generally involves ownership by the nation state, but not at the supra-
national level. Ownership at regional or local government level can also be involved and
some similar arguments to those developed here would apply at that level. Public
ownership has been undertaken for a variety of reasons and has often involved control
over and development of production within the country concerned. Publicly owned
utilities could often have sole rights to produce the product concerned. The linkages
between privatisation and globalisation may then be self-evident. In one direction, public
ownership may place limits on the enterprise concerned from expansion outside its
national market and to enable entry into strategic alliances with foreign partners (see
Andre, 2006, p.7). “[I]t has been argued that private companies have more direct and
faster access to the international capital market than public companies do.” (Tatahi, 2006,
p. 3) In the other direction, entry of foreign companies into the domestic market would be
eased through privatisation. As indicated above, some proponents of privatisation linked
liberalisation with privatisation, and specifically removal of entry barriers, and the
removal of those barriers permits foreign entry into the domestic market. Although
privatisation sometimes involved the retention of some ‘golden share’ by the government,
in general there were few limitations over the eventual ownership of shares in the
privatised companies. “The sizable penetration of foreign capital into British companies
occurred as a result of a combination of circumstances, not all of them attributable to
privatization. The macroeconomic and monetary conditions surrounding privatization
certainly played an important role, but divestitures offered welcome opportunities to
international investors” (Florio, 2004, p. 144). Florio (2004) Chapter 5 provides an
indication for British privatisations of the extent to which shares in privatised companies
were acquired by foreign owners and the acquisitions of privatised firms by foreign
Privatisation is then related with globalisation both in terms of shifts from in effect
guaranteed national ownership of a range of production facilities to facilities for foreign
ownership, and facilitating the expansion of multi-national operations by enterprises.
Privatisation and labour market flexibility
The search for more flexibility of the wage relation was regarded as a key issue since the
1980s as it was supposed to help to reduce costs and improve profitability. In most cases
trade unions were in relatively strong positions in the public sector as compared with
much of the private sector. Consequently privatisation weakened trade unions’ positions
and helped indirectly to promote more flexible wage relations. More generally it changed
the rules in the privatised sectors and introduced more competition, notably in the wage
relation. The reduction of trade union power was a major theme of the Thatcher
government in the UK in the 1980s, with many changes in industrial relations law
designed to diminish the role of the trade unions. This went along side the major
privatisation programme, and indeed the use of privatisation to constrain trade union
power is frequently mentioned as a major motive for privatisation in the UK during the
1980s. Tatahi concludes that “the implementation of the privatisation process involves
reorganisation and restructuring of the balance between these two parties. As a result, the
balance has shifted between these two parties. …. Privatisation and its effects cannot be
ignored in enhancing the flexibility of the labour market, shifting the balance in favour of
capital and resulting in significantly weakening labour.” (Tatahi, 2006, p.7)
‘Technical matters’
The criteria used to justify public intervention and ownership have changed under the
effect of technical evolutions. Some activities, like telecommunications, formerly with
increasing returns, have turned into activities with decreasing returns thanks to technical
innovations, thus rendering the monopolistic situation obsolete. The segmentation of
activities, like in railways or electricity, has been developed and allowed the division of
companies into several segments which could partly be submitted to competition.
Consequently, traditional criteria (increasing returns, externalities) tended to disappear in
favour of the nature of the information which could be easily manipulated or not.
Conversely, the difficulties involved in the contracting out of an activity arising from
asymmetric information, costs of writing and monitoring contracts justified maintaining a
public operator. It is argued that “a major factor behind privatisation is to be found in
developments associated with new technology. These have had the effect of breaking
down the traditional boundaries that divide one sector of the economy from another. New
technology has been generally applicable, adaptable and cheap, with potential use in
production, management and marketing. Accordingly, the economy is going through a
particularly intense period of reorganisation along the lines of vertical and horizontal
integration, especially where new technology is concerned.” (Fine, 1990, p.139).
5.6 Concluding comments
In this chapter we have sought to lay out a range of ideas coming from economic and
political economy analysis which have fed into policies on privatisation and liberalisation
and which have also informed the debates over the effects of privatisation.
Andre, C. (2006), ‘Privatizations in France’, Presom website
Beesley, M. and Littlechild, S.C. (1983), ‘Privatization : principles, problems and
priorities’, Lloyds Bank Review¸ July 1983 (reprinted in M.E. Beesley, Privatization,
Regulation and Deregulation, London: Routledge, (Second edition, 1997)
Epstein, G, (2005), ‘Introduction: Financialization and the World Economy’ in
Financialization and the World Economy Edited by Gerald Epstein, Edward Elgar,
Cheltenham, UK Northampton, MA, US
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