Lecture 7 - Privatisation

Definition

Privatisation is the transfer of ownership and/or control of a state-owned enterprise (SOE) to the private sector.

It can involve:

  • Full sale of assets

  • Partial sale (share flotation)

  • Contracting out

  • Public–private partnerships

Major UK programme: 1980s–1990s under Margaret Thatcher.

2. Why Governments Privatise (Arguments For)

A. Productive Efficiency

Private firms:

  • Face hard budget constraints

  • Must minimise costs to survive

  • Risk bankruptcy if inefficient

State firms may face soft budget constraints (concept by János Kornai).

Result: Lower average costs, reduced X-inefficiency.

B. Profit Incentives & Managerial Discipline

Privatisation introduces:

  • Shareholder monitoring

  • Performance-based incentives

  • Corporate governance mechanisms

Reduces:

  • Overstaffing

  • Political interference

  • Bureaucratic slack

C. Dynamic Efficiency (Innovation)

Competition + profit motive →

  • Investment in R&D

  • Technological improvement

  • Quality enhancement

Example: British Telecom experienced increased competition and expansion after privatisation.

D. Fiscal Benefits

Government gains:

  • Immediate revenue from asset sale

  • Reduced borrowing requirement

  • Lower public sector debt (short-term)

E. Increased Competition

If combined with deregulation:

  • Entry increases

  • Prices fall

  • Output rises

Potential movement toward:

  • P ≈ MC (allocative efficiency)

F. Wider Share Ownership

Privatisation programmes sometimes aim to:

  • Develop capital markets

  • Encourage household investment

  • Promote “shareholder capitalism”

3. Arguments Against Privatisation

A. Natural Monopoly Risk

Industries with:

  • High fixed costs

  • Large economies of scale

Privatisation may simply replace:

Public monopoly → Private monopoly

Private monopolist:

  • Restricts output

  • Raises price

  • Creates deadweight loss

Example: Rail infrastructure under Railtrack, later replaced by Network Rail.

B. Higher Prices

Private firms maximise profit, not welfare.

Can lead to:

  • Price increases

  • Reduced cross-subsidisation

  • Lower affordability

Example: Energy sector criticism of British Gas.

C. Equity Concerns

State firms may:

  • Protect employment

  • Provide universal access

  • Support rural regions

Privatised firms may:

  • Cut unprofitable services

  • Focus on high-income areas

→ Increased inequality.

D. Under-Provision of Merit Goods

Where:

Social Benefit > Private Benefit

Private market underprovides:

  • Transport

  • Water

  • Infrastructure

E. Short-Termism

Private firms may:

  • Prioritise dividends

  • Underinvest in long-term infrastructure

  • Focus on quarterly performance

Particularly risky in capital-intensive sectors.

F. Regulatory Failure

Privatisation often requires:

  • Price caps

  • Competition authorities

  • Industry regulators

Risk of:

  • Regulatory capture

  • High monitoring costs

  • Government failure

6. Evaluation Framework (High-Level Analysis)

Privatisation works best when:

  • Market is competitive

  • Entry barriers are low

  • Demand is elastic

  • Externalities are minimal

  • Strong independent regulation exists

Privatisation works worst when:

  • Industry is a natural monopoly

  • Service is a merit good

  • Equity concerns are significant

  • Information asymmetry is high

  • Regulation is weak