Effects of privatization

    Privatisation programmes come in diverse forms and it is not always easy to determine their success or failure. Studies of the UK experience suggest mixed results. Some privatised companies achieved a highly successful turnaround, notably British Telecom and British Airways, but the verdict on the privatisation of British Rail, the water industry and the health service is far less flattering._12 The Economistdescribed the privatisation of British Rail as a disaster. Experience also differs between countries. In a highly generalised way, one might say that privatization has been successful in the UK while unsuccessful in Russia.

    The effects of privatisation can be evaluated under several headings: effects on

efficiency, effects on government revenue and effects on income distribution.

    A key consideration is the effect of privatisation on efficiency, i.e. on measured

labour productivity or, better still, total factor productivity. The resultant fall in

unit costs can be passed on to the consumer in terms of lower prices and better

quality. In the UK, telephone charges fell by 35 per cent in real terms between

1984 and 1994, whilst electricity prices for business fell by 30 per cent during the

period 1990_–_99. According to the US Department of Justice Antitrust Division

Annual Report 1994, increased competition in the US telecoms industry hastened

the introduction of fibre optic technology and spurred an increase in technological

innovation. Electricity charges also declined in real terms. As a general rule,

experience shows that the more competition in the privatised companies the

greater the likelihood of a positive outcome. This is just as economic theory

would predict. A policy environment that encourages long-run investment in the

privatised companies is also important.

    The effect on government revenue is more complex than might appear. In the

case of an outright sale, the gain to the state cannot be equated with the sale

price. The state has just replaced one asset with another. To calculate the net financial gain to the state, we must compare the present value of the stream of net revenue expected from the firm had it remained in state ownership with the proceeds from the sale. The price paid for the company is thus a crucial variable. If under-priced, the privatisation programme could end up worsening instead of improving government finances in the long term. Also there must be some assessment of how this extra cash accruing to the government is being used. It is being spent on building up military power or on consumer handouts or on long-term investments for the future?

    Last, one must consider the income distribution effects. There are at least four

parties to consider: the state, employees of the privatised firms, the consumer, and

the new owners. The mode of privatisation has an important bearing on the

outcome. Share flotation is one mode, often associated with a certain predetermined

allocation to existing employees.Direct sale. Management buy-outs are another possibility. In each case, careful analysis is needed in order to assess the resultant income distribution effect. It is obviously easy for the state that is strapped for cash to be induced into selling too cheaply.Also shares can be sold too cheaply to the public in order to curry popular favour or to ensure that the flotation will be a ‘success’, as happened in several Western European countries.

    There is little doubt that in most instances privatisation has brought benefits to

the consumer, not just in terms of lower price but also in terms of improved

quality of service and efficiency. There are many areas of the economy to which

the ethos of a state company is particularly unsuited and where privatisation has

yielded unambiguous benefits. Examples are state-owned hotels and restaurants

or manufacturing industries, where quickness of response and an entrepreneurial

approach is especially important. State farms, created on the grounds of

economies of scale, have never become successful enterprises. To some extent,

governments have voted with their feet. The number and scope of privatisation

programmes around the world shows that finance ministries are convinced that

the potential benefits exceed any potential losses. Experience to date would

support this verdict. But it will take time before the dynamic efficiency effects of

privatisation can be fully evaluated.