Privatisation, and choosing between public and private ownership

Overview

Main arguments in favour of privatisation, main arguments against privatisation and effect of privatisation on employment in the industry concerned.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   State the main arguments in favour of privatisation.

   Model answer

   Private owners face the discipline of shareholders, of takeover and of possible bankruptcy, which forces attention to costs. Investment can be financed from capital markets without competing with other public spending. Where the activity can be opened to competition, private ownership makes that possible and rivalry then drives prices down and service up. Management is freed from short-term political interference. And the sale raises revenue for the government while the business subsequently pays tax rather than absorbing subsidy.

2. 2

   State the main arguments against privatisation.

   Model answer

   Selling a monopoly simply converts a public monopoly into a private one, adding a profit margin without adding competition, so prices may rise. Loss-making but socially valuable services lose their cross-subsidy and are withdrawn. Cost cutting may fall on employment, wages and service quality rather than on genuine waste. Long-term investment may be sacrificed to shareholder returns. Regulation must then be created and funded permanently. And assets sold too cheaply transfer public wealth to investors.

3. 3

   Why does privatising a natural monopoly usually require a regulator to be created at the same time?

   Model answer

   Because ownership changes the objective without changing the market. A private owner of a network with no competitors will price to maximise profit, which is precisely the outcome that caused concern in the first place. Unless a regulator caps prices, sets service standards and controls access for competitors, privatisation replaces a public monopoly that at least had no profit motive with a private one that does.

4. 4

   Explain why the gains from privatisation depend more on whether competition follows than on the change of ownership itself.

   Model answer

   Ownership changes the incentive of the managers, but only competition or regulation constrains the price. A privatised firm facing genuine rivals must cut costs and pass savings on to keep its customers, so both efficiency and price improve. A privatised firm facing no rivals has an incentive to cut costs but keeps the saving as profit, and may raise price as well. This is why privatisations accompanied by opening the market to entry have performed much better than those that transferred a protected monopoly intact.

5. 5

   What is cross-subsidy, and why does privatisation threaten it?

   Model answer

   Cross-subsidy means using the surplus earned on profitable customers to fund service to unprofitable ones, such as charging a uniform price for delivery whether the address is in a city or on an island. A private firm has no reason to serve customers at a loss, and a competitor can enter and take only the profitable customers, which removes the surplus that funded the rest. Preserving universal service therefore requires an explicit obligation written into the firm's licence rather than leaving it to the market.

6. 6

   Analyse the effect of privatisation on employment in the industry concerned.

   Model answer

   Employment typically falls, at least initially, because the new owners remove overstaffing that public ownership had tolerated, close loss-making operations and invest in labour-saving equipment. Wages and conditions for the remaining staff may also be reduced where they had been above market rates. Against this, if privatisation is accompanied by competition and output subsequently expands, employment can recover and new firms entering the market create jobs of their own. The initial effect is therefore usually negative and concentrated in particular places and occupations, while any later gains are dispersed.

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