Privatisation policy - Business Environment

On privatisation
In its broadest sense, ‘privatization’ involves the transfer of assets or different forms of economic activity from the public sector to the private sector. In the United Kingdom such transfers occurred throughout the 1980s and 1990s under different Conservative administrations. Although the current Labour government has continued the process to some degree (e.g. with the partial privatization of the National Air Traffic Services), the hey day of huge state sell-offs in Britain has probably passed. In government circles the talk is now of public/private partnerships as a mechanism for increasing private sector investment in the public services part of what has become known as the ‘third way’ in British politics.
In practice, the term ‘privatization’ has been applied to a range of activities that involve a measure of state disengagement from economic activity. Typically these have included:

  • The sale of government-owned assets, especially nationalized industries (e.g.British Telecom, British Gas) or industries in which the government had a substantial shareholding (e.g. BP).
  • The contracting out of services normally provided by the public sector (e.g.school meals, hospital cleaning).
  • The deregulation or liberalization of activities over which the state had previously placed some restriction (e.g. the deregulation of bus routes or postal services).
  • The injection of private capital into areas traditionally financed by the public sector (e.g. the road system).
  • The sale of local authority-owned property to private citizens or organisations(e.g. council houses, school playing fields).
  • The privatization of government agencies (e.g. Her Majesty’s Inspectors for Education).

Of these, the sale of state assets especially the public corporations and nationalized industries has been the main plank of UK privatization policy and the one which has captured the most public and media attention. For this reason, in the discussion below attention is focused on this aspect of the privatization program.The scope of government asset sales in the period 1979–96 is indicated in Table. In the first phase, between 1979 and 1983, these tended to generate relatively small sums of money compared with what was realized in later years and generally involved the sale of government shares in companies such as British Aerospace, Britoil, BP, ICL and Ferranti. Between 1983 and 1988, the government disposed of a number of its largest industrial and commercial undertakings, including British Telecom, British Gas and British Airways, along with Rolls-Royce and Jaguar. These were followed by the sale of British Steel, the Rover Group, the National Bus Company and, more significantly, by the regional water authorities and the electricity industry in the late 1980s and early 1990s. In the most recent phase, major sales have included British Coal, Railtrack, the flotation of the National Grid, the privatization of the nuclear industry and the selling off of the National Air Traffic Services (NATS). It is worth noting that Railtrack, having gone through a period of administration, has subsequently been turned into a not-for-profit organization called Network Rail.

Major-asset sales

In disposing of national assets governments have used a number of different methods, including selling shares to a single buyer, usually another company (e.g.the sale of Rover), selling shares to the company’s management and workers (e.g.the management buyout of the National Freight Corporation), and selling shares on the open market for purchase by individuals and institutions (e.g. the stock market flotation of British Telecom). In some cases the process took place in several stages, as a proportion of shares was released on to the market over several years(e.g. BP); in other cases a one-off sale occurred, with investors invited to subscribe for the whole of the equity (e.g. British Steel). As Figure indicates, proceeds from privatization sales between 1979 and 1991 exceeded £34 billion, with the majority of the revenue being raised in the mid to late 1980s. Estimates for the period 1991–4 suggest that privatization yielded a further £25–£30 billion for the Exchequer. Over the whole period of privatization it is thought that total revenues from the sale of state-owned industries amounted to around £100 billion (at 2000prices). This is equivalent to approximately 2 per cent of total government expenditure(or revenues) for that period.

Proceeds-from-privatisation

Rationale
The roots of privatization policy lie in the attempt by the Conservative government, then under the leadership of Margaret That cher (1979–90), to tackle the perceived deficiencies in the supply side of the UK economy. Central to the government’s philosophy was the belief that the free market was a superior method of allocating economic resources and that large-scale state involvement in business activity hampered economic progress. ‘Rolling back the frontiers of the state’ by reducing the size of the public sector was consequently seen as a key component in improving the country’s economic performance at both national and international level The government’s case for privatization centered round the claim that the sale of state-owned businesses would improve their efficiency and general performance, and would give rise to increased competition that would broaden consumer choice.Under state control, it was argued that businesses had no incentive to strive for efficiency or to respond to consumer preferences, since many of them lacked any direct competition and all of them could turn to government for financial support, if revenue was insufficient to meet operating costs. In contrast, firms which were exposed to the ‘test’ of the market would have to satisfy both the consumer and the financial markets if they were to survive or to avoid takeover by more efficient and competitive organisations.
Allied to this argument was the proposition that privatization would improve the performance of an organisation’s management and workers. Freed from the need to meet objectives laid down by government, management could concentrate on commercial goals such as profitability, improved productivity and cost reduction, and on encouraging greater flexibility and technical innovation within the organisation.Implicit in these claims was the acceptance that a considerable degree of restructuring would need to occur within each privatized company and that this was likely to act as an incentive to the workforce to improve its performance.Additional encouragement was also expected to derive from the use of employee share-ownership schemes, under which current employees within a newly privatized company were offered a proportion of the equity, thus giving them a vested interest in the organisation’s fortunes.

The sale of shares to employees and to the public generally was also presented as a benefit of privatization in that it helped to encourage wider share ownership and to create a ‘share-owning democracy’, with increased sympathies towards capitalist modes of production (and possibly the Conservative party). Concomitantly, the sale of state assets also served to reduce the size of the public sector borrowing requirement (PSBR) since revenue from sales was counted as negative public expenditure and this helped to reduce the government’s debt burden and to take some of the pressure off interest rates, as well as releasing funds for use by the private sector.

Criticisms of privatisation
Opponents of privatization have likened the process to ‘selling the family silver’ disposing of important national assets for short-term financial gains. Under privatization, these assets, once owned by the general public, pass into the hands of those individuals and organizations able and willing to buy shares and this includes overseas buyers who could ultimately gain control of important parts of British industry, unless prevented from doing so by government action (e.g. through a‘golden share’). To add to this criticism, some observers have claimed that valuable assets, bought over many years by public funds, have been sold off too cheaply to private investors who have reaped the benefit at the expense of the general public.Only industries which are not attractive to the stock market are likely to remain in public ownership and this will mean that the tax payer has to pay the bill to support their continued existence.Further criticisms have included the loss of future government revenue from the sale of profitable state-owned businesses and the problem of ensuring that commercial goals are not allowed to displace completely the broader economic goals once pursued by nationalized industries (e.g. the possible closure of unprofitable rural telephone boxes or railway lines under privatization). In essence, the fear is that once freed from government regulation, privatized companies will tend to replace the loss-making ‘public service’ element of their former activities with products or services that offer the greatest levels of profit. While this will benefit some consumers, the cost is likely to be borne by other buyers who have limited market power and, in some cases, no alternative product to turn to. This problem of lack of choice is particularly a cute where the privatization of a state monopoly gives rise to a private monopoly, as initially was the case with many of the privatized utilities. Despite the establishment of ‘regulators’ to oversee the operations of some of the newly privatized concerns and to act as a kind of proxy for true competition, some opponents still feel that the interest of consumers is not fully protected under the current arrangements. They also feel that exploitation through higher prices or other abuses of market power remains possible. Evidence from investigations by the former Monopolies and Mergers

Key-regulatory-bodies for selected privatised utilities

Commission and from the regulatory authorities suggests that this view is not without foundation. This evidence has also conveniently provided the current government with a justification for levying windfall taxes on the profits of the privatized utilities as a means of boosting Exchequer revenues.

Privatization overseas
Before offering an assessment of privatization in the United Kingdom, it is worth noting that most other states have embarked on similar experiments in economic liberalization, irrespective of their size, ideology or level of economic development.
At the end of the 1980s it was estimated that worldwide sales of state assets to the private sector exceeded $25 billion or about £14 000 million and this figure has continued to grow with the ongoing privatization process in eastern Europe and elsewhere. For example, according to The Economist (23 November 1996), in the period 1985–95 the combined revenues from privatization in France, Germany,Italy, the Netherlands and Spain alone were in excess of $70 billion, with France having the lion’s share of $34 billion. For the same period the United Kingdom’s receipts were estimated at $85 billion, making it the most significant privatization program within the OECD.
The following examples of overseas privatization give some idea of the wide range of state assets from different sectors of the economy that have been sold by governments of different political complexions over the last two decades.

  • In Portugal major privatizations between 1989 and 1997 included banks, insurance companies, public utilities and businesses producing cement, oil, paper products, tobacco and beer.
  • In the Netherlands privatizations have included the national airline (KLM) and the water, gas and electricity utilities.
  • In Brazil part of the country’s rail network has been sold off; in Jamaica privatization has included the National Commercial Bank and the Caribbean Cement Company.
  • In France privatizations range from chemicals and oil to insurance, banking and vehicles. The French government is currently (2005) selling off parts of the gas, electricity and nuclear industries and has plans to privatize some of the motorway network.
  • In India the government has divested a significant proportion of public sector enterprises with sales including businesses involved with steel, zinc and petrochemicals. Arguably the most dramatic and exciting experiments in privatization have taken place in eastern Europe, particularly among the transition economies which have moved from a planned economic system towards private enterprise. In the newly unified Germany, for instance, the federal government decided to appoint a special privatization agency (Treuhand) to oversee and assist in the large-scale privatization of former East German state industries and firms, and other governments (including those in Hungary, the Czech Republic and Poland) have committed themselves to similar programs of rolling privatization and have undertaken legal and institutional changes to speed up the process. While progress has varied in the different states and has generally been influenced by questions of economic and political stability (e.g. in the Russian Federation), the large-scale sell-off of public assets by the former communist states will undoubtedly continue into the foreseeable future.

Current evidence suggests that the transition in these countries is proving a significantly more painful experience than that encountered in states already possessing a market-based economic system (see e.g. the article by Nick Potts in the Further reading section at the end of the chapter).

Assessment3
Measured against some of the UK government’s stated objectives, privatization appears to have been successful, and has involved a transfer of ownership of over 7 percent of GDP from the public to the private sector. Apart from the fact that many other national governments have sought to emulate Britain’s approach to asset sales, the privatization program has been cited as an important component of the improvement in the supply side of the economy after 1979. It has also been a critical element in promoting the free market approach which has come to dominate governmental thinking in Britain and elsewhere for over two decades. All of this has evidently been achieved with the support of the British public (although some opinion polls have indicated a decline in the popularity of privatization). In 1979, for instance, only 7 per cent of adults owned shares in public companies. By the early 1990s this figure had risen to 25 percent, or 11 million shareholders, many of whom had bought shares for the first time in the 1980s with the sale of the big public utilities.This significant growth in the number of ordinary shareholders can be explained in a number of ways. For a start, most stock market flotations were accompanied by extensive and costly advertising campaigns which helped to raise public awareness and to attract investors (e.g. British Gas’s ‘Tell Sid’ campaign). Added to this, investors in public utilities were often offered special incentives to buy shares in businesses they dealt with on a regular basis (e.g. cheaper telephone bills) or in which some of them worked and therefore had a vested interest. Perhaps most importantly, and with the benefit of hindsight, some privatization stock appears to have been sold at substantially lower prices than the market would bear and this guaranteed quick profits for people who bought and then sold immediately as prices rose. In the circumstances it is not surprising that many flotations were hugely oversubscribed a fact which led to criticism that some privatization stock had been considerably undervalued.Many shareholders who invested for longer-term capital gains also benefited from underpricing of share issues and in some cases received free additional shares and other benefits (including annual dividends) by holding on to their investment.An analysis by Gary Cook of the share performance of privatized companies shows that some of the earlier privatizations have produced spectacular long-term gains, though some privatized company shares performed less well. Cable & Wireless shares, for example, were issued at an average price of 56p in the early 1980s and were trading at 588p by August 1991. Similarly, BT’s initial issue price of 130p in 1984/5 had risen to 391p by the same date, a three fold increase despite the stock market crash in 1987.
Whatever the reason for the growth in share ownership, it is clear that privatization, along with the sale of council houses, has helped the government to claim that it has encouraged the growth of a ‘property-owning democracy’ in which an increasing number of citizens have a stake in the success of the economy and therefore in the performance of the private sector. That said, it is still the case that the majority of shares in public companies are held by individuals in better-paid professional and managerial occupations and that over all the percentage of all UKshares owned by individuals has fallen dramatically over the last 30 years. In contrast, the holdings of institutional investors (such as insurance companies and pension funds) have risen rapidly a fact which not only gives them significant influence over the future of many public companies, but which also suggests that the claim of wider share ownership has to be treated with a degree of caution.
Notwithstanding this latter point, the government’s relative success in selling state assets also helped it initially to achieve another one of its objectives that of reducing the size of the PSBR. From the early 1980s onwards, public expenditure as a percentage of GDP fell substantially partly as a result of the revenues from the privatization program and by the latter part of the decade the government had a budget surplus (or public sector debt repayment) as revenue exceeded spending.Once again, however, this apparent benefit needs to be seen in context. For a start, much of the improvement in public finances during this period was a result of the government’s restraint on public spending, rather than the effects of privatization, though the receipts clearly helped the government to balance its books. Added to this, by the early 1990s, as the recession took hold, public spending rapidly began to outstrip the amounts raised in revenue, causing a dramatic growth in the size of government borrowing, despite a decade of privatization receipts. Understandably, some critics have asked whether the sale of valuable state assets was in vain and distracted the incumbent government from addressing some of the underlying structural weaknesses in the British economy.
With regard to privatization as a spur to greater organisational efficiency and performance, this is an area in which assessment is particularly problematical. Part of the difficulty arises from the fact that direct comparisons between state and privatized companies are often impossible, since some goods and services have not normally been provided by both the public and private sectors simultaneously (e.g.railways). In addition, even where such provision occurs (e.g. the health service), the public sector usually has to pursue a number of non-commercial objectives laid down by politicians and this makes direct comparisons somewhat unfair, particularly if profitability alone is taken as a measure of performance.
One way of approaching some of these ‘problems’ is to attempt a comparison between the performance of an organisation before privatization and its performance after it has become part of the private sector using measures such as relative profitability, productivity or levels of service. Yet, once again, significant methodological difficulties exist which call into question the validity of many of the conclusions. Industries such as British Gas and British Telecom, for instance, have always been profitable and profits have tended to grow since privatization; but this could as easily reflect the benefits of monopoly price rises as improvements in efficiency resulting from a change in ownership. Conversely, the decline in the fortunes of the once publicly owned steel industry could be interpreted as a decline in efficiency and/or performance under privatization, when in fact a combination of overcapacity in the world steel industry and the impact of the recession have clearly been the main culprits.
Comparisons of productivity can also be misleading and usually fail to take into account the substantial ‘economic’ costs of privatization (e.g. large-scale redundancies).Many state industries were substantially restructured prior to flotation in order to attract investors, and the resulting job losses invariably at the tax payer’s expensehelped many newly privatized businesses to claim substantial productivity gains in their first few years of trading. Perhaps ironically, the greatest improvements in productivity in the period 1984–91 often occurred within industries nationalized at the time such as British Coal and British Rail whose massive redundancy programs helped them to out pace the productivity gains of manufacturing industry by anything up to three times, according to Treasury figures. In such circumstances, it would be easy though probably unreasonable to conclude that while being privatized was good for productivity, it was not as good as not being privatized Further complications arise when one compares the performance of privatized companies which have remained monopolies with the performance of those which have consistently operated under competitive market conditions. Writing in theGuardian on 3 March 1993, Victor Keegan argued that the fortunes of companies such as British Steel, Rolls-Royce and Rover had been seriously affected by the sort of violent cyclical disturbances which had previously driven them into the public sector and that this had significantly influenced their attractiveness to private investors. In comparison, businesses which had faced little effective competition in some areas of the market (e.g. Cable & Wireless, British Airways) and those facing one (e.g. the water companies, British Gas) had invariably performed well for their shareholders; though the price of this success had frequently been paid by customers(in the form of inflated charges) and workers (in the form of redundancy).

Keegan’s conclusion, that it is competition rather than ownership which acts as as per to increased efficiency, is one that is widely held and underlies some of there cent attempts by government and by the regulatory bodies to identify ways of reducing the monopoly power of the privatized public utilities. The proposition is that under a more competitive market structure the commercial pressures of the marketplace force management to seek ways of improving organisational efficiency and performance, for fear of the consequences if they fail to meet the needs of the consumer and the investor. If left to their own devices, the large utilities are unlikely to put them selves to such ‘tests’ voluntarily, and this approach would presumably find favour with shareholders who have a vested interest in maximizing revenue. Paradoxically, in order to improve the position of the consumer, government may be forced to intervene more aggressively and imaginatively in the marketplace, in order to promote greater competition among producers and increased choice for the consumer. Such intervention could easily be justified undercurrent competition policy.


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