Privatisation

Privatisation is the process of returning state owned industries back to the private sector.

Historically, the push for privatisation across Europe and many parts of the developed world from the late 1970s followed increasing criticism of state ownership as a means of promoting economic growth and wellbeing.

Different perspectives

Various schools of economic thought promoted privatisation as an antidote to what they saw as the economic problems resulting from increasing state involvement in the post-war period. This came to a head in the 1970s when many advanced economies experienced rapidly rising prices (from oil and wage shocks), falling productivity, and widespread unemployment.

These schools of thought, which included monetarism, supply-side economics, and crowding out theory, shared one fundamental belief - that excessive state involvement in the economy imposed a considerable drag on economic growth and development.

The main criticism of the state-owned (nationalised) industries was that they were inefficient, had failed to modernise and embrace new technology, and were holding back the ‘more efficient’ private sector.

Advantages and disadvantages of privatisation

Advantages

  1. Privatised firms are subject to the disciplines of the market, which, it is argued, can create many benefits, including lower costs, better performing management, higher productivity and increased global competitiveness.

  2. It is also argued that privatisation would lead to increased efficiency across the supply-side of the economy.

  3. Privatised firms can raise capital from the private capital markets, rather than having to 'bid' for increased funding from central government.

  4. The revenue accruing to the government from selling shares can reduce existing public sector debt, or enable a reduction in taxation, or be used on projects where government involvement is absolutely necessary – such as funding infrastructure projects.

  5. Inward investment from profit seeking foreign firms is more likely to be encouraged – as was the case when the UK oil industry was privatised between 1977 and 1987.

  6. If previously state-owned industries are privatised, and then broken up into smaller business units, the disadvantages of possible diseconomies of scale associated with state owned industries is reduced.

  7. With the smaller involvement of the state, crowding-out can be reduced. Crowding out occurs when the state sector grows at the expense of the private sector, meaning that scarce resources, including capital and labour, are diverted away from more efficient and profitable uses.

Disadvantages

  1. When firms or whole industries are privatised the government no longer has the ability to influence how they are run, and how decisions are made – subject to normal legal requirements (such as health and safety).

  2. Free from government restraint, privatised industries or firms can push up prices or restrict output, and make abnormal profits. This can create a welfare loss, as shown below.

  3. privatisation diagram showing higher price and lower output

    It should be noted that there is also a welfare loss if the industry is state-owned and sets its goal to break-even (where ATC=AR) in which case there is also a welfare loss compared with the competitive equilibrium - the welfare loss is area K,M,N,

  4. If the privatised firms are owned by foreign shareholders, profits may go abroad, rather than retained in the economy.

  5. While privatisation may make it easier for overseas firms to invest in an economy, there is a risk that national security might be jeopardised if the investor is involved in communications infrastructure projects. Although unproven, there have been concerns regarding allowing overseas investors to become involved with the roll-out of 5G.



Moral hazard

How can firms suffer from moral hazard?

Moral hazard
Government failure

Why do governments fail?

Government failure
Regulation

How is regulation used to reduce market failure?

Regulation