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Privatization (sometimes privatisation, denationalization, or, especially in India, disinvestment) is the process of transferring property, from public ownership to private ownership and/or transferring the management of a service or activity from the government to the private sector. The opposite process is nationalization or municipalization.
Privatization is frequently associated with industrial or service-oriented enterprises, such as mining, manufacturing or power generation, but it can also apply to any asset, such as land, roads, or even rights to water. In recent years, government services such as health, sanitation, and education have been particularly targeted for privatization in many countries.
In theory, privatization helps establish a "free market", as well as fostering capitalist competition, which its supporters argue will give the public greater choice at a competitive price. Conversely, socialists view privatization negatively, arguing that entrusting private businesses with control of essential services reduces the public's control over them and leads to excessive cost cutting in order to achieve profit and a resulting poor quality service.
In general, nationalization was common during the immediate post-World War 2 period, but privatization became a more dominant economic trend (especially within the United States and the United Kingdom) during the 1980s and '90s. This trend of privatization has often been characterized as part of a "global wave" of neoliberal policies, and some observers argue that this was greatly influenced by the policies of Reagan and Thatcher. The term "privatization" was coined in 1948 and is thought to have been popularized by The Economist during the '80s.
Arguments for and against
See also: arguments for and against public ownership and the welfare state
Advocates of privatization argue that governments run businesses poorly for the following reasons:
- Performance. The government may only be interested in improving a company in cases when the performance of the company becomes politically sensitive.
- Improvements. Conversely, the government may put off improvements due to political sensitivity — even in cases of companies that are run well.
Corruption. The company may become prone to corruption; company employees may be selected for political reasons rather than business ones.
- Goals. The government may seek to run a company for social goals rather than business ones (this is conversely seen as a negative effect by critics of privatization).
- Capital. It is claimed by supporters of privatization, that privately-held companies can more easily raise capital in the financial markets than publicly-owned ones.
- Unprofitable companies survive. Governments may "bail out" poorly run businesses with money when, economically, it may be better to let the business fold.
- Unprofitable units survive. Parts of a business which persistently lose money are more likely to be shut down in a private business.
Political influence. Nationalized industries can be prone to interference from politicians for political or populist reasons. Such as, for example, making an industry buy supplies from local producers, when that may be more expensive than buying from abroad, forcing an industry to freeze its prices/fares to satisfy the electorate or control inflation, increasing its staffing to reduce unemployment, or moving its operations to marginal constituencies; it is argued that such measures can cause nationalized industries to become uneconomic and uncompetitive.
In particular, the Performance, Goals, and Unprofitable companies survive reasons are held to be the most important because money is a scarce resource: if government-run companies are losing money, or if they are not as profitable as possible, this money is unavailable to other, more efficient firms. Thus, the efficient firms will have a harder time finding capital, which makes it difficult for them to raise production and create more employment.
The basic argument given for privatization is that governments have few incentives to ensure that the enterprises they own are well run. On the other hand, private owners, it is said, do have such an incentive: they will lose money if businesses are poorly run. The theory holds that, not only will the enterprise's clients see benefits, but as the privatized enterprise becomes more efficient, the whole economy will benefit. Ideally, privatization propels the establishment of social, organizational and legal infrastructures and institutions that are essential for an effective market economy.
Another argument for privatization is, that to privatize a company which was non-profitable (or even generated severe losses) when state-owned means taking the burden of financing it off the shoulders and pockets of taxpayers , as well as free some national budget resources which may be subsequently used for something else. Especially, proponents of the laissez-faire capitalism will argue, that it is both unethical and inefficient for the state to force taxpayers to fund the business that can't work for itself. Also, they hold that even if the privatized company happens to be worse off, it is due to the normal market process of penalizing businesses that fail to cope with the market reality or that simply are not preferred by the customers.
Many privatization plans are organized as auctions where bidders compete to offer the state the highest price, creating monetary income that can be used by the state.
Opponents of privatization dispute the claims made by proponents of privatization, especially the ones concerning the alleged lack of incentive for governments to ensure that the enterprises they own are well run, on the basis of the idea that governments must answer to the people. It is argued that a government which runs nationalized enterprises poorly will lose public support and votes, while a government which runs those enterprises well will gain public support and votes. Thus, democratic governments, under this argument, do have an incentive to maximize efficiency in nationalized companies, due to the pressure of future elections.
Furthermore, opponents of privatization argue that it is undesirable to let private entrepreneurs own public institutions for the following reasons:
- Profiteering. Private companies do not have any goal other than to maximize profit.
- Corruption. Buyers of public property have often, most notably in Russia, used insider positions to enrich themselves - and civil servants in the selling positions - grossly.
- No public accountability. The public does not have any control or oversight of private companies.
- Cuts in essential services. If a government-owned company providing an essential service (such as water supply) to all citizens is privatized, its new owner(s) could stop providing this service to those who are too poor to pay, or to regions where this service is unprofitable.
- Inefficiency. A centralized enterprise is generally more cost effective than multiple smaller ones. Therefore splitting up a public company into smaller private chunks will reduce efficiency.
Natural monopolies. Privatization will not result in true competition if a natural monopoly exists.
- Concentration of wealth. Profits from successful enterprises end up in private pockets instead of being available for the common good.
Insecurity. Nationalized industries are usually guaranteed against bankruptcy by the state. They can therefore borrow money at a lower interest rate to reflect the lower risk of loan default to the lender. This does not apply to private industries.
- Downsizing. In cases where public services or utilities are privatized, this can create a conflict of interest between profit and maintaining a sufficient service. A private company may be tempted to cut back on maintenance or staff training etc, to maximize profits.
- Waste of risk capital. Public services are per definition low-risk ventures that don't need scarce risk capital that is needed better elsewhere.
- Not all good things are profitable. A public service may provide public goods that, while important, are of little market value, such as the cultural goods produced by public television and radio.
In practical terms, there are many pitfalls to privatization. Privatization has rarely worked out ideally because it is so intertwined with political concerns, especially in post-communist economies or in developing nations where corruption is endemic. Even in nations with advanced market economies like Britain, where privatization has been popular with governments (if not all of the public) since the Thatcher era, problems center on the fact that privatization programs are very politically sensitive, raising many legitimate political debates. Who decides how to set values on state enterprises? Does the state accept cash or for government-provided coupons? Should the state allow the workers or managers of the enterprise to gain control over their own workplace? Should the state allow foreigners to buy privatized enterprises? Which levels of government can privatize which assets and in what quantities?
In the short-term, privatization can potentially cause tremendous social upheaval, as privatizations are often always accompanied by large layoffs. If a small firm is privatized in a large economy, the effect may be negligible. If a single large firm or many small firms are privatized at once and upheaval results, particularly if the state mishandles the privatization process, a whole nation's economy may plunge into despair. For example, in the Soviet Union, many state industries were not profitable under the new system, with the cost of inputs exceeding the cost of outputs. After privatization, sixteen percent of the workforce became unemployed in both East Germany and Poland. The social consequences of this process have been staggering, impoverishing millions, but to little social benefit in many post-Communist countries. In the process, Russia has gone from having one of the world's most equal distributions of wealth in the Soviet era to one of the least today. There has been a dearth of large-scale investment to modernize Soviet industries and businesses still trade with each other by means of barter.
In speaking about the transformations in the post-communist countries, however, one must take into account the specifics of the communist and socialist regime which ruled those countries for decades. There are no easy answers regarding those issues. Some argue that it was the cumulation of mismanagement and inattention to the market realities that lead to such fatal consequences, given that most of the assets of those companies had not renovated for decades and their technology was outdated. Further, opening of the markets for import of the products which, in many cases, offered higher quality or lower prices, has given the consumers new array of choices to compete with the old national industries.
Privatization in the absence of a transparent market system may lead to assets being held by a few very wealthy people, a so-called oligarchy, at the expense of the general population. This may discredit the process of economic reform in the opinion of the public and outside observers. This has occurred notably in Russia, Mexico, and Brazil.
Moreover, where free-market economics are rapidly imposed, a country may not have the bureaucratic tools necessary to regulate it. This has been a pertinent problem in Russia and in many South American countries, although some other Eastern European countries, such as Poland and the Czech Republic, fared better in this respect, partly through the support of the European Union. Paradoxically, while Britain has long had a market economy, it also faced this issue after it privatized utilities in the Thatcher era; Britain's utilities regulator was often criticized as being ineffective.
Most economists argue that if a privatized company is a natural monopoly, or exists in a market which is prone to serious market failures, consumers may be worse off when the company is in private hands. This seems to have been the case with rail privatization in the UK and in New Zealand; in both countries, public disaffection has led to government intervention. In cases where privatization has been successful, it is because genuine competition has arisen. A good example of this is long-distance telecommunications in Europe, where the former state-owned enterprises lost their monopolies, competitors entered the market, and tariffs for international calls fell dramatically.
British Rail is an example of privatization program that has been deemed a failure and largely abandoned. The track-owning company has been effectively repossessed by the British government, and many of the train-running companies are at risk of having their concession removed on the grounds that they fail to provide adequate services. One of them, Connex, actually had its franchise cut short in June 2003 by the government for what the Strategic Rail Authority called "poor financial management." However, in other cases, particularly in poor countries, privatized enterprises cannot be renationalized so easily. These governments do not have the political will to do it, and there is strong pressure exerted by international lending agencies to maintain the privatization.
If the privatization does not fully transfer property rights to the newly private firm, there may be disincentives for the firm to make capital investments. This was a particular problem in the case of the privatized rail track-leasing company in the United Kingdom.
Many have argued that the strategy of privatization in Russia differed from those seen in more successful post-communist economies such as Hungary and Poland. The defects of the process in Russia, combined with capital market liberalization and failure to establish institutional infrastructure, have led to incentives for capital flight, contributing to post-communist economic contraction in Russia.
Likewise, countries such as Argentina, which embarked upon far-reaching privatization programs, selling off valuable, profitable industries such as energy companies, have seen the rapid impoverishment of their governments. Revenue streams which could previously be directed towards public spending suddenly dried up, resulting in a severe drop in government services.
Privatization can also have a ripple effect on local economies. State-owned enterprises are often required by law to patronize national or local suppliers. Privatized companies, in general, do not have that restriction, and hence will shift purchasing elsewhere. Bolivia underwent a rigorous privatization program in the mid 1990s, with disastrous impact on the local economy.
The Wall Street Journal has reported that the World Bank, historically a supporter of denationalization in developing countries, has also begun to voice concerns over privatization. It no longer believes that privatization should be recommended in all cases. Nobel Prize winner Joseph Stiglitz has written a book on the subject called Globalization and its Discontents. Mexico's President Vicente Fox has come under criticism for his plans to privatize Mexico's electrical power generating industry.
Finally, it has been argued that the Chinese economic reform has illustrated that economic reform can take place in the absence of large-scale privatization.
The above arguments have centered on whether or not it is practical to apply privatization in the real world, but some reject the profit incentive, the theoretical basis for privatization, itself. Some opponents of privatization argue that because the driving motive of a private company is profit, not public service, the public welfare may be sacrificed to the demands of profitability. There is no definitive answer, but it is very often argued that essential services, such as water, electricity, health, primary education, and so forth, should be left in public hands. This argument, of course, relies on the view on state one holds, regarding what it should or should not be obligated to do. What is seen as desirable by a socialist may not be by a supporter of capitalism, and vice versa.
Academic studies show that in competitive industries with well-informed consumers, privatization consistently improves efficiency. Such efficiency gains mean a one-off increase in GDP, but through improved incentives to innovate and reduce costs also tend to raise the rate of economic growth. The type of industries to which this generally applies include manufacturing and retailing. Although typically there are social costs associated with these efficiency gains, these can be dealt with by appropriate government support through redistribution and perhaps retraining.
In sectors that are natural monopolies or public services, the results of privatization are much more mixed. In general, if the performance of the existing public sector operation is sufficiently bad, privatization will tend to improve matters. However, much of this may be due to the imposition of related reforms such as improved accounting systems, regulatory systems, and increased financing, rather than privatization itself. Indeed, some studies show that the greatest gains from privatization are achieved in the pre-privatization period as reforms are made to prepare for the transfer to private hands. In economic theory, a private monopoly behaves much the same as a public one.
Alternatives to privatization
Main article: corporatization
New Zealand has experienced the privatization of its telecommunication industry, its railway system and part of its electricity market. The process of privatization was halted in 1999 when the New Zealand Labour Party won the election. Although most of the electricity generation and the electricity transmission system remain state owned, the government has corporatized this sector as well as New Zealand Post, the Airways Corporation and other smaller state-owned enterprises (SOEs).
The effect of corporatization has been to convert the state departments into public companies and interpose commercial boards of directors between the shareholding ministers and the management of the enterprises. To some extent, this model has enabled efficiencies to be gained without ownership of strategic organizations being transferred. This has been the policy of the People's Republic of China.
See also: List of privatizations
Privatization programmes have been undertaken in many countries across the world, falling into three major groups. The first is privatization programmes conducted by transition economies in eastern Europe after 1989 in the process of instituting a market economy. The second is privatization programmes carried out in developing countries under the influence of international financial institutions such as the World Bank and IMF. The third is privatization programmes carried out by developed country governments, the most comprehensive probably being those of New Zealand and the United Kingdom in the 1980s and 1990s.
Privatization proposals in key public service sectors such as water and electricity are in many cases strongly opposed by opposition political parties and civil society groups. Usually campaigns involve demonstrations and political means; sometimes they may become violent (eg Cochabamba Riots of 2000 in Bolivia; Arequipa, Peru, June 2002). Opposition is often strongly supported by trade unions. Opposition is usually strongest to water privatization - as well as Cochabamba (2000), recent examples include Ghana and Uruguay (2004). In the latter case a civil-society-initiated referendum banning water privatization was passed in October 2004.
Last updated: 05-13-2005 07:56:04