Privatization is the incidence or process of transferring ownership of a business, enterprise, agency or public service from the public sector (the state or government) to the private sector (businesses that operate for a private profit) or to private non-profit organizations. In a broader sense, privatization refers to transfer of any government function to the private sector - including governmental functions like revenue collection and law enforcement.
The term "privatization" also has been used to describe two unrelated transactions. The first is a buyout, by the majority owner, of all shares of a public corporation or holding company's stock, privatizing a publicly traded stock, and often described as private equity. The second is a demutualization of a mutual organization or cooperative to form a joint stock company.
Origin
Edwards states that
The Economist coined the term in the 1930s in covering Nazi German economic policy.
The Oxford English Dictionary notes usage dating from 1942 in Econ. Jrnl, 52, 398.
History
A long history of privatization dates from
Ancient Greece, when governments contracted out almost everything to the private sector. In the
Roman Republic private individuals and companies performed the majority of services including tax collection (
tax farming), army supplies (
military contractors), religious sacrifices and construction. However, the
Roman Empire also created
state-owned enterprises—for example, much of the grain was eventually produced on estates owned by the Emperor. Some scholars suggest that the cost of bureaucracy was one of the reasons for the
fall of the Roman Empire. The rulers were counseled by the Taoist clergy that a strong ruler was virtually invisible.
During the Renaissance, most of Europe was still by and large following the feudal economic model. By contrast, the Ming dynasty in China began once more to practice privatization, especially with regards to their manufacturing industries. This was a reversal of the earlier Song dynasty policies, which had themselves overturned earlier policies in favor of more rigorous state control.
In Britain, the privatization of common lands is referred to as enclosure (in Scotland as the Lowland Clearances and the Highland Clearances). Significant privatizations of this nature occurred from 1760 to 1820, coincident with the industrial revolution in that country.
In more recent times, Winston Churchill's government privatized the British steel industry in the 1950s, and West Germany's government embarked on large-scale privatization, including selling its majority stake in Volkswagen to small investors in a public share offering in 1961.
Opposing
Opponents of privatization dispute the claims concerning the alleged lack of incentive for governments to ensure that their public services are well run, on the basis of the idea that governments are proxy owners answerable 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 do have an incentive to maximize efficiency in nationalized companies, due to the pressure of future elections.
Opponents of certain privatizations believe that certain public goods and services should remain primarily in the hands of government in order to ensure that everyone in society has access to them (such as law enforcement, basic health care, and basic education). Likewise, private goods and services should remain in the hands of the private sector. There is a positive externality when the government provides public goods and services to society at large, such as defense and disease control. As for natural monopolies they are by their nature not subject to fair competition and better administrated by the state.
The controlling ethical issue in the anti-privatization perspective is the need for responsible stewardship of social-support missions. Market interactions are all guided by self-interest, and successful actors in a healthy market must be committed to charging the maximum price that the market will bear. Privatization opponents believe that this model is not compatible with government missions for social support, whose primary aim is delivering affordability and quality of service to society.
Many privatization opponents also warn against the practice's inherent tendency toward corruption. As many areas which the government could provide are essentially profitless, the only way private companies could, to any degree, operate them would be through contracts or block payments. In these cases, the private firm's performance in a particular project would be removed from their performance, and embezzlement and dangerous cost-cutting measures might be taken to maximize profits.
Furthermore, large corporations may pay public-relations professionals to convince decision-makers that privatization is a sensible idea. Corporations typically have far more resources for expert testimony, advertisements, conferences and other propaganda efforts than anti-privatization advocates.
Some would also point out that privatizing certain functions of government might hamper coordination, and charge firms with specialized and limited capabilities to perform functions which they are not suited for. In rebuilding a war torn nation's infrastructure, for example, a private firm would, in order to provide security, either have to hire security, which would be both necessarily limited and complicate their functions, or coordinate with government, which, due to a lack of command structure shared between firm and government, might be difficult. A government agency, on the other hand, would have the entire military of a nation to draw upon for security, whose chain of command is clearly defined. Opponents would say that this is a false assertion: numerous books refer to poor organization between government departments (for example the Hurricane Katrina incident).
Although private companies will provide a similar good or service alongside the government, opponents of privatization are careful about completely transferring the provision of public goods, services and assets into private hands for the following reasons:
Performance. A democratically elected government is accountable to the people through a legislature, Congress or Parliament, and is motivated to safeguarding the assets of the nation. The profit motive may be subordinated to social objectives.
Increased Market Efficiency for Public Goods and Services. A public organization tends to produce more of a public good or service according to the Samuelson condition and Marginal Social Benefit curve. This results in a better positive externality for society. On the other hand, a private firm does not provide sufficient public goods and services, because it provides them on the marginal private benefit curve or private demand curve. A private firm provides less in order to make more profit. Therefore the public goods and services are provided more efficiently for society as a whole by a public organization. (Any market is more efficient for society when marginal social benefits equals marginal social costs, MSB=MSC.)
Improvements. the government is motivated to performance improvements as well run businesses contribute to the State's revenues.
Corruption. Government ministers and civil servants are bound to uphold the highest ethical standards, and standards of probity are guaranteed through codes of conduct and declarations of interest. However, the selling process could lack transparency, allowing the purchaser and civil servants controlling the sale to gain personally.
Accountability. The public does not have any control or oversight of private companies.
Civil-liberty concerns. A democratically elected government is accountable to the people through a parliament, and can intervene when civil liberties are threatened.
Goals. The government may seek to use state companies as instruments to further social goals for the benefit of the nation as a whole.
Capital. Governments can raise money in the financial markets most cheaply to re-lend to state-owned enterprises.
Strategic and Sensitive areas. Governments have chosen to keep certain companies/industries under public control because of their strategic importance or sensitive nature.
Cuts in essential services. If a government-owned company providing an essential service (such as the water supply) to all citizens is privatized, its new owner(s) could lead to the abandoning of the social obligation to those who are less able to pay, or to regions where this service is unprofitable.
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, often foreign, hands instead of being available for the common good.
Political influence. Governments may more easily exert pressure on state-owned firms to help implementing government policy.
Downsizing. Private companies often face a conflict between profitability and service levels, and could over-react to short-term events. A state-owned company might have a longer-term view, and thus be less likely to cut back on maintenance or staff costs, training etc., to stem short term losses. Many private companies have downsized while making record profits.
Profit. Private companies do not have any goal other than to maximize profits. A private company will serve the needs of those who are most willing (and able) to pay, as opposed to the needs of the majority, and are thus anti-democratic. The more necessary a good is, the lower the price elasticity of demand, as people will attempt to buy it no matter the price. In the case of price elasticity of demand is zero (perfectly inelastic good), demand part of supply and demand theories does not work.
Privatization and Poverty. It is acknowledged by many studies that there are winners and losers with privatization. The number of losers —which may add up to the size and severity of poverty—can be unexpectedly large if the method and process of privatization and how it is implemented are seriously flawed (e.g. lack of transparency leading to state-owned assets being appropriated at minuscule amounts by those with political connections, absence of regulatory institutions leading to transfer of monopoly rents from public to private sector, improper design and inadequate control of the privatization process leading to
asset stripping.
Job Loss. Due to the additional financial burden placed on privatized companies to succeed without any government help, unlike the public companies, jobs could be lost to keep more money in the company.
Intermediate views
Others don't dispute that well-run for-profit entities with sound
corporate governance may be considerably more efficient than an inefficient governmental
bureaucracy or
NGO, however many
implementations of privatization can - in practice - lead to the
fire sale of public assets, and/or to inefficient or corrupt - for profit management.
Developed or minimally corrupt economies
A top executive can readily
reduce the perceived value of an asset – due to
information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in
off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative (e.g. pessimistic) estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce sale price. (This is again due to
information asymmetries since it is more common for top executives to do everything they can to
window dress their earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates.
When the entity gets taken private - at a dramatically lower price - the new private owner gains a windfall from the former top executive's actions to (surreptitiously) reduce the sales price. This can represent tens of billions of dollars (questionably) transferred from previous owners (the public) to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the fire sale that can sometimes be in the tens or hundreds of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives).
When a publicly held asset, mutual or non-profit organization undergoes privatization, top executives often reap tremendous monetary benefits. The executives can facilitate the process by making the entity appear to be in financial crisis - this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell.
Ironically, it can also contribute to a public perception that private entities are more efficiently run reinforcing the political will to sell of public assets. Again, due to asymmetric information, policy makers and the general public see a government owned firm that was a financial 'disaster' - miraculously turned around by the private sector (and typically resold) within a few years.
Underdeveloped or highly corrupt economies
In a society with substantial corruption, privatization allows the government currently in power and its backers to siphon a large portion of the entire
net present value of state assets away from the public and into the accounts of their favored power brokers. Without privatization, corrupt officials would have to slowly harvest their corrupt earnings over time. As such, efficient privatization depends on their being a very low of
current corruption among the current government officials since it allows for far more 'efficient' extraction of corrupt rents.
Of course, corrupt governments can also extract corrupt rents quite efficiently in other ways - particularly by borrowing extensively to engage in spending on overly favorable contracts with their backers (or on tax shelters, subsidies or other giveaways). Generations of subsequent taxpayers are then left with paying back the debt incurred for corrupt transfers made decades previously. Naturally, this may lead to the sale of public assets....
In the end, the public is left with a government that taxes them heavily, and gives them nothing in return. Debt repayment is enforced by international agreements and agencies such as the IMF.
Infrastructure and upkeep is sacrificed - leading to a further decay in the economic efficiency of the country over time.
Outcomes
Literature reviews find 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,
many economists argue that these can be dealt with by appropriate government support through redistribution and perhaps retraining.
In sectors that are natural monopolies or public services (such as, say, passenger rail in the United States), the results of privatization are much more mixed, as a private monopoly behaves much the same as a public one in liberal economic theory. The government is actually seen as a more natural provider of public goods and services. However, the efficiency of an existing public sector operation can be put into question requiring changes to be made. Changes may include, inter alia, the imposition of related reforms such as greater transparency and accountability of management, an improved cost-benefit analysis, improved internal controls, regulatory systems, and better financing, rather than privatization itself.
Regarding political corruption, it is a controversial issue whether the size of the public sector per se results in corruption. The Nordic countries have low corruption but large public sectors. However, these countries score high on the Ease of Doing Business Index, due to good and often simple regulations, and for political rights and civil liberties, showing high government accountability and transparency. One should also notice the successful, corruption-free privatizations and restructuring of government enterprises in the Nordic countries. For example, dismantling telecommunications monopolies has resulted in several new players entering the market and intense competition with price and service.
Also regarding corruption, the sales themselves give a large opportunity for grand corruption. Privatizations in Russia and Latin America were accompanied by large-scale corruption during the sale of the state-owned companies. Those with political connections unfairly gained large wealth, which has discredited privatization in these regions. While media have reported widely the grand corruption that accompanied the sales, studies have argued that in addition to increased operating efficiency, daily petty corruption is, or would be, larger without privatization, and that corruption is more prevalent in non-privatized sectors. Furthermore, there is evidence to suggest that extralegal and unofficial activities are more prevalent in countries that privatized less.
Alternatives
Public utility
The enterprise can remain as a public utility.
Non-profit
A private non-profit organization could manage the enterprise.
Municipalization
Transferring control to
municipal government
Outsourcing or sub-contracting
National services may sub-contract or out-source functions to private enterprises. A notable example of this is in the
United Kingdom, where many
municipalities have contracted out their garbage collection or administration of parking fines to private companies. In addition, the British government has involved the private sector more in the workings of the
National Health Service principally through outsourcing the construction and operation of new hospitals to private companies. There are also moves to refer patients to private surgeries to ease the load on existing NHS human resources, and covering the cost of this.
Partial ownership
An enterprise may be privatized, but with the state retaining a number of shares in the resultant company. This is a particularly notable phenomenon in
France, where the state often retains a "blocking stake" in private industries. In Germany, the state privatized
Deutsche Telekom in small tranches, and still retains about a third of the company. As of 2005, the state of
North Rhine-Westphalia is also planning to buy shares in the energy company
E.ON in what is claimed to be an attempt to control spiraling costs.
Whilst partial privatization could be an alternative, it is more often a stepping stone to full privatization. It can offer the business a smoother transition period during which it can gradually adjust to market competition. Some state-owned companies are so large that there is the risk of sucking liquidity from the rest of the market, even in the most liquid marketplaces: this may favor gradual privatization. The first tranche of a multi-step privatization would also in the first instance establish a valuation for the enterprise to mitigate complaints of under-pricing.
In some instances of partial privatization of contracted services, some portion(s) of the state-owned service are provided by private-sector contractors, but the government retains the capacity to self-operate at contract intervals, if it so chooses. An example of partial privatization would be some forms of school bus service contracting, such as arrangements where equipment and other resources purchased with government capital funds and/o those already owned by a governmental entity are used by the contractor for a period of time in providing services, but ownership is retained by the governmental unit. This form of partial privatization eases concerns that once an operation is contracted, the government may be unable to obtain sufficient competitive bids, and be subjected to terms less desirable than the prior operation under state-ownership. Under that scenario, a reverse privatization would be more feasible for the government. (see section below)
Public–private partnership
Notable examples
The largest privatization in history involved Japan Post. It was the nation's largest employer and one third of all Japanese government employees worked for Japan Post. Japan Post was often said to be the largest holder of personal savings in the world.
The Prime Minister Junichiro Koizumi wanted to privatize it because it was thought to be an inefficient and a source for corruption. In September 2003, Koizumi's cabinet proposed splitting Japan Post into four separate companies: a bank, an insurance company, a postal service company, and a fourth company to handle the post offices as retail storefronts of the other three.
After the Upper House rejected privatization, Koizumi scheduled nationwide elections for September 11, 2005. He declared the election to be a referendum on postal privatization. Koizumi subsequently won this election, gaining the necessary supermajority and a mandate for reform, and in October 2005, the bill was passed to privatize Japan Post in 2007.
Nippon Telegraph and Telephone's privatization in 1987 involved the largest share-offering in financial history at the time. 15 of the world's 20 largest public share offerings have been privatizations of telecoms.
Negative responses
Privatization proposals in key
public service sectors such as
water and
electricity in many cases meet with strong resistance from opposition political parties and from
civil society groups, many of which regard them as
natural monopolies. Campaigns typically involve demonstrations and democratic political activities; sometimes the authorities attempt to suppress opposition using violence (e.g.
Cochabamba protests of 2000 in
Bolivia and protests in
Arequipa, Peru, in June 2002). Opposition is often strongly supported by
trade unions. Opposition is usually strongest to
water privatization—as well as Cochabamba, recent examples include
Haiti,
Ghana and
Uruguay (2004). In the latter case a civil-society-initiated
referendum banning water privatization was passed in October 2004.
Reversion
A reversion from contracted ownership of an enterprise or services to governmental ownership and/or provision is called
reverse privatization or
nationalization. Such a situation most often occurs when a privatization contractor fails financially and/or the governmental unit has failed to purchase satisfactory service at prices it regards as less than with state-ownership or self-operation of services. Another circumstance may occur when greater control than viable under privatization is determined to be in the governmental unit's best interest.
National-security concerns may be the source of reverse privatization actions when the most likely providers are non-domestic or international corporations or entities. For example, in 2001, in response to the September 11th attacks, the then-private airport security industry in the United States was nationalized and put under the authority of the Transportation Security Administration.
See also
Corporatization
Deregulation
Marketization
Public ownership
Securitization
Too Big to Fail
Welfare state
Case studies:
Privatization in Russia
Privatization of British Rail
Privatization of public toilets
Development strategies:
Private sector development
Special Economic Zone
Urban Enterprise Zone
Notes
References
Alexander, Jason. 2009. Contracting Through the Lens of Classical Pragmatism: An Exploration of Local Government Contracting. Applied Research Project. Texas State University. http://ecommons.txstate.edu/arp/288/.
Dovalina, Jessica. 2006. Assessing the Ethical Issues Found in the Contracting Out Process. Applied Research Project. Texas State University. http://ecommons.txstate.edu/arp/108/.
Segerfeldt, Fredrik. 2006. Water for sale: how business and the market can resolve the world’s water crisis. Stockholm Network. http://www.stockholm-network.org/downloads/events/d41d8cd9-Amigo%20Segerfeldt.pdf
Bernard Black et al., 'Russian Privatization and Corporate Governance: What Went Wrong? (2000) 52 Stanford Law Review 1731
;Unindexed
Zullo, Roland. (2009). Does Fiscal Stress Induce Privatization? Correlates of Private and Intermunicipal Contracting, 1992-2002. Governance 22.3 (July): 459-481.
Kosar, Kevin R. (2006), "Privatisation and the Federal Government: An Introduction", Report from the Congressional Research Service
Bel, Germà (2006), "The coining of `privatisation´and Germany's National Socialist Party", Journal of Economic Perspectives 20(3), 187-194
Clarke, Thomas (ed.) (1994) "International Privatisation: Strategies and Practices" Berlin and New York: Walter de Gruyter, ISBN 3-11-013569-8
Clarke, Thomas and Pitelis, Christos (eds.) (1995) "The Political Economy of Privatisation" London and New York: Routledge, ISBN 0-415-12705-X
Nico Perrone (2002), Economia pubblica rimossa, Milan, Giuffrè ISBN 88-14-10088-8
Mayer, Florian (2006) Vom Niedergang des unternehmerisch tätigen Staates: Privatisierungspolitik in Großbritannien, Frankreich, Italien und Deutschland, VS Verlag, Wiesbaden, ISBN 3-531-14918-0
Megginson and Netter, From state to market: A survey of empirical studies on privatization,
Journal of Economic Literature 39(2), June 2001, 321-89.
Juliet D’Souza, William L. Megginson (1999), "The Financial and Operating Performance of Privatised Firms during the 1990s", Journal of Finance August 1999
von Hayek, Friedrich, (1960) The Constitution of Liberty
Smith, Adam (1994) The Wealth of Nations
Stiglitz, Joseph Globalization and its Discontents
von Weizsäcker, Ernst, Oran Young, and Matthias Finger (editors): Limits to Privatisation. Earthscan, London 2005 ISBN 1-84407-177-4
Jeb Sprague, 2007. Haiti: Workers Protest Privatisation Layoffs. Inter Press Service.
Roger L. Kemp, PhD, "Privatization: The Provision of Public Services by the Private Sector," McFarland & Co., Jefferson, NC, USA; and London, UK., 2007.
External links
In the Public Interest is a Resource Center on privatization and responsible contracting.
Reports of the Public Services International Research Unit at the University of Greenwich Research database with many articles on the effects of privatization
Category:Public economics
Category:Privatisation
Category:Monopoly (economics)
Category:Market structure and pricing
Category:Economics of regulation
