Has privatisation benefitted the public and consumers?

The ongoing debate on the future of government-linked companies (GLCs) and their management is complex and multifaceted. These articles contributing to this discussion are based on the third Tun Hussein Onn Chair lecture delivered by Jomo KS, now a member of the Council of Eminent Persons.

In most cases of privatisation, there have been some beneficial outcomes, which have served to legitimise the ownership change. Nevertheless, overall net welfare improvements have never been demonstrated in many cases.

Never is everyone better off. Rather, some are better off, while others are not, and possibly even worse off. Or the costs of the partial gains have been high, or even negated by the overall costs, which may be diffused, and less directly, or even imperceptibly felt by the losers.

Since many state-owned enterprises (SOEs) are public monopolies, privatisation has typically transformed them into private monopolies, where opportunities to abuse market monopoly power enable more rents and corporate profits. As this is often the private sector’s yardstick of success, not surprisingly, private monopolies are likely to abuse their market power to maximise rents for themselves. Thus, the privatisation of public services tends to burden the public, especially if charges are raised for privatised services.

Also, in most cases, privatisation has not solved the problem of governments’ fiscal deficits, and may even worsen budgetary problems. Privatisation may worsen the fiscal situation due to loss of revenue sources, or tax evasion by the new private owners, the government is often forced to cut essential public services. Options for cross-subsidisation to broaden coverage are reduced as the government is usually left with the unprofitable activities while the potentially profitable is acquired by the private sector.

In most cases, profitable SOEs were privatised as the prospective private owners were interested in securing and maximising their profits. Fiscal deficits have often been exacerbated as new private owners use creative accounting to avoid tax, secure tax credits and subsidies, as well as maximise retained earnings. Meanwhile, governments lose vital revenue sources due to privatisation if SOEs are profitable, and are often obliged to subsidise the privatised monopolies to ensure the poor and others are still served by the privatised utilities or services.

Privatisation burdens the public when charges or fees are not reduced or when the services provided are significantly reduced. Thus, privatisation often burdens the public in many different ways, depending on how market power is deployed or abused.

Often, instead of trying to provide a public good to all, many people are excluded because it is not considered commercially economic to deliver services to them. Consequently, privatisation may worsen overall enterprise performance. ‘Value for money’ may go down despite ostensible improvements used to justify higher user charges.

Furthermore, SOEs are generally presumed to be inherently more likely to be inefficient. The most profitable and the potentially profitable are typically the first and most likely to be privatised. This scenario leaves the rest of the public sector even less profitable or more inefficient, in turn justifying further privatisations.

One variation of this rationale is that since the government is inherently inefficient and does not know how to run enterprises well, privatisation is needed. Another common argument is that since privatised SOEs are presumably more efficient, and the government has certain obligations to its citizenry, it should subsidise privatised SOEs so that they can fulfil those very same government obligations.

Admittedly, such obligations may not involve direct payment transfers, but rather, further profitable concessions to the privatised former SOE, which may well make far more from these additional concessions than the actual cost of fulfilling government obligations.

Thus, privatisation of profitable enterprises or segments not only perpetuates the exclusion of the deserving, but also worsens overall public sector performance as it is encumbered with all remaining unprofitable obligations. One consequence is exacerbating poor public sector performance as it then becomes a self-fulfilling prophecy. To make matters worse, the public sector is then stuck with financing the unprofitable, thus effectively contributing to the privatisation prophecy.

Privatisation – enriching the politically connected few who secure lucrative rents – has increasingly sacrificed the national or public interest for private profit, even when the mode of privatisation may not seem to obviously benefit them.

Privatisation in many developing and transition economies has primarily enriched these few as the public interest has been sacrificed to such powerful private business interests. This has, in turn, exacerbated problems of corruption, patronage and other related problems.

For example, following Russian voucher privatisation and other Western recommended reforms, for which there was a limited domestic constituency then, within three years (1992-1994), the Russian economy had collapsed by half, and adult male life expectancy fell by six years. It was the greatest such recorded catastrophe in the last six millennia of recorded human history.

Soon, a couple of dozen or so mainly young Russian oligarchs had taken over the commanding heights of the Russian economy, although many have since monetised their gains and invested them abroad. All this was celebrated as a great achievement in the Western media, but the actual record and impact of what really happened suggests the Russian people may have very different views.

Collusion and corruption

It is important to analytically distinguish the question of private or public ownership from the question of competition or market forces. Despite misleading claims that privatisation promotes competition, it is competition policy, not extending privatisation, that encourages competition.

Instead, privatisation itself has been accompanied by widespread evidence of collusion. Formal and more commonly, informal collusion, is rife. Informal collusion is more likely among those involved in public or transparent bidding to provide privatised or contracted-out services. Collusion undermines the possibility of competitive pricing.

Transparent institutions and arrangements, such as public auctions and open bidding for contracts, have often been compromised by secret, informal collusion arrangements. It is also widely acknowledged that those with connections and insider information are better able to secure lucrative contracts and other business opportunities, giving rise to claims of ‘insider’ information abuse.

Greater public transparency and accountability were expected to promote greater efficiency in achieving the public interest while limiting waste and borrowing. But contrary to claims by its proponents, privatisation does not enhance transparency and accountability, or address corruption, as it is rarely implemented on an arm’s length basis. In fact, it may contribute to other problems, including new rent-seeking and corruption.

Privatisation does not enhance efficiency except in so far as enhancing efficiency augments profits. The public sector can be more efficiently run, as it is elsewhere; the challenge remains to ensure that it is better run. Greater public accountability and a more transparent public sector can ensure greater efficiency in achieving the public and national interest while limiting public sector waste and borrowing.

Contradictory goals

SOE reform is often a superior option for a variety of reasons although there are no ‘one size fits all’ solutions regardless of circumstances. Problems need to be analysed in context. It would be erroneous to presume that property rights are always the problem and this cannot be assumed a priori.

There may be other problems and those other problems are not going to go away without properly identifying and resolving them.

For an enterprise to be successful, there needs to be an appropriate system, culture and incentives for progress to be made. Following the privatisation of a particular SOE, desirable changes may take place, resulting in improved performance and outcomes.

But even this does not mean that privatisation per se is responsible for these improvements unless it is established that state ownership itself has blocked the needed changes, in which case there may well be compelling cases for privatisation in such situations.

Correlation does not imply causation. An enterprise may be better run after privatisation due to managerial reforms, behavioural changes or organisational improvements. But if such improvements could have been achieved without privatisation, then one cannot conclude that privatisation itself is needed to bring about the desired reforms.

It is important to consider the kinds of organisational and managerial reforms, including incentive changes, which might be desirable to achieve superior outcomes. In other words, it is important not to assume that privatisation is the answer regardless of the question or the problem at hand.

After all, many SOEs were set up precisely because the private sector was believed to be unable or unwilling to provide certain services or goods. In many instances, the problem with an SOE is not due to ownership per se, but rather to the absence of explicit, feasible or achievable objectives, or even to the existence of too many and often contradictory goals.

In other cases, the absence of managerial and organisational systems, such as flexibility and autonomy, and needed reforms, as well as cultures supportive of them, may be the key problem. In such cases, managerial and organisational reforms may well achieve the same objectives and goals, or even do better at reduced cost, and thus prove to be the superior option.

Many SOEs have undoubtedly proven to be problematic and often inefficient. However, privatisation has not proved to be the universal panacea for the myriad problems of the public sector it has been touted to be. As such, the superior option cannot be presumed a priori, but should instead be the outcome of careful consideration of the roots of an organisation’s malaise.

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JOMO KS was economics professor and Assistant Secretary General for Economic Development at the United Nations. He held the chair at the Institute for Strategic and International Studies (ISIS) Malaysia in 2016-17.  -Mkini