Privatisation vs. Nationalisation

Hello readers, welcome back to my blog. This time I will be discussing Privatisation vs Nationalisation, in other words the Thatcherite’s vs the Corbynite’s. As with most economics problems, there is never ‘a one one size fits all policy’ and so there is no straight forward answer as to which is better.

I will be analysing this issue through Corbyns view i.e. pro nationalisation-Why privatisation may not work in practice. Although I do not support one or the other myself since it often depends on the industry or service in question, I do think that there are a number of myths about privatisation that need to be debunked.

We often hear a lot about the merits of privatisation such as how increased competition may result in efficiency gains, namely productive and dynamic efficiency; however, often the only way to solve the problems that really matter to people such as the shortage of homes, the awful trains or the unsatisfactory economic situation-is to break with the consensus that Mrs Thatcher established in the 1980s.

  • Firstly the long-term costs of privatising industries such as the coalmines were estimated to be much more than the cost of employing the miners. When Thatcher shut down the mines, it resulted in mass structural unemployment as workers who had spent their lives in mining had developed few transferable skills (occupational immobility of labour). Not only did this mean that the government had to pay unemployment benefits but it also caused hysteresis, which left workers in a difficult position unable to feed families and defaulting on mortgage payments which worsened levels of relative poverty. Moreover it meant that workers had very low MRPs and were unable to demand higher wages or work in service sector jobs. The negative multiplier effect of this long-term structural unemployment is argued to have had much more profound and lasting effects than the costs of actually financing the industry, such as a reduction in AD leading to further unemployment and further costs for the government, which would worsen the budget deficit and burden future generations with high levels of national debt. This may lead to Ricardian Equivalence (consumers are forward looking and will therefore reduce consumption to save for future tax rises).

 

  • Privatisation can also result in the demise of unions who lose their collective bargaining power on benefits, perks, holidays, and wages as firm would look for new ways to reduce costs and maximise profits. Even in the boom years of the mid-1980s, the unemployment rate remained high-levels not seen since the 1930s and in the late 1980s, unemployment was still over 2 million. Since then there has been growth in north-south divide and regional inequality. Admittedly one could argue that de-industrialisation caused by the global shift in manufacturing and the transform to a more service based economy was inevitable as the UK started to loose it comparative advantage to the new and emerging Asian tigers; however, this does not been that nationalisation should just be abandoned as an economic policy

 

  • One of the biggest criticisms of privatisation is the Natural monopoly argument e.g. Network Rail, as such industries are likely to be underinvested if left to the free market. A natural monopoly occurs when there is no scope for having competition amongst several firms. Privatisation of such industries would just create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly.

 

  • We should also consider the Public interest. There are many industries that perform an important public service, e.g. health care, education and public transport. In these industries, the profit motive shouldn’t be the primary objective of firms and the industry. For example, in the case of health care, it is feared privatising health care would mean a greater priority is given to profit rather than patient care. American health care system or some of their prisons stand testament to the stark inequality that can arise-42% of ill Americans skipped doctor visits/medication in 2011 because of excessive costs. Furthermore, private companies may choose the market, which is most profitable to operate in leaving less wealthy customers without a service. This could lead to equity concerns-would a private NHS provide enough operations for those on low incomes who tend to need such provisions more. Is there a merit good argument for not privatising at all? Krugman in his blog concludes: There are, no examples of successful health care based on the principles of the free market, for one simple reason: in health care, privatisation just doesn’t work. And people who say that the market is the answer are flying in the face of both theory and overwhelming evidence. By analogy, a major reason for providing universal healthcare, as a public service is that decent medical treatment should not be a privilege reserved for the few. Although some public firms have been shown to be inefficient, as we know from the sad experience of Soviet-style central planning, it is by no means a universal principle.

 

  • Furthermore the government loses out on potential dividends, instead going to wealthy shareholders. For example, train companies in the private sector routinely pay more than £200m a year in dividends to their shareholders. In addition state-owned rail industry could borrow more cheaply from the government than it could if it issued new debt to the bond market.

 

  • Fragmentation of industries. In the UK, rail privatisation led to breaking up the rail network into infrastructure and train operating companies. This led to areas where it was unclear who had responsibility. For example, the Hatfield rail crash was blamed on no one taking responsibility for safety. In addition, the increased competition and choice that may arise from privatisation may not actually improve consumer welfare as too much choice could lead to choice overload.

 

  • Although short-term pressures may motivate the government, this is something private firms may do as well. To please shareholders they may seek to increase short-term profits and avoid investing in long-term projects. For example, the UK is suffering from a lack of investment in new energy sources; the privatised companies are trying to make use of existing plants rather than invest in new ones.

 

  • Prices may actually rise after privatisation as the government may have been operating it at a loss to ensure that prices do not become unaffordable for everyday citizens. For example rail fares in the UK after privatisation were allowed to rise above inflation for certain ticket types thus reducing allocative efficiency. This demonstrates that even regulated privatisation is failing to deliver price competition, the primary argument underpinning privatisation.

 

  • Many of the privatized firms were transferred as monopolies into the private sector and this necessitated regulation to avoid market failure and to ensure performance standards were met. This is costly and is susceptible to regulatory capture and thus it makes more sense for the government to manage these industries directly. The recent chaos on Southern Rail underlines how the relentless drive for profits and dividend pay-outs can threaten essential safety, as well as jobs and reliability of service on the railways.

 

  • State-owned companies solely operate in the best interests of the citizens of their state, as ultimately their primary objective is to maximise utility and create a functioning society for all. On the flipside, privately operated firms generally aim to maximise profits at the expense of their customers and exploit market power by raising prices and making huge supernormal profits damaging consumer welfare. Also some institutions are unable to manage their risks properly, thus they get ‘too big to fail’ which leads to an even worse outcome.

 

  • By considering market structures: If the firm is operating in a market close to perfect competition then there may not be an incentive to innovate as there is perfect information and no barriers to entry meaning that cost reducing technology can be copied or employed by other firms and in the long run only normal profits will be made. If the firm is operating in an oligopoly there is a risk of collusion and price fixing, which could reduce consumer surplus. In a monopoly, there may be X inefficiencies as well as allocative inefficiency (price charged above the marginal cost) due to complacency. It is possible that there may be significant price discrimination, which means that peak time commuters for example will be faced with increased fares. This could worsen geographical immobility as workers are less able to travel across the country and could be regressive if such costs make up a large percentage of an individual’s income.

 

  • Problems with private firms also arise from the Divorce of ownership and control and the Principal agent problem: We have heard that privatisation is likely to result in productive efficiency as such firms must answer to shareholders, therefore they may pay increased dividends at the expense of consumers as they opt for a low quality service. We have also heard that the profits made by such firms can be used to invest in R&D to stay ahead of the game and actually improve the industry. However if firms have are concerned with the political stability or long-term future of the economy for example the impact of Brexit, they may delay such projects as there is a risk they may not see a return. Thus we may see a decelerator effect and the so-called ‘creative destruction’ process may not occur as expected. The government however is able to take a more risk seeking approach as it relies on the public purse and such investment decisions are likely to be in line with the country’s political decisions. Moreover private firms may deleverage and pay of debts rather than providing an improved service or reducing costs to the MES level of output.

 

  • Privatisation may also decrease safety standards due to a greater incentive to cut corners, which is of particular concern for industries such as National Air Traffic Services and defense. These are also Public goods and would not be provided at all by the free market due to the free rider problem thus they have to be nationalised without a doubt.

 

  • Privatisation takes time to be successful if it ever does. e.g. opening Royal Mail up to competition didn’t lead to a competitive market overnight-there was customer inertia, brand loyalty, barriers to entry. The process is also costly According to David Hall, an expert in this field at the University of Greenwich, turning the provision of water into private hands costs almost £1bn a year extra. Were it still to be in the public sector, he estimates, that would amount to about 12% off the average household bill.

 

  • Finally public provision can tackle the issues of externalities. For example a private company might want to cut down swathes of forest to grow crops for biofuel, disregarding the long-term environmental impact. Whereas the government will consider the long-tern environmental effect or take into account any other form of market failure.

 

In conclusion, arguments favouring private over public provision typically favour the few at the expense of the many. Moreover there are a number of key issues with privatisation that are often overlooked. Admittedly there are many flaws with public provision and not every industry would be worth taking back into public ownership, instead there should be a balance between the two and it is highly dependent on the type of industry in question.

Stay tuned for my next posts which include: China’s social credit system, AI and recent mergers and acquisitions.

 

 

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