The Pros And Cons Of Privitisation

In the latest issue of the IMF’s Finance and Development magazine, John Quiggan (author of Zombie Economics) takes through the arguments for and against privitisation (excerpt):

To Sell or Not

...Although the push for privatization took different forms in different parts of the world, it was part of a broader movement aimed at reducing the role of government in the economy and at increasing reliance on markets and prices. In particular, the movement toward privatization reflected the presumed superiority of financial markets over governments in allocating capital...

...A big reversal in the trend toward privatization occurred immediately after the global financial crisis began in 2008. Banks in the United States and Europe were rescued by their national governments on terms that amounted to nationalization, either implicitly or explicitly...

...With the emergence of sovereign debt problems as a central policy concern, however, privatization is back on the agenda. Selling assets seems to be an easy way for governments to raise cash. Meanwhile, economic arguments about the costs and benefits of private and public ownership remain unresolved, and have been further complicated by the challenges to economic theory posed by the financial crisis...

...There are a number of reasons why privatizations have left public sector net worth less well off. In some cases, including that of British Telecom, governments have deliberately underpriced assets for political reasons...

...Worse still, as in parts of the former Soviet Union, are cases in which the privatization process was corrupted...

...But even where governments are motivated to seek the full market price for public assets, the benefits of lower debt often fail to match the cost of forgone earnings. The problem is that investors generally demand a substantially higher return on equity capital than on the high-grade debt issued by governments...

...In most sectors of the economy, the higher cost of equity capital is more than offset by the fact that private firms are run more efficiently, and therefore more profitably, than government enterprises. But enterprises owned by governments are usually capital intensive and often have monopoly power that entails close external regulation, regardless of ownership. In these situations, the scope to increase profitability is limited...

Quiggan comes off, not surprisingly, as a sceptic of privitisation though he does offer a good overview of under what conditions privitisation would be desirable – basically sectors with less capital expenditure requirements, or those with less regulation.

From a Malaysian context, these couple of paragraphs will probably be of particular interest to many:

While toll road projects look good in an accounting sense, they are often failures in economic terms. The risk associated with owning just one part of a large road network means that private investors demand high returns. The cost of a toll road project, as measured by the discounted present value of toll revenue, is typically as much as twice the cost of a similar road financed by public debt and serviced by gasoline taxes or other indirect road user charges.

Moreover, the pattern of prices associated with toll roads is usually the opposite of what would be indicated by economic analysis. The primary cost of using a specific road is the resulting increase in congestion, which is why economists support congestion charges such as those imposed in central London. But, as in the case of London, it is typically the oldest roads that are most congested. Imposing a toll on a new, and uncrowded, road often increases the flow of traffic on older, more congested roads, reducing and sometimes wiping out the net benefits of the road project.

What really grabbed my eye though was his thoughts on healthcare and education:

For-profit provision of health and education services has generally been problematic and, in the case of education, almost uniformly unsuccessful.

The problem in these cases is that there is no real market. The patients and students to whom health and education services are provided rarely pay directly for the services they consume. Instead, providers operate in pseudo markets created by governments and insurers. In this context, the sharp focus on profitability associated with private ownership works not to meet consumer need, but to seek out opportunities to game the system…

Over the years, more and more of Malaysia’s healthcare and education system are being provided for by private operators. Now it seems, this might not be such a good idea.