Is privatisation of State Owned Enterprises good or bad?

Governments often establish business enterprises to provide goods and services — usually when there is a market failure. These are often termed State Owned Enterprises (SOEs).

Typically, these relate to one of five categories:

• Natural monopolies such as telecommunications, water and energy utilities. It is impractical to have more than one provider of each service in a given area due to the physical assets and infrastructure that must be deployed
• Civil Infrastructure including highways and bridges, mass transit systems, seaports and airports. They are typically too big for individuals or even corporations to finance — unless there is a directly correlated source of revenue from day 1
• Public goods are services that are can be used by anyone in the country and don’t get “used up” when there are an increasing number of customers. Things like a postal system or airline to service both metro and regional areas, or the armed forces
• Protected Industries: Some businesses are not competitive due to a reliance on a nascent technology that is not yet commercially viable (like solar power today), or strong competition from other countries (like vehicle manufacturers). Others may be profitable (e.g. arms industries, or oil exploration and refinement) but are of significance to national security
• Governmental support functions: such as tax collection services; land titles offices; registries of births, deaths and marriages; social security services; police and prisons. They support and enable the business and apparatus of “being a government” as a going concern (not just to make the market)

Every so often, a government tries to privatise these SOEs (i.e. selling them off to another company). They hope to raise funds which can be ploughed into delivering their next big ticket electoral promises. Resistance then comes from other market actors such as unions and consumer groups who cite potential job cuts, and increased costs for services.

With these conflicting views on privatisation, two questions must be asked:

1) Is privatisation good or bad?

2) What sort of things should and should not be considered for privatisation?

I’ll answer these in turn

Is privatisation good or bad?

Privatisation often invokes strong emotions from those against it. It is however not inherently bad, and in fact — may often be beneficial. I say this bearing in mind the role of the state in owning an enterprise, the benefits of privatisation more generally, and some often-overstated negatives.

The role of the state in operating an SOE is to provide goods and services where there is a market failure, or when it is a matter of national security. So long as the enterprise can continue to operate without sliding back into said market failure (be it through a decline in the quality or accessibility of services) or pose a risk to national security, then there is no reason why privatisation should not be considered an option.

Based on my own experience, further benefits of privatisation include:

• For the enterprise: increased investment from the new owners to remove fat (and inefficiencies), and modernise operations. This improves business agility to respond and take advantage of market conditions
• For consumers: introduction of the profit motive may see new capabilities and offerings — thus a better value proposition
• For the government: Apart from the obvious cash injection from the proceeds, the government can focus more on their core role of “governing” the country. By not operating a business which runs at a loss, taxpayers no longer waste dollars subsidising it. This is not intended to be an argument for “small government”, but rather one for an efficient one.

There are a few negatives that must be kept in mind, but their effects are often overstated and can be mitigated:

• A private company might be tempted to pursue profit above all else. The government may temper this through stipulations in the sales contract (e.g. buyer must continue to provide services to regional areas — perhaps with a subsidy). A regulator could be established to routinely engage with the organisation to ensure standards are maintained, and the appointment of board members with appropriate principles
• Job lays offs may occur. This is not intrinsically a bad thing. There is no point employing 10 people to do a job that can be done with 7 people, just to keep people in jobs. Those 3 extra people can be better allocated into the labour market in industries to further contribute to the increase of Gross National Income.
• Price hikes can again be agreed through regulatory and contractual measures. For instance, they can be pegged to CPI (inflation), or a cost + X% profit model; with appropriate mechanisms to review as necessary.

What sort of things should and should not be considered for privatisation?

Let us consider how privatisation applies to the five categories discussed above:

Natural monopolies: These should not be privatised in my view for two reasons:

1. They pose an issue around national security. If a foreign government‘s SOE or faceless corporation has control over your telecommunications or electricity grid — they cannot only control whether or not it functions but also perform various types of spying and espionage
2. There is limited opportunity to introduce further competition to the market, and thus innovation and modernisation efforts will focus less on trying to secure more customers through an improved value proposition, but rather around cost cutting

Infrastructure: Things like mass transit systems, ports, and roads/bridges are reasonable candidates for privatisation — but only if they are not in a monopolistic situation. For example: if there are competitor ports nearby, or alternative highway routes to the one just sold.

It is possible to run these at a reasonable profit (Japanese and Amtrak are profitable railways for instance), and the ability to institute “user pays” business models with these items make them inherently fairer.

Public goods: These are good candidates for privatisation. They typically have avenues through which they can make profits (postal systems can charge for courier services, and airlines can run the major routes at a profit), but parts of their business should be subsidised to enable them to provide these services to an otherwise unprofitable customer segment (e.g. regional areas). The obvious exception here is the military which you’d definitely keep nationalised in the interest of national security.

Protected industries: These typically are not good candidates for privatisation. As alluded to above — they are not often not commercially viable due to high costs of underlying technology, materials and skills, or not competitive in a global context without tariffs, subsidies or other protection mechanisms in place. For those that are commercially viable — such as arms manufacturing or oil, it would be advisable to keep a base set of knowledge and assets within government control so that these cannot be denied during times of war or sanctions.

Government support functions: Because of the nature of the information they use (income, asset, health and other sensitive data about individuals), the vulnerable people they often deal with (welfare recipients and prisoners), the possibility of abuse, and the essentially monopolistic nature of their activities — these should not be privatised.

In addition to the above, I believe there are a class of non-monopolistic “essential service industries” in which the government should have a presence, alongside the private sector. These include hospitals, schools, and banks. The government presence ensures that there is an offering all citizens and residents of a country, and also help to keep private sector players competitive (if not in price, then at least service).

Conclusion:

SOEs form an important part of any economy. That said, the core job of a government is to govern, not run a multitude of businesses. As such, unless there are concerns around national security or a market failure — the state should look to privatise where possible, and in some cases — provide a public sector option alongside it.