Privatisation is the sale of a government owned firm to private ownership.
While nationalisation is the opposite. The government buys or takes over a previously privately owned firm.
Examples
During and since Margaret Thatcher, there has been a wave of privatisations. For example: British Airways, British Telecom (BT), Royal Mail and the water industry.
While for nationalisation, here are a few key examples of state-owned services: the National Health Service (NHS) and Network Rail.
Channel 4 currently remains publicly owned. But there has been debate about whether it should be privatised.
Pros of privatisation / Cons of nationalisation
Why privatise a good or service? Here are some key reasons:
- Businesses are likely to have objectives to maximise profits. This incentivises firms to cut costs. Specifically privatised firms are no longer shielded from competition. So they may become X-efficient.
- Higher profits may increase investment. This is “dynamic efficiency“. The investment can reduce costs, which may be passed on to the consumer with lower prices. Alternatively, the investment can increase product quality, increasing consumer welfare.
- There is also an incentive for private firms to acquire brand loyalty. This will increase firm increase profits. Hence, firms have an incentive to increase product quality and customer service.
- Funds from the sale of the firm can increase government revenue temporarily. No longer having the firm on the government’s books reduces the risk to taxpayer of firm failure. The government also receives higher corporation tax revenue from the private firm. This is because of its higher profits.
- Private firms have incentives to adapt to changing consumer demands. One of the reasons for Royal Mail’s privatisation was increasing online shopping. Privatisation allows Royal Mail to have the funds to invest. This can include investment in delivery services relating to online shopping.
- Nationalised firms may have monopsony power. They can use market power to reduce worker wages, reducing workers’ living standards.
Cons of privatisation / pros of nationalisation
But why nationalise a firm? Here are some possible ideas:
- A nationalised firm can exploit economies of scale if it is larger than the privatised firm. This occurs particularly in natural monopoly markets. For example, rail and utilities (gas, electricity, water). In this case, lower long-run average costs can be passed onto consumers. Consumers then pay reduce prices.
- A nationalised firm is less likely to have a profit maximisation objective. Instead it may seek to maximise social welfare. This means prices are set at the allocatively efficient level. This is unlike in a private monopoly. A private monopoly exhibits allocative inefficiency. This is where price exceeds the socially optimal level. In other words, price is not equal to marginal cost.
- As a result of maximising social welfare, the nationalised firm may account for externalities.
- Other stakeholders may be better off as a result of maximising social welfare. This includes workers who are more likely to remain employed and receive higher wages. If privatised, workers may be more likely to lose their jobs. This is because firms may cut costs to increase profits.
- The Government may take a longer term view than business. Long termism may encourage decisions that benefit consumers long term. For example, long term infrastructure investment. In the private water industry, there were sewage leaks and drought stress in summer 2022. These have highlighted a lack of long-term investment in water infrastructure.
- Consider a public company sold off to the private sector. This means the government cannot access the future profits of the company. The government could have used these extra profits. For example to invest in infrastructure or to close the budget deficit.
- There is a risk of a privatised firm gaining monopoly power. Hence this may lead to higher prices under privatisation, compared with monopoly.
Key diagrams
1) Monopoly diagram. This shows the monopoly private outcome vs the allocatively efficient government outcome. It can also reference the dynamic efficiency of the private monopoly.
The private firm may produce at (q,p) to maximise profits, where MC=MR. But the nationalised firm may produce at (q1,p1), the allocatively efficient outcome where MC=AR. This leads to a welfare gain shown by the shaded area.
Alternatively, the private firm is likely to be dynamically efficient. Its supernormal profits are (p-c)q. So the private firm can reinvest more in the quality and in reducing costs.
2) Natural monopoly / economies of scale. This shows why a larger firm may be more beneficial than a smaller firm.
Suppose the nationalised firm is larger than the privatised firm. Then the nationalised firm can exploit the economies of scale. So it produces at lower long-run average cost c. If, instead, the private firm produces the good, it produces at a higher LRATC at c1.
Other possible diagrams can include: externality diagrams or labour market diagrams (to show monopsony power of nationalised body)
Macro effects
Related to the above, privatisation can improve productivity through incentivising efficiency. This shifts long-run aggregate supply right. Growth rises and so may employment.
However in cutting costs, privatised firms may fire workers, reducing employment. At the same time, top CEOs and managers may be rewarded for company performance with higher pay. Hence why privatisation during the 1980s and 1990s coincided with a rise in inequality in the UK.
For aggregate demand, privatisation does mean a fall in government spending on the publicly owned firm. But it also means higher private sector investment.
Further evaluation points
The success of privatisation or nationalisation depends on:
- The extent of economies of scale. In some industries there are economies of scale. But in other industries, there may be diseconomies of scale if the nationalised firm gets too big. In this case, firms would face higher unit costs. Hence leading to higher consumer prices and lower consumer surplus.
- The government’s budget position. A government with a large budget deficit is more likely to sell off a company to the private sector to raise funds. For example, Greece’s government sold off its Piraeus port when it faced a large budget deficit in the euro crisis. [Though, Greece was essentially forced to do this by the IMF and European Commission in exchange for funding from these bodies]. A large budget deficit may also make the necessary investment in infrastructure less likely, reducing quality of service over time. When cutting government spending, investment spending is the easiest to cut (cutting spending on projects that have not yet started is easier than cutting funds of something in progress). But this leads to government underinvestment and a deterioration in service quality.
- The extent of barriers to entry in the industry.
- The degree of regulation of privatised firms. Regulation can prevent privatised firms from exploiting monopoly power by raising prices. In other words, regulation provides “surrogate competition” to the industry.
- Whether the government estimates the allocatively efficient level of output correctly. Otherwise, the nationalised firm can still lead to a (static) welfare loss.
- The objectives of firms. A privatised firm need not maximise profits. It could maximise sales or “satisfice” (aiming to satisfy all stakeholders while achieving reasonable profits). This improves outcomes for other stakeholders, with lower consumer prices and higher employment.
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