You may be familiar with some of these firms: British Airways, British Gas, British Rail. What do these firms have in common? Other than that they start with 'British', these firms were state-owned at some point in time and now they are examples of privatisation.
Fig. 1 - The case of British Airways is an example of privatisation, Pixabay.
The UK government sold these and other firms to the private sector. Why? Let’s find out.
What is privatisation?
Before we take a look into the different types of privatisation and a few examples, let’s define it.
Privatisation is the process of transferring publicly owned assets such as railways, buildings, or factories to the private sector.
This usually involves the sale of nationalised industries and businesses (that were owned and operated by the central government) to private ownership.
In the UK, between 1981 and 2015, we saw the privatisation of more than 15 industries. This included the sale of nationalised firms and industries and also state-owned land and state-owned housing.
Economic liberalisation
We have concluded that privatisation in its narrow sense is the transfer of assets from the public sector to the private sector. We can extend this definition by including some aspects of economic liberalisation and its policies of privatisation.
Economic liberalisation is the process of opening up a nation's market to private ownership and further competition while at the same time reducing government interference in the economy.
How does privatisation work?
The national economy is made up of two sectors: public and private sectors.
The public sector is made up of firms, operations, and industries run by the government.
Some examples of services in the public sector are education, law enforcement and security, social care and healthcare (NHS) to some extent.
Fig. 2 - The NHS is an example of a firm in the public sector, Unsplash.
The private sector refers to firms, operations and industries that aren't run by the government.
The majority of firms you are familiar with like Amazon, Netflix, Apple, etc. are private companies. But private companies can exist in many different industries like finance, real estate, technology, and many more.
Privatisation occurs when government-specific operations are sold to the private sector. Usually, this helps the government save money and increase efficiency.
Methods of privatisation
We know that privatisation is the selling of government-owned firms to the private sector. Although this sounds very straightforward, there are many ways a government can privatise a company. A few methods are:
- Competitive bidding/tendering. This is when private companies bid for a business by way of a tender. The government could also contract out the provision of goods and services to private companies.
- Dilution of capital. This is when the capital is raised and then issued to private investors, causing the shares of the government to become diluted.
- Private placement. This is when the ownership of a company is transferred to a single or many private companies. The government wouldn’t transfer the firm to any private company; they would have to meet their requirements first.
Examples of privatisation
British Airways, one of the most popular airways not just in the UK but also in the world was since its inception in 1974 state-owned by the UK government.
The British Airways Board initially managed to nationalise British airlines, the British Airways Overseas Corporation and British European Airways, as well as two other regional airlines: Cambrian and Northeast Airlines. The merger of all four of these airlines led to the creation of British Airways.
After 13 years of being under state control, British Airways was privatised under the conservative-led government of Margareth Thatcher.
British Rail, the institution that provides railway transportation services in the UK, was under state ownership since 1948. However, the privatisation efforts of Thatcher’s and Major’s conservative governments led to the railway’s privatisation, a process that started in 1994 and was completed in 1997. The ownership of the British railways passed from the government to a private sector railway provider, Railtrack.
Figure 1 below shows some other examples of UK state-owned firms that were privatised during the 1980s and 1990s.
Fig. 3 - Examples of UK firms that were privatised
Features of privatisation
The two examples we just looked at were of state-owned companies before they were sold to the private sector. Many state-owned industries specialised in coal, electricity, or gas were vertically integrated.
Vertical integration happens when the production activities or the production processes (such as extracting natural resources from the ground or utilising coal to power electricity or to sell finished goods and services) are carried out by one single firm.
After the implementation of privatisation policies, the state-owned industries suffered from vertical disintegration, which saw these state-owned, nationalised industries break into smaller parts. For example, a state-owned firm was split into several firms. Each of the firms specialised and carried out the various production activities at different stages.
These firms were split into horizontal layers, where companies in each layer were buying or selling goods and services from different companies above or below the supply chain.
A good example is the gas sector in the UK. The British gas industry was initially fully state-owned; British Gas owned all stages of production, from purchasing the necessary material and producing it to selling and distributing the gas to each of the households. A few years later, the industry was split into separate layers to prevent the creation of a monopoly and to promote competition.
Privatisation and the free market revival
Privatisation hasn’t been historically favoured among those that prefer a strong government presence in certain industries.
Those on the socialist camp, for example, heavily emphasised state-owned industries would bring further efficiency to the economy and would serve public interest more effectively.
Those who supported the case for privatisation had the notion that it would deliver greater efficiency than state-owned industries, as well as further competition in the industry. This came to be known as the ‘free market revival’.
Advantages and disadvantages of privatisation
Just like any other government policy, privatisation has both advantages and disadvantages.
Advantages of privatisation
There are several arguments that justify privatisation, especially among free-market revivalists enthusiasts. Let’s consider the four major arguments in favour of privatisation.
- Increased revenue: as governments sell their state-owned assets or proceed to privatise a state-owned firm, they can, over the short term, gain a considerable source of revenue that can be utilised to finance other projects.
- Reduction of government's borrowing requirement and public spending: a state can sell a loss-making firm in a particular industry and in the long term reduce the subsidies put into maintaining it. Government borrowing will fall as the private sector turns the loss-making firm profitable once more. This means that governments could see more flow of revenue as corporate taxes enable them to receive dividends from the shares they own in the privatised firm.
The UK sold the Rover Group which was making considerable losses at the time. When they sold the industry back into the private sector, their public spending on the subsidies maintaining the operations decreased.
- Promotion of competition: privatisation was often justified as a means to promote competition by breaking natural monopolies such as the gas and electricity industries in the UK. As firms were privatised more, they adopted far more technology-driven competition policies that made them provide and produce goods and services more efficiently.
- Promotion of efficiency: the reasoning behind this notion lies in the belief that assets that are under public ownership are prone to high levels of inefficiency as the public sector is resistant to change. This lack of efficiency wouldn't exist in the private sector as private sector firms are exposed to the possibility of an aggressive takeover and thus have certain strategies to operate in the capital market. These strategies enable them to perform effectively and efficiently in the long run.
Disadvantages of privatisation
The process and concept of privatisation offer a variety of disadvantages. Let’s consider four of them.
Monopoly abuse: privatisation can increase monopoly abuse. Socially owned and public monopolies are transferred into weakly regulated and less accountable private monopolies.
Short term over the long term: many investments that state-run enterprises and nationalised industries make tend to bring long-term profits and benefits. The same thing can not be said for firms or industries that are under private ownership. This stems mainly from the fact that industries or firms under private ownership are more focused on delivering short-term results to keep shareholders and financial institutions happy with the dividend payouts.
‘Selling the family silver’: one of the key arguments against privatisation is the notion that when a private firm sells its capital (such as machinery) only for the sake of increasing revenue, that harms the dividend payout rate to its shareholders. We can apply the same idea to the government and the assets it owns. When a government sells its capital assets only to increase its revenue levels to spend on wages and salaries, it would not be sanctioned by the taxpayers. The counter-argument offered to this is that instead of selling the ‘family silver’, the process of privatisation returns the family's assets from public ownership back to the family's (private) ownership.
The act of selling the ‘family silver’ refers to selling a valuable resource for the sake of immediate and short-term gain or advantage instead of holding on to the resource for long-term use so that it can grow in value.
4. The free lunch syndrome: the idea behind this notion is that state-owned assets have been sold far too cheaply which encouraged the idea among first-time buyers of shares that there was a ‘free lunch’. A free lunch is a situation where an individual has incurred no cost whatsoever when receiving a good or service. The rise of the free lunch syndrome stems from the fact that the offer price (the price at which the market maker or the institution is willing to sell shares) of shares in the recently privatised industries was guaranteed to be risk-free capital gain.
Privatisation of Markets - Key takeaways
- Privatisation is the process of transferring publicly owned assets such as railways, buildings, or factories to the private sector.
- Economic liberalisation is the process of opening up a nation's market to private ownership and further competition while at the same time reducing government interference in the economy.
- Privatisation is not favoured among those that prefer a strong government presence in the economy. Those that do favour it are usually referred to as free-market revivalists and tend to be part of conservative governments.
- British Airways and British Railways are examples of UK state owned firms that were sold to the private sector.
- Some advantages of privatisation are: increased revenue, reduction in government borrowing, promotion of competition and the promotion of efficiency.
- Some disadvantages of privatisation are: monopoly abuse, short term is valued more than the long term, free lunch syndrome and 'selling the family silver'.
