The benefits and limits of privatisation

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Some 40 years ago, the UK became a pioneer in the privatisation of publicly owned industries. Initially the focus was upon a few large businesses. But over time this changed, as the government privatised monopolies or quasi-monopolies and then went on to contract with private suppliers of a wide range of sensitive public services. The experience has now been lengthy and varied enough to learn some important lessons, the most important of which is that the basic principles of economics matter.

If a number of suppliers compete in the market for a good or service, consumers are properly informed about what they are buying and able to switch easily to other suppliers, and business owners bear the cost of failure, then private profit-motivated enterprises are going to be the best way to provide the goods or services in question. But things are very different if consumers have no effective choice or, by virtue of their vulnerability or frailty, are unable to make informed choices at all. In such cases, the state must step in, by writing and monitoring contracts and instructing and appointing regulators.

Whenever that is the case, no general presumption in favour of supply by profit-seeking entities can exist. The fundamental argument in favour of private suppliers is that they would still be motivated to supply goods and services as cheaply as possible. A purely political reason is that private contracts allow government to evade self-inflicted constraints on public sector borrowing even when the proceeds are used to create productive assets. The argument against, however, is that, in the absence of effective monitoring and credible penalties, private suppliers will become ruthless rent extractors: they will deliver shoddy goods and services, impose various hidden costs and shift risks on to others, mainly taxpayers. If so, it must be stressed, this would be entirely rational behaviour. The response has to be regulation. But regulators can be captured — and often are.

The British experience is now long enough to illuminate these possibilities.

In the years of Margaret Thatcher, privatised industries included British Telecom, British Petroleum, British Airways, British Aerospace, British Gas, Rolls-Royce, Rover, British Steel and the electricity industry. Many of these businesses were, or would soon be, operating in fully competitive markets. But the energy and telecommunication industries continued to have their own regulators, even though a measure of competition could be injected into both. This was partly because they enjoyed a degree of monopoly power and partly because security of supply was vital in both cases. Finally came two controversial cases: water and railways. Water is a classic monopoly, while the railways has some monopoly elements.

If we look back at all this, we can see that experience has lived up to economists’ expectations: the greater the competition and the more credible the possibility of bankruptcy, the less controversial the privatisations are today. It is not surprising that water and railways have been problematic. In the former, rent extraction and dumping of environmental costs are at the heart of the complaints. In the latter, the problem is essentially that a way of separating track from train was never achieved.

Yet, as Sam Freedman notes in his recent book, Failed State, something else has happened too. This is the privatisation of public services that are not natural monopolies, but that also do not have informed customers able to look after themselves and, if necessary, shift to other suppliers. Examples include care homes for the elderly and children, prisons and, for a while, the probation service. There is much more to his book than that. But Freedman concludes, on one children’s home, that “it is an astonishing indictment of the British state that it no longer has the ability to provide care for those who need it most, and instead allows blatantly ill-qualified people to charge exorbitant fees to provide unacceptable levels of care.”

Much of this private provision has, it seems, been imposed on local government to conceal responsibility for the refusal, in the UK’s over-centralised polity, to fund services adequately. Yet it also raises big questions. Are profit-seeking businesses really the best way to provide such services? Would it not be better if local authorities did so? Or, given the known failures of the latter, might it be wiser to consider some form of mutual provision as an alternative?

It is time to examine where private provision will not work and then, as Sir Keir Starmer might say, consider some “change”.

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