PART I - Privatization and Deregulation: What Are Their Economic Implications?

The interaction between the public and private sector is something often assessed by academics and politicians alike. A scholar of this interaction need not look far into history to find structures like command economies where the public and private sectors were one in the same. In more modern times, the dominant structure for this interaction is that of neoliberalism, which emphasizes a reduced state presence in the sphere of production. In order for states to achieve this reduced presence, they often use the tools of privatization and deregulation. Knowing this, researchers are still faced with a question: what are the results of using these tools? More specifically, what are the social and economic outcomes of a reduced state presence through privatization and deregulation? This series of articles seeks to cast light on this question.

In the first portion of this series it is argued that privatization yields positive economic effects for a government through efficiency and profitability improvements, but may lead to corruption and income inequality in the social sphere. In the second half it is argued that banking deregulation could increase consumer welfare within a country, providing the conditions are suitable. I will begin by briefly outlining the recent historical forms of privatization to establish an understanding of the form of privatization assessed in this paper. I will then assess the effects of privatization on a modern economy to substantiate my argument. The paper will then proceed to discuss deregulation and how it can have a beneficial or detrimental effect on a countries economy depending on the banking atmosphere within a country. Following this, I will explain the implications of these findings on the political economy and how a reduced government presence in the economy could either lead to the betterment of the economy, or to the monopoly of the private sector over it.

PART I: Positive Impacts of Privatization

Privatization, described as the “transfer of government services or assets to the private sector” (Britannica, 2015) is not a new concept. It’s origins can be traced back far throughout economic history. In recent decades, the idea of private ownership has undergone a dramatic transformation; economies have transitioned from socialist command economies to more neoliberal, privately based economies. Hungary was one such country that, in the early 90’s, underwent the transition from a socialist to a capitalist system, which proved to be a dramatic time for the Hungarian economy. After the transition, unemployment spiked, GDP dropped to a level that was not recovered until almost 10 years later and output declined almost 20% (O’Relley, 2006, 500). Some of these effects, such as the employment drop, were foreseeable. One of the values of the socialist system was full employment, meaning there were a great deal of unnecessary jobs that were eliminated when the businesses were privatized. Considering other countries adopted similar ideologies it is not unreasonable to assume that other countries undergoing this neoliberal transition had similar experiences to Hungary. Overall, this transition period was a time of massive upheaval for the political economy that took several years to stabilize. The purpose of outlining this is to distinguish this form of mass privatization from the form of privatization assessed in this paper. Mass privatization is a fundamental change in the way an economy operates (ie. socialist to capitalist), it is much broader than the privatization of an individual firm or industry. This series assesses more contemporary forms of privatization, the privatization of an individual publicly held firm or industry.

Many scholars argue that the state should move away from it’s role in production and allow the private sector to take its place. One of the main justifications for this is the increase in efficiency when industries are privatized. There are many examples of this effect holding true; to use a drastic case, in 1990 the Argentinian government privatized its national freight and passenger railway company as part of a restructuring effort. This restructuring resulted in an incredible 370% performance improvement and a 78.7% reduction in the number of (presumable unnecessary) jobs (which could have implications upon wealth inequality, a topic discussed in greater detail later) (D’Souza and William, 1999, 1402). Another example can be found in early 1980’s California where over 800 government contracts were delegated out to private entities. The inclusion of the private sector consequently saved the state over $193 million dollars, or 28% over in house estimates (Seidenstat, 1996, 469). In the 1980’s, the provincial government of British Columbia privatized waste collection. As a result, private waste collectors were able to collect the waste 20% more efficiently per household and 28% more efficiently per ton of solid waste (Seidenstat, 1996, 470). There are thousands of instances across tens of counties that exhibit the same types of efficiency gains mentioned here (D’Souza and William, 1999, 1402); so it is clear that privatization is an effective tool for improving firm or industry efficiency.

Privatization can also help in improving the overall profitability of an economy. In a report completed by a division of the World Bank, Kikeri and Nellis (2002, 7) summarized how “profitability, defined as net income divided by sales, increases from an average value of 8.6 percent before privatization to 12.6 percent thereafter” when analyzing empirical studies on privatized firms. D’Souza and Megginson (1999, 1403) find the same result when summarizing two analyses covering 140 companies in over 20 developing countries. They note that both studies find “...statistically and economically significant increases in output, efficiency, (and) profitability...” This profitability is beneficial for the economy, and government, in a number of ways. Firstly as Seidenstat (1996, 469) describes, one of the main purposes of privatization is to lower the operation costs of government while still providing the same services to the public. In the long run this helps governments to better balance their books through cost reduction, new sources of tax revenue (Megginson, 2000, 19), and growth of the private sector economy. In the short run, it can help governments generate revenue from the sale of the public enterprise (Megginson, 2000, 17) which could go towards debt repayment or future investments. One critique of this argument is that privatized firms earn their increased profitability not through efficiency gains, but through exploitation of the market. In review of several studies D’Souza and Megginson (1999, 1404) “...conclude that they (the examples of increased profitability) are related to efficiency improvements rather than the exploitation of market power” thus discrediting that argument. Overall, privatization proves to increase the profitability of an economy by lowering the financial cost of services, opening new sources of tax revenue and growing profits for select industries.

So, privatization increases both the efficiency and profitability of government run firms. A careful spectator would wonder why this trend present, and the simple answer lies in the basic neoliberal principal of competition. The public sector is a non-competitive entity, therefore, there is no motivation for the government to improve a service because the citizens of a country have no alternatives. In the private sector this is not the case. The private sector is host to competition and therefore motivation for industries to improve operations so they can better compete for the consumer dollar. In theory, this motivation leads companies to innovate and increase the efficiency of their operations, thus resulting in overall efficiency and profitability improvements. This principal of competition is why such drastic efficiency gains are present when services are privatized.


Calen Siddall

Picture titled, "The City by night", taken by James Petts on February 21, 2014 obtained through Creative Commons.