Advantages of Privatization

https://www.downsizinggovernment.org/privatization

Since Margaret Thatcher got the ball rolling in 1979, more than 100 countries have raised about $3.3 trillion by selling off thousands of state-owned businesses. The revolution spread from the United Kingdom to Continental Europe, Latin America, Australia, Canada, Israel, and many other places. In dollar value, the bulk of privatization has occurred in developed nations. In those countries, some of the largest reformers relative to the size of their economies have been Australia, New Zealand, Portugal, Spain, and the United Kingdom.

For governments, a main benefit of pursuing privatization is to raise revenue. But for citizens, the main benefit is the positive effect on economic growth from increased efficiency and greater innovation. Businesses that are more productive can pay workers better and cut prices for consumers. Also, by reducing waste they are better environmental stewards.

Many statistical studies have examined the performance of businesses before and after privatization. A 1994 study in the Journal of Finance looked at 61 privatizations in 18 countries and found "strong performance improvements, achieved surprisingly without sacrificing employment security. Specifically, after being privatized, firms increase real sales, become more profitable, increase their capital investment spending, improve their operating efficiency, and increase their work forces."

A 1999 study in the Journal of Finance compared the performance of 85 firms across 28 countries before and after privatization. It found that privatization increased "profitability, output, and operating efficiency." Firms increased sales per employee an average of 23 percent. The statistical results "strongly suggest that privatization yields significant performance improvements," concluded the authors.

A 2003 study on privatization in the Journal of Public Economics found that "the empirical literature has provided systematic evidence that privately-owned companies outperform state-owned enterprises."

A 2004 study by the Inter-American Development Bank of Mexico's reforms found that "privatization leads to dramatic improvements in firm performance and that they are the result of efficiency gains, not transfers from workers or exploitation of consumers." The study found other social benefits: "greater access to services, which usually follows privatization, leads to welfare gains for the poorest consumers that outweigh any increase in prices." Mexico privatized hundreds of companies during the 1980s and 1990s.

A 2012 study looked at more than 50 Canadian businesses privatized during the 1980s and 1990s, including an airline, a railroad, manufacturers, and energy and telecommunications firms. It found, "The overall impacts have been largely positive, in many cases impressively so. Key economic indicators such as capital expenditures, dividends, tax revenues and sales per employee tended to increase." One sign of the success of reforms is that very few privatized firms in industrial countries have been renationalized, even when political parties changed. In Canada, none of the more than 50 major privatizations have been reversed. 

Privatization works, which is why even left-of-center governments generally accept reforms once the dust has settled.

A 2012 review by privatization expert John Nellis found that "the vast majority (but not all) of firm studies or surveys in most countries and sectors [have] continued to find positive post-privatization performance changes in terms of lowered costs, improved labor efficiency, increased outputs, higher returns to owners and shareholders, and, very often, increased investment." In another study, Nellis found that "contrary to popular conception," privatization "has not contributed to maldistribution of income or increased poverty."

A 2001 Journal of Economic Literature article by William Megginson and Jeffry Netter provides a detailed international review of academic studies. They found studies "almost unanimously report increases in performance. . . . Privatization appears to improve performance measured in many different ways, in many different countries." They concluded that privatized firms "almost always become more efficient, more profitable, increase their capital investment spending, and become financially healthier."

Megginson examined hundreds of studies for his 2005 book, The Financial Economics of Privatization. He concluded, "Private ownership must be considered superior to state ownership in all but the most narrowly defined fields or under very special circumstances." Furthermore, "the weight of empirical evidence on the state versus private ownership question now strongly supports those who believe that private ownership is inherently more efficient than state ownership. This is true even for natural monopolies."

Most academic studies on privatization examine quantitative factors, such as efficiency and output. But privatization also creates qualitative improvements, such as greater transparency and improved customer service. The following sections describe a dozen advantages of privatization.

1. Promotes Efficiency and Innovation
2. Increases Labor Productivity

Private businesses in competitive markets have strong incentives to increase efficiency — to produce more and better products at lower costs. Businesses seek profits, which are a measure of net value creation. If a business performs poorly, it will lose money and have to change course, or ultimately face bankruptcy or a takeover.

By contrast, government entities are usually not penalized for excess costs, misjudging public needs, or other failures. They can deliver bad results year after year and still receive funding. Government workers are rarely fired, and there is no imperative for managers to generate net value.

The superiority of private enterprise is not just a static efficiency advantage. Instead, businesses in competitive markets must pursue continuous improvements. They learn by doing and adjust to changes in society, a process called adaptive efficiency. By contrast, governments get ossified by bureaucracy and are slow to adapt.

Businesses routinely abandon low-value activities, but "the moment government undertakes anything, it becomes entrenched and permanent," noted management expert Peter Drucker. As an example, the demand for mail has plunged and the U.S. Postal Service (USPS) is losing billions of dollars a year, but Congress has blocked obvious reforms, such as ending Saturday delivery. Private businesses make such adjustments all the time as demand for their products fluctuates.

Government organizations undermine growth by keeping resources employed in low-value activities, even as tastes and technologies change. That is why Drucker said, "The strongest argument for private enterprise is not the function of profit. The strongest argument is the function of loss." Losses encourage private businesses to drop less-valuable activities and move resources to more promising ones.

In the 20th century, many economists supported government ownership because they thought that expert planners could efficiently organize production. But they ignored the dynamic role of businesses in continuously improving products and production techniques. In a Journal of Economic Perspectives article, Andrei Shleifer said that many economists did not foresee the "grotesque failure" of government ownership, and they did not appreciate the private-sector role in generating innovation.

Lacking incentives to control costs, government organizations tend to employ excess workers. In a survey of its member countries on privatization, the OECD said, "state-owned enterprises (SOEs) tend to be overstaffed. Empirical studies of privatization generally identify the downsizing of a bloated payroll in SOEs among the main sources of efficiency gains." 

Similarly, a World Bank study on privatization noted:

Governments the world over have employed too many workers in their state enterprises. Many of these enterprises were in fact designed as vehicles for job creation and political patronage. Protection from competition, lack of hard budget constraints, and security of tenure of public sector positions have led to chronic overstaffing.

The OECD suggested that SOEs are sometimes overstaffed by 30 percent to 50 percent. With privatization, that sort of bloat can be cut. Surveying international experience, John Nellis found that layoffs of 25 percent are not uncommon after privatization. Postal system reforms, for example, often produce job cuts of that magnitude. 

In Canada, the parliamentary library said that state-owned Petro-Canada "was widely regarded as inefficient, oversized and debt-ridden," and the company's workforce was slashed 40 percent with privatization.

When employment falls after privatization, labor productivity (output per employee) generally rises. One study found that the typical labor productivity increase after privatization is about 20 percent. 

In Canada, the air traffic control system has cut its workforce 30 percent since privatization in the 1990s, but it is handling 50 percent more traffic today.

In the United Kingdom, labor productivity doubled in the electricity and gas industries in the decade after privatization. For British railroads, passenger journeys per employee increased 37 percent in the 15 years after privatization. That improvement occurred as rail safety increased and customer satisfaction remained high.

Japan privatized much of its passenger rail system in the 1990s. The railroads reformed their rigid union rules and slashed their workforces. Labor productivity increased more than 50 percent, on average, in the restructured companies. 

The privatization of Argentina's national railroad in the 1990s produced remarkable results. Labor productivity shot up 370 percent as the bloated railroad workforce was chopped by four-fifths. Despite the workforce reductions, Argentine freight service greatly improved and passenger ridership soared.

Higher productivity generally translates into higher worker earnings and greater output in the overall economy. One study found that privatized firms in Mexico reduced their employment, on average, by about half. But as workforces were cut, labor productivity doubled, and remaining workers at privatized Mexican firms enjoyed substantial wage gains. Surveying the international literature, William Megginson found, "most privatizations result in some employment shedding, but . . . the workers who remain at privatized companies are usually paid significantly more."

Initial job cuts are often just a short-run phenomenon. As productivity improves after privatization, employment often rebounds as companies find new markets and expand sales. A review of privatizations in Canada found that often "employment initially fell, only to rise again over the long term." The study noted, "After many of these companies restructured, which took about five years following privatization, hiring began again."

In sum, privatization often dislocates workers at bloated companies in the short run. But over the longer run, privatized companies grow, employment expands, and compensation rises. The overall economy gains because higher productivity translates into rising incomes. Economic change can be difficult, but governments can ease the process with tax and regulatory reforms to spur creation of new businesses that will create new jobs.

3. Improves Capital Investment

In the private sector, businesses have incentives to maintain their facilities in good repair and to invest to meet rising demands. To fund expansions, they reinvest their profits and raise financing on debt and equity markets.

By contrast, government organizations often consume their funding on bureaucratic bloat and have little left over for repairs and upgrades. Government infrastructure is often old, congested, and poorly maintained. Capital investment falls short and tends to be misallocated. This was a common experience with British industries before they were privatized, and access to private funding to increase capital investment was an important factor in the Thatcher government's privatization drive.

https://www.downsizinggovernment.org/privatization

Norb Leahy, Dunwoody GA Tea Party Leader