As a rule, I've supported the privatisation of state-owned enterrpises - particularly underperforming ones. In many cases it has lead to more efficient provision and better financial performance than under state ownership. But there are key exceptions. The experience with privatised natural monopolies has been decidedly mixed. The key element of market competition is missing and so one has to rely on a government regulator to keep such firms honest. In Britain, for example, the performance of privatised water companies has been a disappointment, with large price hikes, growing pollution and wastage.
A more glaring concern is the growing use of private firms to finance and operate public works, such as highways or hospitals. In many cases this is done under the so-called Build, Operate and Transfer approach or some variant of it. Such a system has three major problems. First, there is an obvious moral hazard around quality. Private firms have an incentive for their work to last until it is transferred to the state - but not a day longer. That can result in cost savings through inferior materials and workmanship leading to higher maintenance costs. This poses a medium-term budget risk to governments.
Second, in most cases if the venture fails, the taxpayer ends up bailing it out. Just as central bankers are lenders of the last resort, so too governments have often had to come to the rescue. As blogger and economics professor John Quiggin has noted:
..these episodes underline the point that, for essential services, government is the provider of last resort. It can sell the assets, and forgo the associated earnings, but it can’t divest itself of the obligation to step in (and pay up) when something goes badly wrong.
A popular alternative has been for governments to agree to vary the terms of the contract to allow firms to impose higher rentals or charges - for example, for a tollway that is losing money. Of course, either outcome undermines the claim that private firms reduce public risk or deliver more efficient services.
The third, and most fundamental, problem with privately financed public works are that they invariably cost more. Not only do firms have to ensure they make a profit, but they also face a higher cost of capital. This is a point that John Quiggin has been making for many years. Meanwhile, Kelvin Hopkins writes in today's Guardian that the cost of privatisation will haunt us for years to come. He makes the point well:
The illogic of private investment being given incentives to replace public investment is compounded by the fact that the cost of government borrowing is much cheaper than servicing private capital investment. The money markets are generally enthusiastic about lending to government because such lending is secure, which is why the interest charged is low. By contrast, private-sector investment always requires a risk premium and profit-taking.
Government's natural advantage is in raising money cheaply. The private sector's is in running organisations efficiently. Public-private ventures should capitalise on these core strengths, with the government raising the money - perhaps via bonds, as Ken Livingstone has suggested - and the private sector partner running the operation. This makes economic and fiscal sense - but has the key failing of not taking government capital spending 'off the books'.