10.2 Privatisation and Deregulation

Question 1

10.2.1 What is privatisation?

Answer 1

Privatisation is the process of selling state-owned assets to the private sector.

Question 2

10.2.2 What is deregulation?

Answer 2

Deregulation refers to the removal of legal barriers to entry, which leads to increased competition and contestability in the industry.

Question 3

10.2.3 What are the different forms of privatisation?

Answer 3

There are four forms of privatisation:

Question 4

10.2.3.1 How does the sale of state-owned assets occur?

Answer 4

The sale of state-owned assets can occur through methods such as floatation (selling shares) on the stock market or through private meetings with buyers.

Question 5

10.2.3.2 How does the government contract out services to the private sector?

Answer 5

The government can contract out services to the private sector while still retaining control and monitoring of output or service quality. The tasks are carried out by private firms. An example is contracting out cleaning services for hospitals in the UK.

Question 6

10.2.3.3 What is a competitive tendering process in privatisation?

Answer 6

In a competitive tendering process, private firms bid to build a project for the government. The winning bid is the one that offers the lowest cost and highest quality, meeting the government’s requirements and standards.

Question 7

10.2.3.4 What is a public-private partnership (PPP)?

Answer 7

A public-private partnership (PPP) is a form of privatisation where the government collaborates with private sector firms to complete an infrastructure project. It involves private firms financing the construction costs and then leasing the project to the government, with annual payments and interest over a specified period. Maintenance costs are borne by the government.

Question 8

10.2.3.5 What is a private finance initiative (PFI)?

Answer 8

A private finance initiative (PFI) is a specific type of public-private partnership (PPP). It involves private firms paying for the construction costs of a project, such as a hospital, road, or bridge, and then leasing it to the government. The government makes annual payments with interest over 25-35 years, while also bearing maintenance costs. This allows governments to undertake infrastructure projects even when they lack immediate financing.

Question 9

Q1: What are the advantages of privatisation and deregulation?

Answer 9

A1: Privatisation and deregulation can promote outcomes like those attained in competitive market structures. Allocative efficiency can be achieved with prices close to or equal to marginal cost. Resources are allocated according to consumer demand with consumers getting what they demand at the quantity they desire. Given that privatised firms can compete significantly on both price and non-price factors, consumer choice is high and prices are low, increasing consumer surplus in the market. The quality of the product being sold is excellent too, given the drive to meet the needs and wants of the consumer. Privatised firms also benefit from allocative efficiency by getting ahead of rivals who are not meeting consumer wants and needs, thus increasing their market share. Over time, this can result in higher profits for the business. The diagram above shows how privatisation can promote competitive outcomes and allocative efficiency with price reductions from Pm to Pc and increases in quantity from Qm to QC. Consumer and producer surplus deadweight losses that occur when there is a concentrated market are recovered, improving social welfare and promoting desirable market outcomes.

Question 10

Q2: How can privatisation and deregulation lead to productive efficiency?

Answer 10

A2: Privatisation and deregulation can lead to productive efficiency where production takes place at the lowest point of the average cost curve. This means all possible economies of scale are being exploited as firms cannot increase output and lower their average costs any further. These lower average costs can translate into lower prices for the consumer, increasing their consumer surplus. Firms benefit from lower average costs, which can lead to higher levels of supernormal profit over time and increases in market share if economies of scale benefits translate to lower prices than rivals.

Question 11

Q3: What is the impact of privatisation and deregulation on cost-cutting and X-efficiency?

Answer 11

A3: Firms have a strong desire to cut costs to maximize their profits and to remain as efficient and competitive as possible given the high level of competition that now exists. This means there will be no waste, cost in excess of average cost, in the business resulting in X-efficiency and lower prices for the consumer, increasing their consumer surplus.

Question 12

Q4: How can privatisation and deregulation lead to dynamic efficiency gains?

Answer 12

A4: The strong profit motive due to privatisation can result in dynamic efficiency gains if supernormal profits are made in the long run. Even in deregulated markets, high levels of competition may force dynamic efficiency gains where profit is reinvested back into the company in the form of technology advances, innovative new products, and R&D. This is beneficial for consumers who will receive brand new, better quality products over time - perhaps able to purchase products that do not yet exist. Prices could be lower over time if technology advances reduce costs for businesses, which are then passed on to consumers. The choice available to consumers would increase too. For the firm, new product development can create monopoly power, especially if products are patentable, and better technology can reduce costs of production, increasing the profit-making potential of the firm even more over time.

Question 13

Q5: How does privatisation generate revenue for the government?

Answer 13

A5: Privatisation through the sale of state-owned assets can generate significant revenue for the government, which can then be used to finance key expenditures in the economy such as health, education, infrastructure, and welfare. This is a strong argument if the government is running a budget deficit and has significant national debt.

Question 14

Q6: How can privatisation, such as through a PFI, benefit infrastructure development?

Answer 14

Privatisation, such as through a PFI (Public-Private Partnership), can allow governments to build infrastructure like new schools, hospitals, and transport infrastructure when they otherwise would not have been able to due to running high budget deficits with excessive national debt. The benefits to the economy, firms, and individuals are tremendous from better quality infrastructure, with the government then paying off this debt in the future once the project has generated a rate of return via increased tax revenues. This allows for the timely development of essential infrastructure without burdening the government’s immediate finances.

Question 15

Q1: What are the potential disadvantages of privatisation and deregulation?

Answer 15

A1: Privatisation and deregulation may not promote competitive outcomes if many firms do not actually enter the industry, perhaps due to other barriers to entry remaining high. Monopoly or oligopoly may form, where incumbent firms use their market power to predatory price, advertise heavily, or flood the market with goods or services to establish their dominant position, frightening off potential competition. This can result in allocative and productive inefficiency, with consumers experiencing higher prices, lower consumer surplus, and reduced choice.

Question 16

Q2: How can privatisation and deregulation impact a natural monopoly market?

Answer 16

A2: If the market is a natural monopoly, where it makes sense for one firm to supply the entire industry to avoid wasteful duplication of resources, privatisation and deregulation that promote competition may not be in the best interests of society. It can lead to allocative inefficiency and lack of economies of scale that a natural monopoly would be able to exploit, resulting in productive inefficiency. This is true as long as the natural monopoly is regulated to produce at allocatively efficient outcomes.

Question 17

Q3: What happens to loss-making goods and services in a privatised or deregulated market?

Answer 17

A3: Loss-making goods and services would no longer be produced in a privatised or deregulated market. Profit-motivated firms will cease production where losses are made. However, private firms and firms in a deregulated industry may make enough supernormal profit to cross-subsidize loss-making goods or services that consumers desire, allowing production to still take place. They can use the supernormal profit being generated from a successful product to subsidise losses of another product.

Question 18

Q4: What are the potential concerns regarding quality and safety in a privatised or deregulated market?

Answer 18

A4: The drive to reduce costs as much as possible to compete with rival firms may lead to shortcuts being taken in production, where the quality of output may not be as good, and product safety becomes a concern. Cost savings might imply poorer customer service, less focus on quality perks, and greater risks in consumption if safety standards are not as tight as they could be. However, in a newly privatised or deregulated market with strong competition, firms will know that taking shortcuts and excessive risks will harm their long-term market share and reputation, and thus are unlikely to compromise quality and safety.

Question 19

Q5: How can privatisation and deregulation impact dynamic efficiency?

Answer 19

A5: Firms in a privatised or deregulated market may not be dynamically efficient. Intense competition can reduce a firm’s ability to make large supernormal profits, restricting reinvestment back into the business. This can result in limited technology advances or innovative new products, reducing consumer choice and preventing price falls in the future. Without significant investment in R&D and new product launches, firms lose their potential for monopoly power through patentable products, decreased market share, and reduced profitability over time.

Question 20

Q6: How can privatisation and deregulation contribute to market failure?

Answer 20

A6: Privatisation and deregulation can lead to or worsen a misallocation of resources and market failure due to under or overproduction. Profit-minded firms may ignore external costs and benefits in production, resulting in the production of more or fewer units than socially desirable. Positive externalities may be underproduced, leading to a lack of increased quantity and choice for consumers, while negative externalities may result in overproduction, generating more cost than benefit for society.

Question 21

Q7: What are the potential long-term consequences of privatisation through PFI?

Answer 21

A7: Privatisation through PFI (Public-Private Partnership) can increase government debt substantially over time. The government must bear the costs of maintenance, leasing, and interest on the infrastructure provided by the private firm for a significant period. These costs often exceed the costs of construction for the private firm. As a result, future generations may have to bear the burden of this debt through higher taxes or cuts to key public services. The long-term consequences include a potential strain on public finances and a transfer of financial risks from the government to the private sector.

Question 22

Q1: What factors determine the impact of privatisation?

Answer 22

A1: The impact of privatisation depends on how many firms actually enter the industry. If barriers to entry are high, such as legal barriers or new firms creating their own barriers, entry into the market will be restricted, increasing the likelihood of monopoly or oligopoly formation. To promote competition, governments must strongly deregulate to keep entry barriers low. The success of privatisation relies on maintaining a competitive market structure.

Question 23

Q2: How does the form of privatisation affect its financial implications for the government?

Answer 23

A2: The form of privatisation used will determine whether privatisation generates revenue or costs for the government. If a PFI (Public-Private Partnership) or contracting out of services approach is used, the cost to the government may be higher than if left to the state sector, burdening future taxpayers. However, if state assets are sold to the private sector, it could generate substantial income as long as the government has priced the sale correctly. If not, revenues will be lower than they should be, creating a significant opportunity cost where certain public services will not receive the full funding they could have benefited from.

Question 24

Q3: What role does regulation play after privatisation?

Answer 24

A3: There is an important role for regulation post-privatisation of an industry. In cases where there is monopoly or oligopoly power in the market, competition policy is necessary to prevent market abuses and protect consumer welfare. Additionally, if the market would fail under private hands due to the existence of externalities in production, policy interventions might be needed to bring production to the social optimum. Without proper regulation, there is a risk of reduced social welfare under privatisation.

Question 25

Q4: How does the size of newly privatised firms impact the outcome of privatisation?

Answer 25

A4: The size of newly privatised firms is important in evaluating whether privatisation will result in economies of scale benefits or losses. Under state control, with one large company supplying the entire market, economies of scale exploitation would have been significant. If privatisation increases competition among numerous small firms, these benefits will be lost, reducing productive efficiency and potentially leading to higher prices for the consumer. It is crucial to consider the impact of the market structure resulting from privatisation on productive efficiency.

Question 26

Q1: What factor heavily influences the impact of deregulation?

Answer 26

A1: The impact of deregulation heavily depends on how many firms actually enter the industry. If non-legal barriers to entry are high or new firms create their own barriers, entry into the market will be restricted, increasing the likelihood of local monopoly or oligopoly formation. To promote competition, governments must deregulate as much as possible to keep entry barriers low. The success of deregulation relies on maintaining a competitive market structure.

Question 27

Q2: What role does regulation play after the deregulation of an industry?

Answer 27

A2: There is an important role for regulation post-deregulation of an industry. In cases where there may be local monopoly or oligopoly power in the market, competition policy is necessary to prevent market abuses and protect consumer welfare. Without effective regulation, there is a risk of reduced social welfare due to the absence of competition and potential market abuses. Regulation can help ensure that the benefits of deregulation are realized in a fair and competitive manner.

Question 28

Q3: What challenges might consumers face in benefiting from deregulation and increased competition?

Answer 28

A3: Consumer inertia, where consumers hesitate to switch suppliers, can hinder the benefits of deregulation and increased competition. The process of switching might be time-consuming, complex, and costly, or consumers might exhibit brand loyalty. Additionally, consumers may not be aware of new firms that have entered the market after deregulation. In such cases, there is no guarantee that deregulation and greater competition will actually benefit consumers through lower prices, better quality, and greater choice. Competition authorities can help address these challenges by facilitating easier supplier switching, providing information about new firms, and reducing bureaucracy associated with switching providers.