Study Notes

Development Strategies - Privatisation

AS, A-Level, IB
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 5 Mar 2019

Privatisation means the transfer of assets from the public (government) sector to the private sector. Countries that pursue privatisation are adopting a market-oriented approach to development.

For some countries, privatisation is part of the process towards moving away from a state-dominated economy towards a mixed economy with both public and private sector operating. Good examples include China, India, Chile, Ethiopia and Vietnam.

Privatizing Vietnam's State-Owned Companies

The case for privatisation

What are the main arguments for using privatisation as a growth and development strategy?

Efficiency: Supporters of privatisation believe that the private sector and the discipline of market forces are a better incentive in the long run for businesses to be run efficiently and thereby achieve improvements in economic welfare. Privatisation may also lead to less corruption.

Innovation: The private sector may be more innovative than the state (public sector) and this might be a factor leading to a more dynamic economy which is less reliant on state subsidy and other forms of financial support.

Income from asset sales: Selling off industries can generate increased revenue for the government which might then be used to help fund increased spending public and merit goods.

Investment: Some state-owned enterprises are privatised and then go on to launch an initial public offering on the stock market to raise fresh capital. This in turn might lead to higher capital investment than when the business was state owned which creates jobs and increases the productive capacity of the economy. The Solow growth model highlights the importance of capital investment for emerging countries wanting to achieve faster growth.

Smaller fiscal deficit: State sector industries (state owned enterprises) often make heavy losses which lead to an increase in the fiscal (budget deficit) and high levels of government debt. Privatisation can therefore lead to a reduction in the deficit and means that the government will have less debt to service leading to lower interest payments. In turn, this might lead to a lower tax burden on businesses and households which could stimulate growth.

Lower prices and higher real incomes: A state enterprise may employ surplus workers which is productively inefficient. Increased efficiency and productivity will eventually lower prices for consumers leading to higher real incomes and an increased ability to save.

Development Strategies - Privatisation

Arguments against privatisation

What are the main arguments against a policy of privatisation as a supply-side growth and development policy?

Job losses: Privatisation often leads to many jobs being lost as profit maximising owners have different objectives from when a business / sector has state control

Affordability of basic services: There are many industries which perform an important public service, e.g. health care, education and transport. There is a case for state-ownership and charging prices below the free market profit maximising price so that basic services are available and accessible to the majority of the population.

Monopoly profits: If a newly-privatised firm has monopoly power, they may use their market (monopoly) power to raise prices to improve their profit margins. This can lead to market failure such as a deadweight loss of consumer surplus and the impact of higher prices will be felt most by lower-income households who might struggle to afford basics such as energy, water and telecoms utilities

Social aims: State-owned firms can put social objectives ahead of profit - privately-owned businesses have less incentive to do this

Privatisation is not the same as deregulation: There is no guarantee that privately-owned firms are necessarily more efficient than state-owned. Much depends on whether a market is contestable rather than the narrower issue of ownership and control.

Inequality of income and wealth: Privatisation can contribute to increasing inequality - much depends on who ends up owning the shares in a privatised business and whether those profits are taxed equitably and stay in the economy?

Privatisation may leave some key industries at risk of foreign takeover and there might be a loss of profit to overseas transnational corporations who bought state assets

Critics of privatisation argue that many state assets are sold off too cheaply and that the government does not get full value for previous investment made in building and supporting the business prior to privatisation.

China steel ‘zombie’ privatisation sets precedent

Context matters

The strength of the case for or against privatisation will be contextual given the different circumstances of each country at various stages of development. Vietnam for example has achieved high rates of growth and is a lower middle income country with ambitions to be an upper middle income country in the relatively near future.

The Vietnamese economy has been built on communist/socialist principles in the past but the government is committed to embedding more market forces into their economy by reducing the number of state-owned enterprises. The Financial Times reported in 2018 that Vietnam aims to generate half of its economic output from the private sector within two years. That is a decisive change in the structure of their economy.

Some of the newly privatised companies have achieved an initial public offering on the Vietnamese stock market allowing them to raise fresh capital to help fund capital investment and grow export capacity. The government in Vietnam often keeps a sizeable stake in companies that complete an IPO allowing them to reap a share of the dividends from profits.

Privatisation does not happen in isolation

Privatisation is fundamentally about a transfer of ownership but the policy can often happen alongside other supply-side strategies such as trade liberalisation agreements with other countries and possible deregulations of industries. Vietnam is a participating country in the Trans-Pacific Partnership.

Some background reading

Privatisation in emerging countries (Estrin, 2018)

Ethiopia privatisation plan gets underway (February 2019)

Modi govt clears deck for Air India's privatisation (February 2019)

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