Privatisation

Question 1

Privatisation and deregulation

Answer 1

• Privatisation involves selling state owned assets to the private sector.
• Deregulation involves reducing legal barriers to entry and opening up the market to more competition.

Question 2

Benefits of Privatisation 1

Answer 2

1. Reduced government interference - State owned industries may be managed for political reasons, e.g there could be under-investment because governments take the short-term view.
2. Private companies are usually more efficient - This is because when working in the public sector, there is often little incentive to cut costs and increase profits. However, private firms will have this profit incentive, therefore they are more likely to develop new and better products.
3. Improved public finances - Receipts from privatisation could help reduce government borrowing. However this is a one off income and the government will lose future profit revenues from losing ownership of the companies.

Question 3

Benefits of Privatisation - Increased competition

Answer 3

The main benefits from privatisation occur when there is successful deregulation and an increase in competition. This will lead to the usual benefits of competitive markets:
• Lower price leading to greater allocative efficiency P=MC
• Better quality of consumer service as firms compete for market share.
• Firms must be more efficient in order to cut costs and remain profitable.

Question 4

Potential Problems of Privatisation

Answer 4

1. Barriers to entry - If there are significant barriers to entry, such as, high fixed costs it may prove difficult to increase competition. Industries like water and railways can be seen as a natural monopoly. Therefore privatisation could create a single private monopolist.
2. Public services should be run in the public interest - Many industries which were privatised are important public services such as railways and gas. Therefore, it may not be appropriate to apply profit maximising principles in these industries.
3. Positive externalities - Industries such as railways have positive externalities, such as reduced pollution and congestion. Therefore in a free market they will be under consumed. If the government manages these industries it can make sure they overcome market failure and take external benefits into account.

Question 5

Regulation of Privatised Industries

Answer 5

After privatisation, regulators were introduced to monitor the behaviour of the newly privatised firms. The aim or regulators is to:
• Regulate prices - prevent excessive price increases.
• Monitor quality of service, performance targets, and investment levels
• Encourage competition – removing barriers to entry.

Question 6

Price-Cap Regulation

Answer 6

• Regulators have the power to limit price increases or order firms to cut prices by a certain amount.
• This is done through CPI – X (RPI-X). This means that firms have to cut prices by an amount x after taking inflation into account.
• In certain industries like water, regulators use CPI + K. Where K is the amount they can increase prices to fund necessary capital investment.

Question 7

Advantages of CPI – X Regulation

Answer 7

1. The system provides an incentive for firms to increase efficiency.
2. Different prices can be set depending upon the circumstance of the industry, therefore the system is flexible.
3. The regulator should be independent of the govt and the firm and can therefore act in the interests of the consumer.
4. If the information the regulator has is good then they can increase allocative efficiency by setting prices close to marginal cost.
5. Since the system started back in 1984 there have been significant cuts in the real prices of telephones and electricity, suggesting it has been successful.

Question 8

Disadvantages of the RPI - X system

Answer 8

1. Regulators have often underestimated the potential cost savings of firms, therefore x has been too low and regulation too soft. This has allowed firms to increase their profits at the expense of consumers.
2. Regulators have been accused of regulatory capture. This occurs when the firm persuades the regulator to look favourably upon the industry; if the firm can control the information the firm receives, this is easier to do.
3. On the other hand, if regulators become too strict with the firm it may hamper investment. Firms may be reluctant to invest if they fear the regulator will make them cut prices.
4. It is possible that there may be fewer incentives to cut costs because, if they do increase efficiency, the regulator may just increase the value of x.
5. Regulators need to look at more than just price. For example, they should consider performance targets and quality of service.

Question 9

Competitive tendering

Answer 9

A system introduced in the UK during the 1980s to force publicly run organisations to request bids from a number of different firms for contracts to supply goods or services. The aim was to drive costs down and improve the efficiency of state funded organisations, including central and local government departments.
Relates to privatisation, regulation, competition policy etc..