Index

  Introduction 4 NA  

1.  The market forces argument 4  

2.  Breakdown of the market forces argument in natural monopolies 6  

3.  Economic key issues which regulators of privatised industries should consider 8  

4.  References 12  

  -3- NA  

Introduction

This essay covers some issues of privatisation and regulation. It is divided into three parts. Part one gives a brief outline of the author`s understanding of the market forces argument for privatisation. In the second part it is explained what is meant by a natural monopoly and why the market forces argument does not hold if an industry is a natural monopoly. The third part then discusses which economic key issues should be considered by the regulatory body of a privatised industry.

Privatisation is the transfer of public ownership away from the state to private ownership.

Regulation is a limitation on the behaviour of firms or organizations, imposed by the government.

From the view of competition it is the aim to remove market distortions which are caused by public enterprises and regulations (Case K. et al. 1999: 356.)

1. The market forces argument

In the past two decades there has been a trend in western economies to privatise their public companies. In the United Kingdom, Margaret Thatcher and also the administration of John Major and Tony Blair were advocates of privatisation measures, all of which were not considered to be successful (e.g. Britain’s railways) ( Journal of Economic Review, 2003). Nonetheless, there are benefits in privatisation and competition for a sector. The next paragraph presents the economic argument for privatisation:

1. The advocates’ argument is that privatization results in competition. This leads

to lower prices, assuming there are no collusions, because consumer demand puts competitive pressure on the companies in the market. As a result they have also to improve service (Sloman, J. 2003: 149) and the pressure leads to a better allocation of resources and, t herefore, to an improvement in X efficiency (internal efficiency). Companies will take action by cutting their

-4-

costs, changing the organizational structure (more customer oriented, not management and worker oriented as in public authorities) and utilising professional management to improve the efficiency of the company in order to stay competitive (Griffiths A. and Wall S., 2003: 179).

2. Most privatised companies are transformed into public limited companies

(plc). Accountability to shareholders puts the company under pressure to perform well, as the owners are looking for good returns on their investments. The market for corporate control thus provides incentives for private firms to be efficient, otherwise share prices will fall and the company is in danger of a takeover (Case K. et al., 1999: 356 / 875).

3. 1After privatisation a company faces greater competition for finance than

before, when governments could lend money at a minimum interest as there was no risk for creditors. Now the firm has to finance investment through the market by issuing shares or borrowing money from financial institutions. But a company has also financial freedom to raise investment capital externally (e.g. for measures to increase efficiency), as governments always have to be concerned about restraining the growth of public expenditure (investment is direct public expenditure). Therefore, privatising a company leads to a greater scope of diversification flexibility and reaction to market opportunities (Sloman J., 2003: 149).

From this point of view, the market forces argument is that privatisation will provide an increase in economic efficiency (Jackson, P. et al.:1994).

-5-