Privatisation can be a windfall - you've just got to pick the winners

Decisions on privatisation of public assets and services should not be driven by ideology, but by sound understanding of how an optimal mix of ownership, creation of competitive market structures, and the appropriate regulatory frameworks can maximise public good. While private ownership may be the right option in some cases, in others government ownership can achieve better outcomes. Neither alternative is a panacea. The key requirements are the creation of competitive market structures and efficient economic regulation in the case of natural monopoly networks.

CEDA's recent publication, Privatisation: A Review of the Australian Experience (exec summ pdf, 121Kb), is a collection of nine perspectives on Australia's privatisation experience authored by prominent economists and commentators. It again demonstrates that such a group will provide at least as many views on a subject as there are members of the group. However, it is useful to emphasise some general conclusions that can be drawn.

First, government's primary motivation for privatisation should be to achieve more efficient provision of goods and services, and not to prop up an ailing budget. This is not to disagree, however, that opportunity costs exist whenever governments invest in business enterprises.

Second, irrespective of the type of ownership, allocative and productive efficiency will improve if markets are subject to competitive market disciplines, and if there are no complex social objectives that conflict with profit maximisation and efficiency objectives.

Third, even under government ownership, public-sector managers are subject to mixed incentives and political influences that can conflict with public interest.

Where possible, industry restructure should seek to establish competitive markets or contestability and to isolate natural monopoly elements. The Kennett Government used this approach in the Victorian electricity industry, where contestable sectors such as generators and retailers/distributors were separated from the monopoly transmission network business. A similar approach is advocated by some as part of the Telstra privatisation debate. The electricity market continues to evolve with mergers and diversification into gas retailing. However, the failure of some states to create more competitive market structures and more effective and efficient regulatory frameworks, has, to a degree, limited the success of the National Electricity Market.

The level of regulatory intervention to achieve non-profit objectives must be dealt with case by case. If competitive market structures can be created, Community Service Obligations (CSO's) are simply defined and funded through budget allocations, and regulation is light-handed and based on economic efficiency objectives, then the case for privatisation is good. However, where externalities are great, and complex regulation and inappropriate price controls can negate potential economic efficiency gains then public sector management and accountability arrangements may in some cases be preferred. For example, prisons and ambulance services have not been successfully privatised.

Effective economic regulation can be the key to successful privatisation where natural monopoly powers exist. But privatisation to create private monopolies, in the absence of appropriate regulation, does not achieve efficient economic outcomes or meet public interest. It is merely an auctioning of monopoly rents or franchises.

Politically, the focus of Telstra privatisation has been on regional service provision. However, bush service levels were not adequate when Telstra was fully government owned. Today Telstra Countrywide's improvements are occurring under a regulatory framework including Universal Service Obligations and Customer Service Guarantees. Increasingly, Telstra is subject to innovative competitive markets, where privatisation is important to provide access to capital and to increase management flexibility. Telstra's Customer Access Network is a natural monopoly that is not easily divested. Telstra's capacity to innovate and compete globally would be impaired, as would opportunities to develop value-adding intelligence in the network. A critical component of successful privatisation will be effective regulation; ensuring competitors open access to the network.

While not all privatisation has been successful, there have clearly been benefits, particularly as a dimension of micro-economic and national competition policy reforms, which contributed to Australia's 1990s productivity improvement. However, the public has focused on negative aspects of privatisation, magnified by the elimination of unprofitable services and the dismantling of domestic cross-subsidies. The decline of public support for privatisation has made a difficult task even harder for governments. There is a need for governments to be more ready to step in with CSO's to meet short-term adjustments and social objectives.

Where to from here? The pace of privatisation has slowed but private-sector involvement will continue to grow. Governments must recognise what services should be provided by the public service and when private sector involvement is beneficial. They must also improve the effectiveness of regulatory frameworks and the process of regulation, both to ensure competition and economic efficiency and to be ready to achieve non-profit objectives through CSO's. Over-regulation through regulatory duplication (Commonwealth and States) and regulatory inconsistencies must be removed.

We may also see more market-based solutions, such as fuel taxes incorporating environmental externalities or congestion pricing on roads. Governments will increasingly utilise other forms of private involvement such as public-private partnerships, including BOOT (Build Own Operate Transfer) arrangements. In such cases governments must improve risk allocation, and the matching of risk and control. As the Victorian Government has discovered in public transport, residual risk rests with governments. Less ideology and more focus on creating competitive market outcomes and optimising the balance between ownership and regulation, will achieve the best public outcomes.