The Performance of Privatisation Vol. III: Privatisation and Efficiency

Privatisation and EFFICIENCY

A COMMENTARY BY THE PRIVATISATION STUDY GROUP OF THE CENTRE FOR POLICY STUDIES

Does anyone today doubt that the privatised industries are now more ‘efficient’ than they were when they were in state hands?

Considerable improvements in the quality of customer service combined with sharp reductions in the prices charged to consumers (both of which will be detailed in Volume 4 of this series); record levels of profitability (resulting in net government receipts averaging £8 billion per year as demonstrated in Volume 2 of the Series); and an improved track record in terms of both labour and customer safety (as seen in Volme 1 of the Series). Collectively, these facts indicate that the post–privatisation performance in these industries is considerably more efficient than it was when the same companies were in state hands.

Yet what is the academic evidence? In this third study of the Series, NERA points out that, given the importance of the privatisation programme to the UK economy, there has been a surprising lack of serious work done on the productivity performance attained by companies which have been freed from state ownership. To a large extent, this comes from the difficulty of quantifying productivity performance across a wide range of industries. In particular, there is the problem of specifying what the researchers term a ‘counter factual’: what would the efficiency trend have been if the industry had remained in state ownership?

NERA’s new study reveals that the most impressive labour productivity performance has been achieved by companies such as Associated British Ports, British Airways, British Steel and BT which were privatised in the 1980s and which operated in competitive markets, or markets which were opened up to competition following the transfer of nationalised industries to the private sector.

The research team analyses the various methods of measuring cost efficiency and how, in theory, this might be influenced by privatisation as well as other factors such as GDP growth, technological innovation, the impact of regulatory regimes which accompany privatisation, and the restructuring of an industry to promote competition in the marketplace (albeit privatisation is often the prerequisite for such market liberalisation). NERA concludes that if a privatised company:

operates in a competitive marketplace, then the effects of competition and privatisation should be mutually reinforcing and cost efficiency performance should improve as a consequence.

Competition has been encouraged in many of the industries privatised by the Government since 1979 – telecommunications is a good example. Many sectors of the gas and electricity supply markets are already fully competitive and, as from next year, residential customers will be able to choose between a wide range of suppliers including well-known supermarket chains (gas customers in the West of England are already benefiting from such a liberalised market).

After exploring some of the theoretical issues involved in assessing the impact of privatisation on productivity and cost efficiency, NERA argues that establishing the impact of a ‘privatisation effect’ necessitates making an educated guess, as far as this is possible, with regard to what might have occurred if the business had remained in state ownership.

In Chapter 4 of the study the authors discuss how these issues have been addressed by academic economists. It is pointed out that the

analysis of the effect of privatisation in the studies reviewed…is based on a comparison of changes in the rate of growth of productivity in the period before and after privatisation, so that a projection of pre-privatisation experience constitutes the counterfactual or baseline against which actual post-privatisation outcomes are assessed.

While studies which employ a total factor productivity analysis provide a more accurate measure of efficiency trends, it is nonetheless emphasised that they are more difficult to calculate than studies which examine changes in labour productivity.

In the final Chapter of the study, the findings of three separate research studies by academic economists are summarised. These three studies, published over the last five years, estimate the productivity performance achieved across a sample of firms and industries which have been privatised since 1979.

The first academic paper by Parker & Martin on ‘The Impact of UK Privatisation on Labour and Total Factor Productivity’ (published in the Scottish Journal of Political Economy) analyses eleven privatised companies, both under state ownership and in the post-privatisation period up to 1992. Following privatisation, the majority of the companies reviewed by Parker & Martin showed:

a marked improvement, especially in labour productivity growth.

Their analysis found that labour productivity gains increased more rapidly than total factor productivity improvements. This would appear to reflect management efforts to tackle the excessive over-manning which was such a common characteristic among nationalised companies. The authors concluded that productivity performance throughout the post privatisation period has been especially strong in British Aerospace, Associated British Ports and British Telecom. Significantly, the improvement in BT’s performance has been greatest since 1989, when it began to face far greater competition from new entrants into the marketplace.

The second research study, by Bishop & Thompson, is a paper on ‘Regulatory Reform and Productivity Growth in the UK’s Public Utilities’ (published in Applied Economics, 1992) which examines the impact of a wide range of reforms which may have effected the efficiency performance of industries which were state owned in 1979. NERA notes that:

The results are nonetheless of considerable interest, and despite the differences in approach, show some consistency with the findings of Parker & Martin.

Looking at nine originally state owned industries or firms over the period 1970 to 1990 Bishop & Thompson’s analysis supports the Parker & Martin study in finding that labour productivity increased more rapidly than total factor productivity during the 1980s.

The third academic paper discussed, ‘The Effects of Privatisation, Restructuring and Competition on Productivity in UK Public Corporations’ by Haskel & Szymanski (Queen Mary & Westfield College, University of London, 1993), reports the findings of an econometric study of the factors effecting trends in labour productivity in 12 nationalised firms or industries between 1972 and 1988. NERA points out that their

…findings are strikingly similar to those reported earlier. In particular, in common with the other studies, they report a major improvement in labour productivity growth in the period 1980 to 1988, compared to the period 1970 to 1980, both in absolute terms and relative to the whole economy.

Haskel & Szymanski provide additional evidence to support the view that the growth in labour productivity is ‘enhanced by a more competitive environment’, they also point out that privatisation has had a noticeable effect on improving efficiency in both British Airways and British Gas.

Reviewing this academic literature NERA concludes that while ‘no very clear-cut evidence on the strength of the privatisation effect’ emerges ‘we believe that some important clues can be discerned’. Four points are highlighted, namely:

• Most importantly, each of the three most comprehensive studies of productivity have concluded that in most of the firms concerned there has been a significant increase in the annual rate of growth of labour productivity, not only in absolute terms but relative to labour productivity growth economy-wide. In some cases, notably British Steel, British Coal, British Telecom, Associated British Ports and NFC (National Freight Consortium), the improvement was quite dramatic.

• The improvement in labour productivity appears to have outstripped the improvements in total factor productivity performance, although there have been some striking improvements in total factor productivity growth post–privatisation, especially in British Airways and Associated British Ports, the latter no doubt linked in part to the abolition of the Dock Labour Scheme.

• Parker & Martin’s analysis suggest that the prospect of privatisation began to affect conduct and performance well in advance of the privatisation date; impressive improvements in labour productivity in the period leading up to privatisation were recorded in British Airways, British Steel, Jaguar, NFC and Associated British Ports.

• The improvement in labour productivity has been associated with a rapid reduction in employment in the publicly owned firms, whether or not these firms were privatised.

These conclusions are supported by earlier research[1] published by the Centre for the Study of Regulated Industries which suggests that efficiency gains are greatest where competition is keenest.

While NERA refers to the difficulties of identifying causal links for the observed changes in productivity performance and the fact that ‘the extent of post privatisation performance available to each set of researchers has been very limited’, the economists deduce that:

…the most important influence on cost efficiency is the effectiveness of product market competition faced by the firm, and that the effects of privatisation and those of more effective competition are mutually enforcing.

Since so many nationalised industries operated as statutory state-owned monopolies, one of the greatest benefits derived from privatisation is the removal of monopoly and the opening up of important sectors of the UK economy – such as telecommunications, energy, and now railway transport – to a contestable market where the customer can choose from a wide range of competing suppliers. Without privatisation, the industries would have continued to be dominated by a single, monolithic public corporation which was inevitably less responsive to consumer demand and taste.

Taking these trends into consideration NERA concludes that:

We would expect the process of extending competition in the utility sector, now well established in telecommunications, electricity generation, commercial and industrial energy supply, and railways, and now in prospect in the domestic energy sector, to be a continuing source of cost efficiency improvement in the industries concerned.

NERA - Thursday, 6th February, 1997