MICHAEL KEATING. Privatisation: When does it work, and when doesn’t it work?

Opponents of privatisation accuse it of being a key part of neo-liberal ideology. But blanket opposition to privatisation seems to me to be equally ideological. Instead, privatisation should be considered on a case-by-case basis. Accordingly, this article discusses the criteria against which the possible privatisation of a government service and its implementation should be considered. 

In a recent article posted on this blog, Privatisation is a clear example of the failure of neoliberalism, (Pearls & Irritations, 24 October), John Menadue, asserted that ‘There is a litany of privatisation abuse and failure in Australia’. I beg to differ as I don’t find such broad-brush statements helpful.

Instead my starting point is that not all privatisations are the same. For example, governments have accepted the responsibility to ensure access to services such as health and legal aid, and governments are the main source of funding for such services, but the services are mostly provided by private contractors who the individual client often chooses for him or herself. Similarly, public works are paid for by governments, and governments control their timing, location and design, but the works are again mostly provided by private contractors, although this was not always the case.

What intrigues me is that as far as I am aware, there has been no substantial criticism of these forms of privatisation. Indeed, when governments privatised the construction of public works there was no public outcry, and instead it was generally accepted that the change led to greater efficiency, with no loss of government functionality that mattered.

So while the critics of privatisation shape their arguments as if they are opposed to all privatisations, implicitly at least, there would seem to be at least some forms of privatisation which are in practice acceptable. In that case, however, then surely the logical step would not be to condemn all privatisations willy-nilly, but instead to consider what criteria would help determine when a privatisation is acceptable and even useful, and when it is not. Unless such criteria are employed, both the opponents and proponents of privatisation would seem to be equally capable of being ideological.

The purpose of this article is therefore to contribute to a more informed assessment of privatisation by discussing some criteria that should be addressed when deciding on each individual privatisation. In addition, even where in principle the particular privatisation meets the criteria and appears to be sound, in retrospect it may well fail because (like a lot of well-intentioned government policies) there was a failure of implementation. So I will also discuss the need for implementation plans to reduce the chances of such failures, but it is important to recognise that in that case it doesn’t mean that the decision to privatise was necessarily wrong.

Criteria when considering privatisation

As economists generally recognise, competition is more important than ownership in determining performance. Accordingly, the first criteria to be addressed when considering a possible privatisation, is the nature of competition in the market. If the organisation is a monopoly, then there is a strong presumption that it should not be privatised. In my personal experience the Hawke/Keating Governments, when they decided to privatise the airlines and banks paid specific attention to the degree of competition in the relevant markets. Furthermore, while John Menadue describes the CBA as being a ‘people’s bank’ before privatisation, I think the experience of most customers was that neither the CBA nor the two publicly-owned airlines were performing any service that their private competitors didn’t provide equally well at much the same prices. And I think the same can be said of Telstra, whose performance has improved enormously since it stopped being part of a government department; although in this case I would agree with John Menadue that it was a mistake to privatise the network business, which is a natural monopoly.

The biggest advantage of competition is that it can usually be expected to drive greater innovation and efficiency compared to a monopoly, irrespective of whether that monopoly is publicly or privately owned. For this reason, governments have contracted out a number of specialised services which they purchase on their own behalf or on behalf of others. Purchasing services for its own use can also give governments greater flexibility, to better accommodate peaks and troughs in the demand for these services, and to adjust to changes in their demand. For example, while some government buildings, housing public institutions, such as the Parliament, the Opera House, art galleries, museums, etc., should clearly remain in government ownership, renting office accommodation and warehouse services often gives the government much greater flexibility to adjust to changing demands. Contracting-out also gives the government access to new ideas and specialised skills, which it only requires infrequently so that it is not economic to provide them in-house. In my opinion, however, governments should generally not contract out their core-business, as that will lead to a loss of skills and capability, which will compromise the effectiveness of government. And unfortunately, I think this has happened in recent times.

The other big advantage of competition is that it provides choice. Of course, there are some government services, such as justice or the determination of entitlements, where choice is completely inappropriate. However, there are other services, particularly human services, where choice and innovation can lead to improved outcomes for the individual client. For example, the former Commonwealth Employment Service (CES), like most government bureaucracies, was very focused on providing a uniform service to all its clients, whereas long-term unemployed people required more individual assistance, which non-government providers were better at delivering. Consequently, and on the advice of an expert group including representatives of welfare organisations, the Keating Government introduced a program to assist long-term unemployed people where they by-passed the CES and were assisted by various approved welfare organisations to become job-ready and to find jobs. As someone who was directly involved in this endeavour, I don’t recall anything other than approval for this example of privatisation, which has since been extended more generally and the CES has been wound up with no significant public outcry.

Another criterion when considering privatisation, which is too often ignored by those who are very aware of ‘market failure’, is the risk of ‘government failure’. To take a topical example, does anyone seriously believe that if the government still owned the Liddell power station, they would not be seeking to extend it beyond its economic life, so it could continue adding to carbon emissions for even longer. More generally, Pearls and Irritations has exposed many examples of poor government decisions to build new infrastructure, and while many of these relate to activities that cannot fully cost-recover and be privatised, there is an argument that investment decisions are better taken by people who are risking their own money, than by people who are spending our money, and who would never risk their own on the same venture.

In this context it is worth exploring the privatisation of electricity a little further. This is a very topical issue at present, and John Menadue quotes approvingly the comment by a journalist that ‘the privatisation and deregulation of gas and electricity has failed consumers’. However, a careful review by the Productivity Commission found that the one period when electricity prices did stabilise was between 1993 and 2000 when much of the privatisation actually occurred and competition policy was introduced. While more recently, the Australian Competition and Consumer Commission (ACCC) in its exhaustive review of the reasons for the increases in electricity prices over the last decade never mentioned privatisation, and subsequently the ACCC at its press conference made it clear that privatisation was not a cause of high electricity prices. Instead, the ACCC found that the main causes of these higher electricity prices were failures of regulation and government policies; including the ‘gold-plating’ of the network standards by the regulator, the deliberate reductions in competition by the Qld. and NSW state governments, and the setting of excessively generous solar feed-in tariff schemes. Interestingly increases in retail margins, which have been the subject of much criticism, only account for 16% of the increase in retail electricity prices over the last decade.

Implementation failures of privatisation

Frequently where government policies are deemed to have failed, it is not because they were conceptually unsound, but because their implementation was poor. Although it should be added, that this poor implementation often occurred because there was insufficient planning at the beginning on how best to carry out that implementation. However, in such cases there is no necessary reason to abandon the policy; rather the response should be to improve the implementation of the policy.

I would contend that the privatisation of vocational education and training (VET) represents such an example. This privatisation has universally been condemned (including by John Menadue), but in my opinion it did not fail because it was conceptually unsound. Indeed, I will argue below that introducing greater choice of provider has had advantages. However, the widely perceived overall failure of VET privatisation was because little attention was given to the need for and nature of the regulatory arrangements that should have accompanied the opening-up of VET to competition.

As has widely been cited, too many shonky training colleges were enabled to access public funding, and frequently their trainees received no or very poor training. Victoria which led the way in introducing VET privatisation was the worst in this respect. By contrast, in South Australia the government learnt from the mistakes of other jurisdictions, and only approved training providers were eligible for public funding, and this approval was required for each course and was based on the provider’s past performance. The result was that the cost in South Australia was reduced by around one third, access was often improved, the system became more responsive, and overall the quality of training was maintained.

Another example of what I consider to be failed implementation, cited by Menadue, is how the NSW government constrained competition between different ports in order to achieve a higher price. However, no neoliberal, as I understand that term, would have favoured such a restraint of competition – that sort of behaviour is only dreamt up by rent-seeking conservatives, and never neoliberals. Furthermore, this example doesn’t prove that the sale of ports was wrong, if those ports had been allowed to compete with each other.

I would equally question John Menadue’s example of the privatisation of hospitals in NSW and SA, which were subsequently bought back. It is not unusual for someone to pay too much for an asset, which they subsequently sell at a lower price. Indeed, there is a well-known example of a TV station being bought back by the original owner at a lower price than he sold it for. The present value of an asset should be determined by the sum of its expected future returns, discounted for time delays and risk. If experience suggest this value has fallen then its repurchase should be at a lower price, but that doesn’t make the original sale wrong in itself. So to my mind, any criticism of this sale and repurchase should only be directed at the governments if they paid too much when they repurchased the hospitals and not necessarily at the original sale.

Finally, John Menadue is properly critical of cronyism where asset sales are not at arms-length. But that is criminal activity, and again it is not a criticism of privatisation per se. Equally, paying excessive fees to various advisers is again breaking the rules governing the use of consultants, and should not be a consequence of any decision to privatise. Furthermore, as someone who has been responsible for a number of major privatisations, I would contend that such failures, while inexcusable, remain exceptional – certainly the onus should be on the accusers to produce the evidence rather than tar all of us involved with such accusations.

Conclusion

My assessment is that not all the privatisations that have occurred since the mid-1980s were wrong, but I acknowledge that not all were successful either. What is most important, however, is to judge each individual privatisation on its merits, and to learn from the experience of past privatisations so that we can do better in the future. Furthermore, where the failures represent regulatory failures it is never too late to introduce the necessary regulatory reforms.

Michael Keating is a former Secretary of the Departments of Finance and Prime Minister & Cabinet. In the former role he was responsible for the advice and management of the major privatisations carried out by the Hawke Government. In the latter role his department was at that time responsible for the development of competition policy, which was introduced by the Keating Government and adopted by the COAG.

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5 Responses to MICHAEL KEATING. Privatisation: When does it work, and when doesn’t it work?

  1. John Goss says:

    There are generally efficiencies when non-core government assets are privatised into a competitive market. But experience has shown that its very difficult to maintain those efficiencies in most markets. For it to work the government has to be very smart with its regulation, as the private sector are always trying to game the system, and they are very good at regulatory capture. Paradoxically, privatisation might be more successful if we had a stronger government sector which had stronger regulatory capacity. I once asked John Deeble what was the point of keeping Medibank Private in government control, given that the government had lots of levers with regard to private health insurance, so would it really matter if the government didn’t own one of the funds. He replied that it was very useful for the government to own one of the funds, as it gave the government inside information about what was going on in the industry, and so it could regulate more effectively because it had more information about what would work and what wouldn’t. I think a similar argument could be mounted with regard to the Commonwealth bank.

  2. Evan Hadkins says:

    I find this piece quite unsatisfactory (normally I find Michael’s pieces quite good).

    “Opponents of privatisation accuse it of being a key part of neo-liberal ideology. But blanket opposition to privatisation seems to me to be equally ideological. Instead, privatisation should be considered on a case-by-case basis.”

    The reason most of us object to neo-liberalism (and privatisation) is not because it is an ideology. And those in favour probably aren’t in favour because it’s an ideology either.

    Considering stuff case by case is sensible. But the measure is applied to diverse cases – it is a generalisation.

    Which brings us to the measures used.

    “I think the experience of most customers was that neither the CBA nor the two publicly-owned airlines were performing any service that their private competitors didn’t provide equally well at much the same prices.”

    Put in reverse: customers got from the CBA and the two airlines service at prices that successfully competed with private competitors. The idea that government is less efficient is not the case – in this case.

    This defies imagination.
    ” the Keating Government introduced a program to assist long-term unemployed people where they by-passed the CES and were assisted by various approved welfare organisations to become job-ready and to find jobs. As someone who was directly involved in this endeavour, I don’t recall anything other than approval for this example of privatisation, which has since been extended more generally and the CES has been wound up with no significant public outcry.”

    Michael must talk to different people to me. The Unemployed Workers Union has a Facebook page. With a little digging he can probably find unemployed people to talk to who experienced the change from CES to private providers.

    “However, the widely perceived overall failure of VET privatisation was because little attention was given to the need for and nature of the regulatory arrangements that should have accompanied the opening-up of VET to competition.”

    This argument seems to be that privatisation and competition are good – so long as they are properly constrained by government. Which seems to presume that they can’t be wrong, only government regulation of them can be.

    “However, no neoliberal, as I understand that term, would have favoured such a restraint of competition . . . ” Maybe Michael doesn’t see himself as a neoliberal; because in education he was asking for restrictions on who competed.

    As to hospitals. Either the market set a wrong value, that wasn’t justified; or markets can just routinely get it wrong. In which case why should allow them to value assets that affect people’s lives – like hospitals.

    Evidence. This article is making considerable claims (“I would contend that such failures, while inexcusable, remain exceptional”) putting the onus of proof on the other side, I don’t really think is credible.

  3. Malcolm Crout says:

    Privatisation is only successful when funded by Government welfare – private health insurance is a case in point. The electricity market was successful in the early years due to the good state of infrastructure which is now clapped out as traditional power generation grinds to a halt. Were it not for solar and wind, the old generation capacity would never have met demand. The gold plating argument is nonsense as the private sector is lining up to buy these assets.
    The CBA, which was exposed by the Royal Commission as a criminal organisation could only be called a dismal failure. Telstra is shrinking with the lowest share price since issue, existing only on NBN (Government) handouts for the crumbling copper network. That half wit Howard sold Australia a dud and managed to lose the technical experience required to build the NBN network.
    The SA Government is being sued by the private company that built the RAH. They installed dodgy panels like the ones that burnt in London, killing people. The operator of the RAH wants out because it can’t provide services to run the place without more cash above the contracted price. The company building the SA Tram system went belly up, forcing the Government to complete the build.
    The NSW Government isn’t doing much better with blowouts in the costs of their system and of course the private contractor is blaming the Government.
    Airports have the most expensive fees in the world. Port fees are the most expensive in the world. The Darwin port (part) was sold to the Chinese who are doing nothing except holding it as a strategic asset – aka a chess piece to screw the Government when the main port expansion gets under way.
    A consequence of the sell off of public assets is that the public service is hollowed out. Decades of experience has been lost and not replaced. The private crowd in the UK have been exposed as screwing the Government out of billions since Thatcher gutted the public sector and it is now revealed they have been supported by Government payments beyond those contracted for decades.
    The private sector are not innovators at all, as most innovation is generated by the CSIRO and other University and Government funded research bodies. Private sector research is a tax dodge but produces very little innovation. The private sector are adopters who commercialise the innovations of Government.
    I’m sorry Michael, but the evidence is contrary to your stated position. The sun is setting on the neoliberal views paraded as competitive forces which is why conservatives are being turfed out of their seats.

  4. Mark Freeman says:

    I agree that in life in general, each case of something should be assessed individually. However this article overlooks an important and expensive common associated component of privatisation of finance via such misleading terms as private public partnership.

    This leads on the one hand to stratospheric project valuations and on the other little proof of the real expenditure. Repayments, tolls, charges or whatever are based on the original valuation and the finance cost works out to be like taking out a house mortgage at credit card interest.

    Around the world infrastructure costs vary significantly well beyond what can be explained by wage and land costs. Australia is in the midst of an infrastructure boom and more than ever we need to be rid of the scourge of privately sourced, designed, project managed and financed projects.

  5. Wayne McMillan says:

    Hi Michael,
    Although a small number of privatisations have been successful, the vast majority as ProfessorJohn Quiggin has rightly pointed out have been dismal failures. The international empirical evidence indicates that very few privatisations are successful and from an all round common good perspective, we are better off to provide most public services via the public sector. The recent brillant work undertaken by Professor Mariana Mazzucato indicates that a vibrant, well-resourced and entrepreneurial public sector is essential to economic and social well-being.
    Regards
    Wayne

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