The seven deadly myths of privatisation


The arguments put by the advocates of public utility privatisation are strong on rhetoric but generally weak on fact, according to JOHN ERNST, associate professor of sociology at the Victoria University of Technology. Ernst, one of a panel of speakers at a March 22 meeting in Melbourne to protest against state government moves to privatise gas, electricity and water utilities, presented the following paper on the British experience of gas, electricity and water privatisation. The paper has been slightly edited for length.

The British experience is likely to be particularly informative of what could happen in Victoria because the Kennett government has been heavily influenced by the British privatisation program. This is reinforced at an operational level by the extensive use of British merchant banks and management consulting firms as key advisers in the restructuring and sale of the State Electricity Commission (SEC), Gas and Fuel Corporation and Melbourne Water.

I want to consider seven major arguments put by those promoting privatisation — which I would describe as the seven deadly myths of public utility privatisation.

1. That privatisation will lead to open and active competition amongst the new utility companies, which will give ordinary consumers new opportunities for exercising choice and exerting their power as so-called "sovereign" consumers.

Despite the emphasis given to the creation of competition as a major factor in privatisation, it is highly unlikely that competition will exist in that part of the market which directly affects domestic and small users of energy and water services — that is, local distribution and supply — because of the "natural monopoly" features of this sector of the market. Clearly, if competition is non-existent, then the capacity for consumers to exercise choice and to obtain the other benefits usually associated with competitive markets, will also not materialise.

This has been the case in Britain, where after years of privatisation (seven years in the case of gas, four in water, and three in electricity), domestic consumers have no more choice today than they did prior to the industries being sold into the private sector. Now as then, ordinary consumers in Britain are confronted with one choice only, that is to receive their electricity, gas or water from a regional monopoly supplier. The only thing that has changed is that the monopoly provider is now privately rather than publicly owned.

It is fair to say that a measure of competition has been introduced into the electricity industry (and to a lesser extent, in the gas industry) in Britain, but this has been restricted to competition for the business of major industrial and commercial users of energy. The impact of this has been that generally prices for major users have declined, arguably at the expense of the "captive" part of the market (i.e. domestic and smaller consumers), who have had to bear price increases

2. That privatisation will lead to lower prices and better standards of service.

With the exception of gas, domestic public utility tariffs in Britain have risen faster than the rate of inflation since privatisation. This has been particularly dramatic in the case of water and sewerage rates, which have risen close to double the rate of inflation, although part of this rise has been due to the need to invest massive sums into the decaying water and sewerage infrastructure and to meet environmental standards.

According to Oxford University economist George Yarrow, electricity prices are now 25% higher for domestic consumers than they would have been had the industry remained in public ownership. And most independent commentators attribute the real terms decrease in gas prices not to "efficiency savings" as a result of privatisation but to the reduction in the price of natural gas from the North Seas fields over the past seven years.

As private companies, the utilities will be expected to earn a higher rate of return by their shareholders than would usually have been the case under public ownership. This in itself suggests that, unless quite startling efficiency gains are made, prices — particularly for the "captive sector" of the market — are likely to increase rather than decrease.

The application of what is known as "economic pricing" policies (full cost recovery, user pays, volumetric charging and the removal of cross subsidies) — which in Victoria was stimulated by the corporatisation measures of the former Kirner Labor government — will accelerate under privatisation. Both the SEC and Melbourne Water have argued that domestic consumers are substantially subsidised by industrial and commercial users, and measures to correct this will result inevitably in steep increases to domestic tariffs.

Increases in tariffs will affect different consumers differently, with low income households being particularly hard hit by price rises — this is because their fuel and water bills take proportionately more of their income than is the case with more affluent households. The rise in electricity charges in Britain has deepened the level of "fuel poverty", and the size of water

bills has given rise to the new phenomenon of "water poverty".

Since privatisation, there has been a 300% increase in the number of income support recipients who are in debt for water charges. The increased difficulties faced by low income families in meeting their escalating water bills, combined with a more vigorous approach to debt management by the private water companies, has also led to an explosion in the level of water disconnections. Between 1991 and 1992, the number of domestic disconnections rose from just over 7500 to over 21,000 (a rise of 177%).

3. That turning the public utilities into private companies results in a dramatic lift in their performance and efficiency.

There is little evidence that privatisation naturally leads to major efficiency and performance gains. Studies carried out by researchers like Dunsire, Hartley and Parker in Britain show that there is no consistent direction of performance improvement once government business enterprises are privatised. Some get better and some get worse.

At a superficial glance, the profit results of the privatised utilities in Britain seem to suggest that the industries are performing well. However, most independent commentators attribute the 137% increase in water company profits since privatisation, for instance, to the extraordinarily generous deal negotiated between the companies and the government prior to privatisation (particularly the inflated estimated rate of return and the excessively low efficiency targets built into the price formula).

The clear winners from utility privatisation in Britain have been the company shareholders (who have made windfall gains) and the senior executives of the newly privatised companies — with salary increases in excess of 100% in many cases. The equally obvious loser from within the industries is the work force — which has been subjected to significant "down-sizing" and which has borne the brunt of any efficiencies extracted by the companies.

4. That the government — on behalf of the taxpayer — will obtain a fair price for the utility industries at the point of sale.

Whatever conclusions history will draw about the British privatisation program, it will definitely not conclude that the Thatcher government struck a great deal for the taxpayers of Britain when it sold the gas, water and electricity industries between 1986 and 1990.

In each case, the industries were sold for considerably less than

their actual worth. At the end of the first day of trading on the stock exchange, for instance, the energy and water utilities were collectively valued at £3.4 billion more than the amount for which they had been sold.

The British Labour Party claims that the revenue retrieved from the sales was less than half the true value of the assets of the utilities. This has been disputed by some commentators, but irrespective of whether this was the case or not, the industries are currently valued by the stock market at over twice the price for which they were originally sold. The "give-away" approach of the Thatcher government reached its height in the sale of the water industry, where, with debt write-offs and cash grants to the industry, it actually cost the British taxpayer a net £1.4 billion to "sell" it to private owners.

Perhaps the British process of selling utilities was wildly perverse and atypical, and perhaps the Victorian government will make a better fist of the task of getting money for value, but I doubt it! Already Victorian treasurer Alan Stockdale is damping down expectations about the net receipts to be obtained from the sale of utilities: "In most cases, we will be doing well to break even", he told the February 14 Age. Privatisation sales are driven by the need for them to be politically successful and for an eager response from the capital market. In this context, a level of discounting in the share price is almost inevitable.

In addition, the government will be confronted with a "trade- off" between maximising revenues from the sales, on one hand, and restructuring the industries for competition and regulation, on the other. The more concessions that are made either to the introduction of competition or to the setting up of a strong regulatory regime, the less the government is likely to raise from the sales. It is hardly surprising, that potential buyers would be willing to pay more for a minimally regulated monopoly, than for a business with competitors and tight regulation.

5. That the sale of major public assets will enable all Victorians to have a stake — through purchasing shares — in the industries.

The desire to create what is amusingly described as a "share- owning democracy" formed a strong motivation in the privatisation program of the British government. Although, to date, this argument has not been articulated with the same fervour in Australia, I suspect that as the privatisation machinery gathers momentum, so will this appeal to popular capitalism.

The obvious flaw in this argument is that it fails to acknowledge

that, under public ownership, all of us taxpayers presently hold a stake in the utilities. So, as was often asked in Britain, why do we need to be encouraged to buy what we already own?

There are also other significant — and perhaps no less obvious — flaws. The opportunity to share in the popular capitalist feast is conditioned by an ability to afford the price of an entrance ticket. Even when it is heavily discounted in the form of cheap shares, lack of income (or indeed information, or interest) will preclude substantial sections of the populace from participating.

This has been very much the case in Britain, where, despite the increase in the number of adults holding shares, significant sectors of British society are under-represented or excluded altogether. The General Household Survey analyses of share ownership reveal — not surprisingly — that the profile of new equity holders in Britain is heavily skewed towards middle-aged, professional men in the south-east of England.

All the privatisation share sales in Britain have managed to do is retrace and deepen the contours of economic inequality in British society. It has effectively represented a transfer payment from all taxpayers to the already wealthy or affluent sectors of British society.

In Australia, the redistributed wealth resulting from privatisation sales will not even be able to be retained within the country (as was largely, but by no means entirely, the case in Britain). Within the vastly smaller capital markets of Australia, the extensive involvement of foreign investors will be required in the flotation and sale of state public utilities.

6. That privatisation needs to be accompanied by only "light touch" or minimal regulation.

Thus far, the Kennett government has revealed precious little of its blueprint for the restructured and privatised utility industries. On those rare occasions when mention has been made of regulation, usually it has been in terms of how regulation needs to be non-intrusive and "light touch" in character.

The treatment of profoundly important questions to do with the control of private monopoly-provided essential services in this dismissive and complacent way amounts to a dereliction of the trust of "stewardship" that we as citizens implicitly place in government.

In my view, the major lesson to be learnt from the British experience is this: that a strong legislative framework of regulation, in tandem with the existence of independent, vigorous

and consumer-oriented regulatory bodies, is an essential precondition for the protection of ordinary consumers. Even the British government belatedly recognised this, and in 1992 additional legislation was introduced to strengthen the powers of the water, gas, electricity and telecommunications regulatory bodies.

Gas has been in private ownership (since 1986) longer than the other industries. A study of the interaction between the gas regulator and the monopoly provider, British Gas, over the past eight years, shows that virtually all of the gains that have been made have been achieved as a result of regulator direction and insistence, rather than because the company was voluntarily willing to concede them.

Regulation is necessary to "keep the bastards honest". Privatisation without effective regulation would be popular with the new owners and managers of the utility companies for obvious reasons, but it would be a disastrous outcome for households.

7. That public utilities can be treated solely as businesses like any other in the marketplace, and that, like other firms, they are simply engaged in the process of producing, supplying and selling commodities.

This is a myth because it fails to recognise the characteristics of utility services that make them different from commodities bought and sold in the market place. That is:

  • It understates the fundamental importance that energy and water services play in the lives of all of us as essential and core quality of life services.

  • It ignores the fact that domestic use of energy and water are relatively unresponsive to movements in price and income (thus limiting the operation of conventional market principles).

  • It glosses over the fact that the supply of energy and water to domestic households is, and will remain (this side of a technological revolution), provided under geographical monopoly conditions (again limiting the operation of conventional market forces).

  • It overlooks the strategic importance of the public utilities to the economy and to urban and rural development.

  • It neglects the "public good' (e.g., public health, recreational facilities) and "public bad" (e.g., pollution) dimensions of the public utility industries.

The metaphor of commodities is grossly inappropriate to the services and the contribution of the public utilities in contemporary society. And the British privatisation experience has brought home the dangers inherent in this approach. This is reflected both at an individual level — i.e. the negative impact that privatisation has had on households — and at a broader level.

The loss of strategic control of the energy industry has resulted, amongst other things, in a projected mismatch between electricity generation capacity and demand in Britain by the middle of the decade, the misuse of a finite natural resource, gas, in electricity generation for short-term commercial gain, and the virtual demolition of the domestic coal industry.

Equally, the ability to use demand management as a means of reducing harmful emissions into the environment has been undermined by the commercial injunctions of the private electricity companies to sell more electricity rather than less.

Against the backdrop of global environmental imperatives and the need for contemporary governments to perform a strategic role in the management of the economy (despite what the New Right asserts!), measures to release public utilities to the control of private and publicly unaccountable managers seem to be ridiculously incongruous and out of step.

Judging from the British experience, once the public utilities are sold, they will stay in private hands for at least a generation, and quite possibly indefinitely.

The way in which the British Labour Party has progressively, but conclusively, drawn back from its initial commitment to bring the utilities back into public ownership expresses a reality that will confront future governments in Victoria. The financial and political hurdles in the way of returning the utilities to their public status will be of such an order that action of this sort is unlikely to be contemplated.

The actions of the Kennett government then take on new meaning. For, unlike most other areas of government policy, which could be reasonably easily revoked by future governments, the privatisation decision could, to all intents and purposes, be irrevocable.