Subscriber OnlyEconomy

Disastrous UK policies teach a valuable lesson on privatising essential services

Privatisation can work in competitive markets, but can it preserve public services?

Street entertainment at the announcement of the Telecom Éireann share offer price and allocation in Dublin in 1999. Photograph: Eric Luke

John FitzGerald's face
John FitzGerald
Fri Jan 5 2024 - 06:00

The ideological approach of the Thatcher government in the 1980s resulted in privatisation of a large number of important government companies, many of them public utilities. The belief was that these entities, under private sector ownership, would be much better run, resulting in lower costs and improving the overall efficiency of the UK economy.

With the benefit of hindsight this drive to sell-off important national assets was ill-thought out. The wholesale privatisations were not accompanied by the development of a suitable regulatory framework to ensure that in private hands the companies would continue to serve the public interest.

UK economist Dieter Helm has highlighted the very serious failings of just three of these privatised utilities, Network Rail, The Royal Mail and Thames Water. Each is a monopoly provider of a vital national service so that their disastrous performance since privatisation has imposed a very heavy cost on the UK public. The inadequate regulatory framework established at privatisation was in each case a key factor in the subsequent failure of these companies to deliver adequate services once in private hands.

The privatised companies had a strong incentive to cut costs to boost the profits of their new owners, but this meant they also stood to gain by cutting back on important investment to tackle problems, such as pollution, that the public interest required, and which weak regulation failed to prevent. However, probably the most serious failure of regulators in terms of consequences was that they did not stop the wholesale financial engineering by the newly-privatised companies.

READ MORE

When the new owners bought the nationalised firms they originally invested their own shareholders’ funds. However, once they had bought the companies they borrowed heavily and essentially drew out their own shareholder funds by paying themselves large profits while the companies became ever more indebted. They also paid their senior executives incredibly high salaries – further salt in the wounds of the British public.

As the share of borrowing grew relative to shareholders’ funds in these highly-geared companies, the ratio of any profit made to the limited shareholder investment rose. In turn that made the shares more valuable. This temporarily helped reassure lenders, who were providing the bulk of the finance, resulting in lower interest rates.

Once these companies were almost fully funded by debt there was no more scope for such financial engineering. If they made a loss they would be unable to service their debts, leaving them insolvent. However, because they provided vital national services, like railways, post and water, they could not be allowed to go bust. Therefore the regulators had little option but to allow the companies to charge the public whatever was necessary to ensure they continued to make a profit and service their debts.

Whatever about the business-as-usual scenario, such highly-indebted companies were unable to make new investments because lenders would no longer trust that they would get their money back. Any new developments would, therefore, need to be financed almost entirely by shareholders rather than partly by lending, as would be normal. The outcome has been a totally inadequate level of new investment in these key public services. Try using railways in Britain – they are unreliable and very expensive compared to the efficient services provided in France or Spain.

The UK wave of privatisations had some influence on other governments, including our own. In 1999 Telecom Éireann, now known as Eir, was privatised. The Irish regulator was unable to prevent the newly-privatised company from undertaking UK-style financial engineering. Leveraged to the hilt, Eir was unable to borrow any more money to finance investment to deliver nationwide broadband. Its shareholders were also unwilling to fund this investment. As a result the State has had to step in and fund this essential element of today’s economic infrastructure.

Fortunately, no other similar experiments in privatisation of utilities were undertaken by Irish governments.

In competitive markets with many firms private companies offer the best means to provide services and deliver needed investment. However, this logic does not hold for essential utilities like water, electricity or gas transmission, which are natural monopolies. Therefore utilities providing vital national services should remain in state hands.

Very often the most efficient approach is for such utilities to buy in particular inputs or services, through competitive tendering, where there is genuine competition. This can keep downward pressure on costs. However, retaining these firms in public ownership ensures that the companies maintain an appropriate capital structure to fund essential investment. This safeguards the public interest.

READ NEXT
LATEST STORIES