Privatization is a transfer of management, ownership, and/or control of any aspect of an enterprise from the public (governmental) sector to the private (nongovernmental) sector. The term (spelled privatization in the United Kingdom and most Commonwealth countries) is very broad, encompassing a wide range of activities and/or assets and methods of transferring those activities from public to private entities.

Privatization runs a gamut from large scale to small scale and from full public transfer to the private sector to more limited partial transfer. The purest example of privatization is the outright sale of a governmental asset or operation to a private corporate entity. Infrastructure assets such as roads and power-generating facilities are often in this category, having in many cases been built, owned, and operated by the government, which then decides, perhaps many years later, to sell the asset to a private operator. The asset may be directly sold, in which case the method of transfer is referred to as an asset sale; alternatively, the shares of an incorporated entity that holds the asset for the government may be floated on public share markets, or those shares may be sold to selected private entities, in which case the method of transfer is referred to as a trade sale.

An alternative method of public-to-private transfer is the concession or lease arrangement. For example, suppose a government decides to transfer a public commuter rail to a private entity. As noted above, the government could sell the rail line directly (an asset sale) or sell the shares of a governmental corporate entity that owns the rail line (a trade sale). A third alternative is for the government to retain ownership of the rail line but lease the line to a private entity for some period of time, after which the line reverts back to public ownership. This arrangement would constitute a lease or concession agreement. If the lease term is long enough (20 years or more; 75or 99-year leases are quite common in the infrastructure field), the government has de facto (i.e., in fact), though not de jure (i.e., by law) transferred ownership because of the long-term control exercised over the asset by the private entity through the lease. Leases and concession agreements can have many different legal provisions, and through these provisions, the degree of privatization can be modified. For example, shorter or more-limited lease terms can allow the governmental owner to retain more management control over the privately managed asset.

Leasing is an example of a widely used method of privatization known as contracting out. In contracting out, a service or activity (as opposed to an asset) is paid for by the government but is provided, by means of a service agreement, through a private entity. Almost any conceivable example of public service has been provided in this way, though some, such as garbage collection and information technology services, are more widely contracted out by governments than others, such as police protection. Outsourcing is another label often used to designate contracting out, though the former term is broader in that it is used for both public-to-private transfers of responsibility as well as private-to-private transfers. If the service is outsourced to a provider in another country, then it is sometimes referred to as offshoring.

This continuum of privatization has led to development of the term public-private partnership (PPP), which is often used synonymously. A broad definition of PPP refers to working arrangements based on a mutual commitment between a public sector organization with any organization outside the public sector. The common theme between privatization and a PPP is some sort of blending of private and public institutions and missions. However, privatization refers to some definite transfer of activity or authority from the public to the private sector, whereas a PPP can also include joint public-private efforts that do not involve such a transfer.

Privatization can be completed in one step or completed through a series of intermediate steps. Corporatization, in which a public operation is first transferred to a new corporate entity that is governmental but is typically run outside governmental budget and policy frameworks, is often a framework used for ultimate privatization. For example, when the Australian central government decided to privatize a number of airports that it owned and operated, it first transferred ownership of and responsibility for those airports to the Federal Airports Corporation (FAC). The FAC operated these airports for a few years before putting them up for sale, mostly using trade sales. Even if corporatization is a final outcome, the final effect may be much the same as privatizing if that corporation operates much like a private company, even though technically a governmental entity retains ownership and control.

Privatization has become widespread throughout the world with, however, a wide variation across industry sectors and countries. One study of transfers of state-owned enterprises (SOEs) to private corporations from 1977 to 1999 counted 2,459 deals in 121 countries, worth approximately US$1.11 trillion. (An SOE is a governmental corporation that is nominally operated as a company but that is typically majority owned and usually controlled by a central government.) Surveys of government managers in the United States have found large numbers of respondents, indicating outsourcing of a wide range of programs in areas as diverse as wastewater to health services.

Rationales

Governments choose to privatize for numerous reasons, the major stated rationales being that the private sector operates more efficiently and cost-effectively than the public sector in many instances, that government can achieve better overall outcomes by focusing on its core missions and core competencies while giving peripheral activities and programs outside its skill set to capable private operators, that privatization allows access to private capital that would otherwise be unavailable, that the method shifts risk to market-based entities better able to handle them, and that greater flexibility in operations is achieved.

Maintenance of the public interest is a prime concern with any privatization, and this constitutes one of the main counterarguments against its use. It is not a given that the public interest will be maintained when private parties with perhaps countervailing interests take over. A related issue is that of equity. Private operators are generally return driven and may be inclined to charge market rates and/or cut costs to maximize returns. This may be inequitable if service cuts or charges fall on groups deemed to be disadvantaged.

In general, economists note that there is a difference between an actual gain in resources and a mere transfer of resources from one party to another in which case government budgets may see a gain but other parties, such as labor unions or consumers, might see a loss. This is especially a problem where a natural or other monopoly exists (e.g., an electrical or telecommunications utility) and in which price and quality is not subject to much competition. Privatization can be said to enhance efficiency only if the gains are above and beyond any shifts of resources across different groups.

There is no a priori case for or against privatization that prevails, so the matter rests on evidence and this is mixed. There are examples of very successful privatizations that have delivered superior incomes for both public and private sectors (e.g., Japan Rail, mostly completed by the 1960s), those that did poorly on both counts (e.g., the initial privatization of British Rail), and many much more ambiguous cases. Probably the most overall successful set of privatizations has been the transfer of SOEs to private enterprises. Many privatized SOEs were running large losses, and being corporate in organization, there seemed to be little economic reason to keep them in public hands. Even here, however, there have been failures, even transfers back to the public sector in a few cases.

In general, it is clear that privatizations, being negotiated arrangements between governmental and nongovernmental entities, will be successful only if the agreements are sound and well implemented and, in some cases, regulated afterward. Some transfers, such as an SOE, will be relatively straightforward to sell to the private sector, while others, such as complex public services, will be more difficult to arrange successfully. Privatizations certainly have wide applicability and do offer one of many alternatives for governments to use in providing services, but to work they need to be designed properly and may not always be the best available method of reform.

Bibliography:

Daniel Berkowitz and Jonathan Holland, “Does Privatization Enhance or Deter Small Enterprise Formation?” Economic Letters (v.74/1, 2001);
Bernardo Bortolotti, Marcella Fantini, and Domenico Siniscalco, “Privatization Around the World: Evidence From Panel Data,” Journal of Public Economics (v.88, 2003);
Ingrid Hagen and Thea S. Halvorsen, Global Privatization and Its Impact (Nova Science Publishers, 2009);
Graeme Hodge, Privatization: An International Review of Performance (Westview Press, 2000);
Sunita Kikeri and John Nellis, Privatization in Competitive Sectors: The Record to Date (World Bank, 2002);
Ira W. Lieberman and Daniel J. Kopf, Privatization in Transition Economies: The Ongoing Story (Elsevier JAI, 2008);
William Megginson, The Financial Economics of Privatization (Oxford University Press, 2005);
Gérard Roland, Privatization: Successes and Failures (Columbia University Press, 2008);
Andrei Shleifer, “State Versus Private Ownership,” Journal of Economic Perspectives (v.12/4, 1998);
Vickers and G. Yarrow, “Economic Perspectives on Privatization,” Journal of Economic Perspectives (1991).

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