privatizare dif publi privat_2005

7/28/2019 Privatizare Dif Publi Privat_2005

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Can Competition Eliminate Public and Private Differences?

A Key to Understanding Privatisation

By Damilola Olajide**

Economists generally view competitive behaviour of firms operating in an

industry as desirable. Competitive behaviour leads to socially desirable

outcomes. When producers compete, they will choose socially acceptable

levels of production and will undertake profitable investments that increase

asset value. As a result, products are of high quality and prices are set at the

opportunity cost of producing the good or service. In this way, competition

ensures that resources are allocated to their best uses. In the absence of any

externalities, competition promotes technical and economic (allocative andproductive) efficiency.

When competition is absent however, the exact opposite may be the case,

leading to inefficient allocation of resources. Producers will set prices above

the marginal cost leading to monopoly prices, and may employ inefficient

production techniques. When a firm does not face competitive pressures of

rivals and possible entrants into the product market, there is little incentive

to indulge investments that improve technology and innovation.

The importance of competition raises an issue of whether ownership does

matter after all. Does ownership change (privatisation) matter if gains in

efficiency can result from increase in market competition? A school of

thought argues that it is competition which affects firm behaviour rather than

ownership. This argument ignores a key issue, which is whether competition

alone is sufficient to eliminate differences in behaviour of public and private

firms. That is, whether the government can perfectly remove public and

private differences.

This contribution paper presents two lines of counterarguments to show whycompetition may not be sufficient for achieving efficient market outcomes.

The limits of competition mark a point of departure from previous

propositions and provide way to understanding why privatisation matters.

Firstly, if competition alone is sufficient, then the government should be able

to effect changes in public firms that improve economic efficiency and

improve asset value without necessarily changing ownership. In this case,

privatisation would not matter. Secondly, if competition alone is sufficient,


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then ownership should have no effect on behaviour (performance), even

when firms operate in a competitive market. Empirical evidence supports the

counterarguments in the sense that both ownership and competition matterfor firm behaviour. Empirical evidence supporting ownership effects on

performance under perfect competitive market assumption is overwhelming.

An understanding of the key differences between public and private firms

and the mechanisms through which the government can perfectly remove

such differences are necessary for an understanding of privatisation or why

ownership matters for firm behaviour and what explains behavioural

differences between public and private firms.

Public and private firms differ in some respects. Three major differences canbe identified. These are objectives, monitoring, and managerial incentives.

Firstly, it is sometimes argued that behaviour differs between public and

private firms because they do not face the same objectives. This argument is

less convincing. Truly, the range of objectives facing public firms is higher

relative to those facing private

firms. Private owners are motivated by profits. Production at lower costs can

achieve this. However, there is no reason why the public firm cannot also be

made to seek profit maximisation and to produce at lower costs. For

example, a corporatised firm seeks profit maximisation, even though it isunder public ownership.

Also, operations of public firms are affected by political intervention.

Politicians tend to manipulate operations of public firms in order to achieve

political ends. Political intervention may take several forms including

maintaining excess employment, transfer of wealth in favour of political

supporters. Public firms also provide a platform for corruption and nepotism.

Political intervention is distortionary to efficient operation and affects the

extent to which profitable outcomes are enhanced in public firms. Thus, a

public firm becomes relatively less profitable and less efficient than

comparable firm in the private sector. It cannot be discountenanced

however, that both private and public firms are subject to political

intervention. The nature and extent of intervention may differ however.

The second source of differences between public and private firms is the

disparity in the ability to monitor managers. Ownership is concentrated in

private firms, whereas ownership is highly diffused in public firms.

Ownership shareholding of a private firm can be traded on the capital


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market. Private owners have incentive to monitor the performance of their

managers through the capital market. Even where shareholders of the private

firm are diverse, the capital market also aligns the interests of shareholdersand managers. This sort of monitoring is less obvious for public firms. Even

when ownership shareholdings in a public firm are traded on the capital

market, ownership shareholding is highly dispersed with no identifiable

shareholder that has sufficient voting rights to effectively control or to block

decisions in the firm. The result is that there is little incentive to monitor

public managers. Also, public managers tend to free-ride on any monitoring

efforts of the government. An implication of the disparity in monitoring is

that operational efficiency will be lower in public firms relative to private

firms, even if both firms operate in a competitive market.

Differential incentive is the most influential source of performance

differences between public and private firms. Ownership matters for firm

behaviour because managers of public and private firms do not face the

same incentives. The public sector managers, who carry out the day-to-day

operations in the firms, lack sufficient incentives comparable to private

sector managers.

The key incentive differences between ownership forms are the claimant on

managerial activities that increase asset value and rewards for efforts thatminimise costs. Under private ownership, activities that increase asset value

and minimise costs are rewarded directly, whereas such activities are not

rewarded under public ownership. Private owners benefit directly from

increase in value of assets of the firm, whereas public sector managers have

no claims on the asset of the firm. Also, private owners are liable for costs of

operating the firm, public servants are not. Therefore, whereas private

owners have incentive to undertake activities that increase asset value and

minimise costs, public servants have little incentive to do the same. Perhaps

the differential incentive view underlies a popular saying in the Yoruba tribein Nigeria that A kii se ise oba laagun, which literally translates, One

needs not sweat in undertaking government works.

Thus, if the government can remove any incentive differences associated

with ownership, public servants will behave exactly in the same way as

private owners, and privatisation might not matter. Governments often seek

to achieve this through mechanisms such as incentive contracts and

regulation. For example, the government can provide incentive regimes such


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as performance and employment contracts in attempt to make public

managers behave exactly in the same way as their private counterparts. Also,

if profitable activities of a private firm will generate social costs such aspollution, regulation may be required. Regulatory contracts can stipulate

activities to undertake and/or to avoid. How perfectly can the government do

these?

The argument borders on measures of asset value and costs. If measures of

asset value and costs are perfect, desirable outcomes as noted in the above

can be achieved. Public ownership is accompanied by appropriate incentive

schemes and private ownership is accompanied by regulation. However, the

point is that incentive contracts and regulations are far from perfect. This is

largely due to differences in the level of information (informationasymmetries) available to parties to such contracts, and regulations and

associated monitoring are costly under private ownership than under public

ownership. Empirical evidence supports these. This is why ownership

change (privatisation) can be considered as an incentive mechanism and/or a

regulatory tool for changing firm behaviour.

In conclusion, if firms of different ownership forms face similar objectives

and both are monitored at the capital market but face differential incentives,

whether they also achieve the objectives similarly will depend critically onthe incentives that motivate the managers who will carry out day-to-day

operations towards achieving the objectives. Since incentives facing

managers vary according to ownership forms, motivations vary, hence

managerial activities towards achieving objectives will also vary. This is

why public and private firms cannot always be expected to behave similarly.

Ownership influences incentives and changes firm behaviour. Thus, the

extent to which competition alone can achieve efficient market outcomes to

the extent that public and private firms will behave exactly in the same way

depends on whether it can perfectly eliminate public and private differences.

This contribution suggests that it cannot do so. An empirical issue to be

addressed is whether privatisation itself provides an optimal ownership form

in the sense that private profitable activities align social welfare.

Damilola, a Research Associate Economics Department, Monash University,

Clayton Melbourne Victoria 3800 Australia, is a Fellow of the Institute of

Public Policy Analysis in Lagos, Nigeria.

*All references for this contribution have been duly acknowledged elsewhere.

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