Thinking it through

Why corporatisation could be a better way to regulate

State ownership has been rejected and privatisation accepted, too often uncritically by neo-liberal reformers. However, corporatisation - sometimes described as a ‘halfway house’ between state-ownership and privatisation - may offer a better model for regulating monopoly public utilities such as water, public transport and electricity in developing countries.

A corporatised enterprise is owned by the state but its directors are independent and unlike many state-owned enterprises (SOEs) performance contracts mean that key employees can be fired if they perform badly. Because ownership and regulation is kept within government, corporatisation means that regulation is moved from the adversarial regime it is in privatisation to a cooperative one, where information asymmetries and opportunities for contractual ‘hold-up’ as discussed by Parker and Kirkpatrick are less severe. But corporatisation may offer a better deal for the poor as well.

In a typical SOE, overstaffing and corruption lead to inefficiencies and high production costs. Political pressure and subsidies keep consumer prices below average production costs and the enterprise tends to overproduce. The quality of goods and services suffers, the state pays, but the poor gain through lower prices and increased access.

In a typical private enterprise competition pushes production costs down and quality standards up. Prices to consumers are lowered as a result of incentives to improve efficiency. In this case the poor might also benefit.

But many public utilities are natural monopolies - they do not face competition. In this case privatisation leads to price rises and a restriction in output. As a consequence, the poor clearly lose out.

In terms of welfare, the aim in regulating a privatised monopoly is to turn gains in efficiency into benefits for the consumer in the form of lower prices. By mimicking competition, regulation pushes privatised monopolists to lower prices and increase output. However, unless the government subsidises production costs, prices will still be higher than with SOEs.

Corporatisation promotes efficiency by making employees stick to performance contracts. Although a corporatised enterprise is unlikely to get rid of all inefficiencies (after all, it knows that in theory the state could rescue it if it got into trouble) or eliminate overproduction (it might still experience some political pressures despite performance contracts) the conversion of efficiency gains into lower prices for the consumer is more likely. Despite prices being higher than with SOEs, overall welfare improves. Targeted life-line subsidies can also be used to compensate poorer groups.

Paul Cook and Raul V. Fabella
Centre on Regulation and Competition
IDPM
University of Manchester
M13 9GH
UK

Paul.cook@man.ac.uk

See also

The possibility of corporatisation being able to serve the poor better is demonstrated through economic models in Cook and Fabella (2002) ‘The Welfare and Political Economy Dimensions of Private vs State Ownership of Enterprise’, The Manchester School, vol. 70 (2) pp 246-261 (an earlier version is available at: htpp://idpm.man.ac.uk/crc/wpdl149/wp1.pdf (PDF)).

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