PUBLIC ENTERPRISE

CHAPTER 3

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Chapters Outline
What is public enterprise
Why the study of PE is interesting
Reasons for establishing Pes
Types of Pes
The privatization debate
Major concern of PEs

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PUBLIC ENTERPRISE
Public enterprise (PEs) was for a long time an important part of the public sector in most
developed or developing countries, but, with privatization, the size and importance of the sector
is declining.

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Why the study of PEs interesting?
1-The sector is particularly important for arguments about the scope of government activity and
the debate and outcome of privatization of PEs has implications for the public sector as a whole.
2- PEs pose particular management problems even compared to the rest of the public sector,
most noticeably the control and accountability of government organizations aiming to make
money.

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PEs were the first target of those aiming to reduce the size of the public sector in the 1980s.
Selling goods and services to the public has passed its heyday.
Starting in the early 1980s it became a focus of political controversy. It is about political
questions that concerns the allowable limit of government activity. Bound up with the
ownership of PEs. As PEs operated at the boundary of public and private sectors in mixed
economies, arguments about them were often about the desirable role of government itself.
The answer in the debate was overwhelming, in developed and developing countries alike, that
governments should dispose of their PEs1.

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 PEs always had particular management problems, including accountability, regulation, social
and industrial policies, investment policy, and financial controls. Control and accountability are
particular problems for PEs, which are deliberately set up to be relatively independent of direct
political control. It has been a perennial problem both for governments and their enterprises. If
control is too tight, there is no advantage in having them set up as entities with a significant
degree of independence. If government control is too loose, an enterprise may not be
accountable to its owners, the public, raising a question as to why it is in government hands at
all. Indeed, one of the arguments for privatization is that PEs cannot be effectively controlled
and their accountability is inherently inferior to that of private companies.

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2- Reasons for establishing PEs
● To ‘correct’ market failure.
The first point refers to services, which are desired, but will not be adequately provided by the
market. Market failure can occur for reasons of natural monopoly, restriction of competition in
some other way, externalities or spill-over effects on others and where the goods produced are
to some degree public goods. To have these industries in public hands may be ‘a way of retaining
the cost advantage of a sole seller while preventing the resource misallocation which would
result from a profit-seeking monopoly’

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● To alter the structure of pay-offs in an economy.
means altering the benefits received by particular individuals or groups. Beneficiaries could
include the employees, consumers or government. One way of altering pay-offs is the extensive
cross-subsidization prevalent in PEs pricing. Rural electricity users may receive services at
uneconomical rates, while other consumers are charged more than the cost to provide that
service. If rural electricity services were provided privately, consumers would either pay more, or
the company might decide that providing the service was simply too expensive.

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● To facilitate centralized long-term economic planning.
is a motivation used in some countries. Government ownership of electricity and rail in France
enabled the provision of services ahead of demand as part of the planning process for the
nation, especially in regard to the government’s attempts to decentralize the economy. Related
to this is a general developmental role of PEs, in particular the public utility sector. In some
sparsely settled countries like Australia and Canada, utilities were established in government
hands from the beginning, due to the inability of private providers to make an economic return.
This was not market failure because of natural monopoly problems, but for developmental ones:
that is, markets were not capable of providing the necessary infrastructure. No one other than
the government had the resources to carry out the development of key services. The choice was
either to have the government provide services or for them not to be provided to consumers at
all.

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● To change the nature of the economy, from capitalist to socialist.
Has been a major factor in some countries. In UK in the post-war period, railways, steel and coal
were nationalized so that the commanding heights of the economy were in government hands.
PEs had been regarded as a form of ‘soft’ socialism, perhaps a transitionary stage on the way to
full socialism. If important industries were in government hands as PEs, this would facilitate the
transition to a socialist state

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3- Kinds of PEs
Public utilities
They provide services – water, sewerage, electricity, gas, and telecommunications – considered
essential for the economy as a whole. These are usually provided as services with connections to
households from a network. This makes for two unusual features:
1- The household connection means there is a real, or at least a tendency towards, ‘natural
monopoly’. Once a network is established, it becomes continually cheaper to add extra consumers.
Competition is constrained, as the cost of providing service to a new customer for a new entrant to
the industry, faced with the cost of establishing a network, should be higher than the rate that could
be charged by the incumbent.
2- The essential nature of public utilities means the services they supply are politically sensitive, with
great disruption to the private economy and households resulting if supplies are interrupted. Water
and sewerage connections are matters of public health as well as natural monopolies; modern life
would seem intolerable without electricity or gas. A telecommunications network is similarly
important, especially for business. All utilities are important, however. If the service provided by
utilities is inadequate in some way, or priced ‘unfairly’, it can quickly become a political issue
regardless of ownership of the industry.

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Land transport and postal service
Both are essential services like public utilities, but, unlike them, they face competition. This is
usually competition from related industries, although direct competition can occur. In US, for
example, the privately owned UPS and Federal Express compete with the US Post Office and
have a greater share of the parcel market than does the PEs. The letter mail is an essential
service, but, while ordinary letter delivery may have tendencies towards natural monopoly, it
faces competition from direct mail, courier services, fax and electronic mail.

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The competition in public transport comes from private transport, such as freight competition
from trucks, while public passenger trains and buses compete with private cars, airlines and
private buses. Public transport services could be considered as much an essential service as the
postal service and governments do find it politically difficult to cut any part of the public
transport system. Both public transport and postal services have a propensity for poor financial
returns. This has led to a run-down in systems, as capital spending is delayed and unions fight to
retain the working conditions of an earlier age. If prices are raised or services cut, governments
face substantial political costs. Even if fewer citizens use public transport, they still seem to want
the service continued and if changes are not made, continuing losses impose greater pressure
on already tight budgets. Public transport seems unlikely to be particularly profitable, so that
while private buyers have been found in such countries as Japan and Australia, there are
continuing problems. Rail privatization in the UK has been controversial and the model of a
separate company, Railtrack, running the track and making arrangements with separate
operating companies has been fraught with problems.

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Enterprises in competitive environments
These are government-owned trading enterprises which compete directly with private
companies and in the same market. This category includes banks, insurance companies, airlines,
oil companies, to name but a few. It is the form of PEs which is the one most examined in any
discussion of how to scale down the public sector. The list of PEs in competitive environments
has been considerably reduced by privatization. The question is, if they are profitable and
operate no differently from competitors, why should they be government-owned? On the other
hand, if they are profitable and well managed, why shouldn’t the government keep them and
use the profits in some socially productive way?

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Regulatory authorities
Such bodies are government-owned and controlled, and finance their activities by the sale of
commodities. They exist in some countries by use of the government’s legal powers, such as to
compulsorily acquire commodities, particularly rural commodities for further sale, or to require
the purchase of insurance for motor vehicles. The use of compulsory acquisition or compulsory
purchase is what distinguishes this group of enterprises, as their main asset is the coercive
power of government. All the above categories show strong linkages between government
ownership and government regulation. Regulation is an important characteristic of PEs. Public
utilities may have a tendency to natural monopoly in most of their operations, but this was most
often reinforced by a legislative monopoly as well. Part of the renewed political interest in PEs
has been a re-assessment of the nature and effects of the regulatory environment.

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4-The privatization debate
The fundamental questions about PEs are whether or not governments should be involved in
enterprise at all, and the circumstances in which government ownership should be retained or
discontinued.
After the election of the Thatcher government in the UK in 1979, there was an intense debate
over the question of privatization, and the 1980s saw an extensive and continuing programme of
sale of PEs. The debate did not stop there and the apparent success of the UK programme was
followed by other countries that saw privatization as a way of concentrating on core activities
and a handy means of raising revenue.
Privatization of PEs has become a worldwide movement with, first, developed countries and,
secondly, developing countries selling all kinds of enterprises. International agencies like the
World Bank and the International Monetary Fund encouraged privatization as a part of any
programme of assistance.

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5- Meanings of privatization
The word ‘privatization’ can mean many things. As the name suggests, it can mean returning
publicly owned assets to the private sector, usually ‘where control of an activity is passed from
the public sector to the private sector by means of an issue of shares’.
This view is too narrow. It makes more sense to see privatization as the reduction of government
involvement in general: as a reduction in production, but also a reduction in provision, subsidies
or regulation, or indeed any combination of the four instruments.

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Some argue that privatization can be carried out through: charging; contracting-out;
denationalization and load-shedding; or liberalization.
Others argue that the menu of activities which make up a definition of privatization includes: the
sale of public assets; deregulation; opening up state monopolies to greater competition;
contracting out; the private provision of public services; joint capital projects using public and
private finance; and reducing subsidies or introducing user charges.
Most argue about PEs is about selling enterprises – reducing production by de-nationalization –
but the other features are also crucial. There is often an interconnection between selling assets
and reducing the regulatory environment. Liberalization, by means of reducing regulation, is a
critical part of privatization, while contracting out and charging are occurring right across the
public sector.

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6- Reasons for the privatization of PEs:
Economic arguments for privatization
Stimulating competition is an attractive part of the privatization programme. In theory,
competition provides powerful incentives to both produce and price efficiently. When faced with
competition, PEs that do not operate in accordance with consumer demand, or who overprice
their products, will lose custom. Any failure to match the performance of competitors will soon
become apparent in the form of loss of market share and deteriorating financial performance.
Effective competition in the markets served by PEs would also reduce the need for detailed,
intrusive and costly government control and monitoring mechanisms.

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If competition is seen as desirable, the different instruments of privatization need to be
compared. Competition could be introduced by selling or deregulating to allow the entry of
competitors. Selling assets only improves competition if an enterprise is already in a competitive
environment; selling a monopoly with its regulation intact does nothing for competition. While a
government might sell a PEs to improve competition, it is financially tempting to effectively sell
the monopoly, as was done with a number of the UK privatizations2. There is need to sequence
reforms so that a public monopoly is not converted to a private monopoly3.

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Another economic argument for privatization of enterprises has been to reduce government
borrowing. Reduction of the Public Sector Borrowing Requirement (PSBR) was an important
element in the Thatcher government programme and is important for other governments as
well. Governments and government enterprises must borrow for capital expenditure for long-
term assets such as power stations. The economic cost of this borrowing is one rationale for
privatization. Financial markets generally prefer a low PSBR. Reducing the PSBR is supposed to
lower interest rates and thus help the economy.
While superficially attractive, the idea has certain flaws. To start with, ‘crowding-out’ of
investment, where interest rates rise because government borrowing is high, is based on the
assumption that government spending or borrowing is inherently wasteful, and private spending
productive.

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Managerial efficiency and privatization
The efficiency argument for privatization claims that private management is inherently superior to
public management. There are argued to be theoretical or practical influences on PEs management
that lead to inferior performance.
There are theoretical differences between them in the structure of incentives available to
management, and, because PEs operate in a political environment, management there may be said to
be less straightforward. Perhaps public service conditions are not conducive
to excellence. But the managerial argument is more than this: it is that public management is
inherently inferior. The private sector is assumed to have a time-tested set of incentives and
accountabilities in place, and as these are not present in the public sector, there must be inefficiency.
The only problem with this view is that evidence is hard to find, and far from persuasive when it is
found. Systematic evidence on the relative efficiency of public and private production is extremely
limited and ‘universal generalizations are drawn on the basis of a few empirical studies and
impressionistic examples’ (Heald, 1983, p. 308).

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Ideological arguments
Wiltshire (1986, p. 358) mentions the ‘ideological fervor which has driven British experience to
the point where New Right forces want to produce a fundamental irreversible redistribution of
power and voting intention’4. Privatization is part of the more general debate about the
respective merits of market and non-market systems of resource allocation. Ideological
considerations are certainly important for the privatization debate. On one side there are those
who argue that privatization affirms the limited role of government and the superiority of
private enterprise. On the other side some opponents of privatization are equally ideological.
PEs is seen as bringing closer a fairer, even socialist, society. This group, therefore, fervently
opposes all privatization.

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7- Major concerns of PEs
Control and accountability
Once any organization is in government hands, there must be questions about its accountability.
In theory, all parts of government are accountable to the political leadership and finally to the
people. The question of accountability was once the major concern in public administration
studies of PEs and statutory authorities, with any concern about ownership coming much later.
Although the main question now is certainly that of privatization, the concern with
accountability remains important. According to Aharoni, PEs inefficiency is not necessarily the
result ofownership; their abysmal record ‘has been the result of the structure of their control
and processes of their management, including their relations with the government’ (1986, p.
407). That accountability is a fundamental problem can be seen from the three distinguishing
characteristics of PEs: ‘First …they must be owned by the government. Second …[they] must be
engaged in the production of goods and service for sale …Third, sales revenues … should bear
some relationship to cost’ (Aharoni, 1986, p. 6). These characteristics can lead to confusion in
accountability.

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PEs are organizations designed to be a part of the government sector, but also to operate
commercially. They operate commercially but have no shareholders; they are government-
owned but are usually not funded by government. They have their own management and
boards of directors, but are also responsible to a minister. A PEs is often required to meet other
objectives, rather than simply trying to maximize profit like a private company.
In private corporations, the shareholders’ ability to sell their stock or vote out management
creates incentives for those who control the enterprise to serve the interests of owners. The
very diffuse, non-transferable shareholding that characterises government ownership, by
contrast, reduces these incentives. Consequently, those who control the PEs pay less attention
to the interests of their taxpayer shareholders, and groups with more concentrated interests,
such as suppliers, consumers and employees, can influence management to favour them over
the taxpayers.

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The problem has been to find a mutually satisfactory accountability system for both government
and the enterprise. At present different parts of the accountability system have particular
problems. All government operations are under the control of a minister, but the minister has
political goals that may not necessarily relate to enterprise performance. And, in a way unlike
accountability in a government department, the minister is somehow responsible for
commercial performance in the marketplace, as well as political performance. Balancing these
two goals is, in practice, very difficult and leads to problems. The minister is directly lobbied by
interest groups, voters, unions and workers, other members of the government, the bureaucracy
of the minister’s own department, bureaucrats in other departments, as well as what could be
considered ‘normal’ links with the board and management of the enterprise. With such
complexity, it is unsurprising that problems of accountability occur.

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Enterprise management is often regarded as risk-averse, desirous of the quiet life, without
adequate rewards or sanctions, and not as competent as in the private sector, in part because
the ultimate sanctions of dismissal or company failure are muted. With goals and objectives
being vague, it may not be possible to decide just how good PEs management actually is. Poor
accountability relationships allow the opportunity for evasion of responsibility. Management can
blame government directions for any shortcoming; governments can blame management;
boards can blame both. Governments have often considered their PEs to be beyond control,
while at the same time PEs managements have been consistently opposed to what they see as
unnecessary levels of intrusion into their activities. The questions of privatization and
accountability are linked. One of the arguments for privatization is that public ownership means
an absence of real accountability. In this view, the absence of the kind of accountability
presumed to exist in the private sector implies that PEs have no place in society. Part of the early
public sector reform process involved reasserting control over PEs, making them pay larger
dividends, and devising better means of ensuring accountability. The success of these changes
was mixed and inevitably led to further privatization. If accountability is poor and improvements
not possible, the case for privatization becomes much stronger.

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Government control and managerial freedom
The extent of controls causes conflict between governments and their PEs. Politicians and the
central agencies of the bureaucracy claim there are insufficient controls, while the management
of PEs claims there is too much interference in management prerogatives. Enterprises see
government controls as being too rigid and time-consuming. Why don’t the politicians simply let
the managers manage? There is an inevitable conflict between freedom from everyday political
control and public accountability.
PEs managers may have more freedom than other parts of the public sector, but they still feel
constrained by government. From the point of view of government, it needs to be emphasized
that these are government-owned organizations controlling activities that can all too easily
acquire political significance irrespective of the type of organization. Since the public owns PEs,
their political representatives are quite entitled to a certain amount of control, on the public’s
behalf. They are in public hands for a reason, so the politicians would be neglecting their duties
if such important areas were left alone. However, the relationship is likely to be unstable and
sub-optimal.

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