The basic argument behind privatization is that governments have few incentives to ensure the businesses they own are well run. On the other hand, private owners do have such an incentive: they will lose money if businesses are poorly run. The theory holds that, not only will the business' customers see benefits, but as the privatized company becomes more efficient, the whole economy will benefit.
Advocates of privatization argue that governments run businesses poorly for the following reasons:
In particular, the first and last reasons become important because money is a scarce resource: if government-run companies are losing money, or if they are not as profitable as possible, this money is unavailable to other, more efficient firms. Thus, the efficient firms will have a harder time finding capital, which makes it difficult for them to raise production and create more employment. On the other hand, income from successful state-owned enterprises can be used for other other, socially-oriented government programs. When governments sell such enterprises, they can lose a major source of revenue. Argentina is a case in point.
In more practical terms, there are a number of pitfalls which may preclude the success of a privatization:
Privatization is the transfer of legal title to state enterprises to private owners. Market theory holds that under the right conditions, private ownership is intrinsically more efficient than state ownership or monopoly ownership because in a competitive environment owners have the incentives to maximize the ability of capital to produce a return. Whereas a monopolist does not care if the firm he or she owns is inefficient, the owner of the firm in a market system wants to increase the productivity and therefore the market value of the firm. For this reason, most economists consider it essential to transfer ownership of state assets from the state to private owners as part of the transition to a market economy in order to stimulate growth and productivity in the economy as a whole. In short, a system of private property benefits not only the individual owners, according to market theory, but also benefits the whole society.
Privatization, according to many economists, propels the establishment of social, organizational and legal infrastructures and institutions that are essential for an effective market economy. Transferring ownership to private hands in order to create a lobby for private enterprise and push for creation of institutions to govern the market. Privatization creates a political lobby pushing for the basic essentials of a market economy: property rights, regulatory institutions, institutions for built-in macroeconomic stabilization (such as government programs or policies that will counteract the business cycle with new government action), institutions for social insurance, and institutions for conflict management[?]. Aside from that, protection of property rights not only requires legal guarantees, but the customs and culture of the market.
For the sake of efficiency, one method of privatization is to require auctions in which bidders compete to offer the state the highest price, which creates real value that can be used as investment capital. Although this strategy allows often corrupt elements to capture control of state enterprises, this strategy would have fostered a viable capital market, which is the mechanism for bringing private savings into investment in enterprises. The state can also allow foreigners to buy privatized enterprises, thereby an outside investor would invest the capital needed to upgrade and modernize the firm, bringing it up to international standards.
There are, however, many conditions which can interfere with the application of this theory to the real world, and there can be great difficulties in getting the process to work out ideally. For instance, in stark contrast to goals of privatization in post-Communist Russia - by far the largest country to experience a rapid privatization of nearly the entire economy - economic decline over the past decade since the collapse of the USSR has actually been far more severe and more protracted than the Great Depression following 1929, and half as severe as the catastrophic depression caused by the effects of World War I, the collapse of the Czarist regime, the Civil War, and the implementation of "War Communism". GDP in post-communist Russia has roughly halved and roughly over half the population is impoverished in a country where poverty had largely been eliminated.
Many have argued that the stategy of privatization in Russia differed from those seen in more successful post-communist economies like Hungary and Poland, and combined with capital market liberalization, and failure to establish institutional infrastructure, have led to incentives for capital flight, contributing to post-communist economic contraction in Russia.
Privatization has rarely worked out ideally because it is so intertwined with political concerns, especially in post-communist economies or in developing nations where corruption is endemic. Even in advanced market economies like Great Britain, where privatization has been popular since the Thatcher era, problems center on the fact that privatization programs are very politically sensitive, raising many legitimate political debates. Who decides how to set values on state enterprises? Does the state accept cash or for government-provided coupons? Should the state allow the workers or managers of the enterprise to gain control over their own workplace? Should the state allow foreigners to buy privatized enterprises, thereby which an outside investor would invest the capital needed upgrade and modernize the firm, bringing it up to international standards? Which levels of government can privatize which assets?
Generally speaking, large-scale privatization of moribund, money-losing state owned enterprises[?] tends to increase unemployment. Cutting the workforce is usually an essential aspect of privatization, which centers on the goal of efficiency. In the Soviet Union, for instance many state industries were often not even value adding, with cost of inputs exceeding the cost of outputs. So privatization often entails downsizing[?], laying off workers, cutting wages, or even shutting down facilities. After privatization, sixteen percent of the workforce became unemployed in both Eastern Germany[?] and Poland. The social consequences of this process have been wretched, impoverishing millions, but to little social benefit in many post-Communist countries. In the former Soviet Union, there has been a dearth of large-scale investment to modernize Soviet industries and businesses still trade with each other using barter quite frequently. In the process, Russia has gone from having one of the world's most equitable distributions of wealth in the Soviet era to one of the least today.
Privatization can also have a ripple effect on local economies. State-owned enterprises can be obliged to patronize national or local suppliers. Privatized companies don't have that restriction, hence shift purchasing elsewhere. Bolivia underwent a rigorous privatization program in the mod 1990s, with disasterous impact on the local economy in this regard.
Some privatizations have already been deemed failures. British Rail is one such case. The track-owning company has been effectively repossessed by the government, and many of the train-running companies are at risk of having their concession removed for failing to provide adequate services. One of them, Connex, actually had its franchise cut short in June 2003 by the government for what the Strategic Rail Authority called "poor financial management." However, in other cases, particuarly in poor countries, unsuccessful privatizations cannot be so easily undone. Governments don't have the resources or the political will to do it, and there is strong pressure exterted by international lending agencies to leave the situation as it is.
The above arguments have centered on whether or not it is realistic to apply privatization theory to the real world, but some reject the profit incentive. Opponents of privatization often argue that because the driving motive of a private company is profit, not public service, the public welfare may be sacrificed to the demands of profitability. There is no definitive answer, but a strong argument can be made for leaving essential services, such as water, electricity, health, primary education, and so forth, in public hands.
New Zealand has experienced the privatization of its telecommunication industry, its railway system and part of its electricity market. The process of privatization was halted in 1999 when the New Zealand Labour Party won the election. Although most of the electricity generation and the electricity transmission system remain state owned, the government has corporatized this sector as well as New Zealand Post, the Airways Corporation[?] and other smaller state owned enterprises.
The effect of corporatization[?] has been to convert the state departments into public companies and interpose commercial boards of directors[?] between the shareholding ministers and the management of the enterprises. To some extent, this model has enabled efficiencies to be gained without ownership of strategic organizations being transferred.