The Reality of Privatisation and Outsourcing

Privatisation is the process of transferring ownership of a business, enterprise, agency, public service, or public property from the public sector (a government) to the private sector, either to a business that operates for a profit or to a non-profit organization.

It is also used by some to describe the outsourcing of public services or functions to private firms, e.g. revenue collection, law enforcement, and prison management.

Potential Benefits of Privatisation

Firstly, it is important to understand why there was such support for the privatisation of state owned assets in the UK. This extract from “The National Wealth – Who Gets What in Britain” captures the mood pre-privatisation under Thatcher:

“At the time it was privatized BT had 250,000 customers waiting for a telephone line to be installed. The public telephone boxes doubled as public lavatories. Electricity and gas prices went down before elections, and up after them. In the water industry, the sewers were crumbling, the beaches a disgrace, the rivers were filthy, and water shortages commonplace. The public images of British Rail, its timetables regularly undone by ‘the wrong sort of snow’ and leaves on the line, was of grubby trains and surly staff.”

Clearly the State owned assets were being poorly managed but is the answer privatisation?

Some of the perceived or potential benefits of privatisation include:

Improved Efficiency : Private companies have a profit incentive to cut costs and be more efficient.

: Private companies have a profit incentive to cut costs and be more efficient. Politicians Make Poor Business Managers : They are motivated by political pressures rather than sound economic and business sense.

: They are motivated by political pressures rather than sound economic and business sense. Short Term Thinking (1) : A government may be unwilling to invest in infrastructure improvements which will benefit the firm in the long term because they are more concerned about projects that give a short term benefit before an election.

: A government may be unwilling to invest in infrastructure improvements which will benefit the firm in the long term because they are more concerned about projects that give a short term benefit before an election. Short Term Thinking (2) : Selling state owned assets to the private sector raised significant sums for the UK government in the 1980s.

: Selling state owned assets to the private sector raised significant sums for the UK government in the 1980s. Shareholders : It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is inefficient then the firm could be subject to a takeover. A state owned firm doesn’t have this pressure and so it is easier for them to be inefficient.

: It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is inefficient then the firm could be subject to a takeover. A state owned firm doesn’t have this pressure and so it is easier for them to be inefficient. Increased Competition : Often privatisation of state owned monopolies occurs alongside deregulation – i.e. policies to allow more firms to enter the industry and increase the competitiveness of the market.

Potential Disadvantages of Privatisation :

Looking at the potential benefits in isolation and why people accepted privatisation as necessary, it would appear that privatisation makes sense. However, with the benefit of hindsight, people started to focus on “how” the assets were sold rather than “why”. The following extract from “The National Wealth – Who Gets What in Britain” captures the frustration felt by many with the manner in which State owned assets were privatised, as follows:

“The main criticism is that they were sold for less than they were worth. From 150 sales between 1979 and 1997, the government raised £90 billion in real terms, or about half the net value of the nationalized industries. The size of this gap is the reason why the shares in privatized companies almost always soared in value in the first few days after the sale. Shares in Amersham International, British Airways, British Telecom and Rolls-Royce were all worth a third more than the offer price within a week. A reluctance to sell shares in stages, or organize competitive auctions, usually denied the taxpayer any stake in the appreciation of the stock.”

“At privatization, nobody even thought to charge a premium for the public land under which BT cables were laid. The NAO later believed the government had sold the English and Welsh water industry for £2.3 billion less than it was worth. The Medway Ports, bought by the management for £29.7 million in March 1992, were sold eighteen months later to Mersey Docks and Harbour Company for £103.7 million. Ownership of the National Grid was transferred to the regional electricity companies at a valuation of £1 billion in 1991. Just four years later the companies themselves valued it for sale at four times this amount. Even the Conservatives were sufficiently embarrassed by this cheeky plan to threaten its owners with a windfall tax. Royal Ordnance, sold to British Aerospace in April 1987 for £190 million, turned out a bargain. Within a year, unwanted factories sold by the taxpayers for £5 million were sold to property developers for £450 million.”

Some of the key disadvantages of privatisation are listed below:

Public Vs Private Monopoly : Where a State owned entity has very significant fixed costs, there is no scope for having competition amongst several firms. In this case, privatisation would just create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly.

: Where a State owned entity has very significant fixed costs, there is no scope for having competition amongst several firms. In this case, privatisation would just create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly. Public Interest : There are many industries which perform an important public service, e.g. health care, education and public transport. In these industries, the profit motive should not be the primary objective of firms and the industry.

: There are many industries which perform an important public service, e.g. health care, education and public transport. In these industries, the profit motive should not be the primary objective of firms and the industry. Loss of Potential Government Dividends : Many of the privatised companies in the UK are quite profitable. This means the government loses out on their dividends, which instead go to wealthy shareholders.

: Many of the privatised companies in the UK are quite profitable. This means the government loses out on their dividends, which instead go to wealthy shareholders. Regulating Private Monopolies : Privatisation creates private monopolies, such as the water companies and rail companies which need to be regulated to prevent abuse of monopoly power. Therefore, there is still need for government regulation, similar to under state ownership.

: Privatisation creates private monopolies, such as the water companies and rail companies which need to be regulated to prevent abuse of monopoly power. Therefore, there is still need for government regulation, similar to under state ownership. Fragmentation of Industries : In the UK, rail privatisation led to breaking up the rail network into infrastructure and train operating companies. This led to areas where it was unclear who had responsibility, e.g. the Hatfield rail crash was blamed on no one taking responsibility for safety.

: In the UK, rail privatisation led to breaking up the rail network into infrastructure and train operating companies. This led to areas where it was unclear who had responsibility, e.g. the Hatfield rail crash was blamed on no one taking responsibility for safety. Short-Termism of Firms : In order to please shareholders, private companies may seek to increase short term profits and avoid investing in long term projects, e.g. privatised energy companies are trying to make use of existing plants rather than invest in new ones, in particular investing in new energy sources.

: In order to please shareholders, private companies may seek to increase short term profits and avoid investing in long term projects, e.g. privatised energy companies are trying to make use of existing plants rather than invest in new ones, in particular investing in new energy sources. Government Funding / Subsidies : If we look at the renewable energy sector, private companies receive Government funding / subsidies which impact how much investment is made in renewable energy. One might argue that it would be more efficient if investment in renewable energy was made directly by the State rather than through private companies that receive subsidies anyway.

As illustrated above, there are benefits and disadvantages of privatisation of State owned assets which are based on many underlying issues. Now let’s take a look at some specific examples of state owned bodies / assets which were privatised during the Thatcher years…

Privatisation in the UK under Thatcher:

British Petroleum (“BP”) :

In May 1914, the Government (on the initiative of Winston Churchill as First Lord of the Admiralty) invested £2.2 million in the Anglo-Persian Oil Company (later renamed British Petroleum – BP) and acquired an estimated 55% of the shares. The Government gave assurances at the time that it would not use its majority shareholding to influence BP’s policy.

In December 1974, as part of the Government’s rescue of the Burmah Oil Company, the Bank of England bought a further 20% of BP shares. BP was never technically nationalised, meaning that the Government could sell shares at any time without specific legislation.

In 1977, the Government sold 17% of its holdings as part of the measures to meet the requirements of the IMF loan to the UK (yes – the UK was bailed out by the IMF in the 70’s).

The Government sold the remainder of its shares in 4 stages between 1979 and 1987.

Proceeds from Privatisation = GBP 6.8bn

Current Market Cap = USD 139.67bn

Britoil :

Britoil was the oil exploration and producing part of the British National Oil Corporation (BNOC). BNOC was originally set up as a public corporation by the Petroleum and Submarine Pipelines Act 1975 to ensure the Government had a stake in every oil and gas development in the UK.

Under the Oil and Gas (Enterprise) Act 1982, BNOC was divided so that the trading part, called BNOC, remained nationalised but the oil exploration and production part was formed into Britoil as a limited liability company.

The Government sold off 51% of its shares in Britoil in November 1982. The issue was considerably under-subscribed. The loss was carried by the underwriters.

In July 1985 the Government minority shareholding in Britoil was sold for £434m.

With the Oil and Pipeline Act 1985, the Government wound up BNOC and replaced it by a small Oil and Pipeline Agency.

Britoil business now owned by BP.

Proceeds from Privatisation = GBP 6.8bn

Current Market Cap = See BP above

British Telecom (“BT”) :

The British Telecommunication Act 1981 divided the Post Office Corporation into British Telecommunications (BT) and the Post Office and allowed for some limited relaxation of the monopoly previously enjoyed by both.

The Telecommunications Act 1984 made provision for BT to be privatised, for its monopoly over telephone services to be removed and for the setting up of the industry regulator – the Office of Telecommunications (Oftel).

BT shares, which City advisers had insisted would flood the market, went to an immediate premium of 91%.

Proceeds from Privatisation = GBP 14.32bn

Current Market Cap = USD 59.94bn

British Gas :

The Gas Act 1986 made arrangements for the privatisation of British Gas Corporation. The principal share sale arrangements were similar to those for British Telecom in 1984, with a public sale of shares and an employee share scheme together with a regulatory authority (Ofgas) established by statute to enforce the terms of the licence conditions under which the industry can operate.

On 1 April 1986, British Gas plc was incorporated as a public limited company and the property, rights and liabilities of the Corporation were transferred to the new company.

Subsequently British Gas plc has been split into three major listed companies in various stages – Centrica plc (which includes the original British Gas trading activities in the UK); BG Group (which includes exploration and production in the UK and overseas) and National Grid (which includes the original gas transmission and gas distribution activities in the UK).

In recognition of the changing energy market, the regulatory body (Ofgas) was merged with that of the electricity industry (Offer) to form the Office of Gas and Electricity Markets (Ofgem) in November 2000.

This was, and remains, the largest single sale of a previously state-owned company in the UK in terms of net proceeds and the number of initial shareholders.

Proceeds from Privatisation = GBP 7.7bn

Current Market Cap = USD 37.29bn

Water Authorities:

The principal objectives were to raise revenues and to rely on the capital market to fund the future large capital requirements of the industry.

There was no provision for the introduction of competition in the water industry, unlike the other main utility privatisations, particularly electricity and gas.

The Water Act 1989 provided for the privatisation of the Regional Water Authorities (RWAs) in England and Wales as public limited companies.

The Act also established the National Rivers Authority, (with responsibilities for water pollution, flood defences, fisheries, recreation and navigation); the Drinking Water Inspectorate (with responsibility to regulate water quality); and the office of Director General of Water Services (OFWAT) (with responsibility for regulation of the economic provision of water and sewerage services).

Water and sewerage services in Scotland and in Northern Ireland remained as state-owned companies.

Proceeds from Privatisation = GBP 3.6bn

Current Market Cap = N/A

The list is quite extensive but hopefully the above examples provide a flavour for the reasoning behind privatising each of the State-owned companies, the proceeds received and the current Market Cap where applicable.

It seems to me that privatising BP, Britoil and the Water Authorities did not take account of the long term benefits that these companies could bring to the state. However, there may be an argument that privatising utility companies such as BT and British Gas increases competition, increases quality and reduces prices for people in the UK. I have not analysed whether that assumption is true or not but would be very interested to take a look at the details!

British Rail Privatisation (under John Major between 1994 and 1997:

The privatisation of British Rail has perhaps been one of the more controversial privatisation efforts. The background of British Rail can be summarised as follows:

British Rail (BR) was a public corporation established under section 1 of the Transport Act 1962 as a successor to the rail and shipping activities of the British Transport Commission.

The British Rail Board operated passenger and freight services within Great Britain and was almost entirely vertically integrated, that is to say it owned its own trains, infrastructure and carried out almost all track and train maintenance itself.

In July 1992 the Government published its White Paper outlining proposals for privatising BR.

The core of the Government’s proposals was the greater involvement of the private sector in the running of the railways through the sale of some of the BR businesses and the progressive contracting out of the management of passenger services. The principal organisational means of achieving these objectives was the separation of responsibilities for track and operations.

Interestingly, the author of the following article reaches an interesting conclusion on the perceived success of the privatisation of British Rail, based on the continued Government subsidies paid to the private rail companies since the 90’s. http://www.sciencedirect.com/science/article/pii/S0155998214000416

“…the British rail industry can barely be called privatised in a meaningful sense any longer, because of the extensive subsidies provided for infrastructure provision and, from 2014, the formal re-designation of Network Rail debt as a public liability. However, the manner in which subsidies have been channelled through Network Rail has allowed backers of privatisation among the train operators and the political elites to maintain their narratives about the promise and outcomes of privatisation. This is because the accounting numbers and their presentation are malleable and implicated in the attempts to create a favourable image of the privatised rail industry.”

So it seems that there is no real benefit to the taxpayer of a privatised rail network and arguments from many sides that the rail networks should be nationalised for the benefit of the taxpayer appear to have a lot of substance (the Green Party are strong supporters of nationalisation of the rail networks).

Privatisation in the UK under Cameron:

Interestingly, the outright sale of State owned assets is not as glaringly obvious under Cameron and Osborne since 2010. However, privatisation by way of outsourcing services has become very prevalent.

You could almost call it privatisation by the back-door without the upfront income stream of the proceeds from selling off assets.

Royal Mail :

The privatisation of Royal Mail stands out as a legacy of the coalition Government.

Reform and possible privatisation of postal services have been discussed in government certainly since the early 1990s.

Two reviews in 2008 and 2010 of the universal postal service (delivery six days a week to nearly every address in the UK) concluded that Royal Mail was in great financial difficulty and that the universal postal service was under threat.

The Labour Government introduced legislation (Postal Services Bill 2008-09) that included the introduction of private capital through a private sector strategic partner, but did not complete the process.

The Coalition Government concluded that a sale of shares was required (including shares for employees). The Postal Services Act 2011 separated Royal Mail from the Post Office Network and two separate companies were set up on 1 April 2012.

Following a very brief and limited marketing campaign, 1,000 million shares were issued; of these, 172 million were sold to individuals (under the Retail Offer), 428 million were sold to financial institutions (the Institutional Offer) , 100 million were given to eligible employees (the Employee Share Scheme) and 300 million were retained by the Government.

, 100 million were given to eligible employees (the Employee Share Scheme) and 300 million were retained by the Government. The first tranche of 700m shares were sold in 2013 and George Osborne announced early in June 2015 that the remaining tranche of 300m Government owned shares would be sold to raise circa GBP 1.5bn but may not be available for public to purchase (go figure that logic out).

Proceeds from Privatisation = GBP 1.98bn in 2013 and potentially another GBP 1.5bn in 2015

RBS :

Over 2008 and 2009, RBS borrowed £45.4 billion ($70.1 billion), worth 500p per share, from the taxpayer and it has yet to pay it back.

The government still owns 81% of RBS.

George Osborne announced in June 2015 that the government intends to sell its stake in RBS despite the value of RBS shares being somewhat lower than that at which they were purchased.

If the government sold RBS off right now, it would be at a major loss (circa GBP 7bn), as the share price was around 354.8p when the announcement was made.

One might argue that the Government had a very strong position to pay far less than market value for its shareholding back in 2008/2009 given the state the bank was in but it appears that the losses of 2008/2009 will be pushed back on the taxpayer.

Lloyds Bank shares are being siphoned off quietly in the background as well and I wouldn’t hold my breath on any material profit being made on the disposals.

Green Investment Bank :

Since the bank was created as a commercial venture at the end of 2012 to back green energy projects and to spur private sector investment it says it has invested 2 billion pounds in 50 projects worth over 8 billion pounds including waste management plants and offshore wind farms.

The move to privatise the bank also comes a week after the government said it would scrap all new subsidies for onshore wind farms a year earlier than previously planned.

Business Secretary Sajid Javid said the government would sell a majority stake, though no decision has been made on the exact size.

Based on the 2 billion-pound figure for total loans, a 70 percent stake could theoretically be worth 1.4 billion pounds, but the government has pledged to sell its stake by the end of the current government’s five-year term, by which time valuations of projects currently underway could vary greatly.

The Government believe the move would give the bank greater freedom to borrow, removing state aid restrictions and allowing the bank to attract more capital.

In order to be free of state aid restrictions currently in place the government would need to sell 70 percent or more of the bank.

One could argue that all of the risk associated with a “start-up” in this case has been borne by the taxpayer with likely very little reward. Once in private ownership the Bank will be gobbled up by the casino banking of the City of London.

The NHS – Is it being Privatised or Not?

I referred to “outsourcing” earlier as a type of privatisation (although some would argue it is not privatisation at all) and the NHS is a classic example. The explanation in the following bullet points are taken from http://weownit.org.uk/evidence/nhs which is a great source of information on all things NHS privatisation / outsourcing!

The Health and Social Care Act 2012 was the most controversial set of reforms in NHS history. It has greatly expanded the role private companies play in delivering health services.

Instead of a publicly funded and publicly owned NHS, the Act created a competitive market for health services in which the government pays for, but does not provide healthcare.

These changes apply to NHS England, but not NHS Scotland, NHS Wales or Health and Social Care in Northern Ireland, which have their own systems of delivering health services.

NHS Scotland, NHS Wales or Health and Social Care in Northern Ireland, which have their own systems of delivering health services. Clinical Commissioning Groups (CCGs) are now responsible for buying in NHS services for patients in England. They may commission services from ‘any qualified provider’, entering into commercial contracts with private companies.

These commercial contracts are subject to competition law, meaning commissioners are required to give private companies the chance to compete for contracts with the NHS.

Private firms providing services for the NHS will often operate under the NHS logo, so it is difficult to know whether your treatment is being provided by a for-profit company.

The Act also removed the Secretary of State’s statutory obligation to provide comprehensive and universal healthcare. This means that decisions about what services a particular hospital will offer or be able to charge for are made by local commissioning groups.

These groups have the power to withdraw or start to charge patients for particular NHS services, which could mean the end of free services for all.

It’s pretty clear that the NHS is basically being privatised through the back door but the label applied is “necessary outsourcing of certain services”.

Beneficiaries of the decision to outsource / privatise healthcare include Care UK, Circle, McKinsey, Serco and Virgin Care. I would strongly suggest you visit http://falseeconomy.org.uk/outsourcing where you will see more detail on the sketchy dealings of these and other companies to which the Government is outsourcing public services.

One critical difference between privatisation and outsourcing is that the likes of Serco do not have to make an up-front payment to purchase all NHS assets. Instead they just enter a public tender for a contract and watch the revenue flow in from the Government.

Very little risk for Serco with most likely significant reward.

From a taxpayer’s perspective, the risk is high and the reward has seemingly been low.

Conclusion:

These are worrying times if you are a firm believer in collective responsibility, social democracy and can see the hierarchy of beneficiaries from both privatisation and outsourcing.

On the other hand, many people agree with the Government’s approach and believe that taxpayers will get better service, better value for money and an improved economy from privatisation and outsourcing.

My personal view is driven by the knowledge of the hierarchy of beneficiaries from privatisation and outsourcing rather than an engrained socialist position on state ownership. The level of corruption and inbreeding involved in awarding these outsourcing contracts coupled with the poor value for money for the taxpayer in privatisation is blatantly obvious and we need a more transparent system to hold the Government and the private companies accountable.

The Government has historically undervalued State owned assets when privatising them and this trend is continuing under the current Tory Government. The lack of transparency and integrity in these privatisation deals should be causing all UK citizens to question the logic and benefits of privatisation.

If the Government were a publicly traded company, the Board of Directors would likely face prosecution for failure of their fiduciary responsibility to the shareholders (i.e. the UK taxpayers). This is something we should all keep in mind and ensure we hold the Government to account in any way possible.

Alphabetic List of Privatisations of UK Government Owned Assets :

Further Reading:

http://www.economicshelp.org/blog/501/economics/advantages-of-privatisation/

http://www.mintpressnews.com/in-greece-privatization-schemes-who-benefits/194824/

http://www.theweek.co.uk/royal-mail/50911/shrink-the-state-cameron-and-clegg-complete-thatchers-task#

http://www.downsizinggovernment.org/privatization

http://www.ifre.com/1987-72bn-bp-privatisation-the-deal-that-defied-black-monday/21103793.fullarticle

http://www.theguardian.com/business/2000/nov/22/thatcher.politics1

researchbriefings.files.parliament.uk/documents/RP14-61/RP14-61.pdf

https://www.tuc.org.uk/sites/default/files/TUC%20and%20NEF%20Outsourcing%20Public%20Services.pdf

http://pubs.socialistreviewindex.org.uk/sr196/sagall.htm

http://www.sciencedirect.com/science/article/pii/S0155998214000416

http://archive.sustecweb.co.uk/past/sustec11-1/page9.htm

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