Privatizing public goods

Imelda Maidir, Department of Economics, Centre for Strategic and International Studies, Jakarta

One of the controversial points in the conditions of the International Monetary Fund for loan disbursement to Indonesia is the obligation of the government to privatize some of formerly state-owned enterprises. This attracts much attention as most of the enterprises deal with the provision of infrastructures, which are long time perceived to be the rights and the responsibility of the government.

In some circumstances, public ownership may achieve social objectives at lower costs. In fact, the high level of subsidies compared to the consumer benefits, and the lack of incentives to respond to market signals and reduce costs indicate the need to revise the distribution of public goods. This would include the reconsideration of government involvement in the provision of public goods.

While water supply, energy and telecommunications are essential services, this does not justify public sector provision.

Food is at least as essential as these public utilities, but given the agricultural failures of centrally planned economies, few would argue that public sector provision increases food security. In spite of political reasons there are no valid economic arguments supporting the idea that such infrastructure should be provided by the government.

Without public ownership, governments can monitor health and safety standards and ensure competition in infrastructure industries, as they do in food industries. In fact, government can more effectively regulate standards when it does not own firms in an industry. Remaining an impartial umpire is difficult when also playing in the game.

Furthermore, private firms can be sued for damages arising from failure to meet standards, but government firms usually cannot. Hence, an infrastructure's monopoly network aspect determines the need for government involvement, rather than its essential nature.

Nevertheless, many economies regard public utilities as essential goods to which users have inherent access rights, with services provided free or at very low prices. However, such perceptions are largely politically determined, bearing little relation to economic realities.

Electricity and telecommunication are no more essential than food or clothing, which private firms typically provide at market prices.

But, water may be an exception. Polluted drinking water can seriously undermine health, but households can only measure water quality by taste and smell. Communities, therefore, require access to at least a minimum life-line amount of clean water at a zero or minimum price, with effective regulatory controls on water quality.

However, once this essential need for water is satisfied, additional water supplies should not be zero priced or subsidized, and operators can fully cover costs of supply.

Therefore, as long as government requires private operators to meet social obligations, private operators can provide additional commercial water supply services. Contracts with private water system operator could stipulate limited volumes of free water from communal wells or pumps, but house connections could be provided at the full cost of supply.

Cross subsidies from other users or, more transparently, government budget funded subsidies could meet these public service obligations.

So, when is state-owned justified? First, effectively assigning private property rights is impractical, such as water catchment areas.

Unbundling of water sectors should precede commercialization or privatization. Resource management functions, which the bill has already reached the house, such as catchment planning and management should be separated form potentially commercial functions of service delivery. Government should be responsible for the former; private operators can compete to provide the latter.

Second, the cost of regulating is too high. The relative cost of public ownership may be low when processes are simple. A private firm has substantial monopoly power, and the information costs of regulating a private monopoly are very high, such as in managing a wholesale electricity market.

Third, having strong public good aspects, as charges cannot be levied. Privatization is likely to result in under provision of pure public goods. But, we must carefully define the notion of public goods. For example, different from water, clean water is produced. Its supply needs to follow the cost minimization principles. Once consumed by one person, no one else can consume it. Therefore, it is possible to exclude people from its use.

Privatization of state-owned enterprise (SOEs) does not always harm the consumer. Noted, some studies have found that if monopoly regulation allowed private firms to function efficiently and protected consumers, privatization in both competitive and monopoly markets improved welfare in 11 out of 12 cases examined. To some extent, gains came primarily from improved services, deliver significant cost savings and better pricing.

Meanwhile, privatizing does not mean a total elimination of the role of the government. It is just putting the government in its more appropriate role, as regulator. The government was still legitimate to ensure the sustainability of these fundamental services.

Privatizing monopoly assets will not benefit consumers unless a carefully structured regulatory environment maintains competitive pressures on private participants and ensures safety and quality standards are met. Poorly developed private property rights and commercial law, and non-transparent bidding and regulatory regimes create major uncertainties for private investors, increasing the cost and risks of privatization.