Privatizing public goods

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.