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23 Oct

LPG reforms – Privatisation

Privatisation refers to the participation of private entities in businesses and services and transfer of ownership from the public sector (or government) to the private sector as well. Privatization is the transfer of control of ownership of economic resources from the public sector to the private sector. It means a decline in the role of the public sector as there is a shift in the property rights from the state to private ownership. The public sector had been experiencing various problems , since planning, such as low efficiency and profitability, mounting losses, excessive political interference, lack of autonomy, labour problems and delays in completion of projects. Hence to remedy this situation with Introduction of NIP’1991. Another term for privatization is Disinvestment. The objectives of disinvestment were to raise resources through sale of PSUs to be directed towards social welfare expenditures, raising efficiency of PSUs through increased competition, increasing consumer satisfaction with better quality goods and services, upgrading technology and most importantly removing political interference.

Objective of Privatisation

Providing strong momentum to the inflow of FDI

 Privatisation aims at providing a strong base to the inflow of FDI.

 Increased inflow of FDI improves the financial strength of the economy.

Improving the efficiency of public sector undertaking (PSU’s)

 The efficiency of PSU’s was improved by giving them the autonomy to make decisions.

 Some companies were given a special category of Navratna and Mini-Ratna.

Ways of Privatisation:

Government companies are transformed into private companies in 2 ways, Transfer of Ownership

 Government companies can be converted into private companies in two ways :

 By withdrawal of the government from ownership and management of public sector companies.

 By outright sale of public sector companies.


 Privatisation of the public sector undertakings by selling off part of the equity of PSUs to the private sector is known as disinvestment.

 The purpose of the sale is mainly to improve financial discipline and facilitate modernization.

However, there are six methods of Privatisation:

 The public sale of shares

 Public auction

 Public tender

 Direct negotiations

 Transfer of control of State or municipally controlled enterprises

 Lease with a right to purchase

Impact of Privatisation Positive Aspect-

1. Improved efficiency:-

The main argument for privatisation is that private companies have a profit incentive to cut costs and be more efficient. If you work for a government run industry managers do not usually share in any profits. However, a private firm is interested in making a profit, and so it is more likely to cut costs and be efficient. Since privatisation, companies such as BT, and British Airways have shown degrees of improved efficiency and higher profitability.

2. Lack of political interference:-

It is argued governments make poor economic managers. They are motivated by political pressures rather than sound economic and business sense. For example, a state enterprise may employ surplus workers which is inefficient. The government may be reluctant to get rid of the workers because of the negative publicity involved in job losses. Therefore, state-owned enterprises often employ too many workers increasing inefficiency.

3. Short term view:-

A government many think only in terms of the next election. Therefore, they 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 benefit before the election. It is easier to cut public sector investment than frontline services like healthcare.

4. 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.

5. 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. It is this increase in competition that can be the greatest spur to improvements in efficiency. For example, there is now more competition in telecoms and distribution of gas and electricity.

However, privatisation doesn’t necessarily increase competition; it depends on the nature of the market. e.g. there is no competition in tap water because it is a natural monopoly. There is also very little competition within the rail industry.

6. Government will raise revenue from the sale:-

Selling state-owned assets to the private sector raised significant sums for the UK government in the 1980s. However, this is a one-off benefit. It also means we lose out on future dividends from the profits of public companies.

Negative Aspect-

1. Natural monopoly:-

A natural monopoly occurs when the most efficient number of firms in an industry is one. For example, tap water has very significant fixed costs. Therefore there is no scope for having competition amongst several firms. Therefore, 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 which can exploit the consumer.

2. 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 shouldn’t be the primary objective of firms and the industry. For example, in the case of health care, it is feared privatising health care would mean a greater priority is given to profit rather than patient care. Also, in an industry like health care, arguably we don’t need a profit motive to improve standards. When doctors treat patients, they are unlikely to try harder if they get a bonus.

3. Government loses out on potential dividends.:-

Many of the privatised companies in the UK are quite profitable. This means the government misses out on their dividends, instead going to wealthy shareholders.

4. Problem of regulating private monopolies.:-

Privatisation creates private monopolies, such as the water companies and rail companies. These need regulating to prevent abuse of monopoly power. Therefore, there is still need for government regulation, similar to under state ownership.

5. 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. For example, the Hatfield rail crash was blamed on no one taking responsibility for safety. Different rail companies has increased the complexity of rail tickets.

6. Short-termism of firms:-

As well as the government being motivated by short term pressures, this is something private firms may do as well. To please shareholders they may seek to increase short term profits and avoid investing in long term projects. For example, the UK is suffering from a lack of investment in new energy sources; the privatised companies are trying to make use of existing plants rather than invest in new ones

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