Privatization is the incidence or process of transferring ownership of a business, enterprise, agency or public service from the public sector(government) to the private sector (business). In a broader sense, privatization refers to transfer of any government function to the private sector including governmental functions like revenue collection and law enforcement.
The term “Privatization” also has been used to describe two unrelated transactions. The first is a buyout, by the majority owner, of all shares of a public corporation or holding company's stock, privatizing a publicly traded stock. The second is a demutualization of a mutual organization.
For example the government may be able to limit prices and make certain demands through contracts, but private companies perform the work for a municipalized industry or service. The reverse process of privatization is called nationalization, when a government takes control of an industry or service from the private sector.
- One of the main arguments for the privatization of publicly owned operations is the estimated increases in efficiency that can result from private ownership. The increased efficiency is thought to come from the greater importance private owners tend to place on profit maximization as compared to government, which tends to be less concerned about profits.
- Most companies start as private companies funded by a small group of investors. As they grow in size, they will often access the equity market for financing or ownership transfer through the sale of shares. In some cases, the process is subsequently reversed when a group of investors or a private company purchases all of the shares in a public company, making the company private and, therefor
Origin of the term
It has been claimed that the term was first used in the 1930s by the economist in covering Nazi German economic policy.
Growth of Privatization
- Privatization may be a popular buzzword today, but the concept has been around since the first municipality hired.
- The difference today is that privatization is encroaching into all areas of public administration.
- And governments are expecting public agencies to compete dollar for dollar with private operators or surrender management of services.
- For years, our country has supported the idea that a public workforce was the best provider of essential services.
- Public employees would reliably and efficiently protect the public safety and deliver water and power, maintain roads and bridges, collect refuse and treat sewage. In return, public employees enjoyed a certain job stability and a wide range of desirable benefits.
- But in the cases of larger cities, especially festering problems with infrastructure led increasing numbers of city planners and public policy makers to look to privatization.
- Today, several of the nation's largest cities, including New York, Indianapolis, Philadelphia, and Phoenix have contracted out a broad spectrum of services that were previously attended to exclusively by city employees.
- New York City opened up bidding from private companies on 40 different municipal services in 1995alone. Smaller cities and towns have instituted outsourcing philosophies as well, and many service businesses, both large and small, have garnered significant new contracts as a result.
- The main obstacle is the lack of information or evidence of the benefits of privatization. Many officials also report they would like more information on certain aspects of privatization. It can be deduced that providing additional information on privatization to city officials will lead to increased economic policy.
Variations in Privatization
The term privatization has been applied to three different methods of increasing the activity of the private sector in providing public services.
- private sector choice, financing, and production of a service.
- public-sector choice and financing with private sector production of the service selected.
- and deregulation of private firms providing services.
In the first case, the entire responsibility for a service is transferred from the public sector to the private sector, and individual consumers select and purchase the amount of services they desire from private providers. For example, solid-waste collection is provided by private firms in some communities. The third form of privatization means that government reduces or eliminates the regulatory restrictions imposed on private firms providing specific services.
- The second version of privatization refers to joint activity of the public and private sectors in providing services. In this case, consumers select and pay for the quantity and type of service desired through government, which then contracts with private firms to produce the desired amount and category of service.
Advantages and Disadvantages of Privatization
The merits and drawbacks of privatization have been subjects of considerable debate among business-people, city leaders, and public employees alike. Indeed, each element of privatization from its apparent cost-saving properties to its possible negative impact on minority workers provokes strong reaction. About the only thing that everyone can agree on is that the trend has been enormously beneficial to owners of small- and mid-sized businesses. Following are some privatization issues that communities, public providers, and private providers all need to consider:
Costs and Productivity
- Proponents of privatization argue that whereas government producers have no incentive to hold down production costs, private producers who contract with the government to provide the service have more at stake, thus encouraging them to perform at a higher level for lower cost. The lower the cost incurred by the firm in satisfying the contract, the greater profit it makes. On the other hand, the absence of competition and profit incentives in the public sector is not likely to result in cost minimization. Of course, small- and mid-sized companies also need to make sure that they do not sacrifice an acceptable profit margin in their zeal to secure a contract.
- Although private firms may pay lower wages and fringe benefits than local governments, the major cause of the cost differences between the private and governmental sectors is employee productivity. Lower labor costs may arise either from lower wages (which means that the government was paying wages higher than necessary for a given skill) or from less labor input (which means that the government retaining more employees than necessary to fulfill need). Private firms have more flexibility than governmental units to use part-timers to meet peak periods of activity, to fire unsatisfactory workers, and to allocate workers across a variety of tasks. Moreover, critics of municipal governments argue that they are less likely to reward individual initiatives or punish aberrant behavior when compared with their private sector counterparts.
Expected quality of service varies from community to community, depending on a wide range of factors such as historical service levels, local taxation, and possible changes in service requirements. Moreover, Public Works observed that good service is sometimes defined differently by citizens, public service providers, and private service providers. Response time and public confidence need to be taken into account when judging the pros and cons of private or public, stated Public Works. Stability may be a concern in the eyes of the public, a government agency cannot walk away at the end of a contract period
Proponents of privatization state that private firms may be more likely to experiment with different and creative approaches to service provision, whereas government tends to stick with the current approach since changes often create political difficulties for elected officials. In addition, private firms may use retained earnings to finance research or to purchase new capital equipment that lowers unit production costs. On the other hand, government may not be able or willing to allocate tax revenues to these purposes as ea
In some cases, local, state, and federal regulations may determine whether a service can even be handed over to a private provider. Moreover, the ultimate responsibility (in the eyes of the public, if not the courts) rests with the public agency that assigns operating rights to a private concern, stated Public Works. The local government will still be held responsible for the cost and quality of the service under contract. given the many competing demands on the government's budget.
Supporters of privatization often cite the competitive environment that is nourished by the practice as a key to its success. Private owners have a strong incentive to operate efficiently, they argue, while this incentive is lacking under public ownership. If private firms spend more money and employ more people to do the same amount of work, competition will lead to lower margins, lost customers, and decreased profits. The disciplining effect of competition does not occur in the public sector. Still, even advocates of privatization agree that private ownership produces the public benefits of lower costs and high quality only in the presence of a competitive environment. Privatization cannot be expected to produce these same benefits if competition is absent. Given this reality, analysts strongly encourage municipal.
Monitoring and Enforcement.
Critics of privatizationof government services contend that problems sometimes arise in various aspects of the process, including the bidding process, the precise specification of the contract, and the monitoring and enforcement of the contract. For example, some observers have raised concerns that potential suppliers may initially offer a price to the government that is less than actual production costs to induce the government to transfer the service to the private sector or to win the contract. Subsequently, the contractor would then demand a higher price after the government has dismantled its own production system. Such “low-balling” in the bidding process may be reduced if the local government requires relatively long-term contracts, or constructs contracts that give them flexibility in hiring and firing outside firms.
Public Personnel Management
magazine also noted that governments need to take several important precautions before handing out a contract in order to avoid litigation and legal liability. These precautions include detailed performance specifications for service providers, guidelines for the evaluation of competitive bids, and labor relations strategies. For their part, private bidders need to make certain that these precautions are reasonable ones that will not unduly impact their ability to perform both profitably and professionally.
Commonly utilized methods of contract monitoring, meanwhile, include performance appraisals, tracking complaints, citizen satisfaction surveys, reports from contractors, field observations, and ongoing cost comparisons.
Privatization is understandably viewed as an alarming trend by public employee groups. In some cases, privatization results in layoffs of public sector employees, although governments often reassign them to other government jobs, place them with private contractors, or offer them early retirement programs. These possibilities have been particularly upsetting to public employee unions, which have been at the forefront of efforts to block privatization. Indeed, one of the principal objections to privatization is that it replaces positions that featured compensation that could be used to support a family with private sector spots that offer modest compensation. Indeed, critics such as the Journal of Commerce and Commercial. private companies are only able to promise meaningful financial savings over public agencies because of the comparatively low salaries they pay their workers. Another charge leveled at privatization initiatives is that they too often have a disproportionate impact on minorities.
Demographic and Geographic Factors
Smaller municipalities may incur relatively high unit costs if they operate their own services as a result of not being able to achieve economies of scale. These localities may benefit from turning to a contractor that serves multiple communities. Privatization is also more acceptable in fast-growing communities. If services are being expanded to cover new residents, private contractors are less likely to displace existing public sector employees. Finally, contracting out varies with the number of services provided to residents. As the number of services increases, differences in the cost and effectiveness with which they are provided become more apparent. Therefore, municipalities providing diverse services may be more open to exploring private sector options than those localities where services are more limited.
Types of privatisation
There are three main methods of privatisation:
- Share issue privatisation (SIP) - selling shares on the stock market
- Asset sale privatisation - selling the entire firms or part of it to a strategic investor, usually by auction or using Treuhand model
- Voucher privatisation - shares of ownership are distributed to all citizens, usually for free or at a very low price.