reforming public enterprises: u.k. reforming …base) and they employed 45,900 people. this analysis...

Reforming Public Enterprises: U.K.

Public Management Service© OECD 1998.

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REFORMING PUBLIC ENTERPRISES -- CASE STUDIES:UNITED KINGDOM

by Shelley Thornton, CIPFA

An Overview of Public Enterprises Prior to Reform

Description of enterprises

1. In the United Kingdom (UK), public enterprises were active in both competitive and monopolymarkets prior to the beginning of the reform programme in 1979.

Competitive enterprises

2. In competitive markets, the UK government owned several major enterprises, including:

• British Airways (BA), the international airlines corporation carrying passengers and freight tomost major national and international airports. In 1979, its turnover was £4,326 million (1992price base) and it employed 57,600 people;

• British Steel, which made a wide variety of industrial and domestic steel products. In 1979,its turnover was £8,674 million (1992 price base) and it employed 190,000 people;

• Cable & Wireless (C&W), which handled long distance and international telephone traffic inmarkets primarily outside of the UK. In 1979, its turnover was £545 million (1992 price base)and it employed 11,100 people;

• Rolls Royce, which made aircraft engines. In 1979, its turnover was £2,073 million (1992price base) and it employed 57,000 people.

• The UK government was also active in the oil market.

Monopoly enterprises

3. In monopoly markets, the UK government was active in seven major industries, which were:

• Telecommunications, provided by the monopoly supplier of services, BritishTelecommunications (BT). BT’s activities included the provision of basic voice telephony forlocal, national and international calls and the provision of value added network services. In1979, its turnover was £8,505 million (1992 price base) and it employed 233,400 people;



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• gas, provided by a single public corporation, the British Gas Corporation. The Corporationtransmitted, distributed and supplied gas in England, Wales and Scotland. In 1979, itsturnover was £7,864 million (1992 price base) and it employed 101,800 people;

• airports, provided by the British Airports Authority (BAA). BAA owned and operated sevenairports in England and Scotland. In 1979, its turnover was £428 million (1992 price base)and it employed 7,300 people;

• water, provided by ten water and sewerage authorities (and also 29 privately owned wateronly companies in England and Wales). The principal activities of these authorities was tocollect and treat water, provide domestic and industrial water supplies and to collect, treatand dispose of sewage. In 19911, the turnover of the authorities was £4.4 million (1995 pricebase) and they employed 45,900 people. This analysis excludes Scotland and NorthernIreland, where water service provision is still largely in public hands;

• electricity, provided by two entities. The Central Electricity Generating Board (CEGB),generated and transmitted the electricity required by the public supply system through itsownership and operation of 80 nuclear and fossil-fuelled power stations and the transmissionsystem. Twelve area boards were the system’s second component. These boards werecharged with purchasing electricity from the CEGB and distributing and selling it tocustomers within their areas. In addition, there was an Electricity Council which had a co-ordinating role, provided some common services and had certain statutory functions.In 19912, the turnover of the electricity supply industry was £13.6 million (1995 price base)and it employed 82,300 people. This analysis again excludes Scotland and Northern Ireland,where electricity provision is structured differently.

• railways, provided by the monopoly supplier, British Rail. British Rail provided main lineservices in the UK, carrying over 3/4 billion passengers and over 100 million tonnes offreight annually on a route network covering more than 10,000 miles. In 1979, its turnover(before grants) was over £3 billion (1992 price base) and it employed over 130,000 people.

• The government was also active in the monopoly market of coal and remains active in thenuclear fuel industry and the London Underground transport system.

• postal services, provided by the Post Office. This remains the only major industry in publichands.

Government objectives for involvement

4. The UK government became involved in these enterprises for a variety of reasons. Between1945 and 1951 the Labour Party drew up a radical programme to nationalise banking, land and ‘basicindustries’ (fuel and power, transport and steel). At the time the government managed to implement mostof its proposals, successfully nationalising many of these industries, but, with the exception of the Bank ofEngland, it was unable to nationalise land and banking. The key objectives for nationalisation were bothideological and pragmatic and included:

• nationalisation was seen as a solution to many economic problems. It could concurrently endstrategic shortages which hampered private sector industrial growth and ensure that supplies



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went to high priority activities. Additionally, due to many factors, and exacerbated by theimpact of two world wars, many of the nationalised basic industries had been unprofitable fora considerable time and needed significant investment and comprehensive re-organisation,which the government could provide.

• a number of the enterprises had (and continue to have) natural monopoly elements, such asthe pipe infrastructure for the water and gas industries and the hill top sites necessary fortelevision broadcasting. The government wanted to ensure that this monopoly power was notabused.

• the government wished to promote and control the development of certain enterprises inorder to pursue social and national objectives, rather than merely economic ones. Forexample, the State wanted to protect against unemployment in certain regions, and to ensureuniversal availability of important services where market forces without intervention woulddictate a more selective provision.

5. The government also became involved in some of the enterprises because it had invested in themwhen they were in financial trouble, primarily in order to protect employment.

Effect on public finances

6. The nationalised industries’ share of the UK’s Gross Domestic Product (GDP) was about 10percent in 1979, a seventh of total investment and about one-tenth of the Retail Prices Index. Theborrowing by nationalised industries is included in the Public Sector Borrowing Requirement (PSBR) andso public financing constraints spill over into the industries’ investment programmes.

7. Specific operating and financial targets were set for nationalised enterprises (and still are forthose that remain) with the key objective of minimising the burden they place on the PSBR. Under theConservative Government, which was in power from the start of the reform programme in 1979 untilApril 1997, nationalised industries were expected to:

• increase their efficiency so as to minimise the burden they place on the taxpayer and thePSBR;

• operate in ways which do not compete unfairly against the private sector;

• seek to reduce the scope of the public sector;

• improve the value for money of their services and increase quality;

• observe the public sector’s high standards of propriety and openness.

8. Nationalised industries were expected to act commercially, within the constraints of their publicsector ownership. They were to do this so as to strengthen their effectiveness and efficiency, except wheredirected to meet other particular policy objectives.

9. The framework within which nationalised industries operated was designed to promote both theefficient allocation and use of their resources, and to integrate the industries’ medium-term commercial



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aims with the requirements of government fiscal policy. In particular this concerned the control of publicexpenditure and larger economic goals. The main elements of the framework were:

• strategic objectives and corporate plans,

• External Financing Limits (EFLs),

• financial targets and limits,

• performance aims,

• investment returns,

• prices,

• and monitoring.

Strategic objectives and corporate plans

10. Individual enterprises divide strategic objectives with the government so as to provide a clearframework for their operations. They also prepare corporate plans which discuss options for expenditure,set out efficiency gains and demonstrate how ministers’ targets are to be met. Corporate plans arereviewed by departmental ministers, following an Investment and Financing Review (IFR). These tworeviews form a part of the Public Expenditure Survey (PES) by which the government allocates publicexpenditure in the three forward years to different programmes, including nationalised industries.

External Financing Limits

11. EFLs were introduced in 1976 and are the most important financial control over nationalisedindustries. They curb the amount of external finance (grants and borrowing, which include certaininstances of leasing) a nationalised industry may raise in any financial year. EFLs are a form of cash limitand are set with the presumption that they will not be exceeded until the yearly review. In fact changesrequire Treasury approval and are announced in parliament. Where an enterprise has exceeded its EFL, thesponsoring department is required to claw back the excess in the following year’s EFL in order tomaintain control over the aggregate level of public expenditure.

12. Due to the volatility of external finance, special arrangements are needed to prevent ‘windfall’gains from undermining control elsewhere. Therefore, EFLs are ‘ring-fenced’ from departmentalexpenditure and from other nationalised industry EFLs. In-year switches from one industry’s EFL toanother’s or from one industry’s EFL to departmental programmes may not normally be made.

Financial targets and limits

13. Financial targets are generally set for a three-year period for individual industries. As a result ofrequiring government firms to earn profits, these financial targets aim to expose public corporations tofinancial conditions analogous to those on private sector companies. The precise form of the target variesaccording to the commercial character of the industry concerned but, for profitable enterprises, are



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generally expressed in terms of operating profit (on a current cost basis) calculated as a proportion ofassets valued at replacement cost.

14. There is also an annual limit on capital expenditure, set in the IFR. Once investment plans havebeen determined, formal approval may be given to allow industries to commit up to 100 per cent of theiragreed investment for the year ahead, up to 85 percent for the second year and up to 70 percent for thethird year. This aids forward planning for the industry.

Performance aims

15. Like financial targets, performance aims are generally set for three year periods. These aimscover costs and standards of service and are particularly important for industries with a degree ofmonopoly power where financial targets would not automatically impose pressures for operatingefficiently.

Investment returns

16. To ensure that investment by nationalised industries earns an adequate economic return, there isa required rate of return (RRR) which new investment programmes must achieve, for example 8 percent inreal terms before tax and financing costs.

Prices

17. Prices charged by nationalised industries are normally expected to cover costs, including anadequate return on capital. However, prices should not be set solely to cover total costs. Instead theyshould be related to the relative costs of particular services and for peak and off-peak usage. That way, theprovision of capacity is properly related to demand and arbitrary cross-subsidisation between differentgroups of consumers (with the consequent waste in resources) is avoided.

Monitoring

18. The performance of nationalised industries within this framework is monitored regularly,through analysis of monthly and other returns by sponsoring departments.

19. The new Labour government is in the process of reviewing the financial and operatingframework for those enterprises that remain in public ownership.

Financial and operational performance

20. The financial and operational performance of these enterprises prior to reform can besummarised as follows:




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• BA made profits before interest and tax of £261 million in 1979 (1992 price base) and £301million on privatisation in 1986 (1992 price base) and its return on capital employed (ROCE)was 12.5 percent in 1979 and 23.1 percent on privatisation;

• British Steel made losses before interest and tax of £314 million in 1979 (1992 price base)and profits of £540 million on privatisation in 1988 (1992 price base) and its ROCE wasnegative in 1979 and 11.3 percent on privatisation;

• C&W made profits before interest and tax of £150 million in 1979 (1992 price base) and£125 million on privatisation in 1981 (1992 price base) and its ROCE was 27.4 percent in1979 and 18.9 percent on privatisation;

• Rolls Royce made losses before interest and tax of £120 million in 1979 (1992 price base)and profits of £200 million on privatisation in 1987 (1992 price base) and its ROCE wasnegative in 1979 and 17.5 percent on privatisation.

Monopoly enterprises

• in telecommunications, BT made profits before interest and tax of £2,404 million onprivatisation in 1984 (1992 price base) and its ROCE on privatisation was 16.7 percent;

• in gas, the British Gas Corporation made profits before interest and tax of £1,628 million in1979 (1992 price base) and £1,417 million on privatisation in 1986 (1992 price base) and itsROCE on privatisation was 13 percent

• in airports, the BAA made profits before interest and tax of £79 million in 1979 (1992 pricebase) and £179 million on privatisation in 1987 (1992 price base) and its ROCE in 1979 was8.6 percent and on privatisation was 13 percent

• in water, the ten authorities made pre-tax profits of £135 million in 1985 and £640 million onprivatisation in 1989

• in electricity, the twelve area boards made pre-tax profits of £659 million in 1986 and £994million on privatisation in 1990

• in railways, turnover (before grants) was £3 billion in 1993 and grants of nearly £1.3billionwere given to ‘balance the books’. Prior to privatisation in 1994, subsidy was still about £1billion a year.

Reform Strategies

Type of reform

21. The general reform strategy adopted for the UK public enterprises sector was, and still is,privatisation; that is the preferred strategy is the process whereby public sector industries are transferred



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to private ownership. Instead of being owned and controlled directly by the government, enterprises areowned by individuals (shareholders) and activities are undertaken primarily for profit.

22. Although the first ‘privatisation’ was actually carried out by the then Labour governmentin 1997, with the sale of 15 percent of British Petroleum (BP), the concept of privatisation first arrived inthe political mainstream in the UK in 1978, in a policy document prepared for the opposition ConservativeParty by its economic advisers. Elected to government in 1979 under the prime-ministership of MargaretThatcher, the Conservatives began their privatisation programme slowly by first selling governmentholdings in enterprises that already operated successfully in competitive private sector markets. Thisprocess began with the tendering of a further sale of its stake in BP and the sale of C&W in 1981.Privatisation became a central plank of government economic policy in 1984, when BT was privatised.Encouraged by the success of this offering, a series of huge privatisations have followed, including publicutilities which had operated in the public sector as monopolies and been legally protected from anycompetition.

23. In a sense, the UK government stumbled upon its privatisation policy. It did not begin as a clearpolicy but rather was a high risk experiment designed to improve public finances. Only when thegovernment’s limited forays into privatisation proved successful did the policy become established andrationalised on ideological grounds.

24. A complete list of major privatisations is given in Figure 1. It should be noted that since 1979the government has actually sold its stake in many more enterprises than those represented in this chart.Additionally, also unseen in Figure 1, the State has privatised several smaller government organisationsthat, in its view, no longer needed public ownership. Such transfers have included the Royal OrdnanceFactories and the Property Services Agency.

Figure 1 : Major UK privatisations

Enterprise Date of privatisationC&W October 1981Amersham International February 1982Britoil November 1982Associated British Ports February 1983Enterprise Oil June 1984Jaguar July 1984BT November 1984British Gas December 1986BA February 1987Rolls Royce May 1987BAA July 1987British Steel December 198810 Water Authorities December 198912 Electricity Boards December 1990Electricity Generators (CEGB) March 1991Rail Rolling Stock December 1995Railtrack May 1996



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Motivations for reform

25. In the UK, the initial motivation for reform was financial. There was a view prevailing that:

• the macroeconomic circumstances of the UK necessitated tight controls over public spendingand the PSBR as a means to restrain inflation;

• public spending in any event should be restrained in order to make room in the economy forgrowth in the private sector;

• government was able to raise revenue by selling valuable State assets;

• there was a need to fund the escalating demand-led aspects of public expenditure, such associal security and other benefit payments;

• the public sector could not supply the level of resources needed to meet the demands placedon all ‘public services’;

• privatisation transferred the burden of investment in the infrastructure from government tothe private sector.

26. Once the initial privatisations proved successful, political rationalisations for the policy weredeveloped. Primarily, reform was aimed at redressing the imbalance between the public and privatesectors and hoped to ‘roll back the frontiers of the State’. It was believed that:

• market mechanisms (competition and private ownership) were the most powerful engines ofeconomic efficiency, innovation, quality and choice and, therefore, the best way to benefitconsumers;

• it was desirable to promote broader share ownership, creating a ‘share-owning democracy’and spreading ‘popular capitalism’ whereby a large part of the population is given theopportunity to have a real stake in industry, perhaps for the first time.

• privatisation helped the economy by reducing the power and influence of public sector tradeunions. It did this by imposing a risk of bankruptcy on firms which served to both stiffen theresolve of management and to encourage greater caution in negotiations on the part ofunions;

27. The government’s push for reform included a concerted effort to ensure the support of managersof State enterprises. To this group, the State stressed that:

• enterprises required greater access to the funds they needed. They had a greater opportunityto do this if they were free to independently raise capital from the financial markets, ratherthan having to rely on public funds awarded from often highly politicised and short-termistgovernment budgeting processes;

• privatisation allowed for more flexible management and scope in decision-making;



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• privatisation changed the corporate culture, allowing a more commercial, customer orientedethos in lieu of a bureaucratic approach which pervaded government-run industries.

28. Apart from a general belief in the efficiency of the private sector, the key trigger to reform ofpublic enterprises has been the need to control public expenditures, including employee costs.Privatisation of an increasing number of enterprises has been spurred on by the need to concurrentlyreduce public expenditure and invest in the modernisation of the nation’s infrastructure in order tounderpin the economic recovery.

Management of the process

29. The privatisation process for each enterprise comprises a number of steps. An outline of thetypical steps to privatisation is shown in Figure 2.



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Figure 2. Outline of typical steps to privatisation

[Illustrative example not based on a particular case]

STAGE 1

PUBLIC CORPORATION

Governed by statuteLoan financedPublic Sector style administrationSome monopoly business

FEASIBILITY STUDY

Study undertaken by civil servants,merchant banks or managementconsultants

MINISTERIAL DECISION

Decision in principle to proceed, choiceof option to be pursued.

In this example sale of the business asone unit by share flotation

MINISTERIAL DECISION

Decision in principle to proceed, choiceof option to be pursued.

In this example sale of the business asone unit by share flotation



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STAGE 2

STAGE 3

SELECT ADVISERS

Merchant bank advisers selected for advice leading up to sale

CONSIDERREGULATION

DEREGULATION

Powers included toregulate or deregulate any

monopoly business

PREPARE BUSINESS

Strengthen managementteam

Introduce private sectorattitudes and methods

PREPARELEGISLATION

Power to unwind the publiccorporation and create PLC(public limited company)

IMPROVED RESULTSPASS LEGISLATION INCLUDINGANY REGULATORY MEASURES

CONSIDER BALANCESHEET

Adjust balance sheet ifnecessary

Power to create andsell PLC

WELL RUN PLC WITH REASONABLE BALANCE SHEET

Companies act company debt/equity ratio soundCommercially orientated management

Reduced monopoly power



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STAGE 4

SELECT/RESELECTADVISERS FORSALE

Merchant bank brokers,solicitors etc. chosenfor sale

GOOD RESULTS

CHOOSE MARKET SLOT PRODUCE BUILD IMAGEPROSPECTUS

Decision taken on how many shares to sell, Advertising startswhether to underwrite sale, where to sell andhow to fit sale in with other issues

Consider producing pathfinder prospectus

FINAL DECISIONS

Final go-ahead givenPrice decided

SELL100% sold

TRANSFER OF OWNERSHIPFROM PUBLIC SECTOR TO

PRIVATE SECTORCOMPLETED



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30. Subsequent steps involve improving trade and the balance sheet to ensure an enterprise isattractive to investors, preparing legislation and determining any regulatory arrangements. Typical stagesin the legislative process are:

• passing primary legislation, i.e. a principal Act of Parliament (the enabling Act forprivatisation of the enterprise or industry);

• There appropriate, to establish the details of any regulatory framework established under theAct and creating secondary legislation, i.e. Orders and Regulations laid before Parliamentsubordinate to a particular Act yet changeable without the passage of a new Act. This alsoincludes administrative instruments such as licences, the details of which may be modifiedwithout any recourse to Parliament.

31. Once the enterprise has been prepared for privatisation, the sale process begins. The exactprocedure depends upon the preferred method for the sale and the nature and size of the enterprise to betransferred. Clearly a major share sale will require a more sophisticated approach than a trade sale ormanagement buy-out.

32. The reform process is led primarily from the centre by the relevant Secretary of State. TheSecretary of State does, however, appoint teams of operational and financial advisers. These adviserscontribute to the development of policy and may be appointed to key positions after the privatisation. Forexample, the Franchising Director and the Regulator of privatised British Rail were both governmentadvisers on the sale.

33. Indeed, each flotation requires a whole array of ‘advisers’ related to the various requirements ofa successful float. Each one needs advertising and public relations to promote interest in the shares,solicitors and accountants to prepare a prospectus, stockbrokers to smooth relations with potentialinvestors, a merchant bank to organise the actual sale, and potentially further banks and brokers tounderwrite the sale. Both the government and the enterprise concerned clearly need to obtain their ownadvice. The costs of such advisers can, therefore, be considerable and typically account for about 3percent of the final proceeds. For example, the flotation of BT in 1984 cost £263 million out of saleproceeds of £3,916 million.

Sales

34. The favoured method for selling the government’s shareholdings in public enterprises is throughinternational and public share offerings by flotation on the UK Stock Exchange. However, not allprivatised companies have been offered for sale in this manner. Some, including subsidiaries of BritishSteel, British Shipbuilders and British Rail (notably Sealink and the railway hotels), have been transferredby private sale. The National Freight Corporation was sold directly to its employees and, additionally, anumber of regional bus companies have been the subject of management buy-outs. Some of theseactivities formed a part of the larger process of preparing the parent corporation for privatisation. Otherstook place because the parent was considered too difficult to float as a whole. The disposal of such assets,however, has yielded small sums relative to the large-scale privatisations by flotation (less than 10 percentof the total).

35. In the cases that the government sells its shareholdings through flotation, the UK general publicand institutional and overseas investors are invited to apply for shares at a fixed price. Most sales, up to



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1991, were underwritten by institutions who agreed, in return for a fee, to buy any shares which were nottaken up. However, in later privatisations, underwriting was dropped because it has proved unnecessaryand uneconomical.

36. If applications are received for more shares than are available, allotments are scaled down. Asone of the aims of the privatisation of public enterprises was to increase the number of shareholders,allotments to those applying for a small number of shares have always been honoured, at the expense oflarge institutional shareholders.

37. In the initial large flotations, particularly BT, there was considerable uncertainty if the enterprisecould actually be sold, not least because the capital markets had never before been asked to absorb solarge a flotation. To increase the potential market, shares were advertised aggressively to small investors,many of whom had never previously invested in equities. In the event, their unexpected enthusiasm for theshares meant that the offer was many times oversubscribed. So much so that restricted share allocationswere made to UK institutions who had to purchase later on the secondary market with the result thatshares opened at a premium of more than 90 percent.

38. Indeed, privatised shares for most of the former public enterprises typically went to a premiumover the offer price as soon as they were traded (the average is 32 percent). Although such premia arecommon for initial public offerings of all kinds, those for privatisations were well above average.

39. Other incentives were offered to small investors, such as bonus share schemes and vouchers tobe credited against future bills. These enticements were given to encourage investors to retain their shares,rather than to sell them immediately.

40. Recent research for the House of Commons’ Trade and Industry Select Committee’s inquiry intoenergy regulation3 has shown that the annualised rate of return (IRR) achieved by private investors whobought shares at privatisation in regulated, network industries and generation companies, and retainedthem until 31 January 1997, is generally higher than the average returns from other shares.

41. Privatisation has increased share ownership — 22 percent of the adult population of the UKowned shares in 1992 compared with 7 percent in 1981. However, many investors sold their shares withina few days or weeks of privatisation and the share registers of privatised firms are now dominated by largeinstitutional investors (see Figure 3).

Figure 3 : Shareholdings held by large institutional investors

Enterprise (Date ofPrivatisation)

% held on privatisation % held in 1994

Amersham (1982) 8.3 74BA (1987) 22.1 83.3British Steel (1988) 36.8 88.4Rolls Royce (1987) 25.9 84Assoc. British Ports (1983) 30 72.1Enterprise Oil (1984) 70 92.7BAA (1987) 24 80.4British Gas (1986) 43.6 75



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42. Employees have generally been treated favourably in privatisations, often being given a smallnumber of free shares and discounts on further shares. This last incentive provides employees with anenticement to raise the share price by improving the performance and profitability of their enterprises.Participation by employees in the free share scheme has typically been over 99 percent, while 60 percentof employees have taken advantage of share discounts.

43. Despite the emphasis on UK small investors, corporate shareholders from the internationalmarkets have featured increasingly in the privatisation process. Typically, in earlier privatisations,40 percent of shares have been sold to the UK general public and 60 percent to corporate investors, but inlater privatisations over 50 percent of shares have typically gone to the public. Corporate investors havetypically accounted for about 10 percent of the sales. Also, merger and take-over bids have featuredprominently in certain industries, (notably in the privatisation of electricity companies), with foreigninterest, and eventual success, being high.

Method of sale and retained government interest

44. Sometimes, the UK government sold its shareholdings in former public enterprises in severalsteps. For example, the privatisation process for BT began in 1984, when the government sold 50 percentof the share capital. A second tranche of 28 percent of the shares retained by the government was soldin 1991 and the remaining 22 percent (with some adjustments for bonus options exercisable by existingshareholders) was sold in 1993.

45. In some cases, shares are retained for employees and bonus offerings. Typically employee andbonus offerings account for 1 percent of shares.

46. The UK government often retains shareholdings as a long-term objective. For example, itretained one special (golden) share in BT with no voting rights. This share contained certain safeguardswhich, inter alia, allowed the government to appoint directors to the board and limit the shareholding ofany one person to less than 15 percent of the voting shares of the company. Similar arrangements havebeen made in other industries. For instance, the special shares in the newly formed water and electricitycompanies were redeemed about five years after privatisation. The primary motivation behind theinstitution of these special shares is to protect the industry from early take-over.

Revenue

47. The revenue realised by HM Treasury from the sale of its enterprises is listed by company inFigure 4 and in total in Figure 5.



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Figure 4 : Proceeds of privatisation (by enterprise)

Enterprise % of equity Proceeds (£ million)C&W 49 224Amersham International 100 71Britoil 51* 549Associated British Ports 52* 22Enterprise Oil 100 392Jaguar 100 294BT 51* 3,916British Gas 100 5,434BA 100 900Rolls Royce 100 1,363BAA 100 1,225British Steel 100 2,48210 Water Authorities 100 5,20012 Electricity Boards 100 7,997British Rail n/a n/a

* First tranche only

Figure 5 : Proceeds of privatisation (in total)

Year Proceeds (£ million)1980/81 5871981/82 4931982/83 4551983/84 1,1391984/85 2,0501985/86 2,7061986/87 4,4581987/88 5,1401988/89 7,0691989/90 4,2251990/91 5,3471991/92 7,9251992/93 8,1841993/94 5,4601994/95 6,4001995/96 2,439

1996/97* 2,0001997/98* 2,0001998/99* 0

* denotes government projections



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Operating and financial targets for competitive enterprises

48. Relatively little change was made to the competitive environment of enterprises alreadyoperating in competitive markets upon privatisation. Additionally, few, if any, operating and financialtargets were set.

Regulatory regimes for monopoly enterprises

49. Many of the privatised industries are, however, regulated, which was a step seen necessary bythe government due to the need to establish an effective proxy for competition where firms were operatingin monopolistic markets. Many of the privatised enterprises retained their monopoly status, at leastinitially, and others will continue to operate in monopolistic markets, at least for part of their operations(such as those industries which have some various natural monopoly elements). Clearly it will remainuneconomical to replicate some of these elements, such as delivery networks (water pipes, gas pipes, etc.).Assuming that a monopolist firm that owns some of this infrastructure aims to maximise profits (anassumption made of the behaviour of entities operating in the private sector), then the outcome would be aconsumer price higher than that which would result under conditions of competition and, presumably,higher than consumer prices under public ownership. This has provided the government rationale forregulation which is designed, in part, to curb this aspect of monopoly behaviour and has the primary aimof protecting the consumer.

50. However, regulation is not only about designing specific controls to constrain abuse ofmonopoly power. Such regulation is multi-faceted and is concerned with the promotion and control of thedevelopment of competition and the furtherance of certain social and national objectives. Six formerpublic industries are now regulated by an industry-specific independent regulatory body or bodies (seeFigure 6). The regulator is appointed by, but independent of, the Secretary of State.

Figure 6 : Industry regulators

Industry Regulator(s)Telecommunications Office of Telecommunications (OFTEL)Gas Office of Gas Supply (OFGAS)Airports Civil Aviation Authority (CAA)Water Office of Water Services (OFWAT)

Environment AgencyElectricity Office of Electricity Regulation (OFFER)Rail Office of the Rail Regulator (ORR)

Office of Passenger Rail Franchising (OPRAF)

51. Privatisation entails, amongst other things, the separation of the role of shareholder from that ofprincipal regulator, previously undertaken by the sponsoring government department. For nationalisedindustries regulation was often informal, combining pervasive government intervention and self-regulation by the industry (reflected in the manner in which it interprets its statutes). Financial targetstended to emphasise the need to keep the EFL to a minimum and, beyond this, there was littleintervention. Often, industries were required to do no more than break even from one year to the next.However, upon privatisation, regulatory regimes became formal and explicit and industry specificregulatory bodies were set up to operate at arm’s length from ministers and the sponsoring government



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department. They have wide ranging powers which are clearly separate from the operationalresponsibilities of the enterprises.

52. There is also a role for the Monopolies and Mergers Commission (MMC) to arbitrate disputesbetween the industry and its regulator and to investigate monopolies, mergers and anti-competitivepractices. Several other bodies are also involved in regulation, including:

• the Office of Fair Trading (OFT) enforces general competition law by advising the Secretaryof State which mergers or take-overs should be referred to the MMC;

• the European Union (EU) regulates through competition law and environmental directiveswhich take precedence over national laws;

• environmental regulators regulate specific aspects, such as the Environment Agency and theHealth and Safety Executive;

• consumer bodies, which represent consumer interests and investigate consumer complaints.Apart from the Gas Consumers’ Council (GCC), which is independent of OFGAS, all theregulators have integral consumer representation mechanisms. This has resulted in a debateconcerning which mechanism is best able to reflect consumers’ interests. Some have arguedthat the GCC is more independent and, therefore, more effective. Conversely, it has beenargued that the GCC has less teeth, as it is less able to influence the industry.

53. Whilst regulatory regimes differ slightly between industries, they all have similar characteristics.Regulation is used to control both economic and technical activities in all industries. Additionally, thereare three common objectives to UK regulation of privatised industries, and a series of specific controlsaimed at meeting these goals (see Figure 7).

Figure 7 : Regulatory objectives and controls

Regulatory objectives Regulatory controlsProtecting Customers Price controls (set to encourage efficiency)

Quality of service controlsPromoting Competition Industry restructuring and restrictions on vertical

integration and horizontal concentration of the marketRemoving barriers to entryControlling market entryCompetition for markets (e.g. franchising andcontracting-out)Comparative competitionGeneral competition policy

Promoting social and nationalobjectives

Obligation to supply or universal service obligation

Uniform tariffsProvision of special services for the old and disabledProvision of emergency or safety and security-relatedservicesPurchasing obligations



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Protecting customers

Price controls

54. To protect customers of privatised enterprises, price controls aimed to limit real price rises havebeen set. In the UK, the principal method of price control has been through the institution of price capsand involves relating the permitted change in the average charge for a bundle of services to movements ina general price index. A formula known as RPI-X has been used, where RPI is the Retail Prices Index (anindex used to measure general inflation in the United Kingdom by tracking prices of specific itemsincluded in a basket of goods) and X reflects expected efficiency gains and investment needs. Clearly,prices under this formula are expected to lag general inflation.

55. Price caps are reviewed periodically, typically every five years. The parameters of the formulaare set to allow some average return to be achieved in the years between reviews, after taking account ofthe need to fund investment and the potential for efficiency gains. The process of setting X thereforerequires detailed modelling of a company’s medium to long term financial profile. This approach allowsthe company to increase profits if efficiency gains are greater than assumed when the formula is set or ifgrowth in sales is higher than expected. If the company increases profits by failing to invest, however, it islikely to find that the allowance made for investment requirements will be clawed back at the nextperiodic review.

56. However, a cost pass through component, may also be added to allow significant cost items,which are outside the control of management (such as fuel or construction costs), to be passed directlythrough to consumers in final prices. In the water industry, for example, the formula is presented as RPI-X+K. In this case the value of K is currently positive to reflect the substantial capital investment requiredby the industry.

Quality of service controls

57. Of course profits can be increased under a price cap by increasing efficiency and reducing costs.However, costs can also be reduced by reducing service quality. Price caps are therefore usuallyaccompanied by additional controls on quality of service which are generally of two types: service-relatedand environmental.

58. Service-related controls cover both the quality of services provided, such as continuity of supply,and customer-care aspects of service provision, such as responding to customer complaints or enquiries.The precise standards vary depending on the industry, with the most comprehensive prevailing in thewater and electricity industries. They include, for example, a requirement to restore unplanned supplyinterruptions within a specified timeframe or to make compensatory payments to all customers affectedwhere this is not achieved.

59. Environmental controls usually involve additional regulatory bodies, which may be industryspecific or generic. For example, the water industry has the Environment Agency responsible forenvironmental concerns related to water resource management issues such as pollution control.

Promoting competition



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Industry restructuring

60. In industries which are vertically and/or geographically integrated, the potential may exist forrestructuring as a means of creating or facilitating the development of competition.

61. The electricity industry in England and Wales was restructured prior to privatisation throughvertical separation of generation, transmission, distribution and supply and the horizontal division of theCEGB’s generation business which was opened to competition. To prevent early vertical reintegration,limits were placed on the extent to which National Power and PowerGen, the main successor generatingcompanies, could enter the supply market in each regional electricity company’s authorised supply period.Despite this, there are cases in which vertical integration is the most logical form for an industry. Forexample, it has been used in the electricity industry in Scotland, to serve some of its most remote regions.

62. British Rail has also been restructured. The network is maintained as a regulated nationalmonopoly whereas the rolling stock is owned by separate companies and leased to train operatingcompanies which provide services under franchise arrangements. This system allows the subsidisation,and thus continuance, of uneconomical routes.

63. Whereas most restructuring occurs before privatisation, it is also possible, but very difficult, tore-structure afterwards. Industries privatised early, such as British Gas, were not re-structured prior toprivatisation and it has been a very painful process trying to inject competition into the industries postreform. This is probably one of the key lessons learned from UK privatisations —it is better to planindustry re-structuring and privatisation at the same time.

Removing barriers to entry

64. Controls may be imposed to ensure that the industry incumbent does not create barriers for newmarket entrants, by, for example, restricting or refusing access to infrastructure, setting excessive accesscharges, using creative (discriminatory) charging to protect vulnerable markets, or cross-subsidisingcompetitive markets by loading costs into monopoly areas. These controls include prohibitions on cross-subsidies and discriminatory charging and requirements to offer equitable access and publish tariffs andcharging schemes for scrutiny by regulator and the public.

Controlling market entry

65. Market entry is often controlled, by limiting the number of licences issued to ensure thedevelopment of effective competition, by allowing new entrants time to establish themselves or to beinnovative.

Competition for markets

66. In some markets, direct competition may not be feasible in all or part of the market. However,opportunities may exist to introduce competition for the right to supply the market. This might beachieved, for example, through competitive tendering of franchises or contracts for service provision, orby making provisions for ‘inset’ competition. This sort of competition allows a competitor to apply for apublic supply licence (authorising it to supply a particular geographic area) and, therefore, to challenge theright of the incumbent to act as the primary (or ‘public’) service provider in an area which the incumbent



21

would otherwise supply unopposed. Once the franchise, contract or public supply licence is awarded, thereis no further competition in the market until they need renewal.

Comparative competition

67. Even if there is no competition in or for a market, the regulator and the capital markets may beable to compare the relative performance of a company with similar companies. This has been done in thewater and electricity distribution businesses.

General competition policy

68. Once in the private sector, enterprises are subject to both UK and EU competition law. UK lawis likely to change in the near future to take account of Articles 85 and 86 in the Treaty of Rome, whichhave a strong prohibitions against anti-competitive agreements, cartels and abuse of a dominant positionin a market.

Promoting social and national objectives

69. Profit motivated enterprises will not voluntarily provide uneconomical services or support‘uncommercial’ practices which promote social and national objectives. Additional controls may thereforebe needed to satisfy the government’s wider policy objectives. These might include:

• the institution of an obligation to supply (i.e. a universal service obligation);

• the requirement to retain uniform tariffs, for example between urban and rural areas;

• the requirement to provide special services to certain groups such as the old and disabled;

• the requirement to provide emergency services and/or services which are safety or security-related;

• purchasing obligations, for example to encourage diversity and avoid dependence on limitedsources of supply.

70. Such obligations are met either by cross-subsidisation by monopolistic suppliers, by monopolyfranchises or by levying competitors to ensure the costs are shared among industry participants.

Autonomy/freedoms

71. Privatised enterprises enjoy a great deal of autonomy and freedom outside of the regulatoryframework. Privatisation has, to varying extents, freed them from the constraints of government control.They are free of direct political interference in decision-making and limits on investment driven bypolitical and macro-economic forces rather than commercial criteria. In some industries however, such asBritish Gas, enterprises complain that the regulatory process, which has replaced direct governmentinterference, is driven, to a significant degree, by the same political processes.



22

72. Privatisation has allowed enterprises to tap into the world’s capital markets to fund newinvestments and, through the possibility of hostile take-over and bankruptcy, to be disciplined by thosemarkets. Access to capital markets has allowed firms to reshape their activities, diversify into newventures, acquire other firms, dispose of peripheral businesses and enter foreign economies. This hasallowed them to make substantial investments outside of public expenditure. Despite these freedoms,some observers believe that many industries have not taken full advantage of these possibilities, at least tothe degree expected.

73. Although price regulation is rigorous, privatised enterprises have been given greater freedoms toprice commercially. For example, BT has been able to differentiate charges for national calls on ‘low cost’routes and to charge for directory enquiry calls, which were originally free.

Staffing issues

74. Nationalised enterprises were characterised by politically-appointed management boards. Thesalaries for top managers of UK State owned firms tended to be set to ensure parity with top civil servants,and were thus often well below prevailing rates in private sector firms. This has changed bothdramatically and controversially since privatisation. Directors and chief executives are drawn from boththe public and private sectors and are self-selecting, except where the government has retained a special(golden) share allowing it to appoint board members. Even when the government withholds a specialshare, it has only appointed a few of the directors to each board, leaving the majority of choice to theenterprise. In addition to this near-private sector freedom in board selection, remuneration packages fordirectors of privatised firms are now more likely to be at market rates and include performance relatedbonuses and share options. Figures 13 and 19 illustrate some of the increases in remuneration for directorsfollowing privatisation.

75. Privatisation has also allowed firms greater freedoms in more general personnel policies. Manyenterprises have shed significant numbers of staff (see Figures 12 and 18) yet overall wage bills haveincreased in real terms. For example, BT’s average number of employees fell 37.5 percent between1984/85 and 1994/95 but its average wage bill rose by 38.5 percent in real terms over the same period.

76. Most employees of the nationalised industries were not civil servants, but did have similar termsand conditions to the civil service. These terms and conditions were, effectively, ‘bought out’ by newemployment packages.

3. Impact of Reforms

Financial and operational performance


77. As relatively little change was made to the competitive environment of privatised enterprisesalready operating in competitive markets, any subsequent improvements in performance may reasonablybe attributed to new found freedom from government restrictions on decision making and access to capitalthrough financial markets.



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78. A study carried out by Bishop and Green in 19954 concluded that many of these enterprisesperformed better as a result of their freedom from public control than some of their peers which had neverbeen nationalised. More persuasive, is that these positive returns were often achieved in what were insome cases extremely unfavourable economic conditions. These enterprises were able to take advantage ofcommercial and financial freedoms that had been denied them prior to privatisation. In particular, somewere able to restructure their operations and reduce their workforce in anticipation of the onset ofrecession, whilst others were able to limit their exposure to recession by diversifying into less cyclicalbusinesses. The best performers, however, were those in the privileged position of being privatised withdominant positions in expanding markets.

79. This confident picture is confused, however, as it is difficult to separate economic success andfailure from general economic trends. Since the major privatisations, the UK economy has experiencedboom and recession. So, in 1990, before the slump, the enterprises reported higher real profits than atprivatisation and, by 1993 reported lower real profits than in 1990. Indeed, Rolls Royce and British Steelboth reported losses, although both returned to profitability in 1994.

80. However, Bishop and Green found that sectoral factors do explain many of the differences in theperformance of these enterprises. For example, British Steel’s losses compare with total losses for theEuropean steel industry and, although Rolls Royce made losses, it had actually improved its share of theworld aircraft engine market from 8 percent in 1982 to 25 percent in 1993 while maintaining its R&Dexpenditure. Other enterprises, such as BA and C&W, similarly performed better than European andworld averages for their industries.

81. Figures 8 to 13 summarise some key performance data for competitive enterprises between 1979and 1994.

Figure 8 : Competitive enterprises - turnover

Enterprise 1979(1992 prices)

£m

Onprivatisation(1992 prices)

£m

1994(1992 prices)

£m

%change

1979 (*orprivatisation)

to 1994Amersham 100 95 312 212BA 4326 4436 6047 40British Steel 8674 5404 5039 -42C&W 545 773 4523 730Rolls Royce 2073 2551 3437 66Associated British Ports 320.7 259.6 222 -31Enterprise Oil n/a 434.9 534 23*Note: shading denotes increased turnover



24

Figure 9 : Competitive enterprises - profit before interest and tax


£m


£m

1994(1992 prices)

£m

percentchange


to 1994Amersham 17 11 42 147BA 261 301 430 65British Steel -314 540 92 129C&W 150 125 1037 591Rolls Royce -120 200 86 172Associated British Ports 69.7 19.8 93 33Enterprise Oil n/a 211.2 90 -57*Note: shading denotes increased profit

Figure 10 : Competitive enterprises - return on capital employed

Enterprise 1979 %

On privatisation %

1994 %

Amersham n/a 13.3 20.4BA 12.5 23.1 7.9British Steel negative 11.3 2.1C&W 27.4 18.9 18.7Rolls Royce negative 17.5 4.3Associated British Ports 16.1 6.4 9.2Enterprise Oil n/a 27 4Note: shading denotes increased ROCE since 1979

Figure 11 : Competitive enterprises - share price

Enterprise Onprivat-isation

1990 1994 %change1990 to1994

%all shares

%sectorbenchmark

Amersham 100 348 927 166 118.5 126.2BA 100 226.2 377 67 37 41.6British Steel 100 127.5 144 13 -12 -9.9C&W 100 277 404 46 19.6 9.7Rolls Royce 100 178.3 175 -2 -20 -17.1Associated BritishPorts

100 160.3 247 54 26.4 30.8

Enterprise Oil 100 658 399 -39 -50.3 -51.7Note: shading denotes share price increase above all shares and sector benchmarks



25

Figure 12 : Competitive enterprises - average employment

Enterprise 1979000s

Onprivatisation

000s

1994000s

% change1979 (*or

privatisation)to 1994

Amersham 1.3 2 3.4 162BA 57.6 40.3 49.6 -14British Steel 190 54 41.3 -78C&W 11.1 12 41.3 272Rolls Royce 57 41.9 49.2 -14Associated British Ports n/a 9.6 2.4 -75*Enterprise Oil n/a 0.1 0.7 600*Note: shading denotes decreased employment levels

Figure 13 : Competitive enterprises - highest paid director


£000s

Pre-privatisation(1992 prices)

£000s

1994(1992 prices)

£000s

%change


to 1994Amersham 42.5 66.5 238.8 462BA 75.7 n/a 616 714British Steel 97.4 188 460.4 373C&W 52.1 74.7 721.2 1284Rolls Royce 130.5 197.3 286.2 119Associated British Ports n/a 79.1 239.2 202*Enterprise Oil n/a 154 367.1 138*Note: shading denotes increase in remuneration of highest paid director

Regulated enterprises

82. Analysing the post-privatisation performance of enterprises in regulated sectors is more difficultthan for those in competitive sectors because conventional indicators of performance, such as profitability,may reflect market power rather than efficiency.

83. Generally, however, Bishop and Green found that the profits of monopolistic enterprisescontinued to decline after the recession was over, unlike their more competitive counterparts. Experienceshows that, for the regulated enterprises, ownership change is by no means the sole effect on performance.Bishop and Green argued that other government policies directed at the enterprises have had a far greaterimpact. In particular, changes to financial controls and internal organisational structure have both beeninfluential in improving performance, but the most striking gains have arisen where markets have beenmade more competitive.

84. It is difficult to generalise on performance across all privatised regulated industries andcompanies, simply because of their number and diversity as well as the lack of data and agreement onindicators. However, studies of individual industries have tended to support Bishop and Green’s findings.For example, Burns and Weyman-Jones5 found that productivity of the regional electricity companies up



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to the third year following privatisation had not increased significantly since privatisation (2.5 percent onaverage, although it fell in some cases) and suggested that this was due to the leniency of the regulatoryregime which did not offer sufficient incentives to improve efficiency.

85. Figures 14 to 19 summarise some key performance data for three of the regulated enterprisesbetween 1979 and 1994. Bearing in mind the difficulty of using indicators and in making generalisations,these Figures show increases in turnover, profits, return on capital employed, share price and directors’remuneration, but decreases employment levels.

Figure 14 : Regulated enterprises - turnover


£m


£m

1994(1992 prices)

£m

% change1979 to 1994

BAA 162.2 439 1098 577British Gas 2981 7687 10386 248BT 3224 6876 13675 324Note: shading denotes increased turnover

Figure 15 : Regulated enterprises - profit before interest and tax


£m


£m

1994(1992 prices)

£m

% change1979 (*or

privatisation)to 1994

BAA 79 179 352 346British Gas 1628 1417 -8 negativeBT n/a 2404 2906 21*Note: shading denotes increased profit

Figure 16 : Regulated enterprises - return on capital employed

Enterprise 1979%

On privatisation %

1994%

BAA 8.6 15.1 10.9British Gas n/a 13 negativeBT n/a 16.7 17.7*Note: shading denotes increased ROCE since 1979 (*or privatisation)

Figure 17 : Regulated enterprises - share price

Enterprise Onprivatisation

1990 1994 %change1990 to1994

%all shares

%sectorbenchmark

BAA 100 389 892 129 80 94.7British Gas 100 217.5 267 23 1 4.4BT 100 299.5 369 23 1 -7.3Note: shading denotes share price increase above all shares and sector benchmarks



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Figure 18 : Regulated enterprises - average employment

Enterprise 1979000s

Onprivatisation

000s

1994000s

% change 1979 to1994

BAA 7.3 7.5 8.5 16British Gas 101.8 91.9 79.4 -22BT 233.4 244.6 165.7 -29Note: shading denotes decreased employment levels

Figure 19 : Regulated enterprises - highest paid director


£000s

Pre-privatisation(1992 prices)

£000s

1994(1992 prices)

£000s

%change

1979 to 1994

BAA 63 109.2 494.6 685British Gas 67 120.8 358.3 435BT n/a n/a 612.4 n/a

Note: shading denotes increase in remuneration of highest paid director

86. In regard to price of services, the regulated enterprises have had some considerable successes.For example, since privatisation:

• BT has cut prices by over 35 percent in real terms;

• the average household gas bill has fallen by more than 20 percent in real terms, evenincluding Value Added Tax (VAT) which has been included on fuel bills since privatisation;industrial prices are down by more than 40 percent;

• household electricity prices excluding VAT have fallen by 7 percent in real terms andindustrial prices by 10 percent.

87. Yet, despite these reductions, there have also been substantial price increases in particular in thewater industry, where prices for water and sewerage services have increased significantly to fund massiveinvestment programmes, primarily instigated by EU environmental directives.

88. In addition to generally improved prices for consumers, quality of service improvements havealso been noted. For example, since privatisation:

• in telecommunications, there is more service choice for the home and business and there arefar more telephone boxes on the street and almost all are operational;

• customers no longer have to stay at home all day for a service engineer to arrive --all utilitiesare now obliged to offer morning or afternoon appointments;

• the UK’s waters and rivers are now amongst the cleanest in Europe;



28

• electricity disconnections are down over 95 percent and gas disconnections are only one thirdof the level before privatisation ;

• consumers are compensated if things go wrong or if they do not receive the service to whichthey are entitled;

• regulators report steady improvements in the handling of complaints and billing queries.

Effect on public finances

89. Privatisation reduces the amount of government borrowing during the years in which the assetsare sold (for amounts see Figure 5), and in subsequent years if the enterprises were borrowing in order toinvest more than their current profits. However, these ‘gains’ were less than the net worth of theenterprises transferred (see paragraphs 2.18 to 2.19).

90. Additionally, the treatment of the proceeds of privatisation in the accounts of the UK publicsector is curious. Historically, government purchases of shares and assets were treated in nationalaccounts as public expenditure rather than, more accurately, as investment. Therefore, all revenues fromprivatisation are treated as the reverse of their purchase, that is as “negative” expenditure.

91. This treatment has the effect of reducing public sector borrowing, rather than as a means offinancing the difference between public sector revenues and expenditure figures. So, for example, in 1987,a year of high proceeds from privatisation (see Figure 5), the reported PSBR was only 1 percent of GDPyet, when the figures are adjusted to remove privatisation proceeds, PSBR was 2¼ percent of GDP —asignificant difference. The accounting treatment also has the effect of reducing the reported level of publicexpenditure. Therefore, the reported level of General Government Expenditure (GGE) is lower than itactually is. For example, in 1986, reported GGE was 47.8 percent of GDP yet, when the figures areadjusted to remove privatisation proceeds, GGE was 48.6 percent.

92. Clearly the impact of privatisation on public finances is not confined to the one-off effect of theproceeds of a given sale. There are a whole range of other effects to be taken account of including:

• removal of the enterprises’ gross trading surpluses (or losses) from public revenue;

• removal of the enterprises’ capital requirements from public expenditure;

• receipts by government of dividends on shareholdings;

• tax receipts on all dividend payouts;

• interest payments by enterprises to the private sector;

• interest payments by enterprises to the government.

93. Figure 20 sets out the range of effects which the sale of BT had in the first full year afterprivatisation. Despite the sale of 50 percent of BT, at a price of £3.9 billion, the net impact of thetransaction (excluding proceeds for the sale of the second tranche) is to raise the 1985/86 PSBR by £230million. Because BT re-invests a substantial proportion of its profits, the cash flow impact of removing it



29

from the public sector is considerably smaller than the stream of earnings foregone. Thus the mismatchbetween private sector accounting conventions, which rely on accruals, and public sector rules, based,until resource (accruals) accounting is introduced, on cash flows, makes privatisation appear financiallyattractive. Or, at least more financially attractive than it actually might be.

Figure 20 : The effects of privatising BT on the 1985/86 PSBR

£ millionRemoval of BT’s gross trading surplus from public revenue +3,000Removal of BT’s capital requirements from public spending accounts -1,900Receipts by government of its dividend on 3 billion shares (net) -200Advanced Corporation Tax receipt on all BT dividend payouts -170Interest paid by BT to rest of private sector -150Interest paid by BT to the government -350Net effect +230

Competition

94. Presently, competition has been introduced, to greater or lesser extents, in all industries. Itexisted previously where enterprises that already operated in competitive markets were privatised, but hashad to be introduced in monopoly markets. Clearly some industries lend themselves to competition moreeasily than others. For example, it has been far easier to promote competition in the telecommunicationsindustry than in the water industry.

95. The development of competition in the UK telecommunications market could have beenintroduced almost immediately but has been a managed process. This was done in order to minimisemarket disruption, particularly in the provision of basic telephony, and to encourage innovation, such as inthe provision of specialised services. Competition has, therefore, been introduced at different rates in thedifferent market segments. So, for example, the market for equipment sales was completely liberalised in1986, once the government had developed independent standards and an approvals system to ensure thesafety of apparati. BT’s monopoly over the supply and maintenance was thereby ended. However, thespeed and extent of entry into the market for basic telephony has been strictly controlled to, first, allowMercury time to become established and, second, to allow BT time to rebalance its tariffs gradually so asto reduce cross-subsidies from its lucrative national and international business calls to high cost, lowrevenue social provision lines. Without protection during this time, new entrants would have been able toskim off the lucrative business. It was, however, the complete liberalisation of the telecommunicationsmarket in 1991, and the awarding of supply licences to others, that was the real spur to consumer choicefor services and lower prices.

96. On the other hand, the nature of the water industry provides limited opportunities forcompetition. Consequently, competition has been facilitated by ‘inset’ competition, which allows a newsupplier to operate within the area of an existing supplier to supply a green field site or a large user.However, successful take-up of the facility has been limited to, at present, one undertaking after fiveyears.



30

4. Lessons Learned

97. In general terms, it can be said that privatisation has been beneficial, in regard to improvedfinancial performances, lower prices and increased quality of service provision. By being freed from Statecontrol, managers of the enterprises now have the incentives to use resources efficiently, to offer enhancedservices and to provide the best returns for shareholders. The threat of takeovers, where they exist, providea further spur to improved performance. This is particularly true in those industries which alreadyoperated in competitive markets prior to privatisation. It is also true in those enterprises which operated inmonopoly markets but where policies to introduce competition have worked most effectively. This has ledsome commentators to conclude that it is not so much a ‘privatisation miracle’ as a ‘competition miracle’.

98. As the environment in which the regulated enterprises changes, in order to survive, they areincreasingly forced to compete to win and keep customers, luring them with better prices, products andquality of service. The role of the regulators has been crucial in this process especially in regard to theintroduction of competition and the setting of price caps and standards of service quality. Clearly,regulation needs to evolve in line with industrial changes and the intention must surely be, in someindustries, to withdraw intrusive regulation of any kind once competition has developed sufficiently. Forexample, price controls have already been dropped in telecommunications and in industrial gas andelectricity supply.

99. However, despite these many obvious gains, there are also dis-benefits of privatisation, whichinclude:

• losses to the public purse where assets have been sold at less than full value. The net worth ofthe public sector is reduced as are future earnings for the public;

• media focus on what is viewed as corporate excess, including excessively high profits anddisproportionate rewards being earned by monopolistic enterprises for the benefit ofshareholders and top managers, all to the disadvantage of consumers;

• failure to achieve real competition in some industries and the need for elaborate systems ofregulation. Initially, regulation was not strong enough in many industries to encourageefficiency gains and so regimes have been tightened.

100. All of these concerns have, at some time, dominated the media headlines and made privatisationunpopular despite its many gains. In this respect, they offer the key lesson to be learned, namely how toget a balanced message and information about privatisation across to the general public.

101. The last two dis-benefits, however, present the real lesson for others embarking on privatisationsof monopoly enterprises. For, despite the apparent objectives of regulation, the benefits of competitionpolicy and the incentive regulatory system have not been made clear. Better communication of the role ofprofit, and the shared benefits between owners and customers of a periodic price capping system isrequired if the public is to consent to the current system. Profits made from a regulated monopoly arelikely to be judged an abuse, and so without improved public understanding of an incentive system whichmakes additional profit the quid pro quo for even lower prices in the future, there is a danger of publicdemands for change destabilizing regulation. The recent imposition of a windfall tax amounting to some£5 billion on the network industries is a measure of the unpopularity of the privatised utilities. This tax,



31

other than satisfying public outcry also has economic justifications, in that it compensates for laxregulatory regimes and recognises that the enterprises were sold too cheaply upon privatisation.

102. Also there is currently an unfortunate lack of a clear vision integrating market and non-marketprocesses. For example, in the water industry, consumers have seen leakage as wasteful and indicative oflack of investment for many years but the regulators are only just responding by establishing clearenvironmental and service standards for each company.

103. Despite the perceived dis-benefits to, and criticisms of, privatisation, there has generally beenlittle pressure to re-nationalise the privatised industries and enterprises; the only real pressure has been toimprove the regulatory frameworks. This is partly a result of ideology but also partly of pragmatism. Tore-nationalise the enterprises or buy back significant numbers of shares in them would be very expensiveat current market rates. Politically, the new Labour government has expressed its overall commitment forcompetition, and though the party plans to instil stronger and more accountable regulations in someprivatised industries, it has no plans to buy back any privately held shares. Yet, while supportive of thegains privatisation has achieved thus far, the new government appears to have little desire to continue thereforms by selling the Post Office (the last major State-owned enterprise) and has backed down from thepossibility of the politically sensitive privatisation of the London Underground transport system.Additionally, a change in reform tactics may be imminent, as Labour has voiced its support forpublic/private partnerships, through, for example, the Private Finance Initiative.



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Bibliography

BISHOP, Matthew and GREEN, Mike (1995), Privatisation and Recession — The Miracle Tested,Discussion Paper 10, The Chartered Institute of Public Finance and Accountancy (CIPFA)’s Centrefor the Study of Regulated Industries (CRI)

BISHOP, Matthew and KAY, John (1988), Does Privatisation Work — Lessons from the UK, Centre forBusiness Strategy, London Business School

BOULDING, Peter (1997), Whither Regulation? Current Developments in Regulated Industries 1997,Occasional Paper 7, CIPFA’s CRI

BURNS, Philip and WEYMAN--JONES, Thomas G (1994), The Performance of the ElectricityDistribution Business — England and Wales, 1971--1993, Discussion Paper 8, CIPFA’s CRI

CAWTHRON, Ian (1997), Regulated Industries: Returns to Private Investors, 1984--1997, OccasionalPaper 3, CIPFA’s CRI

CRI (1996), The UK Regulated Industries Financial Facts 1994/95, Statistics Series, CIPFA’s CRI

CRI, Price Waterhouse (1996), Regulated Industries — The UK Framework, Regulatory Brief 2, SecondEdition, CIPFA’s CRI

HM Treasury (1995), Guide to the UK Privatisation Programme

HM Treasury (1995), Privatisation — Sharing the UK Experience

JACK, Michael MP, Financial Secretary to the Treasury (1996), Utility Regulation — A PoliticalPerspective, Occasional Lecture 1, CIPFA’s CRI

KENNEDY, David (1997), Competition in the Water Industry, Discussion Paper 16, CIPFA’s CRI

National Audit Office (1992), Report by the Comptroller and Auditor General, Department of theEnvironment: Sale of the Water Authorities in England and Wales, Her Majesty’s Stationery Office(HMSO)

National Audit Office (1992), Report by the Comptroller and Auditor General, The Sale of the TwelveRegional Electricity Companies, HMSO

VASS, Peter (1997), ‘Regulated Industries’ included in Public Services Yearbook 1997--98, CIPFA’sPublic Finance Foundation, Pitman Publishing.



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NOTES

1 Data is not available in 1979, pre-privatisation

2 Data is not available in 1979, pre-privatisation

3 Ian Cawthron (1997), Regulated Industries: Returns to Private Investors, 1984-1997, Occasional Paper 3,CIPFA’s Centre for Regulated Indistries (CRI)

4 Matthew Bishop and Mike Green (1995), Privatisation and Recession C The Miracle Tested, Discussion Paper 10,CIPFA’s Centre for the Study of Regulated Industries (CRI)

5 Philip Burns and Thomas G Weyman-Jones (1994), The Performance of the Electricity Distribution Business CEngland and Wales, 1971-1993, Discussion Paper 8, CIPFA’s Centre for the Study of Regulated Industries (CRI)

reforming public enterprises: u.k. reforming …base) and they employed 45,900 people. this analysis...

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