Transcript Privatization and regulation, according to politicians

Università degli Studi Bergamo
Highways: costs and regulation in Europe
Privatization and regulation, according to
politicians’ benefits
by
Giorgio Ragazzi
Università di Bergamo
Massimo Di Domenico
IEFE-Università Bocconi
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•The promotion of privatisation processes for state-owned
enterprises (SOE) has been supported by the idea that it enhances
efficiency and competitiveness of an economy.
•Empirically, however, the success of privatisation programs is
mixed; it is difficult to identify the determinants of success or
failure.
•One possible key explanation of these different performances may
be found in political economy explanations.
• Governments might pursue goals other than the enhancement of
efficiency. Because of their private agenda and the influence of
lobbying groups, politicians might choose privatisation even when
this is not in the best interest of the economy.
•Politicians’ rent seeking and political motivations can be
important drivers of the decision to privatise SOEs.
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•Political motivations may condition the choice of the method of
privatisation.
•Some empirical analysis of privatisation processes show that
privatisation is a bi-partisan decision. Both left- and right-wing
governments have put privatisation programmes on their agendas.
However, because of different priorities they have opted for
different ways of implementing these programmes.
•Together with ideological political motivations, it is important to
analyse the rent seeking activity by politicians and it is in this field
that our paper would like to introduce some contributions.
•Our analysis will investigate privatisation and regulation from the
point of view of the politicians’ interests, without taking into
account the welfare effect of such a discretional behaviour and
considering firms operating in a competitive market and in natural
monopolies .
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Privatisation of SOE in competitive markets
•To start with, let us consider a SOE in a competitive market.
•The firm’s budget is:
pQ=cQ+sQ+G1
where p is the market price for output Q, c is the profit maximizing
firm’s unitary cost, sQ is the additional cost due to political
influence over the firm’s managers activity, G1 is the yearly firm’s
profit (loss) flowing to the Government.
•The additional cost sQ may reflect inefficiencies due to poor
control by politicians, but also the pursuit of social goals in the
form of overmanning, extra salaries, social investments etc. to
increase political support.
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•The politicians’ utility function can be written as follows:
Ut=Us(sQ)+Ug(G1)
where Us is the politician’s utility from control of the SOE (an
increasing function of the cost sQ). Hereafter we refer to this utility
as the “political rent” for politicians.
•Ug represents the utility politicians derive from the profit flow
(loss) generated by the firm and accruing to the state budget. Indeed
firm’s profits help to reduce the fiscal burden of citizens or/and
allow to increase public expenditures. We refer to Ug as ”financial
rent” for the politicians.
•Politicians, then, face a trade-off between increasing the political
rent or the financial rent. Politicians, for example, could be in
favour of increasing the number of the firm’s employees in order to
receive greater political support from unions. However, this could
be detrimental to the firm’s profit (G1), thus reducing the politicians
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financial rent.
• If the SOE is privatized, politicians loose their influence on the
firm, i.e. they loose the political rent.
•Therefore, a necessary condition for privatisation to be
implemented by politicians is:


t 0
t 0
U g P   G1t (1  rp ) t ]  U rt (1  rp ) t
•where P is the total price collected by the Government by selling
the firm and rp is the politicians discount rate for future profits G1.
•After privatisation, extra costs due to political influence will be
removed. The firm’s new shareholders profits will be G2=G1+sQ.
•Therefore, a necessary condition for politicians to sell the firm and
for private investors to acquire it must be:


t
t
G
(
1

r
)

P

G
(
1

r
)

 1 p
t 0
t
2
t
t 0
•where r is the market discount rate(interests rate plus risk
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premium).
• The likelihood that a SOE will be privatised increases if:
–politicians are “shortsighted”, i.e. discount the present value of future cash
flows from the SEO at a higher discount rate than the market. Likely to
happen if probability of being re-elected is low.
–public deficit is a critical issue: Ug is more important for politicians than the
political rent Us;
– extra costs (sQ) due to political influence are high, and so it is high the
potential for increasing efficiency by private shareholders.

U
– the present value of political rent is low 
t
r
(1  rp ) t
, because of
moral/judicial pressures and/or low probability to be re-elected.
t 0
•Given the maximum divestiture price P* politicians could pursue
two avenues:
• sell the firm at the maximum price, in order to raise funds for social
expenditures or to decrease taxes;
•sell the firm’ shares at a price lower than P* to the general public, in order to
obtain political support from shareowners.
•Pricing is therefore affected by ideological issues.
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Privatisation of a monopoy
•Let us consider a SOE in a natural monopoly (e.g. highway)
regulated by politicians.
•Tariffs are a political issue. Political support could be increased in
two ways, and again politicians face a trade-off.
• Increasing tariffs improves the public budget (G1).
•However, increasing tariffs reduces consumers’ surplus and thus
also votes and support.
•The politicians utility function is then:
Ut=Us(sQ)+Ug(G1(p))+Up(S(p))
where the utility terms Up represents the political costs (votes lost)
when tariffs are increased and S(p) is the consumer’s surplus.
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•Let us consider a state-owned natural monopoly, without
an independent regulation authority.
• Sale of natural monopolies to the private sector does not
improve their efficiency (highways are a case in point).
• Costs are mostly depreciation and financial charges;
technological innovation is limited; there are very limited
possibilities for over employment (as a consequence of
political influence).
• The main reason for privatization is politicians’ desire to
raise cash, to reduce public debt, even if this means
relinquishing the political rent.
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Natural monopoly and tariffs determination before
and after privatisation
•Let us now consider the political cost of tariff increases (the utility
Up). A privatisation process weakens the link between tariff
increases and citizens’ discontent directed at politicians.
•In this situation politicians may privatise for two reasons: to ease
restructuring of a loss-making firm, or to derive a new type of
political rent from the relationship with the privatised firm.
•An example of the first case is the privatisation process of the
water sector in England under the Thatcher Government (low tariffs
before privatisation because of strong political opposition - tariff
increase after privatisation without sensible decrease of political
support for the government).
•In the second case the Ministry in charge of regulating the firm
may be interested in augmenting tariffs in order to obtain favours
from the privatised firm (e.g. election campaign contributions,
favours etc). This would constitute a new source of rent, possibly
more than compensating the loss of political rent form control.
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•Politicians and privatised firms may justify tariff increases with the
need to cover costs. Since citizens cannot check the tariff setting
process, there’s a problem of asymmetric information.
• Hence privatisation makes it possible to increase tariffs without
undermining the support for politicians and provides a new source
of political rent for them.
•In this case the politicians’ utility function is:
Ut=Up(S(p))+Ur((p))
where  is the firm profit. When the company was a SOE,
politicians benefited from higher tariffs only in so far as these
increased budget revenues; the value of this benefit for politicians is
likely to be much lower than the benefit they may derive from
allowing the private firm to increase its profit. The private firm is in
a strong position to lobby, influence public opinion, provide direct
benefits to politicians. Therefore, one may expect tariffs to be
higher after privatisation.
•Tariffs represent an important variable and should be properly
regulated: low tariffs discourage new investments; high tariffs,
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instead, are wasteful for consumers.
Important conclusion can be drawn:
–political influence and discretion is detrimental for
social welfare;
–when the firm is government-owned, politicians face
a trade off between increasing the consumer surplus or
increasing resources for public finance purposes;
–after privatising SOEs, politicians face a trade off
between consumer surplus and firm profits. They must
deal with two interest groups: consumers, very
numerous, but unable to organise themselves; the firm,
with large resources for lobbying.
–the second situation is more detrimental for social
welfare than the first; hence it needs to be more
thoroughly investigated.
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