A Critical Appraisal of the Theoretical Underpinnings of Privatisation: Evidence from the Electricity Sector in South Africa

Written by Siyaduma Biniza 1

Both nationalisation and privatisation have become highly contentious issues. The central difficulty of arguing in favour of, or against, privatisation stems from the theoretical limitations, methodological and empirical challenges, and the contextual complexity of the outcomes of privatisation. Besides these challenges, and partly due to these challenges, the lack of a sound theory on the impact of ownership on the performance of private and public enterprises means that there are no clear or universalistic policy recommendations regarding privatisation or nationalisation. Moreover, the theory of privatisation lacks any considerations about the necessary conditions for the success or failure of privatisation. Nevertheless, the privatisation agenda has been strongly pursued despite these limitations. This essay critically analyses the theoretical underpinnings of privatisation and its limitations using evidence from South Africas electricity sector. I should point out from the onset that it is quite usual that privatisation is not explicitly defined in the discourse. This is partly because there are many variant forms of privatisation. For example, privatisation can be done through managerial or investors ownership, public sector partnership, public private partnership and other forms. However the analysis of privatisation usually juxtaposes private versus public ownership and assesses the impact of ownership in relation to the political motivation of politicians or profit-maximising motivation of capitalist managers and investors (Boycko, Shleifer & Vishny, 1996). This obscures the impact of corporate or public governance, public-private working relations and other context-specific factors which all affect the performance of privatised enterprises ex post and ex ante. Nevertheless privatisation is usually justified using this method. Efficiency is a very important concept in the theory on privatisation albeit a biased definition of efficiency. Generally the theoretical perspective has been a synthesis of

Siyaduma Biniza is currently a B.Com. (Hon) in Development Theory and Policy student at the University of the Witwatersrand, holding a B.Soc.Sci in Politics, Philosophy and Economics from the University of Cape Town.

micro-foundations and some empirical evidence (Fine, 2008; Bayliss & Fine, 1998) which asserts that state owned enterprises (SOEs) are inherently relatively inefficient because of the expenditure-driven motivation of political actors in comparison to private actors who are driven by cost-minimisation and profit maximisation (Sheshinski & LpezCalva, 2003). This view is based on neoclassical economics micro-foundations which is the assertion that firm behaviour is strictly defined by profits maximisation which partly depends on costs minimisation (Varian, 2010). However, as we shall see later, this is an economically imperialist type of criteria to judge the performance of SOEs. The implication is that the relative efficiency of private actors as opposed public actors depends on the degree of commitment to profit maximisation and cost minimisation. Public ownership is asserted as being de facto inefficient due to political expedience which requires excessive spending to create employment, support patronage networks or straightforward corruption (Sheshinski & Lpez-Calva, 2003). In other words the inefficiency of public ownership stems from the view that political actors will not strictly pursue to minimise costs and maximise profits. On the other hand, because private ownership is driven by profit maximisation, which necessitates cost minimisation in a perfectly competitive market (Varian, 2010), private ownership relatively more efficient than public ownership. Therefore, any form of privatisation is relatively more efficient outsider-investor-ownership is asserted being specifically most efficient form of ownership as opposed to managerial privatisation and public-private ownership (Sheshinski & Lpez-Calva, 2003). This is because outsider-investors fit the neoclassical assertion and the implication of maximally efficiency (Varian, 2010); whereas simply hiring nonpartisan managers is less efficient because they are not immune to political expedience. However, this is not a simply economic argument but an ideological argument because it assumes that private firms are immune to political expedience even if this would maximise profits. Even if we accept this contentious claim, the relative efficiency of private ownership still depends on the neoclassical assumptions related to perfectly competitive markets. Perfectly competitive markets are characterised by full information and no transaction costs. But this observation highlights a theoretical contention and a conundrum for advocates of privatisation because under these conditions ownership would not matter given that both public and private owners would have the same information and face the same transaction costs meaning that they would choose the same utility-

maximising decisions according to neoclassical theory (Sheshinski & Lpez-Calva, 2003). However, perfect market conditions do not exist due to inherent transaction costs and informational asymmetries which are common feature of markets which means that institutions such as governments or firms can play a crucial role in overcoming inefficient outcomes associated with imperfect markets and inherent transaction costs (North, 1993; Stiglitz, 2002; Tisdell & Hartley, 2008). For example, due to market imperfects and transaction costs, a natural monopoly may arise. An example of this is the case of electricity generation and distribution where its widely accepted that there are economies of scale which incentivise monopoly instead of perfect competition. In such cases public ownership can be useful to avoid adverse outcomes associated which pricing in a monopoly or socially inefficiencies. But when markets are less imperfect the case for public ownership is less convincing (Sheshinski & Lpez-Calva, 2003). So the real challenge for privatisation theory, which is also its greatest limitation, is its lack of a sound theory that can define the distinct cases when markets are not too imperfect such that privatisation would the more efficient choice of ownership and also provide the necessary conditions for the success of privatisation. This lack of a sound theory means that there are no clear or universalistic policy recommendations regarding privatisation or nationalisation. Moreover, besides the implicit assumption that competition is all that is need for the success of privatisation, the theory of privatisation lacks any considerations about specific necessary conditions for the success or failure of privatisation. However, even competition is identified as prerequisite condition this is insufficient because in practice privatisation is simply driven by a quantity theory of competition that only asserts the usefulness of many supplying firms (Fine, 2008). But of course, competition is more than simply having many firms since perfect competition relies on full information and minimal, or no, transaction costs as previously discussed. Nevertheless, privatisation in practice tries to breakdown SOEs in order to allow private sectors investment and ownership. This practice, which is a result of the limitations of privatisation theory, is closely related to the failure of privatisation in electricity provision in many Sub-Saharan states including South Africa. The emphasis and processes of privatisation in these countries has sought to unbundle SOEs (Bayliss, 2008); in order to stimulate many smaller firms that collectively fill the

functions that the SOEs fulfilled singularly. This has not been sufficient to stimulate private participation as evidenced by the unsuccessful privatisation of electricity in South Africa. South Africas attempts to privatise electricity provision failed due to this limited conception of competition and how to regulate the privatisation process. The goal in privatising electricity provision was to have private sector investment and this was done through unbundling of distribution (Bayliss, 2008). But this was not enough since private sectors investment was not achieved and electricity provision suffered greatly because a consequence of the attempt was that public investment spending on electricity was reallocated without the required private investment. So it is not enough to simply present a viable investment opportunity for the private sector because there are various risks associated with information asymmetries and transaction costs which are not considered in privatisation in practice due to the theoretical limitations of relying on the quantity theory of competition. Nevertheless, the South African case shows that simply because there might be an economically viable opportunity for private investment doesnt need mean that there will be successful privatisation. It as if public reform, in the form of privatisation, can take the private sector to the water but cannot force it to drink. Thus, privatisation theory has an unfilled a gap in its micro-macro mechanisms. Firstly, although there is a clear micro-foundation to the privatisation debate, there is no conclusive or extensively clearly defined theory of privatisation which can fully account for the divergent outcomes at the microeconomic level let alone at the macroeconomic level. Secondly, this lack of a clear theory of privatisation or the impact of ownership on performance makes it difficult to have conclusive policy recommendation. Thirdly the dispersion in evidence and theory due to divergent outcomes of privatisation in practice further complicates policy-making because there are no clear implications or logical mechanisms between theory and outcomes. Therefore this means the macro space, with regards to privatisation, also remains unoccupied and there is no clear direction or ex ante and ex post implications of privatisation and policies promoting privatisation.

Bibliography Bayliss, K., 2008. Water and Electricity in Sub-Saharan Africa. In K. Bayliss & B. Fine, eds. Privatization and Alternative Public Sector Reform in Sub-Saharan Africa: Delivering on Electricity and Water. London: Palgrave MacMillan. pp.88-118. Bayliss, K. & Fine, B., 1998. Beyond Bureacrats in Business: A Critical Review of the World Bank Approach to Privatization and Public Sector Reform. Journal of International Development, 10, pp.841-55. Bayliss, K. & Fine, B., 2008. Privatization in Practice. In K. Bayliss & B. Fine, eds. Privatization and Alternative public Sector Reform in Sub-Saharan Africa: Delivering on Electricity and Water. London: Palgrave MacMillan. pp.31-54. Bourguignon, F. & Seplveda, C., 2009. Privatization in Development: Some Lessons from Experience. Policy Research Working Paper 5131. Washington DC: The World Bank The World Bank. Boycko, M., Shleifer, A. & Vishny, R.W., 1996. A Theory of Privatisation. The Economic Journal, 106(435), pp.309-19. Fine, B., 2008. Privatization's Shaky Theoretical Foundations. In K. Bayliss & B. Fine, eds. Privatization and Alternative Public Sector Reform in Sub-Saharan Africa: Delivering on Electricity and Water. London: Palgrave MacMillan. pp.13-30. North, D.C., 1993. The New Institutional Economics and Development. Economic History Paper Series. mimeo. Sheshinski, E. & Lpez-Calva, L.F., 2003. Privatization and Its Benefits: Theory and Evidence. CESifo Economic Studies, 49(3), p.429459. Stiglitz, J.E., 2002. Information and the Change in the Paradigm in Economics. The American Economic Review, 92(3), pp.460-501. Tisdell, C. & Hartley, K., 2008. Why do Governments Need Microeconomic Policies? In Microeconomics Policy: A New Perspective. Cheltenham & Massachusetts: Edward Elgar. pp.16-43. Varian, H.R., 2010. Intermediate Microeconomics: A Modern Approach. 8th ed. New York & London: W. W. Norton & Company.