Why privatisation has been a success story

It is an irony about privatisation, a process pioneered in the UK, but as the rest of the world takes up the fashion for selling off state assets with abandon, Britain has seriously cooled to whether it was ever such a good idea in the first place. Since privatisation is arguably our biggest single contribution to the evolution of post-war commerce, this needs some explaining.

Privatisation was never a popular policy; many saw it as little more than Margaret Thatcher's gift to the English middle-classes. Each one was bitterly fought by the Government's political opponents, and for everyone who made a bob or two out of all those juicy stock market giveaways, hundreds more didn't and resented the easy gains made by those who did.

There was a time, however, when privatisation was generally accepted as "a good thing", theoretically at least. Most of us bought the argument that business is on the whole, with adequate regulation, much better left to the private sector.

That is plainly no longer the case. The tendency these days is to highlight the failings of privatisation rather than its achievements. This is more than just a politically led swing of the pendulum. Knocking privatisation is not a pastime confined to Labour-leaning commentators. The Tory press has been as vicious in lambasting "fat cat" salaries and "excessive" shareholder returns as anyone on the left. It was The Times which first urged the case for a windfall profits tax, and The Daily Telegraph which has been most consistent in its attacks on excess among the utilities.

Labour has naturally capitalised on all this, turning public suspicion and hatred of the utilities into an electoral issue. Though it has no intention of renationalising these industries, it does intend to crack down on them hard - so hard, in fact, that many of the real gains in efficiency, standards of service and innovation which privatisation has brought about in the UK economy may be undermined.

So what has gone wrong here? Why has such an obviously attractive and rewarding policy resulted in such an overpowering popular backlash? The problem is that along with the cure, privatisation can have some very unappealing side-effects, particularly in its early years. These have been most apparent in the last three of the Government's big privatisations - water, electricity and rail - but they were also there in the early years of British Telecom, now seen as a triumph of privatisation.

Think back to 1987. Here was this vast, unwieldy public utility, making profits of pounds 100 a second or whatever it was, and yet half its telephone boxes didn't work, quality of service was lousy, it was generally perceived to be expensive, there was no realistic alternative and you still had to join a waiting list to get a new telephone line.

BT was once memorably described, probably accurately, as the most hated institution in the land. Here was a privatised utility that behaved in the same cavalier fashion towards its customers as if it were still in the public sector. Abuse of monopoly might be tolerated when the utility forms part of the state, but not when in the private sector. BT was forced to reform itself, and fast.

None of these strictures are recognisable in today's British Telecom. Even the Labour Party has embraced it as a model for the rest of corporate Britain. Today we have better quality of service, more choice and lower prices in Britain than almost anywhere else in the world apart from the United States. BT is also at the forefront of international developments in telecoms. Liberalisation and privatisation are the two key causes of this extraordinary turnaround. The lesson seems to be, therefore, that provided privatisation is also accompanied by liberalisation, initial teething difficulties are eventually overcome to produce publicly recognised advances.

With water, electricity and rail, it is proving much more difficult to introduce competition into the market, virtually impossible in the case of water. As a result we have had to rely solely on regulation to protect the public interest. This regulation has frequently been seen as wanting. Perhaps more seriously, these industries have embraced wholeheartedly all the worst manifestations of corporate excess.

The general perception, mostly accurate, is that of excessive profits, excessive executive pay and options, excessive returns to shareholders, under-investment and a raw deal for customers. Ergo, regulation and privatisation haven't worked.

There is a flip side to the coin, however. Would the situation have been any better had these industries not been privatised? The answer is almost certainly no. There would, it is true, be no excessive profits or pay packets, or fabulous returns for shareholders. But, equally, nothing would have changed. These companies would have remained bloated and inefficient enterprises, and despite their public ownership, largely unaccountable for their failings.

Yorkshire Water's inability two summers ago to provide its customers with water was certainly as bad a case as they come of management and regulatory failure, but it would be wrong to think of it as a failure of privatisation as such. Indeed, the fact that Yorkshire Water is privatised, that the service offered is now not just a public service but also a consumable commodity, gives customers channels of redress and accountability they would never have had amid the fudge and obfuscation of the public sector.

What then to do about the problem of excess? Labour's proposed solution is to fiddle around with price cap regulation, the cornerstone of economic regulation of the utilities. The difficulty with this approach is that it is actually price cap regulation which provides one of the key underlying economic justifications for privatisation - incentive to improved efficiency. In other words, Labour may be throwing the baby out with the bathwater if it attempts to address the problem of excess by abandoning the concept of price cap regulation.

The reason for this is that the system is set up, almost deliberately, to allow excess. Prices are capped at a pre-specified level for a period of time, generally five years. If the utility exceeds the regulator's assumptions about the scope for cost-cutting, then the gains go to shareholders. This is where the "excess" comes from. However, if the system works as it should, these gains are later realised on behalf of the customer at the time of the periodic price review, when there should be a big step down in prices. The excess thus ultimately ends up with the customer.

The fact that regulators have perhaps not been as harsh as they should have been at the time of these periodic reviews demonstrates a failure in regulation, but it doesn't mean that the whole system of price cap regulation is wrong. Certainly there is a powerful case for reform of the institutions of regulation - more accountability, greater transparency and the like.

But what Labour wants to do goes a lot further. It wants to put price reviews on an annual basis, and moreover, to introduce a method of sharing any excess generated between customers and shareholders. It can readily be seen that the effect of this when combined with the windfall profit tax will be to remove virtually all incentive to improved efficiency.

Indeed it might actually work the other way, with utilities failing to meet assumed rates of return and customers having to share in the consequent losses. There would be no incentive to improvement.

By attempting to remove some of the more unpalatable effects of privatisation, then, Labour will also be destroying the radical, reforming aspects of the process, to the ultimate detriment not just of shareholders, but of customers, too. Is that what we really want?