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11 July 2022

Private Island

James Meek’s 2014 book Private Island is an engaging critical examination of the history and effects of privatization in the UK. In this context, privatization is when a government sells an asset, company, or entire industry it has previously owned and managed. Though privatization has a huge impact on how we access things like energy, water, housing, healthcare, transportation, and post, it’s not widely discussed or understood.

Private Island focuses on the UK, where privatization was pursued aggressively by Margaret Thatcher’s government in the 1980s and has continued since. The book’s UK-centric analysis is interesting for its own sake, but it also illustrates a number of principles that apply more generally. These principles highlight challenges associated with the privatization of public utilities, i.e. essential infrastructure.

Broadly speaking, we can consider infrastructure essential if it is necessary to maintain a society’s standard of living, it requires technical expertise to operate, and people are obliged to use it. This definition is fuzzy, and different people are likely to have different ideas about what constitutes essential infrastructure. A particular industry can also have essential and non-essential segments. For example, low-cost housing might be considered essential infrastructure while luxury housing isn’t. The challenges discussed below don’t necessarily apply to non-essential industries or infrastructure.

When governments privatize essential infrastructure, they’re selling a significant amount of control over their citizens. People are obliged to use the privatized services, many of which are naturally monopolistic, making it hard for other businesses to compete. Privatization also tends to be accompanied by a light-touch regulatory policy, which leaves privatized companies with a lot of control over how their services are administered.

A government that doesn’t manage critical infrastructure eventually loses the expertise to regulate it effectively. Private Island’s analysis of many privatized industries in the UK clearly demonstrates this fact. Such a government would struggle to take over, or re-nationalize, an essential industry in crisis. This is a strategic failure: it entails a dependence on private organizations for society to function at a basic level. These private organizations might even be owned by foreign entities. For example, over ten percent of Great Britain’s electricity supply is currently managed by Électricité de France, a company wholly owned by the French state, and a huge proportion of essential infrastructure across industries in the UK is owned by private foreign investors.

Supporters of privatization say that it allows all citizens to benefit by becoming small shareholders of utility companies. However, history shows that even when shares are given directly to employees or the general public, privatization ultimately leads to consolidation. Consider post-Soviet states, in which a small number of people came to own virtually all privatized utilities. Or Thames Water, which was listed on the London Stock Exchange when it was privatized in 1989 and is now privately owned by a small consortium of international investors, including the sovereign wealth funds of China and Abu Dhabi.

Proponents also say that privatization leads to greater efficiency and better services. However, private ownership isn’t inherently more efficient than governmental ownership, nor is the opposite true. Both can be highly effective, and both have issues that prevent them from completely serving the public interest, i.e. providing the best and most efficient service possible.

For private ownership, the main problem is that managers tend to be motivated by shareholder profit or political power rather than public good. They are likely to spend as little as possible on things like maintenance, system upgrades, and research and development. While this policy may be efficient from a profit perspective, it reduces the efficiency and quality of the services themselves. Additionally, because their services are essential, private utility companies are likely to be bailed out by government if they fail. Private mangers are thus incentivized to make risky decisions for financial gain.

For government ownership, the main problem is presence on a government’s balance sheet. This can subject utility companies to political whims. For example, a company may be unable to finance necessary projects when governments don’t want to be seen as taking on more debt for political reasons. Additionally, if a company receives significant grant funding or subsidies from government, it is likely to prioritize self-preservation over high-quality and efficient service provision.

This discussion suggests that there could be a third way for the management of public utilities that addresses the challenges of both privatization and complete government control. Here is my attempt at designing one:

All essential industries have a market participant called the third-way entity (TWE). The TWE is chartered and governed by legislative statute, but it operates independently from the government. It is a non-profit company with no shares managed by a board of directors. It is initially endowed by the government and then must acquire and service its own debt; its loans do not necessarily come from government.

The TWE’s lack of shareholders promotes operation for the public good rather than profit or other interests. The fact that it is not owned by government liberates it from political vagaries, but the potential for statutory intervention discourages self-serving practices. The need to acquire and service its own debt promotes efficient operation, though this effect is somewhat limited by the fact that the TWE’s services are essential, so it is likely to be rescued by the government in case of failure.

Effective directors and employees can be attracted with competitive performance incentives in the form of pay rather than shares. These incentives must be designed to encourage the provision of quality services to as many citizens as possible, as efficiently as possible.

The TWE may be directly responsible for the production and maintenance of all equipment it needs to function. More likely, however, it contracts with other companies to acquire the assets that it operates. In this case, it must work with private suppliers to ensure a resilient supply chain and healthy market conditions.

The TWE may or may not be monopolistic within its industry. If not, there must be a maximum share of the market that private participants are allowed to control. This prevents the TWE from becoming ineffectual, and allows the government to retain competency in operating and regulating essential infrastructure. It also allows the TWE to serve as a provider of last resort that can take over the operations of failed private market participants. In most cases, a non-monopolistic TWE encourages competition, which increases service quality, and unlocks private investment, which increases market capacity.

There is a separate government regulator, distinct from the TWE, that sets rules for its corresponding industry. Its goal is to prevent corruption and ensure all market participants operate in ways that serve the public interest.