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HOW NOT TO PRIVATIZE

Why governments privatize

When governments finally decide to privatize, they do so overwhelmingly for one and one reason only: budgets. Governments are broke beyond measure and need to do something drastic to cut expenses… so that they may keep buying votes. The "solution"? Privatize… the government way.

For any government, privatizations are win–win scenarios. They receive a mountain of money… which they don't have to share with people (i.e. the idiots that built the companies being privatized). They "externalize" problems they know those companies will be facing due to the many decades of irrational management (i.e. they won't be blamed) and on top of that they have a patsy to point at! Lastly, they get to keep all the taxes that were previously used to subsidize those companies (when was the last time you have seen a meaningful tax cut for regular citizens?). What is not to like?

As a bonus, if people complain, they can always force companies into irrational pricing or other "social initiatives" at their own cost through regulations! The perfect crime!

How governments privatize

Governments go about privatizing by addressing the basic issues of government enterprises outlined above. We will do the same.

Monopoly: governments understand that granting a single, massive monopoly to a single company is a non–starter. It is so because of all the other companies would complain. Therefore a sufficiently large monopoly must be broken–up, so that the biggest friends of the government participate in the bonanza. Politicians cannot afford to alienate the Power Elite that pays for their elections. And the people? Thank you very much… The way a monopoly is broken–up is a political decision. As such, it is purely driven by lobby influence. It has nothing to do with market share, price or any other rational issue. As such, the mini–monopolies that are created simply represent the balance of forces between Power Elite groups and not free market forces.

Infrastructure: any buyer of government enterprises understands that without infrastructure said enterprises are worthless. What's the point of owing the phone company if you don't own the phone wires? And so politicians select one of two methods: they segment (chop) the infrastructure to match the mini–monopolies or they create a government–controlled organization to "manage" the infrastructure to ensure all buyers have access to it.

Irrational rules: buyers will immediately attempt to rationalize the operation of their purchases because they understand fully that under government management those companies were losing money. It is only natural. However, politicians have to maximize votes and therefore some sort of accommodation takes place. Governments impose some irrational rules to minimize vote loss while the buyers rationalize the remaining ones.

Operating at a loss: politicians understand full well that Power Elite buyers purchase government companies to make profits. They also understand full well that prices will rise. However, rising prices are not good for vote maximization and therefore they impose price limitations. Said limitations are usually determined by political expediency and Power Elite pressure and are totally un–related to free market operations. Furthermore –here comes the fine print– governments typically "donate" large amounts of money to companies for sale to make them more "appetizing" to potential buyers.

Consequences of government privatization for owners

Let's analyze the consequences of government privatization decisions.

Monopoly: as mini–monopolies are established based on political considerations, they are ill–prepared for markets, let alone free ones. They are either too big or too small or containing the incorrect territory or demographics or purchasing capacity or…or…or… Basically, they have a hard time operating in markets because they did not evolve from markets. They are not adapted to markets; they are adapted to political decisions without any regard to profits… which is exactly the one thing the new owners do not want! So from the beginning these mini–monopolies are set–up for failure. They stumble along making a large number of mistakes which their customers invariably pay for. They raise prices, they layoff personnel, they cut services, they "commoditize" products. In summary, they do whatever is necessary to make profits… which is exactly what people do not want!

Infrastructure: there are two possible scenarios.

a)    Infrastructure was split according to each mini–monopoly's territory. This brings a large problem. Said infrastructure was never designed to be split. It was designed to operate as one system. Hence, the new owners rush to create arbitrary boundaries and limits hence creating all kinds of problems for their customers. Simple phone calls suddenly become "long–distance" ones. Water pressure drops. Natural gas feeds become inconsistent and so forth.

b)    Infrastructure was handed over to a government organization to ensure "fair" access (whatever that may mean). This organization is again a government organization. As such, it operates in a non–profit manner, but this does not mean cheap; it only means irrational. Government bureaucrats at the head of said organization still think in terms of unlimited budgets. Therefore they end up imposing ridiculous "maintenance" and "connection" and "distribution" and "debt reduction" and…and…and… fees to the new owners… who promptly pass this cost to the customer. This means that now the customer must pay for raising prices and raising distribution costs.

Irrational rules: what in the beginning seemed like an acceptable accommodation between irrational rules imposed by the government and rationalization, it soon becomes clear that it was a mistake. Forecasts were typically widely optimistic. Profit margins aren't. Irrational rules are pervasive, inflexible and prevent major business decisions. The whole mess is, for any intent and purpose, un–workable. Net effect? Loss of profitability.

Operating at a loss: two issues:

a)    Money donations from governments to for–sale companies. These amounts are typically gargantuan and are supposed to wipe–out company debts… which were acquired by government mis–management in the first place. Of course, we, the people, pay these sums of money through taxation (direct or indirect). As with any government the left hand has no idea what the right hand is doing; the government typically prints to pay for companies' debts (no impact on government operations) while at the same time they get to keep all the sale proceeds. In other words, we pay for debt payments that companies incurred, we pay for the settlement of those debts, we pay higher prices for services due to government mis–management and the government gets to keep all the sale money! This is not keeping your cake and eating it too; this is selling the pastry store and keeping it too!

b)    Government–imposed price caps: they are usually written in stone for political reasons (politicians do not want to lose votes with constant price increases). This would not be so bad if governments would not be addicted to printing money. However, as inflation increases, price caps became meaningless and utterly insufficient to maintain the financial viability of the mini–monopolies… which have the strange tendency to go broke.

In summary, due to the manner in which governments privatize companies, many said companies:

a)    Are stuck with an market–inefficient mini–monopoly which cannot be fixed

b)    Cannot manage properly the infrastructure

c)    Are subjected to inflexible rules which interfere with all business decisions

d)    Operate at a loss or near–loss

Consequences of government privatization for customers

Of course, most of these elements are not visible to customers; however, what they do see (or perceive to be precise) is more than enough. They see:

a)    Prices going up and up and up

b)    Services and offers going down and down and down

c)    No "socially–sensible" rules or regulations

Is then any wonder that people do what people always do in such circumstances? They complain! Loudly!

Which brings us to "the cycle".

The cycle

If you believe that the consequences of the manner in which governments privatize enterprises ends here, you are in for a shock. This model of privatization is a cycle that repeats itself endlessly. The cycle operates more–or–less like this:

  • Government with "right" tendencies (i.e. as opposed to "left" tendencies) gets into power
  • Government with "friends" sells the "privatization" idea to the public promising Walhalla
  • Government privatizes "favoring" their friends
  • Friends begin to operate in a "freeish" market by raising prices to their correct levels
  • People complain loudly and demand government "action"
  • Government steps in with "price caps",       "subsidies" and "quotas" and other "socially-oriented" measures
  • People end up paying for privatized services twice: the near market price + raise in taxes
  • Companies don't make enough profits. Companies go broke.
  • Friends sell broke companies back to the government for a tidy profit.
  • Reset and Reboot – on to the next cycle

The reason why companies end up being re–sold to the government is because there are no other buyers. Seeing what the government did to those companies, no enterprise in their right mind would buy them. However, mini–monopolies have one last card to play: blackmail. They threaten the government with walking–away from the companies should the government refuses to pay ludicrous amounts of money. Walking away would imply people without water or phones, or natural gas or electricity; something that is political suicide for politicians. Hence, they pay. Or, more precisely, we pay… again.

This is a cycle that is not very common in industrialized nations, but in under–industrialized ones is all too common. It is triggered by the financial troubles a country may be in. If government finances are more–or–less in the standard "kick–the–problem–forward" mode, this cycle does not happen. However, if they are in "panic" mode, this cycle happens time and time again simply because the government cheats. They print money, create inflation and demand that privatized companies maintain fixed prices. This is the one absolutely 100% sure way to go broke. Remember, just because it hasn't yet happened in your country, it only means that it is in your future, not that it won't happen.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Privatization Follies Part 3

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