Just for fun: nationalisation/privatisation pre-1990

By Paul Walker 26/05/2013

In an earlier posting I discussed the theory of privatisation. This theory has largely developed since around 1990. But what was the thinking before then? What was the logic behind the nationalisations of the early and mid 20 century? What was the thinking on privatisation before 1990?

Privatisation as an important economic and political issue is a relatively recent phenomenon. Even the word is of recent origin, dating back to only around 1959. (The second edition of the Oxford English Dictionary gives an etymology of the word dating back to 1959.) Before the Thatcher government came to power in the United Kingdom in 1979 and started implementing the first, widely known, privatisation programme during the 1980s, very few people anywhere around the world had heard of privatisation or knew what it meant. While there were attempts at reform involving denationalisation before the mid-to-late 1970s, such sales were sporadic and limited, and there were no systematic, on going, asset sales programmes until 1974 when the first wave of genuine privatisation started in Chile, a few years before the United Kingdom’s privatisation programme got underway.

A number of commentators have argued that the early privatisation programmes weren’t so much the result of the deliberate implementation of a preplanned strategy founded on a well developed theoretical base, but rather were ad hoc policies developed in practice, evolving over time, with the theory catching up later. This argument is commonly made with respect to the Thatcher governments privatisation programme in the United Kingdom. Bortolotti and Siniscalco (2004: 5) state that, “[c]uriously, the United Kingdom embarked on the first large-scale privatization programme in the late 1970s largely on faith, as the main privatization theories were not yet developed”. Pirie (1988: 9-10) notes, “[i]t is highly significant that the election manifesto which the Conservatives put forward under Mrs Thatcher in 1979 referred to the sale of only the shipbuilding and aerospace industries and the National Freight Corporation. The fact that dozens of pieces of privatization have been successfully implemented indicates that the British government developed the techniques in practice. Privatization in Britain was not the end-result of an ideological victory in the world of ideas; it was something which was so successful in practice that the government did more of it.” Arguing in a similar vein Veljanovski (1989: vii) writes, “[t]he remarkable thing about the whole [privatisation] process is that it was unpredictable, and it followed no coherent over-arching strategy. Privatisation evolved, each sale was self-contained and each pattern of disposing of assets, from the legal requirements to the terms of sale, was ad hoc.” In a review of the Thatcher government’s economic policies Samuel Brittan (Brittan 1989: 6) goes so far as to argue that privatisation became an important policy plank for the Conservative government simply because it was easier to carry out than other policies: “[ … ] privatization was hardly mentioned in the 1979 Conservative manifesto, except for shipbuilding, aerospace and National Freight. But it became a major thread when it was found easier to carry out than many other Conservative aspirations.”

In addition, Kay and Thompson (1986) lay the charge that privatisation in the United Kingdom lacked any clear rationale. They summed up their view in the title of their paper “Privatisation: A Policy in Search of a Rationale”. They argue that “[ … ] the reality behind the apparent multiplicity of objectives [of privatisation in the United Kingdom] is not that the policy has a rather sophisticated rationale, but rather that it is lacking any clear analysis of purpose or effects; and hence any objective which seems achievable is seized as justification.” (Kay and Thompson 1986: 19). (It should be noted that the view that privatisation was not part of the Thatcher governments original objectives but was more a piece of political opportunism has been challenged by former British Chancellor of Exchequer Nigel Lawson. Lawson (1993: 199) has written, “[t]he limited and low-key reference to denationalization in the 1979 manifesto has led many commentators [ … ] to suppose that privatization was not part of our original programme and emerged as an unexpected development into which we stumbled by happy accident. They could not be more mistaken. The exiguous references in the 1979 Conservative manifesto reflected partly the fact that little detailed work had been done on the subject in Opposition; partly that the enthusiasts for privatization were Keith Joseph, Geoffrey Howe, John Nott, David Howell and me, rather than Margaret [Thatcher] herself; and, perhaps chiefly Margaret’s understandable fear of not frightening the floating voter. But privatization was a central plank of our policy right from the start.”)

Following the increased importance of privatisation in practice came a, belated, increase in interest from economists. By the early 1980s the role of the state in the economy were being increasingly questioned and it was at this time that the first formal theoretical and empirical investigations of privatisation began to appear. There were, of course, discussions of the proper role of the state before this time with consideration of the economic consequences of privatisation going back at least as far as Adam Smith. On the sale of crown lands Smith (1776: Book V Chapter II Part II p.824) famously wrote:

“[i]n every great monarchy of Europe the sale of the crown lands would produce a very large sum of money, which, if applied to the payment of the public debts, would deliver from mortgage a much greater revenue than any which those lands have ever afforded to the crown. [ … ] The crown might immediately enjoy the revenue which this great price would redeem from mortgage. In the course of a few years it would probably enjoy another revenue. When the crown lands had become private property, they would, in the course of a few years, become well improved and well cultivated. The increase of their produce would increase the population of the country by augmenting the revenue and consumption of the people. But the revenue which the crown derives from the duties of customs and excise would necessarily increase with the revenue and consumption of the people”.

In the period between the end of World War 2 and the 1980s there was some, if not vigorous, debate as to the correct economic role of government, including state ownership of firms, but there was little or no formal modelling of either privatisation or nationalisation despite the prevalence of state ownership at this time. As late as 1989 George Yarrow (Yarrow 1989: 52) could write:

“[u]nfortunately, at the theoretical level, economic analysis has not accorded a high priority to the question of the likely effects of ownership on industrial performance. Despite a number of distinguished contributions from property rights theorists, the literature is much less well developed than in other areas of the subject. Thus, as an examination of economics textbooks will show, it is hard to find convincing positive theories of public enterprise behaviour. This may be because of factors such as the complexities arising from international differences in the frameworks of accountability and control for state industries but, whatever the cause, the point is simply that, on this issue, the cupboard is remarkably bare”.

During this period many governments and economists favoured, for various reasons, at least some degree of state ownership of firms. (It is interesting to note that Shleifer (1998: 135n1 and 138) argues that economists pre war and pre depression were more skeptical about state ownership; Alfred Marshall is one example:“[t]he same may be said of the undertakings of Governments imperial and local: they also may have a great future before them, but up to the present time the tax-payer who undertakes the ultimate risks has not generally succeeded in exercising an efficient control over the businesses, and in securing officers who will do their work with as much energy and enterprise as is shown in private establishments”. (Marshall 1920b: 253-4). “Starting from the fact that the growth of the national dividend depends on the continued progress of invention and the accumulation of expensive appliances for production; we are bound to reflect that up to the present time nearly all of the innumerable inventions that have given us our command over nature have been made by independent workers; and that the contribution from Government officials all the world over have been relatively small”. (Marshall 1920b: 593). “A Government could print a good edition of Shakespear’s works, but it could not get them written. When municipalities boast of their electric lighting and power, they remind me of the man who boasted of “the genius of my Hamlet” when he has but printed a new edition of it. The carcase of municipal electric works belongs to the officials; the genius belongs to free enterprise”. (Marshall 1907: 22). Carlson (1994: 83) portrays Eli Heckscher’s view of state ownership, in 1918, as “Heckscher also considered the time ripe for new reflections on state enterprises. If his reasoning prior to the war had laid stress on proposals for improvements to enable state enterprises to live up to the more stringent requirements now being imposed on them, he was now (SvT 1918, p. 520) clear “that it is a contraction and not an expansion of state business activity, even such as existed before the war, that we need.” The criterion which Heckscher (1918a, pp. 6-7, 21-23) propounded for the choice between state and private enterprise was now: who will best serve the interests of the consumer? And the answer (just as with Cassel) was that private firms in a competitive environment always have a sword of Damocles hanging over them which keeps efficiency alive and weeds out incompetent companies by natural selection – “survival of the fittest”. In the case of publicly-owned corporations, however, “their survival or death really has no connection at all with their capacity for managing their affairs” but is decided on “political grounds or [by] prejudices concerning the expediency or otherwise of state production”. Because state-owned corporations do not live under the sword, what they supply is not automatically adapted to market demand, and they are not compelled to develop new techniques and products. “For state monopolies the watchword, more or less inevitably, is the well-known phrase “Quieta non movere – don’t ruffle the prevailing calm.” And on the occasions when they do experiment, it is often popular fancies and not the prospect of profit that are the guiding star”.) Megginson and Netter (2001: 323) note that:

“[t]he Depression, World War II, and the final breakup of colonial empires pushed government into a more active role, including ownership of production and provision of all types of goods and services, in much of the world. In Western Europe, governments debated how deeply involved the national government should be in regulating the national economy and which industrial sectors should be reserved exclusively for state ownership. Until Margaret Thatcher’s conservative government came to power in Great Britain 1979, the answer to this debate in the United Kingdom and elsewhere was that the government should at least own the telecommunications and postal services, electric and gas utilities, and most forms of non-road transportation (especially airlines and railroads). Many politicians also believed the state should control certain “strategic” manufacturing industries, such as steel and defense production”.

Scitovsky (1952: 374) argues that concerns over the power of private monopolies explains the creation of state-owned monopolies in telephone, telegraph and public utilities in most European countries during this period. But monopoly was not the only reason for public ownership. As Vickers and Yarrow (1988: 125) point out, when dealing with the case of the U.K., there were a number of other motivations for state control:

“British Petroleum (BP), in which a controlling interest was acquired by the Government before the First World War with the object of securing fuel oil products for the Navy; the British Sugar Corporation, created by the Government in 1936 to promote domestic production of beet sugar for reasons of national security; Cable and Wireless, acquired in two stages (1938 and 1946) with a view to extending state ownership in telecommunications activities; Short Brothers and Harland (aircraft and aircraft components), acquired during the Second World War because the company was not being operated efficiently and the Government was not prepared to see it collapse; Rolls-Royce and British Leyland (now the Rover Group), both taken into public ownership in the 1970s to mitigate the consequences of impending bankruptcy”.

As far as the U.K. nationalisations of the 1940s are concerned Jewkes (1948: 145) is sceptical of there being any economic basis for them, “[b]ut the experience of the British Labour Government in the first years of office suggests that, in fact, no objective economic principles were being applied in choosing industries for nationalisation”. Millward (1997: 215), on the other hand, put forward the hypothesis that these nationalisations can be explained by

  • The infrastructure industries of electricity, gas, water, transport, and communications display the classic problems of natural monopoly and externalities on a substantial scale and this explains why in many western countries, and in Britain specifically form the middle of the nineteenth century, they were subject to increasing government control.
  • The failure of arm’s length regulation of the infrastructure industries in the interwar period explains why in the 1940s public control took the form of public ownership and why this has support over a wide political spectrum.
  • Manufacturing, commerce, and agriculture did not have problems of natural monopoly and externalities on anything like the same scale and were left largely in private hands.
  • The fundamental class division between wage earners and owners of capital to be found in the neo-marxist characterisations of capitalist society played a limited role in the 1940s drive to public ownership and had a clear manifestation only in that large industry whose working conditions and economic fortunes in the nineteenth and twentieth centuries appeared to suffer most from the cold winds of market forces – the coal industry.
  • The election of a Labour government in 1945, and its commitment to economic planning together with the specific historical context of reconstruction following the Second World War go along way to explaining the particular institutional arrangements which emerged in the public sector, specifically the nationwide dimension of public ownership, the legal form of the public corporation, the means of achieving coordination within the fuel and transport sectors, and the nationalization of the Bank of England.

Writing in 1953 Jewkes notes that, “[i]t is only recently that the claim has been made that nationalization is a more efficient way of organizing an industry than is possible whilst it remains in private hands”. (Jewkes 1953: 616). (Jewkes adds that “[t]he claim that nationalization represents a more efficient manner of running industry and of translating decisions regarding prices and investment into actions can best be examined in terms of the fundamental changes introduced in any industry subjected to nationalization. They are:
1. The nationalized industry is a larger operating unit than those it replaced. From this arises the claim for the economies of scale.
2. The nationalized industry is monopolistic. Out of this arises the claim that it can adopt more complete integration and coordination of related functions.
3. The nationalized industry is not operated for private profit. From this it is asserted that price and investment policy can be made more rational and that the collaboration between different classes of workers in the industry can be made more willing, smoother and, thereby, fruitful”. (Jewkes 1953: 617).)

Carlson (1994: 77) makes the case for defence policy as the motivation behind the first (partial) nationalisation of an incorporated company in Sweden:

“[t]he state’s first major involvement in the incorporated company form was initiated in 1907, under Lindman’s Conservative government, when the state become half-owner of the mining company LKAB. This action of the Conservatives was dictated largely by considerations of defence policy”.

In the U.S. context, Troesken and Geddes (2003) argue that for the case of the municipal acquisition of waterworks in the period 1897$-$1915 the data supports the explanation that municipalities were unable to credibly precommit to not expropriating value from the private water companies once investments were made, resulting in a rational reduction in investment in water provision by private companies. This rational underinvestment was then used by local governments as an pretext for municipalising the private water companies. Similar results were found for the municipalising of gas companies in the U.S. Troesken (1997) argues that the data are consistent with commitment and small market theories of public ownership. The commitment hypothesis, again, refers to the inability of municipalities to be able to credibly precommit to not expropriating value from the private companies once investments were made, while the small market hypothesis argues that in small towns inadequate consumer demand prevents suppliers from exploiting scale economies and from recouping their large capital investments.

Towards the more radical end of the spectrum of views of economists, Joseph A. Schumpeter (Schumpeter 1950: 228-31) argued that, in England at least, an extensive programme of nationalisation could accomplish a big step forward towards socialism. His list of industries ready for nationalisation included the Bank of England; insurance; inland transport, in particular railroads and trucking; mining, in particular coal mining; the production, transmission and distribution of electricity; iron and steel and the building and building material industries (It’s interesting to note that much of what Schumpeter recommended came to pass within a short period after the publication of the first edition of his book. The first edition appeared in 1942 and the Bank of England was nationalised in 1946, road and rail transport in 1948, the coal industry in 1947, electricity in 1948 and the iron and steel industry in 1951 (and again in 1967).) He added to this list a number of other industries – the armaments or key industries, movies, shipbuilding, trade in foodstuffs – that could also, for `special, mostly non-economic reasons’, be nationalised. In addition he noted that `as an economist’ he had no objection to make to land nationalisation.

Shleifer (1998: 133) sums up the prevailing thinking among the majority of more mainstream economists as “[ … ] economists were quick to favor government ownership of firms as soon as any market inequities or imperfections, such as monopoly power or externalities, were even suspected”. On the basis of fears about monopoly power Sir W. Arthur Lewis (Lewis 1949: 101) argued for the nationalisation of land, mineral deposits, the generation of electricity, telephone service, insurance and the motor car industry. Similar concerns led James Meade (Meade 1948: 68) to suggest that the iron and steel and chemical industries, to take just two examples, should not `long escape socialization’. On the other side of the English Channel Maurice Allais (Allais 1947: 66) went as far as to recommend the trial nationalisation of a small number of the most important firms in each industry to make possible the comparison of public and private ownership. But Allais was not alone in making this suggestion, back on the English side of the channel, Arthur Lewis (Lewis 1949: 102) argued in a similar vein:

“[t]here is a case for having some private firms in industries mainly nationalised, to act as a check on the efficiency of the public firms, and to provide an outlet for ideas which the public firms might suppress (this is particularly important in a country dependent on foreign trade). And equally there is a good case for public firms in many industries that are largely in private hands, to serve similarly as a yardstick and as an opportunity for experiments”.

There was, however, also a minority view which was sceptical about state ownership. Jewkes (1965: 13-14) agues that state owned industries could not help but be politicised:

“[t]hus it is claimed that a government may take responsibility for some new public service but take the whole operation `out of politics’ and thereby escape any increase in its own administrative burdens. [ … ] Experience in the past twenty years suggests that that view is naive. Nationalization has not taken industries out of the political area. It has pushed them more firmly into it”.

By the late 1970s-early 1980s the sceptical minority was becoming larger, the mood was turning against government ownership among both politicians and economists. “In the eighties the opinions of many public economists began intensively to deviate from the Musgravian view which has long been prevalent. The allocation of resources became the field of central interest. [ … ] Theories of public enterprises similarly began to concentrate on the question of how a regulating government could give the best incentives for efficient production in the firm. Internal subsidization was increasingly considered undesirable, as was any form of pricing with redistributive features. Furthermore, stabilization by public enterprises fell into disapproval. [ … ] This view on allocation, distribution, and stabilization dismissed many of those arguments in favor of public enterprises [ … ] in particular the desirability of distributional and stabilization politics of public firms”. (Bos 1994: 21).

One factor driving the changes in economists’ point of view as the slow accumulation of empirical evidence that was beginning to suggest that private firms were, by and large, more efficient than public firms. The theoretical question this raised was, Why?

During the first ten years, 1980-1990, efforts to explain the empirical results consisted of either informal, somewhat ad-hoc, models of the advantages of bringing market pressure and institutions to bear on state-owned firms, or formal models which, in the main, utilised a principal-agent framework to analyse the differences between public and private firms. The major problem with these formal frameworks is that they assume that contracts are complete/comprehensive and so cannot credibly address the issue of ownership and thus cannot satisfactorily explain why privatisation/nationalisation should make any difference to the operations of a firm.

It turns out that incomplete contracts are in fact a necessary condition to explain the differences between the two forms of ownership. In a world of complete or comprehensive contracts there is no difference between private and state owned firms. In both cases the government can write a contract with the firm that will anticipate all future contingencies – it will detail the managers’ compensation, the pricing policy of the firm, how changes in technology will the change the firm’s products etc – and thus the outcome under both forms of ownership will be the same.

It is at this point that my previous post takes over. That post discussed the post 1990 literature.