Rail to Royal Mail: the dangers of flawed privatisations

October 10, 2013 11:21 am

Rail to Royal Mail: the dangers of flawed privatisations

By Philip Augar

Intervention addresses the symptoms but not the causes of malfunctioning, writes Philip Augar

Is the UK’s privatised utilities market broken? It is a fair question on the day when Royal Mail – once seen as an untouchable public asset – makes its stock market debut, when Ed Miliband, Labour party leader, finds public resonance with the idea of a price freeze in the energy sector and when the government has to step in to cap rail commuter fares. The need for price intervention illustrates the risks of privatising a state-owned utility. If the regulatory balance is wrong or the competitive structure ineffective, the public ends up paying too much, corporate profits become too high and private sector shareholders get a free ride from taxpayers.This is not to say all privatisation is wrong. Margaret Thatcher, the mother of privatisation, recalled “just how revolutionary – how all but unthinkable – it seemed at the end of the 1970s”. Yet the nationalised industries her government inherited were a mess, and the case for privatisation seems obvious in hindsight. According to the Institute for Government, at the time they constituted 10 per cent of the economy and consumed 14 per cent of total capital investment but their rate of return on capital was less than 2 per cent. They had indifferent management, bad customer service and poor labour relations. They were obvious candidates for radical reform, and during the next two decades a wave of deals transformed public finances and the FTSE 100 index.

Two types of business were sold off. The first group, including British Petroleum, British Airways and Rolls-Royce, competed in the global industrial market place. Privatising enthusiasts argued persuasively that the dead hand of state ownership was a drag on the global free market, curtailing investment, innovation and entrepreneurship.

The second were utilities, most of which had a monopoly position in the UK. Encouraged by the City, which foresaw several big pay days, free marketeers argued that private sector ownership would provide funds to invest in infrastructure, boost efficiency and improve services. The BT privatisation kicked off this wave in 1984, followed by the 1986 “Tell Sid” British Gas campaign; water in 1989; electricity in 1990; and British Rail in 1993.

The pioneers of utility privatisation knew about monopoly issues and created artefacts to control profits and prices, and encourage competition. They tried to achieve transparency in service levels and price; a level playing field for new entrants; and firm regulation to ensure fair play.

They were only partly successful, and the consequences are emerging now. Failure to construct an effective market mechanism risks creating faux competition, characterised by cosy rivalry rather than the head-to-head battles that drive down prices and transform public service. In turn, this facilitates low-risk profit opportunities for the private sector on the back of officially condoned oligopolies and hidden state subsidies.

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Critics find some or all of these elements in energy, water and telecoms, but they are most starkly evident in rail. A series of academic studies shows that privatised rail is a public problem because passenger revenues do not cover operating or investment costs. Consequently, the system requires public subsidy in the form of artificially low track access charges for the train operating companies, which enables them to make profits and pay dividends. The public is further baffled by an incomprehensible fare structure. Such opacity is not what privatisation should be about.

All this raises the question of whether an important and complex infrastructure system such as the railways should ever have been considered for privatisation.

Mysterious pricing, hidden state subsidies, consumer confusion and inbuilt advantages to established operators appear endemic in the privatised utilities. Price freezes address the symptom but not the cause of an improperly functioning market, an issue that will need watching in the case of Royal Mail.

Nearly 30 years after the BT sell-off, the first of the big utility privatisations, the time is surely right for the government to review the effectiveness of the market mechanism in all the privatised utility sectors. And then to tell Sid.

The writer worked as an investment analyst on the BT privatisation. His latest book is ‘Reckless: the rise and fall of the City’