a bargaining theory of privatisation

A BARGAINING THEORY OF PRWATISATION

bY Jonathan HASKEL

Department of Economics Queen Mary and Westfield College

London and

Stefan SZYMANSKI

Centre for Business Strategy London Business School

Introduction

It is widely believed that privatised firms are more efficient than public sector firms. This belief, at least in part, motivated the UK government’s privatisation programme of the last decade. Because of this belief governments throughout the world are developing their o w n programmes (including, amongst others, Poland, Argentina, Brazil, Hungary, South Africa, Japan). One of the main reasons for believing privatisation raises efficiencylproductivity is that privatised companies appear to enjoy falling unit labour costs. In this paper we argue that privatisation may indeed be associated with lower unit labour costs through lower wages and employment, but that this need have nothing to do with productivity. Our starting point is that economists have had

* The authors gratefully acknowledge the financial support of the Em- ployment Department. The views expressed in this article do not necessarily represent those of the Department.

208 J. HASKEL & S. SZYMANSKI --

some difficulty in explaining why privatisation should raise efficiency. In their influential book, Vickers and Yarrow (1989) present a simple model (pp. 35-39) which shows that i f the private sector is more effec- tive in motivating and monitoring managers then privatisation may be more efficient. This same issue is referred to in Kay and Thompson (1986), Bos (1987), Bos and Peters (1988) and Rees (1988). Yet in each case the greater efficiency of the private sector (in some respect or the other) is assumed.

Instead of focusing on monitoring efficiency in this paper we look at the effect which privatisation has on the bargaining positions m d outcomes for the management and the workforce. Our paper difl'ers from the literature in three ways. First, we do not assume that the private sector possesses any intrinsic advantage in management of product markets over its public sector counterparts, i.e. there is no agency problem. Second, we model the labour market as well as the product market under privatisation. Surprisingly, little or no attention has been paid to the effect of privatisation on labour markets and the role of unions in wage bargaining'. This is particularly important in view of the findings that private enterprises have lower costs than public enterprises (see Yarrow (1986) for a summary). Since the bulk of costs are wage costs, an explicit theory of wage formation under private and public ownership is required. Third, we have assembled a data set of 17 UK firms which were publicly owned in 1973 and all of which have now been privatised or undergone substantial changes in their objectives. We check the predictions of our model against the data and find that the picture is fairly consistent.

If we are to model wage costs we require a plausible description of how wages are determined. Our model is essentially the =Right to Manage" model of Nickel1 (1982) in which managers bargain with unions over wages and then set prices (and output) unilaterally.

1 For example, Vickers and Yarrow hardly deal with unions at all. Yarrow (1986) provides a short informal discussion loolung at the incentives to build reputations in repeated wage bargaining games and argues that privatisation has ambiguous effects on union power. Kay, Mayer and Thompson (1986) contains only one chapter (written in 1984) on the subject. Bishop and Kay (1989) look at labour productivity but do not look in detail at wage bargaining. Finally, Gravelle (1984) analyses a model of bilateral monopoly union and firm efficient bargainingunder public and private ownership. In a general model he finds that no strong conclusions can be drawn on the relative efficiency of public and private ownership.

A BARGAINING THEORY OF PRIVATISATION 209

Managers are agents who maximise an objective function dictated by a principal; in the private sectm the principals are shareholders and in the public sector the principal is the government.

I t is often argued that there are two fundamental differences between publicly and privately owned firms: - Objectives: Broadly speaking the goal of private firms is the

maximisation of profit. The objectives of public corporations may include profits but are also likely to reflect other considerations. Ultimately i t is the responsibility of government ministers to set the objectives of public corporations. The main preoccupation of ministers is reelection. This means that objectives are set in such a way as t o find favour with the electorate. This implies that the public corporation’s objectives will consist of a weighted combination of the interests of consumers and producers (including workers)- who we assume constitute the electorate. Budget Constraints: The private sector is constrained by the threat of bankruptcy. This is not generally true of the public corporation, for whom the government stands asguarantor. Since the government cannot be bankrupted, the budget constraint of the public corporation is looser.

These two differences drive the results of our paper. Both differences have been used extensively in the past to characterise public as opposed to private enterprise. In an influential paper Weingast, Shepsle and Johnsen (1981) explored the implications of public sector decision making driven by politicians’ objectives. The idea that public sector firms face a soft budget constraint has been widely explored but is perhaps most famously associated with the analysis of Kornai (1971).

Perhaps surprisingly we find that the government is generally better able to achieve its objectives through private ownership than i t is through public ownership. Indeed, if we were t o adopt the assumption that the objective of government is the maximisation of social welfare (which in general we do not) then privatization would raise social welfare. This result does not rely on any agency problem. Agents carry out fully the instructions of principals regardless of the form of ownership. This is striking since the general model of Vickers and Yarrow concludes that unless there is some agency problem public ownership will be more efficient (because prices are set at socially optimal levels). The reason for this difference is that in our model under public ownership output and employment are relatively high. Because the public corporation attaches weight not only to profits but also to

-

consumer surplus and the welfare of the uniodworkforce, the social surplus which this generates is bargained over with unions. The union can then obtain high wages, which are also associated with large financial deficits in the public sector. Under private ownership bankruptcy acts as a credible threat to the union in wage bargaining. Wages will therefore be lower. Ofcourse, if there is monopoly the private sector is unlikely to be more efficient, but so long as there is some competition in product markets then the private sector generates a higher level of consumer surplus, profit and union welfare (taken together) than public ownership, This situation is analogous to the problem of control of the money supply. Delegating monetary decisions to independent central bankers is widely believed to create greater price stability than government control. If the aim of government is price stability it may dobettertodelegate thejobto an independent central bank rather than to impose direct control. In this same way privatization may be thought of as delegating decision making to independent profit maximisers.

The comparison between a public firm transferred into the private sector is perhaps too stark, so we also develop a model of regulation. Our model of regulation involves managers bargaining with the union over a wage and then bargaining with the regulator (appointed by the government) over a price. Prices cannot be set unilaterally by the government since the firm can credibly threaten to produce no output (if, for example, prices are set so that profits are zeroY. We assume that the regulator has a different objective from the politicians. Whilst it is plausible that politicians make choices which maximise the probability of reelection a regulator is likely to work within a more formal set of constraints. Our assumption is that regulator is obliged to maximise the interests of consumers (consumer surplus in our model). Regula- tion improves on the final allocation when the number offirms is small. For large numbers, however, regulation produces no benefits. This is

2 It can be argued thmt if the government promised the firm an arbitrarily mal l profit then it would have the right incentives to produce the eocially optimal level of output. This is equivalent to the government imposing a first best solution. Whilst theoretically correct, this does not seem to us to reflect accurately the regulatory process (for example, when BT negotiatm with the regulator the X-factor in the RPI-X formula). One possibility is that managers possess insider power due to their experience and knowledge of the industry. If they fail to carry out instructions they can be fired but this will be costly for the government in terms of lost output and training costs as new managers are introduced, see e.g. Beesley and Littlechild (1989).


because when there are large numbers of firms competition ensures that prices fall to socially efficient levels anyway.

The plan of the paper is as follows. In section 1 we present the model and analyse the results for the implications of privatisation and regulation for output, employment, wages, prices, profits, consumer surplus and union utility. We also show what happens when the objectives of the government alter towards narrower commercial aims. Many have argued that this has happened over the 1980's. In section 2 we present data from company accounts on the evolution of output, prices and profits after privatisation and the change in objectives. We contrast this performance against comparable sectors in the economy. Section 3 summarises our results and concludes.

1 The model and theoretical results

Our model is amodel of price and wage setting in individual firms. Our assumptions are: 1.

2.

3.

4.

5.

Unions and managers bargain over wages but unions have no say in price setting. This is the assumption of Nickel1 (1982), and is supported by direct survey evidence on the contents of wage contracts, see Oswald and Turnbull (1986). Bargaining is summarised by the maximisation of the Nash product of the relevant objective functions. The weights on the Nash products are interpreted as discount rates reflecting the impatience of either side to reach agreement (Binmore, Rubinstein and Wolinsky, 1986). Objectives i. Private firms maximise profits. ii. Governments maximise a weighted combination of consumer

surplus, profits and union welfare. iii. Regulators maximise consumer surplus. iv. Unions maximise the utility of their members (the union is

assumed to be a risk neutral utilitarian, a widely used assumption, see e.g. Jackman, Nickel1 and Layard (1991)).

Prices and wages are set sequentially; managers and unions negotiate a wage initially, then managers choose output levels subject to this wage. Competition in product markets is characterised by Cournot- Nash conjectures in the objective function of managers.

212 J. HASKEL & S. SZYMANSKI

6.

7.

8.

9.

10.

Public sector unions bargain over industry wages with management, In the private sector each firm bargains individually with its own workforce (or union) -this may be thought equivalent to the plant bargaining of the UK or enterprise unionism in Japan. Private sector unions do not collude. Managers implement the instructions of the principal (government or shareholders) at zero cost. There is therefore no agency problem. Under regulation, prices are set as the outcome of a bargain between the regulator and profit maximising managers of a monopoly firm. One way of interpreting this is that the regulator could instruct the firm to set price equal to marginal cost but that the firm could then threaten to produce zero output. The regulator therefore has to bargain with the managers of the firm over price settingin the same way that managers negotiate with unions over wages. (In both cases there is an implicit assumption that there is some advantage to incumbency which prevents a market from operating - in the first case i t may be the specific human capital of managers, in the second case insider advantages.) The technology is linear (q = d)

Demand is linear

where q = quantity, I = employment, p = prices, n is the number of firms in the industry and a and Bare parameters.

n

(P = P - & I )

i= 1

We wish to capture three possible scenarios describing the man-

Private sector management (free private enterprise). agement of firms: i. ii. Public sector management. iii. Regulatory control.

From assumption 3, we can write down the objective functions of the bargaining parties:

Unions: u = (w -E)l where U = unionutility, w = wages, iii = outsideopportunitiesfor workers

Private firms: A = p q - wl where IT = profits


Public Sector Manager:

where $I= public sector budget constraint3 and CS = consumer surplus cs + (1 + $4 7r+ AU= y,

Regulators: CS = yf;

Our basic model is solved in two stages: Choose the output level which maximises the manager's objective function for any given level of wages (by setting the first order condition equal to zero). Choose the wage level which maximises the Nash product of the manager's objective function and union ut i l i ty , given the level of output chosen at the previous stage (from the first stage the Nash product can expressed purely a s a function of the exogenous parameters and wages). The solution for wages i s also found by setting the first order condition equal to zero. Given tha t wage can now be expressed in terms of the exogenous parameters, so can all the other variables of interest. In particular we can derive expres- sions for output, employment, prices, profits, union utility and total welfare.

1.

2.

To compare the effects of the different control structures we have to solve each stage of the bargaining problems. This gives a large number ofresults which are reportedin detail in Haskel and Szymanski (1990a and b) available on request from the authors. In this paper we

3 Note that the public sector budget constraint increases the importanceof profits in the public sector manager's objectives. In addition the managers give some weight to the preferences of both consumers and workers who form part ofthe electorate. The weights on the different elements ofthe objective function depend on the importance ofeach group in getting the politiciansreelected. We normalise the weight on consumer surplus to unity and the weight on the preferences of the workforce/union is A. 4 Note that with a linear demand curve and homogeneous product CS can be expressed as 1/2 q2 where q is industry output. 5 The Nash productRisgiven in the usual way byf2=U"x *in the private sector and R =Un x vi1, i = 1,2 in the public and regulated cases respectively. The 6's can be interpreted as discount rates (see e.g. Binmore, Rubinstein and Wolinsky (1986) and we assume that they are identical for each of the parties. In general this need not be the case, and i t is possible to achieve almost any results if discount rates differ sufficiently. Haskel and Szymanski (1990a and b) provide more detailed results when discount rates may differ.

2 14 J. HASKEL & S. SZYMANSKI _ _ - ~ ~

simply report some results under quite basic assumptions: the public corporation’s budget constraint is not binding (@= 0) and the discount rates (Nash weights) of all the parties are identical. The results are reported in Table 1.

To summarise our results in this case: 1. output:

2. Employment:

3. Wages:

4. Prices:

5. Profits:

6. Unions:

Highest in the public sector, lowest in the private sector. Highest in the public sector, lowest in the private sector. Are highest in the public sector and identical in the cases of free private enterprise and regulation. Are lowest in the public sector and highest under free private enterprise. Are negative in the public sector and positive in the private sector. Unions are best off in the public sector and worst off in the private sector.

Several broad conclusions emerge from this analysis. First, privatisation will lead to falling output and employment.6Second, wages fall after privatisation. This would explain the findings of lower costs in private firms (Yarrow, 1986). Note, Yarrow argues that the lower costs show that monitoring of managers is more efficient in the private sector, but it is also consistent with our model which does not rely on differential monitoring. Third, privatisation will also lead to higher prices and profits.

6 Whether this explains increased productivity in private enterprises (Yarrow, 1986) depends on the production function, but our model at least has the potential to do so.

A BARGAINING THEORY OF PRIVATlSATlON 215

9 a p - b 32 -- ( a j2

Table 1 : Results for identical discount rates, non-binding government budget con stra I n t

-

('35+;::2"(25'

ocrtput

Employment

Wages

Prices

Jrofts

1 I Jnton U I

Prlvate Sector Publlc Sectof Regulation

3n(aB-E) 4a2(n+ 1)

ap + 3 E 4

3 ap-iij -- 16(n+1)( a 1

3(ap - E) 4 a

a6 + 3Ur - 4 Z 4(1-1)

ap + 3 E 4 a

9

32 16n 16n n + l 9 31(n+l ) ) [ n )2[ apuE)' -+-+- - -

9(ap - ur) 16a2

as + 3E 4

a/3 + 9iii 16a

2 16 J. KASKEL & S. SZYMANSKI -.

2 TheData

The model that we have set out above predicts the consequences for output, employment, prices, wages and profits followingprivatisation or a change in objectives of the government. In this section we review the evidence on these variables'. To do this we have assembled data from the company accounts of seventeen companies that were publicly owned in 1973. The list of companies is set out in Table 2. To look a t

Table2: Panel of companies and key dates

C o m m Date of Industry Privatisath Frst Date of Reorientatiori

British krports Authority (fN4)

Brtlsh Always Group (BA)

Wiish Coel Corporation (BCC) knish Gas Corporation (EGC)

knish Reitway h r d : Rail Onty

British Shipbuilders (Bs) British Steel Corporation (Bsc)

Brtlsh Tekom plc (BTj

(BR)

Civil Aviation Authotity (CAA)

Uectricity Supply Industry (ESI) North of Scotland Hydro-Electrlc

South of Scotland Oectncity

London Regional Transport (LRT)

Board (NSHEB)

Industry (SSEI)

Post m i : Posts N a t W l Girobank (Giro)

Reglanal Water Authorities:

Scottish Transport Group (STG) Aggregate (RWA)

1986 (Atports Act, CA4 assumes regulation)

1982 (Reorganisation into 3 dwisms)

1982 (Oil and Gas (Enterprise) Act)

1981 (Reorganisation of raltways into 5 businesses)

1981 (Strike and start of sales) 1980 (End of strike. new

management) 1881 (Telecom separated from

Post office, Brtish Telecommurncatons Act)

1986 (Acquires new regulatcry

1983 (Energy Act) 1983 (Energy Act)

1983 (Energy Act)

1986 (Cornpetiton in local bus se~ce9 starts following Transport Act, 1985)

1981 (Separation from BT) 1985 (Formation of Qrobanh

pic) 1983 water Act)

1986 (Competition In local bus

1985 (Coal lnclustry Act)

powers)

SeMces starts following Transport Act, 1985)

7 In this paper we discuss the evidence only for output, profits and competitive advantage. In another paper we discuss the evidence on wages and employment (Haskel and Szymanski (1991)). That paper confirms the pattern of movementa in wages and employment described in the previous section.

A BARGAINING THEORY OF PRIVATISATION 2 17

performance we need a date from which to calculate any changes and a yardstick measure. To choose a date, we have identified significant changes in the objectives ofcompanies, and these are set out in Table 2, under the broad heading of reorientation or reorganisation. Where applicable we have also identified the date of privatisation. All our companies have experienced some degree of reorientation. For example, in 1981/2 a new management team under Lord King was assembled at British Airways; Ian MacGregor was brought in at British Steel in 1980. The 1982 Gas Act made a number of provisions for British Gas t o operate commercially, and in 1986 bus route tendering was introduced for LRT and STGB. Naturally, some of these dates are open to questions ofinterpretation. We have camed out a number ofdifferent calculations using different dates; the figures reported are representative.

For a yardstick measure, we have split our firms into production and service sectors. We feel that the widely divergent behaviour of the production and service sectors gives a good deal of information despite only a two-way split. Naturally a finer disaggregation is possible, but this is true for whatever level chosen. Lastly, we have mostly expressed our data in terms of growth rates. We do this because we wish to abstract from effects such as economic growth, changes in demand and technical progress that causes warranted movement in some variables.

2.1 output

Table 3 sets out the data on output. For this table we have attempted to obtain an index of volume. Obviously our choice is constrained by availability here, and so we have used a series of different volume measures. Of necessity these are in some cases only indicative of the true output of the firm.

The first two columns show the performance over the 1980’s, and we have split the period into 1979/1982, covering the period of deep recession, and 1982/1989, a period ofrecovery. In common with the rest of the economy, output in most industries fell in the early period, and recovered later. This suggests that our output indices are giving a sensible picture. Column 3 calculates the average growth rates for the post reorganisation period and column 4 shows the yardstick measure. For clarity, column 5 shows the sign of the post-reorientation performance less the yardstick sector; a minus means that output grew relatively slower post-reorientation.

8 (1988).

For further details on these re-Orientation dates, see Vickers and Yarrow

218 J. HASKEL & S. SZYMANSK[

Table 3: Output (growth p.a)

1979-82 1982-89 Post Post (3)-(4) Post Post (6)-m Priv Prrv

Y'stck w g R e w

Y'stck

(1) (2) (3) (4) (5) (6) (7) (8) - __~-.

knish krports Authorrty (total termnal pax)

Brltrsh krways Group (reverue tonne Mlwnetres) Brklsh Gas Corporaton (gas sold, mll therms) Brnish Railways Board; ral only @ax 8 tonne miles) Brkrsh ShIpbUllderS (tonwP) Bmlsh steel Corporaton (tonnage) Brftish Tekom plc (connecttons) CAA (movements handled)

Industry (M kwh)

North of Scotland Hydro-Electnc Board (M kwh1 SSEB (M kwh) Condon Regional Transport (psx miles)

(million kerns) Natmal Girobank (# current accounts)

Mb-W supply

Post m; posts

0.024 0.065 0.079 0.049

0.006 0.078 0.078 0.037

0.019 0.010 0.010 0.039

-0.015 0.018 0.014 0.033

-0.217 -0.188 -0.214 0.017

-0.066 0.013 0.010 0.019

0.050 0.034 0.033 0.033

-0.032 0.056 0.087 0.049

-0.015 0.023 0.030 0.042

-0.027 -0.012 0.025 0.042

-0.013 0.010 0.016 0.042

-0.035 0.041 0.021 0.049

0.031 0.046 0.039 0.033

0.184 0.099 0.042 0.044

RegionalWaterAuthotk~~ 0.009 0.004 0.003 0.042 (ml supplied per day) Scottish Transport -0.028 -0.012 4.019 0.049 Group @ax carnedj

0.100 0.055 +

0.204 0.055 +

-0.023 0.069 -

/ /

/ I

/ /

0.039 0.044 -

/ /

/ /

/ /

/ /

/ /

/ /

/ /

/ /

/ /

Notea (i~ pax=peeaengere,m-rnlm (I) BCC excluded be- fgurea aWected by c ~ e l smke (nr) mlurnns are annclel m m g e gmwth rat-

(t)foreechfirm 1979-82, (2)forsschfm 1982-89 (3) for eech firm, poot re-onentattan. where reonentaton date III in taMe 1 (4)fortheyardatlcksector. postreonsntatlon, when,therectorbman~ctumgoroervcmaeappro~te [(S) the egn of cohnn (3) less cdwnn (4)] (6) for each firm pcd p e t i s a t m ~)kxtheyerdstckeactor. postptwatriat~n. ~erethemctorPmanutectunngorBe~cesas~plate [(8) the ergn of column (6) lsso colunn (711

A BARGAINING THEORY OF PRIVATISATION 2 19

For a clear majority of our sectors, output, on the measures available, did indeed grow relatively slowly. This is consistent with the theory. The exceptions a re BAA, BA, CAA and the Post Ofice. For BA the only available output measure is revenue tonne kilometres for scheduled routes, and so a rise in output might not necessarily reflect an increase in passenger miles flown.

The post privatisation figures are in column six, with the yardstick data in column seven and the relative performed in column eight. The picture here is mixed, with the relative output growth in the sectors which had growth in the post reorientation period. An important point to emerge here is t h a t the post-reorientation movements a re as significant, if not more so, than those post privatisation.

Comparing other general surveys, Bishop and Kay (1988, Table 21) show output growth figures for a different panel of companies, pre- and post-privatisation. They find that for their panel output generally rose in absolute terms; but their choice of units i s unclear, they have no yardstick sector to compare, and do not look at post-reorientation data.B Yarrow (1986) gives data on real turnover, but turnover i s likely to be affected by changes in the price of intermediate inputs. Vickers and Yarrow (1988, Table 9.7) give data on coal output, bu t the picture is clouded by a severe fall during the miners strike in 1984/5.

2.2 Prices

To calculate prices we have employed a number of methods. We first experimented with dividing turnover by our output volume index, using the accounts datalo. Clearly, in some cases this is wholly inappropriate; for Girobank, for example, the volume measure is the number of cheque accounts. We have therefore chosen to exclude a number of sectors such a s these, leaving the sectors in Table 4. This still leaves two problems; turnover includes intermediate inputs, and the volume index is, strictly speaking, inappropriate where sectors produce multiple goods. Theresultingnumbers should therefore be regarded a s only indicative of t rue trends. As a cross check we have therefore calculated price data directly from the sub-sections of goods in the RPI

9 data in annual average form. 10 lump-sum grants would bias upwards any price measure.

Comparison with our yardsticks is obscured because they do not present

Note we have subtractedgovernment grantstkom the turnover datasince

220 J. HASKEL & S. SZYMANSKI -

and the PPI". The consistently available data are measures for gas, electricity, coal and water.

LookingatTable4, where wehave calculatedgrowth rates, we can see that the picture of post-reorganisation price changes shows pre- dominantly relative falls. A majority of firms have had price falls relative to the yardstick; note that the yardstick is the RPI and PPI where appropriate. As a cross-check the RPI based data give post- reorientation rises of 1.9%for gas, 3.5%for electricity and 1.4% for coal; and the PPI data give 4.3%for gas cookers, 1.4% for coal, 6.3% for water and 4.0% for iron and steel. This fails to reverse any of our conclusions based on accounts data.

Overall then, the data are a t odds with our theory, which predicted that prices would tend t o rise post-reorientation. I t may reflect the poor quality of data or might be explained by the imposition of price regulation by government. This happened in the electricity industry in 1983/1984 for example (Wyman-Jones, 1989). The results for the energy sector are also likely to be affected severely by dramatic changes in the price of oil in 1986.

We have been unable to find any systematic evidence on prices with which to compare our results. Firms may have a4usted along the quality dimension; the evidence surveyed in Bishop and Kay (1988) is inconclusive.

11 To calculate these numbers we have taken the RPI categories: gas, electricity, and coal and smokeless fuels; and the PPI categories: gas cookers, coal (SIC 11131, water for industrial use, andiron and steel (SIC 2210). Sources are Department of Employment Gazette (various issues) and Annual Abstract of Statistics, Table 18.3 (various issues).


Table 4: Prices (growth p.a)

British krports Authority

British Gas Corporation

British Railways Board; ral only

Brltish Shipbuilders

British Steel Cormration

Civil Avlation Authority

Electricity Suppb Industry

North of Scotland Pydro-Electric Board

South of Scotland Electricity Board

London Regional Transport

Post Office, msts

Regional Water 4uthordtes, aggregate

jcottish rransporl Group

1979-82 1982-89 Post- Post- (3)-(4) Post- Post (6)-(7 Reorg Reorg Priv Riv

RPIPPI RPI

(1) (2) (3) (4) (5) (6) (7) (8)

0.168

0.184

0.126

0.352

0.087

0.290

0.176

0.194

0.173

0.156

0.188

0.136

0.165

0.058

0.043

0.043

-0.244

0.039

0.032

0.032

0.047

0.035

0.038

-0.005

0.062

0.048

0.088 0.042

0.043 0.052

0.048 0.060

-0.133 0.052

0.042 0.056

0.017 0.045

0.019 0.047

0.019 0.047

0.028 0.047

0.049 0.042

0.014 0.060

0.058 0.047

0.047 0.042

0.099

0.01 7

/

/

/

/

/

/

/

/

/

/

I

0.045

0.045

/

/

/

/

/

/

/

/

/

/

/

Note w e note (110 10 Table 3

222 J. HASKEL & S . SZYMANSKI

2.3 Profits

The measurement of profits has a number of conceptual difficul- ties. First, accounting conventions may differ between firms so that the data may not be strictly comparable. Second, there exist a range of measures in the literature: margins, return on sales, return on capital, etc. Deciding between these indicators has been taken up in a recent article by Davis and Kay (1990). As they point out, rates of return can give bizarre results, often owingto the construction of the denominator. For example, the accountsfor BS show a return on assets employed of -431.6% for 1986/7, because it was decided by the accountants that the assets employed by BS were worthless. Bishop and Kay (1989) show that post privatisation the return on sales for BA has risen and the return on capital employed has fallen.

Following Davis and Kay (1990) we have calculated measures of what they term the competitive advantage accruing to our firms. Competitive advantage seeks to discover the added value to the inputs of being in a particular firm. It is then defined as value added less the quantity of inputs valued at their opportunity cost, expressed for convenience as a percentage of the opportunity cost of the inputs. For example, in a firm with no capital a worker who produces f 1.10 ofvalue added at the firm, and who could earn El outside the firm therefore confers on the firm a competitive advantage of 10%.

Table 5 sets out our calculations for competitive advantage for the 1970'~~ the 1980's and the post-reorganisation period. Competitive advantage is value added less input costs over input costs. Without value added data we are forced to use turnover less government grants. Costs are wage costs plus capital costs. Wage costs are simply calculated as the wage bill, although this understates the opportunity wage if workers earn rents. Without capital price indices, capital costs are capital stock (at historic cost) times the interest rate. We have insufficient data on capital valued a t current cost to calculate capital rents on this basis.

Since we have insufficient data on economy-wide competitive advantage, we do not have a yardstick sector in the same way as we had in the tables above. We therefore have chosen to compare the post- reorientation data with the 1972/79 data, where our conjecture would be that the latter period was one of less commercial aims for the firms. The theory would therefore predict that competitive advantage would improve. As the table shows this is indeed the case. In fact every firm bar two has shown an improvement; of the two exceptions, STG has shown a worsening of less than 1%. Note that a number of the firms


Table 5: Competttlve advantage for specified periods by natlonallsed Induatry

Brrtish krports Authority

British Airways Group

Brrtish Gas Corporation

Brtish Railways Board, rarl only

British Shipbuilders

British Steel Corporation

British Telecom plc

Ciwl Awation Authority

Electricrty Supply Industry

North of Scotland Hydro- Electric Board

South of Scotland Electricity Board

London Regional Transport

Post office; posts

National Girobank

Regonal Water Authorities; aggregate

Scottish Transport Group

-0.051 -0.200

-0.032 -0.068

-0,059 -0.006

-0.136 -0.354

/ -0.139

-0.199 -0,192

-0.123 -0,067

-0.439 -0.151

-0.125 -0.125

-0.2121 -0.065

4.114 -0,056

/ -0.284

-0.050 -0.017

/ 0.027

-0.103 -0.059

-0.145 -0,178

-0.029 -0.030

0.036 0.036

0.016 0.016

-0.348 -0.351

4 . 2 9 9 4,274

-0.062 -0.091

0.111 0.091

0.004 -0.ooO

-0.097 -0.098

-0.003 -0.003

-0.037 -0.036

-0.369 -0.343

0.038 0.006

0.012 0.035

0.074 0.088

-0.148 -0,146

+ -0.042

+ 0.026

+ 0.029

- /

/ /

+ /

+ 0.138

+ /

+ /

+ /

+ /

/ /

+ /

/ /

+ /

- /

Notes (I) For caicuhtlon eee text (11) date m averages over the years shown at the head of the columns The reorgatusaton dates em form table 2

224 J. HASKEL & S. SZYMANSKI -~ -

have negative competitive advantage, suggesting the inputs would be better employed elsewhere.

I t is difficult t o relate our findings to others in the literature, since there are not many time-series to compare with. Yarrow (1986, Tables 3 and 6) shows that pre-tax profit margins have generally risen post privatisation, but there are only data from 1981 to 1984/5. Vickers and Yarrow (1988) report data on the Water Authorities for 198415 and 1985/6, the NCB and British Gas for 198516 and 198617. The data show that operating profits fell, fell and rose respectively, but two years is really too short to make reliable comparisons. They do present data for BAfor 198W1987, which show a rise in pre-tax profits over the period12 - a similar finding to Ashworth and Forsyth (1984). The picture from Bishop and Kay (1989) is mixed, both between industries and between measures. Generally, profitability in real terms and return on capital and sales have improved post-privatisation in a slim majority of firms. A similar story emerges from Hyman (1989, Table 31, who looks at data on nominal operating profit 1980/1 to 1986/7.

Lastly, in Haskel and Szymanski (1990a), we use similar data to look at wages and employment growth. We find there that in a clear majority of sectors both these fell relative to the yardstick sector following privatisatiodre-orientation. This is as the theory predicts.

3 Summary and conclusions

The standard positive rationale for privatisation centres on the agency problem. Privatisation passes a firm into the private sector where there is superior monitoring. This forces firms to indulge in more cost-reducingactivities and so costsfall. In this paper we have modelled costs explicitly as wages, where wages are determined as a bargain between firms and workers. To investigate privatisation we have contrasted bargaining in the public and private sector. We have also looked at bargaining under regulation. There is no asymmetric information in the model. The results of the model are driven by differences in objectives and budget constraints.

In the public sector, firms have wider social objectives. They therefore set relatively high output and employment. Wages are high because unions have a larger surplus over which to bargain. Public

I_-__. __

12 There is a slight fall in 1987 due to Chernobyl and Libyan incidents.


sector firms make losses and welfare depends on the weight given to unions in the social welfare function. In the private sector firms have purely commercial objectives. They restrict output and employment and unions obtain lower wages because the narrower set of objectives and tighter budget constraint reduce the total surplus over which bargaining takes place.

Our model can explain a number of facts t ha t appear in the literature. First the model predicts that output, employment and wages fall and profits and prices rise when objectives change. I t therefore can explain the changes in performance in advance of privatisation when the government has introduced more commercial targets for publicly owned industries. Second, the fall in wages tha t the model predicts can explain why i t is often found tha t private sector firms have lower costs than in the public sector.

Using data from a panel of 17 firms tha t were publicly owned in 1973 we have looked at the evolution of output, prices and profits post- privatisation and post-reorientation. Set alongside our results for wages and employment, we have shown tha t most of the predictions of the model are supported in the data. Our results on prices contradict the model most consistently, but the quality of the da ta i s poor.

Whilst we feel our approach gives fits well with the data, i t is not beyond criticism. Assuming differences in objectives is always somewhat arbitrary. Defining the exact objectives of the public corporation is always problematic. Similarly, the assumption ofprofit maximisation in the private sector might also be challenged. Managers and shareholders may hold multiple objectives, which need not even be consistent.

Our assumption about budget constraints might also be criticised. I t is not clear why governments a re unable to impose ha rd budget constraints on public industry, although this probably has something to do with credible commitments and the political process. I t is also t rue that private corporations, particularly large ones in sensitive industries, may not have particularly hard budget constraints and may well be able t o extract subsidies from government.

Finally, our bargaining model is somewhat stylized. The source of bargaining power for each party is not clear bu t we assume that i t h a s to do with the value of incumbency. Thus, union members cannot be replaced by cheaper workers because of factors such as turnover cost (as in the insider-outsider models of Lindbeck and Snower (1989)). Regulated firms also exercise insider power (knowledge of operations,

etc.) which enables them to bargain with government. Both these assumptions are not implausible.

We propose to take up a number of further issues in future work. In particular, we have derived our results for special functional forms for demand, technology and union utility. We believe that our results could be proved in a more general framework. Also we have not controlled for other factors that may have affected output, profits etc., such as changes in market power and Trade Union conditions. This requires further data collection and the use of panel regression techniques.

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BOS D., 1987, "Privatisation of Public Enterprise", in European Eco- nomic Review 31,352-360.

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a bargaining theory of privatisation

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