To what extent is there competition in the markets where state-owned industries were privatised? To see more of our products visit our website at .

To what extent is there competition in the markets where state-owned industries were privatised?

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Amy ChapmanAmy Chapman

• In the early 1980s a large number of public utilities such as gas, electricity and water were state-owned.

• These industries were not considered to be well run, and required large government subsidies.

• The Thatcher government started to privatise these state-run industries.

• It was the privatisation of British Telecom in 1984 which prompted public interest with the debate as to whether it was desirable to replace a public monopoly with a private monopoly.

• The break up of state-owned monopolies into competing companies would appear to stimulate competition and benefit consumers.

• Gas, electricity, water and telephones are industries characterised by distribution networks such as pipelines and grids.

• But, if these monopolies were natural monopolies, where one supplier can always enjoy lower costs than competitors through economies of scale and scope, then genuine competition hardly exists.

• Any duplication of these networks has always been seen as a wasteful use of resources.

• There are only two solutions to the natural monopoly network issue of only having one network yet trying to achieve increased efficiency through private market pressures.

• The first solution is to have a regulatory body to prevent the newly privatised company from exploiting consumers.

• The second solution is to allow access to the network system to new competitors.

• However, both solutions involve difficulties.

• Regulation requires a regulatory body to be created.

• This may require the setting up of a new specialist body.

• The management of the privatised monopoly has an incentive to outwit the regulatory body regarding the true state of costs and profitability.

• It is also possible that frequent close contact between the regulator and senior management may cause the regulator to become biased towards, or less critical of, the company. This is called regulatory capture.

• The regulatory body will have to determine a pricing strategy for the company. In the case of telephones the relevant body used an ‘RPI minus X’ pricing strategy.

• This would require structural change at the outset, as the state-owned monopoly is broken up for sale to private investors.

• However, this approach is a more uncertain process for the government which is anxious to ensure a successful disposal of a nationalised industry.

• A regulatory body is probably still required to ensure fair competition between all potential users of the network.

• An important issue is the level of prices to be charged for access to the network which is called access pricing.

• In November 1983 the government only licensed British Telecommunications PLC (BT) and Mercury Communications (Mercury) to provide the basic telecommunications service.

• Although this was described as a duopoly, BT was the fourth largest telephone business in the world, and was thus privatised intact as a dominant monopoly.

• The 1984 Telecommunications Act created the Office of Telecommunications (Oftel) to regulate the industry.

• Oftel’s strategy was to limit BT’s price increases by a factor less than the movement of the Retail Prices Index. This became RPI minus 3% for the first five years of privatisation.

• Was the privatisation of BT a success when it still retained a market share of over 90%?

• However, the last decade of the century did see some new competitors for BT.

• Also, competition from mobile phone operators had continued to grow. Only 5% of all phone minutes were provided by mobile phones in 1996, but this had grown to 20% five years later, and 31% in 2006.

• But, problems arose as to how much BT charged rivals for access to its network.

• Under pressure from the regulator BT agreed to open its local network to rival operators.

• In August 2006 Ofcom (which had replaced Oftel), lifted all price controls on BT 22 years after privatisation on the grounds that competition in the fixed line market was now sufficient to restrain BT’s pricing situation.

• The objective of the Thatcher government to sell a 51% stake in BT according to the Economist was to: “shift the burden of financing BT’s new digital exchanges to the private sector to make a killing for the Treasury. A competitive telecoms market, and the benefits it would bring to consumers, would come later.”• The aim was not to stimulate efficiency by encouraging new entry into this sector

• So BT was left intact and Oftel had a testing time as regulator.

• Any view that the first privatised utility has been a great success is very much open to question.

• It was clear that the delaying tactics of BT in unbundling the local network loop, shows how an incumbent monopolist can frustrate the objective of a liberalised telecoms market.

• The UK subsequently fell behind much of Europe in terms of broadband access.

• Privatisation of UK state-owned firms began in 1981 and now there are hardly any remaining nationalised industries. Privatisation can take several forms and have several objectives of which creating competition is only one.

• The process of privatisation has typically involved the creation of specialist regulatory bodies which have attempted to stimulate efficiency by means of the price-capping RPI-X formula.

• Oftel, the telecoms regulator, had a very active role in pushing BT towards facing a more competitive telecoms market.

• The telecoms market has become more competitive and since 2006 BT has no longer been the subject of price regulation.

• The initial public offering of 51% of BT’s share in 1984 was greatly over-subscribed and seen as a triumph in popularising the sale of state-owned assets. How might one offer a critical view of this situation?

• Creating greater competition through privatisation might be assumed to stimulate efficiency. Why is profitability not a good guide to measuring changes in efficiency in imperfectly competitive markets like telecoms?

• Consumers are one stakeholder group whose interests tend to be seen as key in an event like privatisation. Employees and shareholders are two other stakeholder groups. What might one expect their experience to have been from the privatisation of BT?

• Average telecom charges fell in real terms after 1984. To what extent was price regulation responsible for this and what other factors must also have played a part?