The Challenges of Privatization: An International Analysis

By Bernardo Bortolotti; Domenico Siniscalco | Go to book overview
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1 The Economic Theory of Privatization


The economists' debate about the proper scope of government in the economy is as old as the economics discipline. Therefore we leave to historians of the economic school the daunting task of tracing back the evolution of this debate. 1 The purpose of this chapter is less ambitious, as it aims to provide a concise survey of the main results in the economic theory of privatization.

This field of research started developing in the 1980s and burgeoned during the 1990s, parallelling the spreading out of the privatization process around the world and with the advance of the contract, political economy, and auction theories.

Curiously, 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. As Vickers and Yarrow (1988) note, the UK programme was triggered mainly by dissatisfaction with the performance of the SOE sector and by the need to square public finances. It was certainly not worked out as the Cartesian application of sophisticated theories, but by adopting a practical approach based on the intuitions of some great economists of the past, such as Hayek. 2 However, the UK path-breaking experience was important not only for practical reasons, but also because it provided economists with a laboratory for empirical analyses, allowing the testing of hypotheses and the development of new theories.

This chapter is organized as follows: it starts by introducing several irrelevance results showing that private or public ownership may not matter for the behaviour of firms. These neutrality results are useful benchmarks which hold under strong assumptions, the main one being a government's complete contracting ability. When incomplete contracts are introduced, ownership and governance structure are shown to matter, as they dramatically alter incentives with important consequences for company performance. The incomplete contract approach has strong normative implications which allow for the identification of the costs and benefits of privatization. However, this approach


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