From the archive: testing time for UK privatisation

As the Government puts the for sale sign up outside the Post Office, we look back 20 years to David Parker and Steve Martin's thoughtful analysis of how British Gas, British Airways and other public sector behemoths fared once set free in the private sector

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Last Updated: 11 Jul 2013

David Parker and Steve Martin apply a special yardstick to measure the success of that bedrock of Thatcherite Conservatism - privatisation.

Four rock-solid principles underpinned the Thatcher administration: tax reduction, sound finance, monetary restraint and privatisation. Today those guiding lights flicker rather than flame. Tax increases were announced in the March budget, the PSBR is running out of control and 'monetarism', a religion of early Thatcher administrations, is quietly ignored in government circles. Who last heard a minister trumpeting 'monetary targets' or referring to Professor Milton Friedman in awed tones?

Privatisation - that bedrock of 1980s Conservatism - at least escapes with its reputation intact. Or does it? More than £45 billion of state assets have been transferred to the private sector since 1979 and BT's current share offer is expected to add a further £5 billion. Of the great state monoliths, only coal, rail and the Post Office remain in the public sector and plans for privatising coal and rail are well advanced. If the Government placates backbencher fears that privatising the Post Office will raise the cost of rural deliveries and close the village Post Office, then the Royal Mail and its associated businesses may follow coal into the private sector later this Parliament.

The proportion of the UK workforce employed in nationalised industries fell from 7.2% in 1979 to 1.9% by mid-1992. Has such massive restructuring - the most important since the Attlee administration nationalised strategic industries immediately after the war - led to improved economic performance? Political rhetoric argues 'yes' but statistical evidence of revitalisation is lacking. The Conservatives have clung doggedly to the belief that privatisation, by extending share ownership, weakening trade union power and providing a useful flow of receipts to the Exchequer, is necessarily a 'good thing'. The pro-privatisation lobby contrasts private sector companies - accountable to their shareholders, operating in competitive markets and financially free-standing - with unwieldy public sector organisations which suffer short-term political meddling, operate mainly in mono-polistic markets and are underwritten by taxpayer subsidies.

Transferring state industries to the private sector, so the theory goes, will shake-up sleepy management, substitute commercial objectives for political expediency and improve operating performance. So it does. The transformation of National Freight under Sir Peter Thompson's direction enjoys folklore status in business schools and is backed up by impressive financial results. The same applies to BA, everyone's favourite story of changing corporate culture. BA now stands for British Airways and no longer for Bloody Awful. BT and British Gas, freed from political constraints on takeovers, joint ventures and operations outside the UK, have begun to transform themselves from national to global operators. Both are now well-placed to take advantage of further liberalisation in world telecommunications and energy markets. Restrictive working practices caused the seemingly irreversible decline of Britain's traditional ports. Since Associated British Ports (ABP) replaced the British Transport Docks Board and was privatised, decline has been reversed. ABP has been winning back business from port operators, particularly the private wharves ports on the Humber and Trent rivers.

On the other hand, not all privatisation folklore is favourable. Lay-offs and closures at British Aerospace are well documented; Jaguar's dramatic losses have sent a shiver through its parent company, Ford; and overseas ventures have proved high risk, especially for inexperienced management. BT's sale last year of its stake in the Canadian company Mitel, at a loss of £120m, is scarcely one for the album.

Anecdotal evidence aside, how have the bulk of Thatcher's privatised concerns performed during the '80s and early '90s? Measuring the effect of privatisation on performance is difficult, not least because the precise link between privatisation and success is not always clear. In a 1988 study, Matthew Bishop and John Kay of London Business School concluded that privatised industries show improved performance and profitablility but that performance improvements appear to cause privatisation, 'rather than the other way round'. Bishop and Kay may have a point. The Conservatives quickly recognised that the City preferred to buy successful operations. This led to often massive investment and reorganisation prior to privatisation which, when combined with improved managerial efforts around the time of leaving the public sector, complicates evaluation of privatisation itself. Recession, too, has clouded the issue. Many privatisations occurred at a time when the economy was bubbling. How well have managements coped with the pressures of recession after their supposed revitalisation by market forces?

Finding an appropriate measure with which to assess the performance of privatised industries adds further complications. Profitability, a favourite measure of accountants and some economists, is not appropriate for organisations which have spent time in the public sector, often pursuing other goals besides profit. Most nationalised industries were set a rate of return target but, for monopolies, that target could be achieved simply by raising prices. At other times, the target rate of return was postponed by government in favour of holding down price rises as part of anti-inflation policy. Thus, employee added value is a more appropriate measure than profitability. It measures the amount of value a firm adds to its inputs (raw materials, components, energy) during production while transforming them into outputs (finished goods or services). The more efficiently this is done the higher the value added which is measured, after adjusting for the effects of inflation, as profit before tax plus interest payments, wages and depreciation. This figure is divided by labour hours to give an amount of value added per labour hour employed expressed as a percentage growth rate.

How, in terms of employee added value, have the UK's major privatisations of the 1980s performed? British Airways, the British Airports Authority (BAA), Britoil, British Gas, British Steel, British Aerospace, Jaguar, Rolls Royce, National Freight, Associated British Ports (ABP) and BT made up the majority of business assets transferred by privatisation in the UK in the 1980s. The research shows that growth in British Airway's employee added value was highest prior to privatisation. The intention to privatise was announced in 1980, but the sale was postponed until February 1987 due to law suits arising from the failure of the Laker airline and the need to renegotiate the agreement regulating traffic on the Atlantic routes. British Airways was unusual therefore in the length of time from the Government's decision to privatise to privatisation occurring. This gave plenty of time for the new management under Lord King to transform the business.

Growth in employee value added was also at its highest in the run up to privatisation at BAA, British Gas and Jaguar. The announcement of the intention to privatise was associated with improved performance in the cases of British Airways, BAA, British Gas, British Aerospace and BT. There was also a marginal improvement at ABP, the former British Transport Docks Board, in the sense that the decline in employee value added slowed down.

Figures for performance since privatisation show a marked slow down in the growth in employee value added at British Airways, British Gas and British Aerospace. This is consistent with the view that privatisation may be associated with one-off efficiency gains. The carrot of privatisation produces concentrated managerial effort leading to improvement and performance gains. Post-privatisation, however, these gains may falter. On the other hand, it is difficult to see how some of the massive value added gains recorded just before privatisation, particularly at British Airways, could have continued.

At BAA, British Steel, Jaguar and Rolls Royce employee value added has actually declined since privatisation. In other words, transfer to the private sector was associated with deteriorating performance, not the expected improvement. Of the 11 concerns studied, only National Freight, ABP and, more marginally, BT, recorded higher employee value added growth after privatisation than in the run-up to privatisation. British Gas, British Aerospace, National Freight, ABP and BT had a higher employee valued added growth immediately after privatisation than in the nationalisation period. The Britoil results merit special attention. Britoil was bought out by BP in 1988 and its later performance cannot be measured. After privatisation in November 1982 and before BP's purchase, performance seems to have been lacklustre. This is only so because of an unfavourable movement in oil prices in mid-decade.

To assess the longer-term effects of privatisation, performance must be tracked through at least one business cycle. The results for the recession period show the average growth in employee value added between 1988 and 1992 (except for Jaguar which had not published its 1992 results at the time of writing). Given that recession can dramatically curtail the prospects for value added gains, the performance of British Airways, British Gas, British Aerospace and BT is encouraging. The first three of these four recorded better growth in this period than immediately after privatisation. Other organisations have performed less well. In the recession period, employee added value declined at BAA, British Steel, Jaguar, Rolls Royce, National Freight and ABP. Of these, National Freight, ABP and British Steel were particularly exposed to the effects of recession as they are dependent upon trade flows and, in the case of British Steel, buoyancy in the engineering, construction and motor industries. It is harder to excuse BAA's results given its monopolistic control of the major UK airports. Jaguar's collapse is staggering.

Commentators often suggest that state regulation and a lack of competition facing certain privatised enterprises lead to poorer performance. State regulation of the public utilities may distort efficiency incentives, especially where profits are directly or indirectly suppressed. The relationship between British Gas and its regulator Ofgas is notoriously frosty and at times the relationship between BT and Oftel has been far from harmonious. Where competition is severely restricted, managements have less incentive to be efficient. Cost rises can be passed on to captive customers in the form of higher prices. However, there is no solid evidence from these results that performance has suffered because of regulation and a lack of competition. It has to be recognised, of course, that our figures cannot identify what performance would have been in the absence of regulation and if more competition had been imposed at privatisation. Of the three regulated enterprises studied, BAA, British Gas and BT, BAA's record has been mediocre, but British Gas and BT have performed relatively well. According to reports from their regulators, both have also recorded improvements in quality of service and real tariff reductions.

Taking a broad view, privatisation has most clearly improved performance at British Airways, British Gas, British Aerospace (despite recent hiccups), National Freight, ABP and BT. In other words, in around half of the firms studied, value added growth accelerated in the run-up to privatisation and usually remained at a higher rate after privatisation than during the last years of state control. The picture at BAA is more mixed. There, the run-up to privatisation saw gains but later performance has been less impressive. Interestingly, Britoil, British Steel and Rolls Royce did best prior to privatisation.

Privatisation's winners are British Airways, British Gas, BT and, most surprisingly perhaps, given recent adverse publicity, British Aerospace. National Freight and ABP, both of whom have stumbled slightly in the recession, follow close behind. The fact that ABP inherited more than its fair share of decrepit ports riddled with restrictive working practices from the British Transport Docks Board makes its transformation even more creditable.

The end of term report for British Steel and Rolls Royce is less good; and for BAA and Jaguar, depressing. In both cases managements have some explaining to do and their work cut out to reverse a performance slide. Jaguar is rationalising heavily and economic recovery in the US and the UK will bring some relief. Good performance in the early '80s on the back of favourable dollar-sterling exchange rates masked longer-term failures at Jaguar. BAA's underlying efficiency can also be questioned.

These results suggest that when coal, rail and perhaps the Post Office are privatised, performance improvements cannot be guaranteed. The management of existing privatised concerns poses problems enough. Governments cannot wash their hands of strategic industries such as aerospace or public utilities. Regulating the gas, electricity, water and telecommunications industries in order to balance consumers' interests with an adequate return to investors will not be easy. Privatisation offered an answer to problems concerning the effective control of state-owned industries, but it has created its own set of problems regarding the public regulation of major industries. As with other areas of economic policy, privatisation may come back to haunt the government.

Employee added value measures the extent to which a business adds value during production. Profit before tax plus interest payments, wages and depreciation are divided by labour hours and expressed as a percentage growth rate. Employee added value was measured over five periods. With the exception of the post-announcement period, performance was usually recorded over four years to smooth the effect of atypical years. Post-announcement periods varied according to the time from announcement to sale Privatisation - that bedrock of 1980s Conservatism - at least escapes with its reputation intact. Or does it? More than £45 billion of state assets have been transferred to the private sector since 1979? and BT's share offer in? is expected to add a further £5 billion. Of the great state monoliths only coal, rail and the Post Office remain in the public sector and plans for privatising coal and rail are well advanced. If the Government placates backbencher fears that privatising the Post Office will raise the cost of rural deliveries and close the village Post Office, then the Royal Mail and its associated businesses may follow coal into the private sector later this Parliament.

Professor David Parker is dean of Hertfordshire Business School; Dr Martin is an economist at the University of York.

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