Regulating Public vs. Private Operators

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Whether the regulator is regulating a publicly-owned operator rather than a privately-owned operator changes the nature of some issues. For example, government interference may be greater with a government-owned operator. Direct control of a public enterprise may be less costly than direct control of a private operator. However, direct control in either instance may lower operating efficiency for reasons indicated above. Also, a government’s promise to not engage in political interference with utility operations is less credible with public ownership than with private ownership.

Using financial incentives may be less effective for a state-owned provider than for a privately owned provider. Using incentive regulation to motivate improved performance is effective for private operators whose profit motives are clear. However, in the case of public enterprises the regulator must identify the objectives of the managers who may be more affected by political influence, government budgeting, and bureaucratic management than are their counterparts in privately-owned operators.2

Another financial incentive used by regulators is the levying of fines on operators for poor performance. These are generally effective for private operators if enforced, but there is a serious question about whether fines are a deterrent for public enterprises because it is the public that ultimately pays the penalty.

Ownership also affects other issues. Pricing is generally more efficient with private enterprises because the government must allow private operators’ prices to cover costs over time in order to encourage investment.3 Competition is more complicated with public enterprises than with private enterprises. Public enterprises have had success thwarting competitive entry, but experience has shown that subjecting public enterprises to competition improves efficiency relative to public ownership with no competition.

Also, the absence of equity markets for public enterprises complicates estimating the cost of capital. On the other side, the public sometimes raises concerns about private ownership of infrastructure industries, such as concerns about private investment incentives not capturing public needs for services and about foreign owners not understanding local markets and local needs.4

Footnotes

  1. See Regulation of Public vs. Private Companies, of Existing vs. New Firms.
  2. Price Level Regulation and Quality, Social, Environmental chapters cover these techniques.
  3. See, for example, the case study of India electricity in Bakovic, Tenenbaum, and Woolf, March 2003.
  4. Determination of Cost of Capital (Debt and Equity) covers issue of estimating the cost of capital.