Thursday, November 18, 2010

Privatization-nationalization cycles

The past two decades have seen an impressive wave of privatizations all around the world, especially in utilities and resources. This trend has recently been reversed though, with several large nationalization waves, in particular Latin America. This kind of cycle is not new, as especially the gas industry has gone through several waves each way during the last century. Why all this back and forth?

Roberto Chang, Constantino Hevia and Norman Loayza observe that nationalizations typically happen when the price of the output of reference is high and inequality of wages is also high. The opposite is the case for privatizations. They can explain this with a model of a benevolent government that maximizes a social welfare function represented by the average utility of workers. Under nationalization, all workers are paid the same and exert little effort. Under privatization, firms can discriminate workers, who then put more heart at work, creating wage differentials. When prices for the commodity increase, this generates larger rents for the most productive, and inequality increases.

The story is then of a inequality-efficiency trade-off for the government. In the naturalized state, inequality is low, but so is efficiency. If prices are low, it is more important to increase efficiency, and the firm is privatized. But as it becomes more efficient and discriminates its workers, inequality becomes more important, and the firm is nationalized back. And the cycle continues, with an average of 12 years of privatization and 25 years for nationalization. While this is a very stylized story, after all the model assume an economy with a single sector that has no impact on world prices, it is still a compelling story.

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