Inefficiency, Public Enterprise and Privatisation

There is a general perception, based upon casual observation and some systematic empirica! study, that public enterprises are inefllcient.! This paper takes this to be true, and is concerned with the problem of providing a rigorous analysis and explanation of this inefficiency.2 Privatisation, which, in the U.K. at least has received its primary impetus from political and ideological motivarions,3 has also been supported by some economists4 because it is seen as a way of correcting these ine~ciencies. To test this argument, the analysis of public enterprise ine~ciency will be extended in this paper to the issue of privatisation. The analysis is an application of the theory of agency,s and in particular makes extensive use of the model of the adverse selection or incentive compatability problem. 6 Privatisation is regarded essentially as a change in the structure of this principal-agent model. Briefly, the adverse selection agency model deals with the situation in which an agent is supposed to take decisions on behalf of a principal, but has his own objectives which may lead him to act in his own as opposed to the principal’s interests. If the principal possessed all the information held by the agent, such conflict would not be possible. However, in the adverse selection model the agent possesses some ‘private’ info~ation which is not available to the principal. The agent will report a message concerning this