Un-Crown Them: Privatizing Crown corporations has been a successful, and lucrative, strategy. Yet many remain in state hands

Crown Corporations, Frontier Centre, Worth A Look

The most extensive wave of privatizations in Canada followed, and to some extent imitated, the trailblazing privatizations initiated in the United Kingdom by the Margaret Thatcher government. Most privatizations in Canada occurred in the 10-year period from the mid-1980s to the mid-90s. One major privatization, Canadian National Railway Co., produced for Canadians and others significant benefits — the total welfare gain from the privatization of CNR alone was about $15-billion.

The last decade has been a relatively quiet period in terms of privatization at both the federal and provincial levels. There are a number of reasons for this privatization hiatus. Certainly a major contributing factor, at least at the federal level, is that the low-hanging fruit has already been privatized. Currently, the remaining candidates for privatization in Canada would be both economically and politically more problematic than those that took place previously. However, in 2009 the then-minority Harper government at least mooted the possibility of privatizing a number of “not self-sustaining” Crown corporations that included the Canadian Broadcasting Corp., VIA Rail Canada Inc. and the Cape Breton Development Corp.

Indeed, the recently announced sale of the Commercial Reactor Sales and Service Division of Atomic Energy of Canada Ltd. may indicate a renewed interest in further privatization by the now-majority Harper government. At the provincial level, there is a much greater amount and variety of Crown corporations. Prominent examples include the provincial electric power corporations and a range of infrastructure entities, such as BC Ferries Corp.

Our overall conclusion is that the privatization of entities operating in competitive markets has been social welfare-improving. Indeed, our major policy conclusion is that this kind of privatization is a no-brainer. The evidence for this conclusion is clear, strong and convincing in cases where shares are issued to the public (CNR, Potash Corp., Suncor Energy Inc.) and mostly inferential in the case of direct sales to the public (Alberta liquor stores, Canadair, Teleglobe). The only two privatized entities that might be considered as failures are Fishery Products International and Air Canada. FPI obviously suffered with the collapse of the cod fishery. Air Canada operates in a cyclical and often unprofitable industry. If it had remained as a Crown corporation it might have performed worse.

Despite the overall success of Canadian privatizations, much of the Canadian economy remains in state hands. There are still many federal and provincial Crown corporations. In addition, health care, water, sewage treatment and many other municipal services are still provided by government.

There are, of course, many barriers to privatization. In addition to political and bureaucratic barriers, tax implications are sometimes a deterrent for provincial privatizations. First, Crown corporations cannot carry forward tax losses, which will reduce the sale price. Second, privatized companies will pay taxes to the federal government, thereby reducing the aggregate funds that will remain in the province.

Corporations often have a portfolio of different businesses. For example, Canada Post Corp. is in the businesses of both delivering regular mail and delivering packages (it owns Purolator). These businesses operate in different markets with different competitors and different structural conditions. Also, the socio-political mandates may differ by business. The potential for privatization must be assessed for each business, not the corporation as a whole. It might make sense to privatize some businesses operated by a particular Crown corporation, but not others.

Rather than analyzing each potential privatization, we think it makes more sense to develop some general principles about their privatization. To begin, it is useful to categorize these businesses (not Crown corporations) into one of three groups: those businesses that would operate in competitive markets after privatization (competitive business: CB); those businesses that would have significant market power after privatization (market power business: MPB); and those businesses that would have significant revenue after privatization, but that would not have positive cash flow if they are required to maintain their public-purpose mandate after privatization, for example, a universal service mandate (non-viable businesses: NVB).

As far as we are aware, no Canadian government has formulated a framework to guide its privatization regime. A clear normative framework is an important part of a privatization program because the way in which an entity is privatized, and the nature of the post-privatization regulatory environment, is likely to play an important role in determining the social welfare consequences of its privatization. We propose the following meta-rules: 1 If a Crown corporation has multiple businesses, it should be broken up into separate, corporatized businesses before privatization. 2 Government should privatize competitive businesses. 3 Direct or indirect subsidies or benefits resulting from entry restrictions and regulations that had been received by competitive businesses before privatization should be explicitly removed at the time of privatization. This policy should be made transparent to potential purchasers. 4 MPBS could reasonably be privatized under an appropriate post-privatization regulatory regime. However, governments should put the regulatory framework in place before privatization. Ideally, this regulatory regime would encourage competition, reduce inefficiencies in the privatized entity and be transparent on potential windfall taxes. 5 CBS and MPBS with an appropriate regulatory regime in place should be completely privatized unless, and this is very unlikely, the company is too large relative to the equity market. Partial privatization is often the worst of both worlds. 6 In general, NVBS should not be privatized. If a government does want to privatize a NVB, it should clarify its policy agenda going forward before any sale. This should include clarification about whether the NVB will be required to pursue an ongoing public purpose and, if so, it should specify the nature, use and extent of subsidies to achieve these purposes (for example, for the subsidization of rural consumers). 7 Governments that dispose of businesses through share issues should sell them at the revenue-maximizing price rather than giving them away or selling them at a reduced price. Obviously, giving shares away reduces total privatization proceeds. It also means government will have to recoup these foregone proceeds through taxes, which has a deadweight loss. Furthermore, giveaways lead to wide share dispersion, which might entrench poor management and inhibit efficiency improvements.

Of course, governments will be tempted to break these rules when it is politically beneficial to do so. Credible commitment by governments is notoriously difficult, especially in parliamentary systems that lack numerous veto points. Politicians tend to revert to either maximizing revenue (for example, by selling enterprises with currently legislated monopoly power as is, rather than creating a more competitive environment), or by maximizing interest group support (for example, by providing direct or indirect ongoing subsidies to privatized entities) or by maximizing votes (for example, by under-pricing IPO shares), rather than by maximizing long-run social welfare. However, promulgating clear ex ante privatization rules that would essentially be enforced by the administrative state raises the cost of reneging somewhat, as it provides a quasiveto point.

Excerpted from A Review and Assessment of Privatizations in Canada, by Anthony E. Boardman, Sauder School of Business, University of British Columbia; and Aidan R. Vining, Faculty of Business Administration, Simon Fraser University, and published by the School of Public Policy, University of Calgary.