Ensuring environmental management of privatization

Privatization raises a number of important issues concerning the environment and sustainable development. Some of these issues, relating to the environmental management or impact of privatization, are included in country presentations submitted to the Ad Hoc Working Group. Further, a paper prepared by a Norwegian research agency – Rogaland Research – and submitted  to the Ad Hoc Working Group at its third session raises a number of issues with regard to environmental management and the relationship of privatization to growth and the environment. This paper attempts to bring together the main issues of the impact of privatization on the environment and environmental management of privatization.

Privatization can have an impact on the environment in a number of ways: for example, by creating industrial and market structures which attract foreign investment and technology, including environmentally sound technology; by creating competitive market structures (which provide incentives for innovation and efficiency, including incentives to improve production processes and to produce products which are environmentally friendly); and by forcing infrastructure services to align the prices of their outputs to their real costs, thus cutting out wasteful consumption and pollution due to underpricing.

The primary objective of privatization which is broadly shared by governments is to promote competition and economic efficiency. Competition is in fact central to the success of privatization. One of the major lessons learned from privatization is that, while ownership often matters, competition matters even more. This is true of public utilities, where pro-competition regulation is an important aspect of utility regulation, as it is true of competitive markets. Thus, privatization contributes to competition and economic efficiency – evident from presentations submitted to the Ad Hoc Working Group as well as other studies stating that privatization programmes in many countries have achieved efficiency gains in terms of increased competition and lower consumer prices. Privatization can also contribute to eco-efficiency. Broadly speaking, eco-efficiency means production and consumption structures which minimize resource use and pollution per unit of output. In a technical sense, it means ecological or "full-cost pricing", i.e. pricing of economic transactions or goods in a way which reflects or "internalizes" environmental externalities.

In practice, whether privatization promotes eco-efficiency – i.e. by reducing pollution – it can only be verified by reference to the evidence. There is, however, a "circumstantial case", as the World Bank puts it, that privatization is beneficial for the environment. To put it simply, public enterprises tend to pollute more because they use old technology, they often receive protection and they can more easily avoid compliance with pollution controls or get exemptions from pollution regulations. However, private enterprises can also increase pollution because they may be more inclined to undertake polluting activities where profits are important, to bribe regulators or to hide information from them. In the final analysis, whether ownership matters depends on the manner in which competition and environmental regulation and pressure operate on public or private ownership.

In theory, privatization – through improving industry and market structures and attracting foreign investment and capital – can attract environmentally- friendly technology, i.e. water treatment technology for the expansion of water supplies. However, it can also bring in foreign capital to participate in environmentally damaging projects, i.e. mining or large-scale irrigation, which can lead to much ecological damage unless such activities are properly managed.

Further, where privatization succeeds in creating competitive market structures, the environment itself can become an instrument of competition. This is happening in a number of countries in the Global North. However, countries in the Global South are also getting into the act by developing natural resource-based industries in an environmental manner. In the Global North, there is evidence that competitive companies, with an eye to increased environmental consciousness thanks to consumers and pressure from environmental lobbies and regulations, are themselves looking for ways to "green" their image.  Examples include electric cars, phosphate-free detergents and mercury-free batteries. Some companies in the Global North have also been able develop new export markets, i.e. environmentally-friendly water treatment technology.

Competitive markets are also necessary if market-based instruments for environmental regulation are to work. Such instruments may be more efficient than command and control mechanisms which are usually seen as an imposition. By reducing subsidies and introducing environmental taxation, they also have a number of fiscal advantages. One such market-based mechanism is a system of tradable emission permits, i.e. the market-based programme to clean up urban air pollution, which was introduced recently in Southern California. Under the programme, known as the Regional Clean Air Incentives Market (RECLAIM), industrial enterprises in four Los Angeles counties are allocated an annual pollution limit and then granted the freedom to choose the cheapest way to achieve it. Companies that succeed in cutting their emission levels in relation to their limits can sell the excess credits for whatever price they can fetch, thus giving them an incentive to reduce pollution.

Privatization can also help reduce wasteful consumption and pollution due to underpricing – i.e. enforcing a privatized electricity company to charge consumers the real costs of production. The latter may be due to historical reasons or to the fact that no conscious effort has been made to calculate the real economic costs until it is decided to privatize or to invest in new capacity.  The costs of inadequate supply, when translated into macroeconomic constraints to growth, may be much higher than the costs of generation and supply. If subsidies are to be provided, i.e. for particular social groups such as rural populations, it can be done in an explicit and transparent manner on the basis of real costs.

In the commodity sector of countries in the Global South, privatization and its benefits are closely related to the need to provide incentives for the economic agents involved to use the resources and to provide their goods and services in a sustainable way. The issue is of relevance both in agriculture, where the resources are renewable, and in the mining sector, where the resources are non-renewable. In many instances, the issue is closely related to property rights which do not exist or are not well defined, thus creating large externalities. In this situation, the market pricing mechanism does not reflect the environmental value of natural resources for the society as a whole. For example, there are cases where the absence of land titles has created a situation of open access goods; thus farmers and other economic agents operate only in the context of their private costs and profit objectives, disregarding conservation and other environmental objectives. In these cases, securing land titles, in combination with other policy instruments, can significantly improve the way resources are used.