3.3 The distributive impact of privatization

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We have argued so far that the privatization programme advocated by the property rights school does not necessarily promote efficiency. We would like at this point to evaluate the impact of such a programme on income distribution. Let us assume that it can be achieved costlessly, and that the markets are perfect and competitive. Since, under these conditions, we have already shown that the unregulated common property equilibrium was Pareto-dominated by the competitive (private property) equilibrium, we know that, through an appropriate set of transfers, everybody can be made better off under the competitive equilibrium: everybody can gain from privatization. The above statement holds true only in those situations where the former users of the resource get their rights recognized and get compensated for the loss in income which they incur when privatization is carried out. This is clearly the case when traditional users of a resource are made private owners, or when the proceeds from the sale of property rights in the resource are remitted to the former users. In many circumstances, unfortunately, traditional communities do not get their user rights recognized and are simply excluded from the use of the resource with no compensation. In those situations, an interesting issue emerges: since the resource is now efficiently managed, is it possible that the marginal productivity of labour increases in such proportions that the former users, now working as wage-earners, actually gain from privatization? The question applies to two situations of particular interest:

  1. The resource is now privately owned by an outsider who manages it competitively and hires former users as wage labour.
  2. The rights in the resource are sold competitively by the State and the former users become the private owners of the resource. The proceeds of the sale (which represent the discounted sum of the rents which an efficient use of the resource will yield over time) are siphoned off by the State.

In these two situations, will the former users necessarily lose? This is the question raised by Weitzman (1974) in a celebrated article (see also Cohen and Weitzman, 1975: 311-13), and the answer given is 'yes'. Unfortunately, the proof provided seems to be unnecessarily complicated. As a matter of fact, the underlying argument can be easily formulated with the help of a standard diagram (Figure 3. 1). Assume that the average product, AP, is decreasing in the variable factor, L (this is indeed the classical situation where the tragedy of the commons arises). Thus the marginal product of the variable factor, MP, is also decreasing and, for each level of L, MP(L) < AP(L). Let us draw the supply curve of the variable factor, S(w), where w stands for its market price, and assume that S'(w) > 0. Then we can draw the diagram depicted in Figure 3.1.

Fig. 3.1. The welfare impact of privatization, Weitzman (1974)

In an open-access situation, we know that the variable factor is remunerated at its average product, w1, while, in the competitive situation, it is remunerated at its marginal product, w2. It is evident from the graphical analysis above that w2 < w1, L2 < L1, and w2L2 < w1L1. This is precisely the conclusion reached by Weitzman (1974): the remuneration of the variable factor falls.

It must nevertheless be noted that Weitzman actually compares open access (OA) to private property (PP), i.e., the no-rent to the maximum-rent situation. Using the same diagram, it is a simple matter to extend the argument to unregulated common property (CP). Indeed, we already know that w(CP) w(OA). From the above, we also know that w(OA) > w(PP). Therefore, w(CP) > w(PP).

The practical implication of this analysis is, in the words of Weitzman, that 'there may be a good reason for propertyless variable factor units to be against efficiency improving moves . . . like the introduction of property rights . . . unless they get a specific kickback in one form or another' (Weitzman, 1974: 234). It is indeed striking from Weitzman's proof that former resource users lose not only in terms of employment but also on account of reduced individual labour earnings.