Privatization and Competition

State-owned enterprises often engage in actions not sustainable in a competitive industry.  For example, a state enterprise's prices are often set according to political criteria.  Favored groups or politically preferred products are sold below cost, while cross-subsidies from premium-priced products provide the necessary revenue support.   In the absences of barriers to competition, competitors will naturally be attracted to the market for the premium-priced products, and they will undermine either the pricing structure or the revenue of the state enterprise.  Thus an airline fare structure in which international fares provide a significant cross-subsidy for domestic fares is not sustainable if international air travel becomes competitive.  Other state-owned airline practices, such as providing free, on-demand flights for high government officials, providing jobs to politically connected unemployed individuals, or ignoring international developments in best-practice technology and management, are also not sustainable in a competitive environment.

Privatization can be an important component of a pro-competitive approach to producing social benefits.  Privatization, if done well, does not attach any special political responsibilities to the privatized company.  By ensuring that an enterprise is run on a commercial basis, privatization removes political obstacles to promoting competition.  Experience shows that competition generally brings significant benefits to consumers in the form of lower prices, better quality products or services, more choices, and a higher rate of innovation.  Moreover, if the form of competition that evolves fails to produce some socially desirable outcome, governments can choose to take explicit, competitively neutral actions to address the shortcoming.  For instance, government subsidies might be provided to particular groups of consumers to address particular social goals.   More generally, re-regulation is always an implicit political risk in an industry that has undergone privatization and liberalization.  Companies can manage this risk by ensuring that customers receive and recognize clear benefits from a private, competitive industry.

The relationship between the privatization of Kenya Airways and benefits to Kenyan consumers is still developing.  The turnaround of Kenya Airways in preparation for privatization brought noted improvements in quality of service.  Moreover, the privatization established a strategic investor with significant control rights and protection from government appropriation under the Kenyan Foreign Investment Protection Act.  Privatization also reduced the government's ownership share of Kenyan Airways to 23%.   Thus privatization has ensured that Kenya Airways will be operated consistently on commercial terms.  In doing so privatization has enabled a focus on customer needs and has lessened the political obstacles to the further development of competition.   However, Kenya Airways received as part of its privatization government guarantees that will hinder the development of additional competition in the medium term.  In particular, the government committed:

Establishing these guarantees involved a policy tradeoff between ensuring a successful privatization and restructuring of Kenya Airways, and promoting competition.  This tradeoff should be considered in the context of the role of the Kenya Airways' privatization in a broader transition to pro-competitive policies.

International comparisons provide some indication of the competitiveness of the Kenyan air transport market.  The table below compares round-trip low unrestricted fares from Nairobi to London, 23 January 1998 to 31 January 1998, with similar round trips from neighboring African countries.  The table suggests that Kenyan travelers face somewhat higher fares than Ugandan and Ethiopian travelers, but lower fares than travelers from Tanzania.  Other fare quotes can be obtained on-line for similar illustrative comparisons.  A representative survey of fares is needed for a thorough, statistically significant analysis.

BA-(AF/AF) $2,125.90
(AF/AF)-BA $2,125.90
KQ-(AF/AF) $2,125.90
Y2-(KQ/KQ) $1,846.00
Y2-BA $1,879.00
(QU/BA)-(KQ/KQ) $2,108.00
Dar es Salaam--London
(TC/BA)-BA $2,355.00
(TC/BA)-(BA/KQ) $2,355.00
(TC/BA)-(LX/SR) $2,355.00
Addis Ababa--London
ET-(BA/MS) $1,902.00
(ET/BA)-(BA/MS) $1,902.00
(ET/BA)-(BA/MS) $1,902.00
Notes: Fares are the three lowest fares in U.S. dollars. The "-" divides outbound and inbound flights; the "/" divides indicates legs of an (indirect) flight. Key: AF - Air France, BA - British Airways, ET - Ethopian, KQ - Kenyan Airways, LX - Crossair A.G., MS - EgyptAir, QU - Uganda Airlines Corp., SR - SwissAir, TC - Air Tanzania, Y2 - Alliance. 
Questions for Discussion
  1. Which is worse, a publicly owned monopoly or a privately owned monopoly?

  3. To what extent will a profit-maximizing monopolist past along cost reductions into its prices?

  5. A temporary priviledged position for a privatized firm ("convalescent patient") might be justified on grounds similar to the traditional "infant industry" argument.  What are relevant considerations in the "infant industry" debate and how might they relate to privatization?

Go to Kenya Airways: Case Study in Privatization

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