LEGISLATION: United Kingdom Fine Tunes Its Privatized Utilities

With the arrival in Washington of free-economy Republicans, pressure to turn over traditional government functions, including waste management, to the private sector has gained momentum. Still, the tantalizing lure of less government, coupled with the assumption that private-sector management automatically produces cost-efficient operations, deserves close examination. For example, consider Britain's utilities-privatization effort, which is beginning to show its flaws.

Rising stock prices and the large salaries of utility executives have sparked a privatization backlash. Lawmakers are now asking managers angry questions about their bonuses, and consumers want to know why bills are soaring while company profits are better than ever.

Supporters of Britain's privatization efforts now concede that the public will not tolerate big utility profits, regardless of how well the industry is regulated. "There is something about the British psyche that is envious, even contemptuous, of people who earn large sums of money," said the editor of Privatization International, a London-based trade journal. "Especially if you are a public utility."

The electric utilities have come under such fire lately that steep rate cuts are expected. Meanwhile, some water companies have promised refunds if their rate-setting methods are found to have run afoul of regulations.

Stephen Littlechild, an academic who created the industry's incentive-based rate scheme and who now serves as the government's electric power czar, wants to change the country's regulatory approach to its 12 regional electric companies. Recent reforms, including rate adjustments last August that brought price cuts of up to 18 percent and a cap to keep rate increases below annual inflation, don't seem to be enough. Now, Littlechild is considering an even tougher formula for future refunds to customers.

Naturally, Littlechild's proposals have caused utility stock prices to tumble - as much as 23 percent. Consumer groups, however, point out that such a loss represents only half of the gain realized by the companies since privatization.

"People are now seeing the free market as the cause of our problems," said a London utility analyst. "[Littlechild's actions have] blown a hole in the system."

Not every privatized state enterprise has endured the same scrutiny as the utilities. For example, former state monopolies in the airlines, steel and telecommunications fields have generally been praised.

Privatization programs got their start during the 1980s when a free-market mania hit the United Kingdom. Indeed, the British zoomed ahead of other European nations in selling their bloated, stodgy state-owned electricity, gas, water and telephone utilities to private operators, who quickly trimmed down and reinvigorated the operations.

The idea was simple: government rate controls would protect consumers and the companies could make profits by cutting costs and increasing productivity. By comparison, most U.S. utilities cannot exceed the profit margins fixed by state regulatory commissions. On the other hand, trimming expenses and sharpening efficiency gave British utilities the opportunity for gigantic profits.

Regional electric companies doubled their profits between 1990 and 1994. Meantime, some water companies enjoyed a four-fold increase in profits. Littlechild thought the system was working fairly and properly, despite these gains, until he learned of a proposed take-over of a regional electric company. After the take-over target convinced its shareholders to reject the original bids, the would-be buyer then sweetened its deal with huge sums of money for shareholders. Littlechild was shocked that the buyer had such funds available.

Sizable cash incentives and hefty executive bonuses made Littlechild worry that his vaunted rate system was creating a windfall for the companies and that the firms were not fully disclosing their finances.

Now, British electric utility executives ruefully acknowledge that their greed may have undermined public confidence in the current system. The welfare of shareholders seemed to matter more than the public interest.

As state and local officials in the United States contemplate private sector take-overs of basic government services, they should keep in mind the backfire of privatization in Britain.