The Benefits of Private Finance Initiative

The UK nationalised the famous bank northern rock in 2008, the reason why is due to the mortgage crisis.Two years later, the bank got split into assets and banking in order to attract buyers and change it back to the private sector.

Nationalisation Of Northern Rock

Nationalisation can have a big effect in the economy of a country, nationalisation occurs when the government changes a private sector company to public and becomes part of the state. The governments nationalise industries for their best interest, there are many reasons of nationalisation it can be externalities, free market failure, saving banking system…etc. The UK massive industries were nationalised in 1950s until they were got privatise back in the 90s, examples: Bank of England, the coal industry, Railways …and many more.

Northern rock has been nationalised in 2008, it is mainly due to the 'credit crunch'. In 2008, there has been a massive increase for sub-prime mortgages which led lack of funds for lending, therefore loans became almost impossible to get from the banks. Northern Rock had a high percentage of risky loans, when the crisis hit they could not raise enough funds and they had to ask Bank of England for emergency funds, the customers heard that northern rock asked for help they withdrew all of their savings, on that day costumers withdrew more than £2 billion.

The bank of England was treating northern rock as a public company with around £100 billion added to the national debt, few days after they announced that northern rock is to be nationalised and lost more than 90% of its shares.

Privatisation Of Northern Rock

Privatisation happens when a public business sector which means a government owed business changes to private owned business (private sector), More than 95% of the UK GDP is private-owned businesses. On the past years the UK economy shifted from the public sectors to the private ones, Some high profile enterprises changed to the private sectors examples : British gas, British air ways, British coal….and many more.

The reason for the UK government to privatise those huge industries are all the benefits that comes with the privatisation, it is known that private industries are always seeking to improve in technology in order to reduce the costs and make a bigger profit, in other words privatisation increases efficiency, a manager in a public sector company doesn't receive any profit of the company, his salary is fixed therefore he will not make any effort on cutting the costs and making the company more efficient.

The other major benefit of privatisation is that private sectors industries are not influenced by politics; it's the total opposite of state owned business where they employ twice as much employees in order to increase the employment rate and have positive image worldwide. Not long before the nationalisation of Northern rock, the UK government announced that this nationalisation would be non-permanent.

By 2009, many rumours suggested that Northern Rock is going to be sold by the end of the year, when those suggestions went public it attracted big industries and banks to buy Northern rock, one of those were Santander, Blackstone, National Australia Bank and Virgin Money. Soon after, one of the biggest financial service companies worldwide called Credit Suisse advised Northern rock to get split into 2 sections; One part called "assets" and the other "banking" in order to separate the bad part of the bank from the good, the bad part of the bank was full of sub-prime mortgages with an incredible rate of 125% of a house value.

At the end of the year, Virgin money decided to buy northern Rock from the government for £700m on 2011.After virgin money acquired northern Rock there has been a massive job losses, with more than 2000 jobs lost.When Northern rock was sold to virgin money, the taxpayers owned more than £1 billion therefore it means that the taxpayers gifted that money and will not get back that money.

What Is Private Finance Initiative?

Private finance initiative appeared in 1992, which is a specific procedure of financing projects where private companies are in charge of financing, managing and completing the project. PFI firms have built more than thousands of schools, hospitals and prisons The main advantage of PFI is that the tax payers are not funding those projects directly, the private company will fund and build the infrastructure could be a prison, hospitals, schools, railways, roads…etc. The government will then pay the private company back by long term payments with interest, usually a PFI contract can last to 30 years.

There are many benefits with PFI, one of them is how efficient are private companies, they will always try to reduce the costs in order to make bigger profit. The second advantage is how fast the project will get finished, the government will pay the PFI company for completing the project but if any delay will occur in delivering the project, the PFI company will pay extra charges towards the government , therefore PFI firms are usually fast in delivering the project in order to escape the extra charges.

There has been many controversies about PFI firms, around 17 schools built under PFI projects were shut down due to building faults were discovered, the PFI firms built them cheaply with dangerous design and poor material, now the government has to repair those mistakes which will cost them a big amount of money.

Market Failure

Markey failure happens when the market fails to produce the ideal outcome for society in the free market, there is complete market failure and partial market failure. Complete market failure: this happens when we can't find the product on the market at all. Partial market failure: this means that you can find the product on the market but at a high price and at low supply. There are many ways a market can fail, the first one is called information failure this occurs when demerit goods consumed more than produced and merit goods are not produced enough to the high demand.

The other common failure happens when the consumers will not pay for a public good, but he will use it anyway. Monopolies can be a market failure by having expensive goods and lack of production therefore it will have a bad effect to consumer welfare.

Bail Out Of Northern Rock

The bank of England ball out northern rock because the NAO said the bank was too big to collapse, and the tax payers will pay in order to save the bank, later on the government announced that the tax payers will lose £50bn and it may be more.

Northern rock needs to pay the UK government about £15bn and £27bn for tax payers. The government has spent an astronomic amount of money on crisis advisers, approximately £500m.SubsidiesSubsides can help reduce the price of a good, the government will help the company by giving them money in order to increase the supply therefore the price will drop, and the demand will rise. As we can see in the diagram on the right the Supply line will shift to the right which means the price will drop from 30 to 22 therefore the demand will rise from 100 to 140 which will drop the price of the market.

The government is able to subsidies the firms with the money of taxes as we can notice in the diagram below the cost of subsidies is £1960.There are many cons for subsidies:" The Government will need to increase the taxes in order to increase an important amount of money to subsidies." The firm that are subsidised by the government will not care to reduce their costs because they will receive the money from the government anyway. Therefore, the government needs to be careful who they are subsiding and they need to subsidies firms that are giving only positive externalities and benefiting the citizens.

Competitions Commission

The competition commission created in 1999, in order to investigate if a company is allowed to merge with another in order to keep a healthy competition and avoid monopoly in the market. The main task for the competitions commission is to ensure a healthy competition in order to benefit the economy, if they finish an investigation and find something doggy they will alert the government and make recommendations.

They also have the right to investigate different markets and look for firms that are abusing of monopoly, they have recently released a report about the British supermarket, surprisingly the report showed that the supermarket competition is pretty fair in the UK. Breaking-up the banks: In 2009, there has been many speculations and controversy about splitting-up banks in order to have a heathy competition. The government announced that 4 new banks could appear in the next years, the main reason for this split up is to make sure that the tax payers will get their money back, they said that the new banks that are coming will not have any toxic assets in other words they would be clean. Many criticism came with this new idea, the main one was that the US could benefit from this split-up and try to step in the UK market and make big profit from it.

Deregulation

Deregulation lowers barrier to entry in the competition, which means the government will allow new competition in a specific market, which will help reduce a monopoly and increase competition therefore it would be easier to enter the industry. Deregulation will benefit the consumer by lowering the prices because of the competition. The UK has deregulated many of its industries by privatisation ( Royal mail, British gas, British airline….etc.)There was a financial deregulation in the 90s, where before the government was regulating the banks by obliging them to have a certain amount of cash. After the 90s the government allowed the banks to have their own freedom and make their own banking rules.