It is usually argued that publicly owned firms are less efficient than those in the private sector. The standard approach to explaining this apparent X-inefficiency is based on agency theory. In Discussion Paper No. 1192, Research Fellow Jonathan Haskel and Amparo Sanchis model worker effort as determined by a bargain between firms and workers. Workers dislike effort because it lowers utility. Firms prefer high effort because it raises productivity. Public-sector firms are assumed to be social welfare maximizers and compared to private-sector firms, therefore, they bargain for lower effort levels since they have the interests of consumers and workers at heart. The authors' model predicts that under certain conditions privatization should raise effort and so lower X-inefficiency, and that wages may increase or decrease.

The model can explain a number of features of the data, the first being the difference that privatization makes. In the private sector, firms are interested in profits and so bargain hard for low crew sizes. In the public sector, firms are interested in wider social objectives and so do not press so hard in the bargain. So the model predicts greater X-inefficiency in the public sector. Second, the model can explain why bargained wages might rise with privatization, as observed in a number of UK cases. The reason is that with effort in the bargain as well as wages, firms might be happy to settle for higher wages if workers put in more effort. Third, the model also predicts less X-inefficiency in more competitive sectors. The reason here is that more competition lowers the surplus available for workers in the bargain. If workers take some of that surplus in lower effort then competition raises effort.

Privatization and X-Inefficiency: A Bargaining Approach
Jonathan Haskel and Amparo Sanchis

Discussion Paper No. 1192, June 1995 (IO)