Privatization

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Privatization is the incidence or process of transferring ownership of a business, enterprise, agency or public service from the public sector (the state or government) to the private sector (businesses that operate for a private profit) or to private non-profit organizations. In a broader sense, privatization refers to transfer of any government function to the private sector - including governmental functions like revenue collection and law enforcement.[1]

The term "privatization" also has been used to describe two unrelated transactions. The first is a buyout, by the majority owner, of all shares of a public corporation or holding company's stock, privatizing a publicly traded stock, and often described as private equity. The second is a demutualization of a mutual organization or cooperative to form a joint stock company.[2]

Contents

Origin

Edwards states that The Economist coined the term in the 1930s in covering Nazi German economic policy.[3][4]

The Oxford English Dictionary notes usage dating from 1942 in Econ. Jrnl, 52, 398.

History

A long history of privatization dates from Ancient Greece, when governments contracted out almost everything to the private sector[5]. In the Roman Republic private individuals and companies performed the majority of services including tax collection (tax farming), army supplies (military contractors), religious sacrifices and construction. However, the Roman Empire also created state-owned enterprises — for example, much of the grain was eventually produced on estates owned by the Emperor. Some scholars suggest that the cost of bureaucracy was one of the reasons for the fall of the Roman Empire.[5]

In Britain, the privatization of common lands is referred to as enclosure (in Scotland as the Lowland Clearances and the Highland Clearances). Significant privatizations of this nature occurred from 1760 to 1820, coincident with the industrial revolution in that country.

In more recent times, Winston Churchill's government privatized the British steel industry in the 1950s, and West Germany's government embarked on large-scale privatization, including selling its majority stake in Volkswagen to small investors in a public share offering in 1961[5]. In the 1970s General Pinochet implemented a significant privatization program in Chile. However, it was in the 1980s under the leaderships of Margaret Thatcher in the UK and Ronald Reagan in the USA, that privatization gained worldwide momentum. In the UK this culminated in the 1993 privatisation of British Rail under Thatcher's successor, John Major; British Rail having been formed by prior nationalization of private rail companies.

Significant privatization of state owned enterprises in Eastern and Central Europe and the former Soviet Union was undertaken in the 1990s with assistanced from the World Bank, the U.S. Agency for International Development, the German Treuhand , and other governmental and nongovernmental organizations.

A major ongoing privatization, that of Japan Post, involves the Japanese post service and the largest bank in the world. This privatization, spearheaded by Junichiro Koizumi, started in 2007 following generations of debate. The privatization process is expected to last until 2017.

Types

There are three main methods of privatisation:

  1. Share issue privatisation (SIP) - selling shares on the stock market - the most common type of privatisation
  2. Asset sale privatisation - selling an entire organization (or part of it) to a strategic investor, usually by auction or by using the Treuhand model
  3. Voucher privatisation - distributing shares of ownership to all citizens, usually for free or at a very low price.

Share issues can broaden and deepen domestic capital markets, boosting liquidity and (potentially) economic growth, but if the capital markets are insufficiently developed it may be difficult to find enough buyers, and transaction costs (e.g. underpricing required) may be higher. For this reason, many governments elect for listings in the more developed and liquid markets, for example Euronext, and the London, New York and Hong Kong stock exchanges.

As a result of higher political and currency risk deterring foreign investors, asset sales occur more commonly in developing countries.

Voucher privatisation has mainly occurred in the transition economies of Central and Eastern Europe, such as Russia, Poland, the Czech Republic, and Slovakia.

A substantial benefit of share or asset-sale privatisations is that bidders compete to offer the highest price, creating income for the state in addition to tax revenues. Voucher privatisations, on the other hand, could be a genuine transfer of assets to the general population, creating a real sense of participation and inclusion. If the transfer of vouchers is permitted, a market in vouchers could be created, with companies offering to pay money for them.

Differing views

Supporting

Proponents of privatisation believe that private market factors can more efficiently deliver many goods or service than governments due to free market competition. In general, it is argued that over time this will lead to lower prices, improved quality, more choices, less corruption, less red tape, and quicker delivery. Many proponents do not argue that everything should be privatised. According to them, market failures and natural monopolies could be problematic. However, some Austrian school economists and anarcho-capitalists would prefer that every function of the state be privatised, including defense and dispute resolution.

The basic economic argument given for privatisation states that governments have few incentives to ensure that the enterprises they own are well run. One problem is the lack of comparison in state monopolies. It is difficult to know if an enterprise is efficient or not without competitors to compare against. Another is that the central government administration, and the voters who elect them, have difficulty evaluating the efficiency of numerous and very different enterprises. A private owner, often specializing and gaining great knowledge about a certain industrial sector, can evaluate and then reward or punish the management in much fewer enterprises much more efficiently. Also, governments can raise money by taxation or simply printing money should revenues be insufficient, unlike a private owner.

If private and state-owned enterprises compete against each other, then the state owned may borrow money more cheaply from the debt markets than private enterprises, since the state owned enterprises are ultimately backed by the taxation and printing press power of the state, gaining an unfair advantage.

Privatising a non-profitable state-owned company may force the company to raise prices in order to become profitable. However, this would remove the need for the state to provide tax money in order to cover the losses.

Proponents of privatisation make the follwing arguments:

Opposing

Opponents of privatisation dispute the claims concerning the alleged lack of incentive for governments to ensure that their public services are well run, on the basis of the idea that governments are proxy owners answerable to the people. It is argued that a government which runs nationalized enterprises poorly will lose public support and votes, while a government which runs those enterprises well will gain public support and votes. Thus, democratic governments do have an incentive to maximize efficiency in nationalized companies, due to the pressure of future elections.

Opponents of certain privatisations believe that certain public goods and services should remain primarily in the hands of government in order to ensure that everyone in society has access to them (such as law enforcement, basic health care, and basic education). Likewise, private goods and services should remain in the hands of the private sector. There is a positive externality when the government provides public goods and services to society at large, such as defense and disease control. As for natural monopolies they are by their nature not subject to fair competition and better administrated by the state.

The controlling ethical issue in the anti-privatisation perspective is the need for responsible stewardship of social-support missions. Market interactions are all guided by self-interest, and successful actors in a healthy market must be committed to charging the maximum price that the market will bear. Privatisation opponents believe that this model is not compatible with government missions for social support, whose primary aim is delivering affordability and quality of service to society.

Many privatisation opponents also warn against the practice's inherent tendency toward corruption. As many areas which the government could provide are essentially profitless, the only way private companies could, to any degree, operate them would be through contracts or block payments. In these cases, the private firm's performance in a particular project would be removed from their performance, and embezzlement and dangerous cost-cutting measures might be taken to maximize profits.

Furthermore, large corporations may pay public-relations professionals to convince decision-makers that privatization is a sensible idea. Corporations typically have far more resources for expert testimony, advertisements, conferences and other propaganda efforts than anti-privatisation advocates.

Some would also point out that privatising certain functions of government might hamper coordination, and charge firms with specialized and limited capabilities to perform functions which they are not suited for. In rebuilding a war torn nation's infrastructure, for example, a private firm would, in order to provide security, either have to hire security, which would be both necessarily limited and complicate their functions, or coordinate with government, which, due to a lack of command structure shared between firm and government, might be difficult. A government agency, on the other hand, would have the entire military of a nation to draw upon for security, whose chain of command is clearly defined. Opponents would say that this is a false assertion: numerous books refer to poor organization between government departments (for example the Hurricane Katrina incident).

Although private companies will provide a similar good or service alongside the government, opponents of privatisation are careful about completely transferring the provision of public goods, services and assets into private hands for the following reasons:

Intermediate views

Others don't dispute that well-run for-profit entities with sound corporate governance may be considerably more efficient than an inefficient governmental bureaucracy or NGO, however many implementations of privatization can - in practice - lead to the firesale of public assets, and/or to inefficient or corrupt - for profit management.

Developed or minimally corrupt economies

A top executive can readily reduce the perceived value of an asset – due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative (e.g. pessimistic) estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce sale price. (This is again due to information asymmetries since it is more common for top executives to do everything they can to window dress their earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates.

When the entity gets taken private - at a dramatically lower price - the new private owner gains a windfall from the former top executive's actions to (surreptitiously) reduce the sales price. This can represent 10s of billions of dollars (questionably) transferred from previous owners (the public) to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the firesale that can sometimes be in the 10s or 100s of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives).

When a publicly held asset, mutual or non-profit organization undergoes privatization, top executives often reap tremendous monetary benefits. The executives can facilitate the process by making the entity appear to be in financial crisis - this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell.

Ironically, it can also contribute to a public perception that private entities are more efficiently run reinforcing the political will to sell of public assets. Again, due to asymmetric information, policy makers and the general public see a government owned firm that was a financial 'disaster' - miraculously turned around by the private sector (and typically resold) within a few years.

Underdeveloped or highly corrupt economies

In a society with substantial corruption, privatization allows the government currently in power and its backers to siphon a large portion of the entire net present value of state assets away from the public and into the accounts of their favored power brokers. Without privatization, corrupt officials would have to slowly harvest their corrupt earnings over time. As such, efficient privatization depends on their being a very low of current corruption among the current government officials since it allows for far more 'efficient' extraction of corrupt rents.

Of course, corrupt governments can also extract corrupt rents quite efficiently in other ways - particularly by borrowing extensively to engage in spending on overly favorable contracts with their backers (or on tax shelters, subsidies or other give-aways). Generations of subsequent taxpayers are then left with paying back the debt incurred for corrupt transfers made decades previously. Naturally, this may lead to the sale of public assets....

In the end, the public is left with a government that taxes them heavily, and gives them nothing in return. Debt repayment is enforced by international agreements and agencies such as the IMF. Infrastructure and upkeep is sacrificed - leading to a further decay in the economic efficiency of the country over time.

Outcomes

Literature reviews [8][9] find that in competitive industries with well-informed consumers, privatisation consistently improves efficiency. Such efficiency gains mean a one-off increase in GDP, but through improved incentives to innovate and reduce costs also tend to raise the rate of economic growth. The type of industries to which this generally applies include manufacturing and retailing. Although typically there are social costs associated with these efficiency gains[10], many economists argue that these can be dealt with by appropriate government support through redistribution and perhaps retraining.

In sectors that are natural monopolies or public services (such as, say, passenger rail in the United States), the results of privatisation are much more mixed, as a private monopoly behaves much the same as a public one in liberal economic theory. The government is actually seen as a more natural provider of public goods and services. However, the efficiency of an existing public sector operation can be put into question requiring changes to be made. Changes may include, inter alia, the imposition of related reforms such as greater transparency and accountability of management, an improved cost-benefit analysis, improved internal controls, regulatory systems, and better financing, rather than privatisation itself.

Regarding political corruption, it is a controversial issue whether the size of the public sector per se results in corruption. The Nordic countries have low corruption but large public sectors. However, these countries score high on the Ease of Doing Business Index, due to good and often simple regulations, and for political rights and civil liberties, showing high government accountability and transparency. One should also notice the successful, corruption-free privatisations and restructuring of government enterprises in the Nordic countries. For example, dismantling telecommunications monopolies has resulted in several new players entering the market and intense competition with price and service.

Also regarding corruption, the sales themselves give a large opportunity for grand corruption. Privatisations in Russia and Latin America were accompanied by large-scale corruption during the sale of the state-owned companies. Those with political connections unfairly gained large wealth, which has discredited privatisation in these regions. While media have reported widely the grand corruption that accompanied the sales, studies have argued that in addition to increased operating efficiency, daily petty corruption is, or would be, larger without privatisation, and that corruption is more prevalent in non-privatised sectors. Furthermore, there is evidence to suggest that extralegal and unofficial activities are more prevalent in countries that privatised less.[11]

Alternatives

Public utility

The enterprise can remain as a public utility.

Non-profit

A private non-profit organization could manage the enterprise.

Municipalization

Transferring control to municipal government

Outsourcing or sub-contracting

National services may sub-contract or out-source functions to private enterprises. A notable example of this is in the United Kingdom, where many municipalities have contracted out their garbage collection or administration of parking fines to private companies. In addition, the British government has involved the private sector more in the workings of the National Health Service principally through outsourcing the construction and operation of new hospitals to private companies. There are also moves to refer patients to private surgeries to ease the load on existing NHS human resources, and covering the cost of this.

Partial ownership

An enterprise may be privatised, but with the state retaining a number of shares in the resultant company. This is a particularly notable phenomenon in France, where the state often retains a "blocking stake" in private industries. In Germany, the state privatised Deutsche Telekom in small tranches, and still retains about a third of the company. As of 2005, the state of North Rhine-Westphalia is also planning to buy shares in the energy company E.ON in what is claimed to be an attempt to control spiraling costs.

Whilst partial privatisation could be an alternative, it is more often a stepping stone to full privatisation. It can offer the business a smoother transition period during which it can gradually adjust to market competition. Some state-owned companies are so large that there is the risk of sucking liquidity from the rest of the market, even in the most liquid marketplaces: this may favor gradual privatization. The first tranche of a multi-step privatisation would also in the first instance establish a valuation for the enterprise to mitigate complaints of under-pricing.

In some instances of partial privatisation of contracted services, some portion(s) of the state-owned service are provided by private-sector contactors, but the government retains the capacity to self-operate at contract intervals, if it so chooses. An example of partial privatisation would be some forms of school bus service contracting, such as arrangements where equipment and other resources purchased with government capital funds and/o those already owned by a governmental entity are used by the contractor for a period of time in providing services, but ownership is retained by the governmental unit. This form of partial privatisation eases concerns that once an operation is contracted, the government may be unable to obtain sufficient competitive bids, and be subjected to terms less desirable than the prior operation under state-ownership. Under that scenario, a reverse privatisation would be more feasible for the government. (see section below)

Public–private partnership

Notable examples

The largest privatisation in history involved Japan Post. It was the nation's largest employer and one third of all Japanese government employees worked for Japan Post. Japan Post was often said to be the largest holder of personal savings in the world.

The Prime Minister Junichiro Koizumi wanted to privatise it because it was thought to be an inefficient and a source for corruption. In September 2003, Koizumi's cabinet proposed splitting Japan Post into four separate companies: a bank, an insurance company, a postal service company, and a fourth company to handle the post offices as retail storefronts of the other three.

After the Upper House rejected privatisation, Koizumi scheduled nationwide elections for September 11, 2005. He declared the election to be a referendum on postal privatisation. Koizumi subsequently won this election, gaining the necessary supermajority and a mandate for reform, and in October 2005, the bill was passed to privatise Japan Post in 2007.[12]

Nippon Telegraph and Telephone's privatisation in 1987 involved the largest share-offering in financial history at the time.[13] 15 of the world's 20 largest public share offerings have been privatisations of telecoms.[13]

The United Kingdom's largest public-share offerings were privatisations of British Telecom and British Gas. The largest public-share offering in France was France Telecom.

Negative responses

Privatisation proposals in key public service sectors such as water and electricity in many cases meet with strong resistance from opposition political parties and from civil society groups, many of which regard them as natural monopolies. Campaigns typically involve demonstrations and democratic political activities; sometimes the authorities attempt to suppress opposition using violence (e.g. Cochabamba protests of 2000 in Bolivia and protests in Arequipa, Peru, in June 2002). Opposition is often strongly supported by trade unions. Opposition is usually strongest to water privatisation — as well as Cochabamba, recent examples include Haiti, Ghana and Uruguay (2004). In the latter case a civil-society-initiated referendum banning water privatisation was passed in October 2004.

Reversion

A reversion from contracted ownership of an enterprise or services to governmental ownership and/or provision is called reverse privatisation or nationalization. Such a situation most often occurs when a privatisation contractor fails financially and/or the governmental unit has failed to purchase satisfactory service at prices it regards as less than with state-ownership or self-operation of services. Another circumstance may occur when greater control than viable under privatisation is determined to be in the governmental unit's best interest.

National-security concerns may be the source of reverse privatisation actions when the most likely providers are non-domestic or international corporations or entities. For example, in 2001, in response to the September 11th attacks, the then-private airport security industry in the United States was nationalized and put under the authority of the Transportation Security Administration.

See also

Case studies:

Development strategies:

Notes

  1. ↑ Chowdhury, F. L. ‘’Corrupt Bureaucracy and Privatisation of Tax Enforcement’’, 2006: Pathak Samabesh, Dhaka.
  2. ↑ "Musselburgh Co-op in crisis as privatisation bid fails.". Co-operative News. 2005-11-01. http://www.thenews.coop/index.php?content=story&id=835. Retrieved 2008-05-21. 
  3. ↑ Edwards, Ruth Dudley (1995). The Pursuit of Reason: The Economist 1843-1993. Harvard Business School Press. pp. 946. ISBN 0-87584-608-4. 
  4. ↑ Compare Bel, Germà (2006). "Retrospectives: The Coining of 'Privatisation' and Germany's National Socialist Party". Journal of Economic Perspectives 20 (3): 187–194. doi:10.1257/jep.20.3.187. 
  5. ↑ 5.0 5.1 5.2 International Handbook on Privatization by David Parker, David S. Saal
  6. ↑ Central Europe's Mass-Production Privatization, Heritage Lecture #352
  7. ↑ Dagdeviren (2006) "Revisiting privatisation in the context of poverty alleviation" Journal of International Development, Vol. 18, 469–488
  8. ↑ "Privatisation in Competitive Sectors: The Record to Date, World Bank Policy Research Working Paper No. 2860". John Nellis and Sunita Kikeri (World Bank). June 2002. http://ssrn.com/abstract=636224. 
  9. ↑ "From State To Market: A Survey Of Empirical Studies On Privatisation" (PDF). William L. Megginson and Jeffry M. Netter (Journal of Economic Literature). June 2001. http://faculty-staff.ou.edu/M/William.L.Megginson-1/prvsvpapJLE.pdf. 
  10. ↑ "Winners and Losers: Assessing the Distributional Impact of Privatisation, CGD Working Paper No 6" (PDF). Nancy Birdsall & John Nellis (Center for Global Development). March 9, 2006. http://www.cgdev.org/docs/cgd_wp006.pdf. 
  11. ↑ Privatisation in Competitive Sectors: The Record to Date. Sunita Kikeri and John Nellis. World Bank Policy Research Working Paper 2860, June 2002. Privatisation and Corruption. David Martimort and Stéphane Straub. One career city manager in America, Roger L. Kemp, wrote a library reference volume titled Privatization: The Provision of Public Services by the Private Sector," which was originally published in 1991 and republished in 2007. In this volume, based on a national literature search of best practices among municipal governments in this field, Dr. Kemp recommended that administrators owe it to their taxpayers and citizens to seek private alternatives to selected public services. He felt that city managers should go to the marketplace to determine the cost of contracting for selected public services, while keeping quality consistent with the same service provided by the municipality. Sometimes, Kemp noted, it's more cost effective to have certain public services provided by contract by the private sector. In some cases it can be less expensive for the private sector to provide public services, but the benefit to society may actually turn out to be less as well.
  12. ↑ Takahara, "All eyes on Japan Post"Faiola, Anthony (2005-10-15). "Japan Approves Postal Privatisation". Washington Post (The Washington Post Company): p. A10. http://www.washingtonpost.com/wp-dyn/content/article/2005/10/14/AR2005101402163.html. Retrieved 2007-02-09. 
  13. ↑ 13.0 13.1 The Financial Economics of Privatisation By William L. Megginson, p. 205 - 206

References

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