Privatization

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Privatization (alternately "denationalization" or "disinvestment") is the transfer of ownership from the public sector (government) to the private sector (business). A transfer in the opposite direction could be referred to the nationalisation or municipalization of some property or responsibility.

The term is also sometimes used to refer to government subcontracting a service or function to a private firm. See "Alternatives to privatization" below. "Privatization" has also has been used to describe an unrelated, nongovernmental interaction involving the buyout, by the majority owner, of all shares of a holding company's stock- privatizing a publicly traded stock.

Contents 1 Types of privatization 2 Pro-privatization and anti-privatization arguments 2.1 Pro-privatization 2.2 Anti-privatization 3 Outcomes 4 Alternatives to privatization 4.1 Municipalization 4.2 Sub-contracting 4.3 Partial ownership 5 Notable privatizations 6 Negative responses to privatization 7 Popular cultural references 8 See also 9 References 9.1 Unindexed 10 External links

[edit] Types of privatization

There are three main methods of privatization:

• Share issue privatization (SIP) - selling shares on the stock market
• Asset sale privatization - selling the entire firms or part of it to a strategic investor, usually by auction or using Treuhand model
• Voucher privatization - shares of ownership are distributed to all citizens, usually for free or at a very low price.

Share issue privatization is the most common type.

Share issue 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 (eg underpricing required) may be higher. For this reason, many governments elect for listings in the more developed and liquid markets. Euronext, the London, the New York and the Hong Kong Stock Exchange are popular because they are highly developed and sophisticated.

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

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

A very substantial benefit to share or asset sale privatizations is that bidders compete to offer the state the highest price, creating revenues for the state to redistribute in addition to new tax revenue. Voucher privatisations, on the other hand, would be a genuine return of the assets into the hands of the general population, and create a real sense of participation and inclusion. Vouchers, like all other private property, could then be sold on if preferred.

[edit] Pro-privatization and anti-privatization arguments

[edit] Pro-privatization

Proponents of privatization believe that private market actors can more efficiently deliver many goods or service than government due to free market competition. In general, 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 privatized; the existence of problems such as market failures and natural monopolies may limit this. However, a small minority thinks that everything can be privatized, including the state itself.

The basic economic argument given for privatization is 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 there are both private and state owned enterprises competing 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. Furthermore, the state has the advantage of being exempt from paying taxes on land, income, and purchases.

Privatizing a non-profitable company which was state-owned 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.

• Performance. State-run industries tend to be bureaucratic. A political government may only be motivated to improve a function when its poor performance becomes politically sensitive, and such an improvement is easily reversed by another regime.
• Improvements. Conversely, the government may put off improvements due to political sensitivity and special interests — even in cases of companies that are run well and better serve their customers' needs.
• Corruption. A monopolized function is prone to corruption; decisions are made primarily for political reasons, personal gain of the decision-maker (i.e. "graft"), rather than economic ones. Corruption (or principal-agent issues) during the privatization process - however - can result in significant underpricing of the asset. This allows for more immediate and efficient corrupt transfer of value - not just from ongoing cash flow, but from the entire lifetime of the asset stream. Often such transfers are difficult to reverse.

• Accountability. Managers of privately owned companies are accountable to their owners/shareholders and to the consumer, and can only exist and thrive where needs are met. Managers of publicly owned companies are required to be more accountable to the broader community and to political "stakeholders". This can reduce their ability to directly and specifically serve the needs of their customers, and can bias investment decisions away from otherwise profitable areas.
• Civil-liberty concerns. A company controlled by the state may have access to information or assets which may be used against dissidents or any individuals who disagree with their policies.
• Goals. A political government tends to run an industry or company for political goals rather than economic ones.
• Capital. Privately held companies can sometimes more easily raise investment capital in the financial markets when such local markets exist and are suitably liquid. While interest rates for private companies are often higher than for government debt, this can serve as a useful constraint to promote efficient investments by private companies, instead of cross-subsidizing them with the overall credit-risk of the country. Investment decisions are then governed by market interest rates. State-owned industries have to compete with demands from other government departments and special interests. In either case, for smaller markets, political risk may add substantially to the cost of capital.

• Security. Governments have had the tendency to "bail out" poorly run businesses when, economically, it may be better to let the business fold, often due to the sensitivity of job losses.
• Lack of market discipline. Poorly managed state companies are insulated from the same discipline as private companies, which could go bankrupt, have their management removed, or be taken over by competitors. Private companies are also able to take greater risks and then seek bankruptcy protection against creditors if those risks turn sour.
• Natural monopolies. The existence of natural monopolies does not mean that these sectors must be state owned. Governments can enact or are armed with anti-trust legislation and bodies to deal with anti-competitive behaviour of all companies public or private.
• Concentration of wealth. Ownership of and profits from successful enterprises tend to be dispersed and diversified -particularly in voucher privatization. The availability of more investment vehicles stimulates capital markets and promotes liquidity and job creation.
• Political influence. Nationalized industries are prone to interference from politicians for political or populist reasons. Examples include making an industry buy supplies from local producers (when that may be more expensive than buying from abroad), forcing an industry to freeze its prices/fares to satisfy the electorate or control inflation, increasing its staffing to reduce unemployment, or moving its operations to marginal constituencies.
• Profits. Corporations exist to generate profits for their shareholders. Private companies make a profit by enticing consumers to buy their products in preference to their competitors' (or by increasing primary demand for their products, or by reducing costs). Private corporations typically profit more if they serve the needs of their clients well. Corporations of different sizes may target different market niches in order to focus on marginal groups and satisfy their demand. A company with good corporate governance will therefore be incentivized to meet the needs of its customers efficiently.

[edit] Anti-privatization

Opponents of privatization dispute the claims concerning the alleged lack of incentive for governments to ensure that the enterprises they own 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 privatizations believe certain parts of the social terrain should remain closed to market forces in order to protect them from the unpredictability and ruthlessness of the market (such as private prisons, basic health care, and basic education). Another view is that some of the utilities which government provides benefit society at large and are indirect and difficult to measure or unable to produce a profit, such as defense. Still another is that natural monopolies are by definition not subject to competition and better administrated by the state.

The controlling ethical issue in the anti-privatization 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. Privatization 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 privatization 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.

Some would also point out that privatizing 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 organisation between government departments (for example the Hurricane Katrina incident).

Furthermore, opponents of privatization argue that it is undesirable to transfer state-owned assets into private hands for the following reasons:

• Performance. A democratically elected government is accountable to the people through a legislature, Congress or Parliament, and is motivated to safeguarding the assets of the nation. The profit motive may be subordinated to social objectives.
• Improvements. the government is motivated to performance improvements as well run businesses contribute to the State's revenues.
• Corruption. Government ministers and civil servants are bound to uphold the highest ethical standards, and standards of probity are guaranteed through codes of conduct and declarations of interest. However, the selling process could lack transparency, allowing the purchaser and civil servants controlling the sale to gain personally.
• Accountability. The public does not have any control or oversight of private companies.
• Civil-liberty concerns. A democratically elected government is accountable to the people through a parliament, and can intervene when civil liberties are threatened.
• Goals. The government may seek use state companies as instruments to further social goals for the benefit of the nation as a whole.
• Capital. Governments can raise money in the financial markets most cheaply to re-lend to state-owned enterprises.
• Lack of market discipline. Governments have chosen to keep certain companies/industries under public ownership because of their strategic importance or sensitive nature.
• Cuts in essential services. If a government-owned company providing an essential service (such as the water supply) to all citizens is privatized, its new owner(s) could lead to the abandoning of the social obligation to those who are less able to pay, or to regions where this service is unprofitable.
• Natural monopolies. Privatization will not result in true competition if a natural monopoly exists.
• Concentration of wealth. Profits from successful enterprises end up in private, often foreign, hands instead of being available for the common good.
• Political influence. Governments may more easily exert pressure on state-owned firms to help implementing government policy.
• Downsizing. Private companies often face a conflict between profitability and service levels, and could over-react to short-term events. A state-owned company might have a longer-term view, and thus be less likely to cut back on maintenance or staff costs, training etc, to stem short term losses. Many private companies have downsized while making record profits.
• Profit. Private companies do not have any goal other than to maximize profits. A private company will serve the needs of those who are most willing (and able) to pay, as opposed to the needs of the majority, and are thus anti-democratic.

[edit] Outcomes

Nellis and Kikeri^[1] have shown that in competitive industries with well-informed consumers, privatization 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^[2], 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, the results of privatization are much more mixed, as a private monopoly behaves much the same as a public one in liberal economic theory. In general, if the performance of an existing public sector operation is sufficiently bad, privatization (or threat thereof) has been known to improve matters. Indeed, Megginson & Netter^[3] showed that the greatest gains from privatization are achieved in the pre-privatization period as reforms are made to prepare for the transfer to private hands. Changes may include, inter alia, the imposition of related reforms such as greater transparency and accountability of management, improved internal controls, regulatory systems, and better financing, rather than privatization 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 liberites, showing high government accountability and transparency. One should also notice the successful, corruption-free privatizations and restructuring of government enterprises in the Nordic countries. For example, dismantling telecommunications monopolies have 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. Privatizations 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 privatization 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 privatization, and that corruption is more prevalent in non-privatized sectors. Furthermore, there is evidence to suggest that extralegal and unofficial activities are more prevalent in countries that privatized less.^[4]

[edit] Alternatives to privatization

[edit] Municipalization

Transferring control of a nationalized business to municipal government is an alternative sometimes proposed to privatization.

[edit] Sub-contracting

It is possible that 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 by tender to private companies.

In addition, the British government is debating the possibility of involving the private sector more in the workings of the National Health Service, principally by referring patients to private surgeries to ease the load on existing NHS human resources, and covering the cost of this.

[edit] Partial ownership

An enterprise may be privatized, with a number of shares in the company being retained by the state. This is a particularly notable phenomenon in France, where the state often retains a "blocking stake" in private industries. In Germany, the state privatized 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 spiralling costs.

Whilst partial privatization could be an alternative, it is more often a stepping stone to full privatization. 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, and thus must be sold off bit by bit. The first tranche of a multi-step privatization would also in the first instance establish a valuation for the enterprise to mitigate complaints of under-pricing.

See also Public-private partnership.

[edit] Notable privatizations

See also: List of privatizations

Privatization programmes have been undertaken in many countries across the world, falling into three major groups. The first is privatization programmes conducted by transition economies in Central and Eastern Europe after 1989 in the process of instituting a market economy. The second is privatization programmes carried out in developing countries under the influence of international financial institutions such as the World Bank and IMF. The third is privatization programmes carried out by developed country governments, the most comprehensive probably being those of New Zealand and the United Kingdom in the 1980s and 1990s.

Privatization has been notably successful in telecommunications in Europe because genuine competition has arisen: the former state-owned enterprises lost their monopolies due to legislation and technological change, competitors entered the market, and prices for broadband access and telephone calls fell dramatically.

A controversial provatization was the privatization of British railways. The UK track-owning company Railtrack, in effect a natural monopoly, was effectively repossessed by the British government. Train operation remains in the hands of private operators with franchises awarded by the Department for Transport (except for Merseyrail the franchise of which is awarded by Merseyside Passenger Transport Executive).

There are various precedents in history which some would claim as examples in which improper privatization, or the failure of government to conduct certain functions, caused various complications.

1. In the reconstruction of Iraq, the government decided to contract out many different reconstruction functions to private firms. Shortly thereafter, those firms have been accused of cutting corners and being generally ineffective in reconstructing the country. Halliburton, in particular, was accused of, among other things, skimping on the cost of providing meals to soldiers. Various other complaints include the lagging reconstruction of water and electricity utilities, and providing defective equipment to soldiers.
2. Many, such as Dick Polman of The Philadelphia Inquirer, noted that prior to Hurricane Katrina, the government had "privatized many of FEMA's basic functions". The uncoordinated action between private emergency relief agencies, as well as the military (which would often turn back relief trucks) resulting in the poor response to the storm that many would claim was a result of this privatization.

[edit] Negative responses to privatization

Privatization proposals in key public service sectors such as water and electricity are in many cases strongly opposed by opposition political parties and civil society groups. Usually campaigns involve demonstrations and political means; sometimes they may become violent (eg Cochabamba Riots of 2000 in Bolivia; Arequipa, Peru, June 2002). Opposition is often strongly supported by trade unions. Opposition is usually strongest to water privatization - as well as Cochabamba (2000), recent examples include Ghana and Uruguay (2004). In the latter case a civil-society-initiated referendum banning water privatization was passed in October 2004.

[edit] Popular cultural references

• The Pet Shop Boys wrote a satirical song about privatization called "Shopping" in 1987. It appears on their album Actually.

[edit] See also

• Nationalisation - the reverse process

• Cooperative
• Deregulation
• Public ownership ("government ownership")
• LIBM theory
• Reprivatization
• Securitization (see "government securitization")
• Welfare state
• Marketization
• Special Economic Zone
• Urban Enterprise Zone
• National security privatization
• Private sector development
• Privatisation of British Rail

[edit] References

1. ^ "Privatization in Competitive Sectors: The Record to Date, World Bank Policy Research Working Paper No. 2860", John Nellis and Sunita Kikeri, World Bank, June 2002.
2. ^ "Winners and Losers: Assessing the Distributional Impact of Privatization, CGD Working Paper No 6", Nancy Birdsall & John Nellis, Center for Global Development, March 9, 2006.
3. ^ "From State To Market: A Survey Of Empirical Studies On Privatization", William L. Megginson and Jeffry M. Netter, ''Journal of Economic Literature, June 2001.
4. ^ Privatization in Competitive Sectors: The Record to Date. Sunita Kikeri and John Nellis. World Bank Policy Research Working Paper 2860, June 2002. [1] Privatization and Corruption. David Martimort and Stéphane Straub. [2]

[edit] Unindexed

• Kosar, Kevin R. (2006), "Privatization and the Federal Government: An Introduction", Report from the Congressional Research Service
• Bel, Germà (2006), "The coining of `privatization´and Germany's National Socialist Party", Journal of Economic Perspectives 20(3), 187-194
• Clarke, Thomas (ed.) (1994) "International Privatisation: Strategies and Practices" Berlin and New York: Walter de Gruyter, ISBN 3-11-013569-8
• Clarke, Thomas and Pitelis, Christos (eds.) (1995) "The Political Economy of Privatization" London and New York: Routledge, ISBN 0-415-12705-X
• Mayer, Florian (2006) Vom Niedergang des unternehmerisch tätigen Staates: Privatisierungspolitik in Großbritannien, Frankreich, Italien und Deutschland, VS Verlag, Wiesbaden, ISBN 3-531-14918-0
• Juliet D’Souza, William L. Megginson (1999), "The Financial and Operating Performance of Privatized Firms during the 1990s", Journal of Finance August 1999
• von Hayek, Friedrich, (1960) The Constitution of Liberty
• Smith, Adam (1994) The Wealth of Nations
• Stiglitz, Joseph Globalization and its Discontents
• David T. Beito, Peter Gordon, and Alexander Tabarrok (editors); foreword by Paul Johnson (2002). The voluntary city: choice, community, and civil society. Ann Arbor: University of Michigan Press/The Independent Institute. ISBN 0-472-08837-8. 

[edit] External links

• Privatization page on the NCPA website
• Privatization of Social Security The original 1983 Cato/Heritage plan—now almost complete.
• Privatization in the United States and Australia Sozzani, Joseph
• Privatization Database - World Bank data on privatization in developing countries (1988 to 2003).