State Owned Enterprises: Privatization in Crisis

International Conference on

Resurgence of State-Owned Enterprises:

The Role of Ownership Policy and Governance Systems

Department of Industries and Commerce, Government of Kerala

Jomo Kwame Sundaram

UN Assistant Secretary General for Economic Development

10 December 2010

“Despite economists’ reputation for never being able to agree on anything, there is a striking degree of unanimity in the advice that has been provided to the nations of Eastern Europe and the former Soviet Union (FSU). The legions of economists who have descended on the formerly Communist economies have provided advice very similar …. The three ‘-ations’ — privatization, stabilization, and liberalization — must all be completed as soon as possible.”

Larry Summers (1994)

PrivatizationRefers to changing status of business, service, industry

from state, government or public to private ownership or control

Sometimes refers to use of private contractors to provide previous public services

Privatization strictly defined only includes cases of sale of 100% or majority share of SOEs, or SOE assets, to private shareholders

Definition sometimes so broad it includes cases when private enterprises awarded licenses to participate in previously exclusively public sector preserve 3

BackgroundFiscal + debt crises in 1980s forced many

countries to seek support from IMF, WBWB, IMF attributed developing countries’

inability to adjust to shocks to ISI, SOE inefficiency

policy prescription of liberalization, deregulation, privatization

Privatization: pillar of WB SAPsMany developing countries forced to privatize

by WB loan conditions, but many others just followed the fad 4

Arguments for privatizationReduce “financial + administrative

burden of government”, particularly services, infrastructure

‘Promote competition, improve efficiency, increase productivity’ in service delivery

‘Stimulate private entrepreneurship, investment’

‘Reduce public sector monopoly’ 5

Neoliberal Privatization Advocacy

• Policy innovation: Mass Privatization• Economic rationale: private ownership

superior to state ownership• Most important, political rationale: - privatization eliminates the power base of

the communists, and - must privatize during the “exceptional

period” or ‘window of opportunity’ before anti-reform coalition - of managers and workers in SOEs - forms

Crisis of privatization• Limited success, failures of privatizations on their own

terms now acknowledged• Abuse of privatizations too• Success, efficiency of some SOEs (Posco, Bao Steel)

now grudgingly acknowledged• After almost 3 decades of privatization, following WC,

Reagan, Thatcher,

2008-09 crisis bailout-nationalizations• Need for nationalized core for developmental

banking sector (CPC, Buiter)

7

Reforming PrivatizationMass privatization destroys firms,

creating a vicious circle of firm and state failure, resulting in “patrimonial capitalism”

New mantra: Strategic ownership via competitive ownership after state-sponsored restructuring is best way to privatize, create “liberal capitalism”

Key SOE problems• Causes of inefficiency in SOEs?

• Will privatization improve efficiency?

• Can SOE inefficiency be solved by other means?

• Will privatization benefit public or consumers?

• Adverse consequences of SOEs +privatization? 9

SOE inefficiency causes• Unclear, contradictory objectives

• Performance criteria ambiguous

• Co-ordination problems among govt agencies, inter-departmental rivalries

• Ineffective monitoring or over-regulation

• Moral hazard: ‘soft budget’ constraints

• Monopoly power of SOEs

• Lack of managerial skills 10

Privatization efficiency?No. Why?• Ambiguity not due to public ownership

• SOEs can be run efficiently

• Privatization will not solve ‘principal-agent’ managerial problems

• For natural monopolies (e.g. public utilities), inefficiency due to monopolistic industry/market, whether public/private monopoly

Will privatization benefit public or consumers?No. Why?• Since many SOEs are public

monopolies, private control more likely to abuse monopolies to maximize profits

• Privatization burdens public when user charges raised for privatized

services, services reduced, etc; less cross-subsidization, subsidies

• But dispersed share distribution can undermine effective monitoring 12

Privatization for whom?• Private interests only interested in

(potentially) profitable activities/ enterprises

Govt left with unprofitable activities

Privatization will worsen overall publicsector performance

• Privatization enriches politically connected few, while public interest increasingly sacrificed for private profits 13

Arguments for privatization refuted

• Privatization prioritizes profit maximization at expense of social welfare, public interest

• Privatization adversely affects public, especially poorer consumers, public sector employees

• Privatization only temporarily reduces fiscal deficits, as public-sector loses income from profitable SOEs, and stuck with unprofitable ones

• By diverting private capital from green-field investments to privatization, growth retarded, rather than encouraged 14

Partial privatization?• Private shareholders reduce probability of

reversal of efficiency-enhancing SOE reforms, e.g. with change of government

• Privatization often involves partial divestment, with majority control still with government or govt “golden share” retains control

• Partial divestiture not really privatization because government control of firm behaviour virtually unchanged

• Public-private partnerships (PPPs) varied, many options: creative possibilities

Adverse consequences• Increased “costs” to public of

reduced, inferior services

• Increased costs of living, poorer services, utilities – especially in remote, rural areas – due to “economic costing” of services

• Implications of 2 sets of services, affordability 16

Other adverse consequences• Reduced, minimal new investments

by private contractors concerned with short-term profits

• Reduced jobs, overtime work, real wages for employees

• Corruption: Beneficiaries chosen due to political, personal connections, instead of through transparent,

competitive, bidding process 17

Confusions in debate• Ownership, market distinct issues

• Privatization supposed to free market forces, encourage competition

• But (formal, informal) collusion, e.g. cartel-like agreements

• Many SOEs set up because private sector unable or unwilling to provide services or goods concerned

• Such arguments relevant in some cases18

Privatization myths• Managerial, organizational reforms may achieve

same objectives, goals, or even do better• Managerial, organizational flexibility,

autonomy, cultures may be key• Better option not determined a priori• SOE problems often not problem of ownership

per se, but due to absence of explicit, feasible, achievable goal, or too many, often contradictory goals

19

SOEs may need reform• Many SOEs set up because private

sector unable or unwilling to provide services or goods concerned

• Such arguments still relevant in cases• Public sector can be well run, e.g. in

East Asia, Europe• More transparency + accountability,

better incentives can ensure greater efficiency in achieving public, national interest, while limiting public sector waste, borrowing 20

SOE problems rarely need privatization• Improve management, perhaps with

increased autonomy, new incentives, e.g. with greater decentralization, devolution

• Competition, enterprise reorganization – rather than privatization -- more likely to induce greater efficiency

• Reform should consider variety of modes of marketization and other reform options

privatization only one of many options available

21

Privatization not over• Privatization not miracle cure, not

universal panacea

• Privatization may be followed by desirable changes even if not responsible for improvements

• Recent nationalizations often to socialize costs, losses; some likely to be reversed soon, e.g. GM in US

• Fiscal consolidation sell SOEs 22

Possible Mechanisms Linking Mass Privatization + Increased MortalityPrivatization Unemployment Stress MortalityPrivatization Loss of firm-provided

medical care Mortalitysocial consumption Stress Mortality

Privatization Firm failure Stress Mortality Economic decline Mortality

Privatization Fiscal crisis/state failure Stress Mortality Less health spending Mortality Increased violence Mortality

Privatization Inequality Status loss Mortality

Post-communist Mortality Crisis

Mass Privatization and Life ExpectancyTable 2. Mass Privatization and Life Expectancy by Country and Region

Region Country Mass Privatization

Year Life Expectancy Change (1989-2002)ω

Balkans Georgia Yes 1995 1.04 / 1.43% Armenia Yes 1994 2.81 / 3.89% Azerbaijan No - -5.11 / -7.35% Baltics Lithuania Yes 1993 1.29 / 1.83% Estonia No - 1.71 / 2.46% Latvia Yes 1994 1.53 / 2.21% Central Asia Kyrgyz

Republic Yes 1994 -3.52 / -5.14%

Uzbekistan No - -2.50 / -3.61% Kazakhstan Yes 1994 -6.66 / -9.79% Turkmenistan No - -1.25 / -1.90% Tajikistan No - -3.99 / -5.68% Central Eastern European

Czech Republic

Yes 1994 3.50 / 4.88%

Slovenia No - 0.94 / 3.73% Slovakia No - 2.73 / 1.30% Poland No - 3.55 / 5.00% Hungary No - 3.09 / 4.44% Former Soviet Union Russia Yes 1992 -3.57 / -5.16% Ukraine Yes 1995 -0.59 / -0.86% Belarus No - -2.20 / -3.13% SEE Romania Yes 1995 0.56 / 0.80% Bulgaria No - 0.31 / 0.44% Bosnia No - 0.96 / 1.31% Macedonia No - 1.60 / 2.22% Croatia No - 1.80 / 2.50% Albania No - 1.85 / 2.56% Moldova Yes 1994 -0.55 / -0.81%

Total ∆ Avg. ∆ Privatization -0.38 / -0.61% Avg. ∆ Non-Privatization +0.23 / 0.36% Difference of Avg. LE ∆ Privatization – ∆NonPrivatization -0.61 / -0.97% Average LE Difference1 Avg LE Privatization – Avg LE

NonPrivatization -0.90

68

69

70

71

Life

Exp

ecta

ncy a

t B

irth

(ye

ars

)

1991 1994 1997 2000Year

Mass Privatizers Non Mass Privatizers

Data Source: WHO European Health for All Database 2007

Postcommunist CountriesMass Privatization and Life Expectancy

Total of 644 State-owned Enterprises Privatized (less 10%)

50

06

00

70

08

00

90

01

00

0

Adult W

ork

ing

Ag

e M

ort

ality

Rate

s(p

er

100

,000

pop

ula

tion

)

1989 1992 1995 1998 2001Year

Russia Belarus

Data Source: WHO European Health for All Database 2007

Belarus and Russia

Mass Privatization and Adult Mortality Rates

Total of 644 State-owned Enterprises Privatized (less 10%)

Mass Privatization begins

Total of 112,625 State-owned Enterprises Privatized (over 50%)

Privatization reversal (re-nationalization)

’98 Russian Financial Crisis(Per Capita GDP drops 30%)

The Economist in Denial

62

63

64

65

66

67

68

69

70

71

1970 1980 1990 2000 2010

Life expectancy at birth, in years

The Economist in Denial

62

63

64

65

66

67

68

69

70

71

1970 1980 1990 2000 2010

Life expectancy at birth, in years

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