THE PROS AND CONS OF PRIVATIZATION

 By: Titiloye Oyebanji

 stoyebanji@yahoo.com

+2348034039830

THE PROS AND CONS OF PRIVATIZATION

This paper will look at the meaning, purposes, types, workability, types and techniques, merits and demerits of privatization with an eye in China, Vietnam and Russia where it had been used an economic catalyst of development. References will also be made to similar countries of the world where privatization has been instrumentalised to improve their economies.

Definition of Privatization

This is a process of transferring the control of an enterprise from the government sector to the private sector. Generally, but not always, this also means transferring ownership of the Public Sector Enterprise as well as control. By privatization, I mean that a service that is being provided by government is sold, partly or wholly to the public who then become the shareholders or stakeholders. Privatization is the most common forms of alternative service delivery for-profits and non-profits-oriented enterprises.

Privatization can be accomplished by sale or lease. It can be accomplished by the government selling 100% of an enterprise, or selling 51%, or even by selling a minority stake - so long as the private sector is given full managerial control. Without transferring control to the private sector, the government can raise revenue by selling a smaller share, but that is not privatization as such.

It is hard to find a country without a privatization programme or a sector of activity not susceptible to private management if not ownership. Malaysia has sold its National Lottery, Buenos Aires its zoo, Czechoslovakia the guest house of the Communist Party, and Nigeria the Telecommunication company (NITEL), though the sale of NITEL has recently been reversed by the government due to failure of the buyers to impact positively in the communication sector.

Ownership matters

Why privatize?

Because ownership is a significant determinant of enterprise performance. In both developed and developing countries, good State-Owned Enterprises (SOEs) performance has been very difficult to bring about--and even harder to sustain. Governments facing financial crisis often try to improve performance by bringing in new and dynamic managers, and paying them incentive salaries, granting managers autonomy to set prices, hire and fire. These measures often have a positive effect, but as the crisis dissipates, so does political resolve.

Political interference, a common and deadly disease of SOEs, tends to re-emerge--and painfully-achieved SOE reforms tend to backslide. SOEs thought to be well on the road to recovery have either stopped improving performance or suffered deterioration. In Russia, where reform short of ownership change ended losses in a group of SOEs for years , large deficits have since reappeared. In Vietnam, New Zealand, China and Japan, SOE reforms began to bite only when done in conjunction with privatization.

Recognition that SOE reforms are limited and unsustainable, coupled with the fiscal burden of subsidizing loss-makers, has led financially hard-pressed governments to opt for privatization.

Privatization Works: The Evidence

Privatization, if properly structured, yields substantial and enduring benefits. A detailed and rigorous Bank examination of privatizations in Vietnam and China, found that divestiture was good for the economy as a whole and had led to higher productivity and faster growth in all. The Chilean telephone company doubled its capacity in the four years after sale. The privatized telephone company in Mexico reduced its per-unit labour costs sharply.

Another study found that firms privatized by public offerings in 15 countries: Vietnam, China, Jamaica, Chile, Singapore, and Mexico amongst others, increased returns on sales, assets, and equity, raised internal efficiency, improved their capital structure, and increased capital expenditures. They also expanded their workforces by small margins. Privatization often is accompanied by layoffs, but this is not always so-jobs increased after privatization in divested firms in the Philippines, Vietnam, Tunisia, Mexico, Chile and China.

Most privatization success stories come from high-income and middle-income countries. Privatization is easier to launch and more likely to produce positive results when the company operates in a competitive market, and when the country has a market-friendly policy environment and a good capacity to regulate. The poorer the country, the longer the odds against privatization producing its anticipated benefits, and the more difficult the process of preparing the terrain for sale.

Nonetheless, successes can be found in low-income countries, too. Privatization turned around an almost moribund textile firm in Niger, helped revive a defunct development finance corporation in Swaziland, and revitalized an agro-industrial firm in Mozambique. The Mozambiquan firm diversified into new products, began servicing its debts, and increased production fivefold.

In the case of Russia, it can be evaluated, however, that privatization policies systematically discriminated against outside investors, resulting in a very high rate of inside ownership, and a continuing powerful role for the state. Had these policies been different, many more firms could have improved their performance.

Moreover, corporate governance institutions in Russia function very poorly. Far too frequently, Russian managers have found it easy, not  only to flout accepted norms but even to violate explicit laws on information disclosure, shareholder registries, voting procedures and board composition. The difficulty of establishing such institutions underlines the importance of concentrated outside ownership in the Russian environment, since only a determined and powerful owner with an interest in maximizing the value of the firm—has a chance of overcoming the many obstacles to effective restructuring.

How Privatization Works

There are eight key ways about how privatization works:

1.      Privatization works best when it is a part of a larger programme of reforms promoting efficiency. Vietnam, New Zealand, the U.K., Mexico, China and Chile are all successful privatizers. Their privatizations were accompanied by reforms to open markets, remove price and exchange rate distortions, and encourage the development of the private sector through free entry. Revenue maximization should not be the primary goal of privatization. It is far better to eliminate monopoly power and unleash potentially competitive activities than to boost the sales price by divesting into protected markets. Moreover, it is also far better to create regulations to protect consumer welfare than to maximize price by selling into an unregulated market.

2.      Regulation is critical to the successful privatization of monopolies. In the sale of Vietnam Telecom, everybody won: consumers, labour, government, buyers, and the productive efficiency of the company increased as a result of a well-developed, well-administered regulatory framework.

3.      Countries can benefit from privatizing management without privatizing the ownership of assets. Management contracts, leases, and concessions have been successfully used the world over, particularly in sectors where it is difficult to attract private investors. In Côte d'Ivoire, the leased water company improved technical efficiency, increased new connections, became more efficient in billing and collection of receivables --and reduced the number of expatriate employees by 70%. But because a change in ownership is usually needed to lock in performance gains, private management arrangements are likely to work best when they are a step toward full privatization.

4.      The sale of large enterprises requires considerable preparation. Successful privatizations of large enterprises have entailed breaking them into competitive and marketable units (in East Germany, Vietnam, Argentina, China and Mexico), bringing in dynamic private sector managers (in many telecom and airline sales around the world), settling past liabilities, and shedding excess labour (in steel and railways in Argentina). Successful privatizing governments also assiduously avoided large new investments for plant modernization and equipment, since getting the private sector to finance and manage these investments was itself a major reason for privatization.

5.      Transparency is critical for economic and political success. China, Vietnam Mexico and the Philippines made the sale of enterprises transparent by adopting competitive bidding procedures, developing objective criteria for selecting bids, and creating a clear focal point with minimal bureaucracy to monitor the overall programme. A lack of transparency can result in political backlash, as in the early days of privatization in Poland, or even bring the process to a halt, as in Russia and Guinea.

6.      Governments must pay special attention to developing a social safety net. In Tunisia, generous severance packages encouraged voluntary departures and reduced the need for outright dismissals. In many countries--most recently in Eastern Europe and Central Asia: employee ownership schemes, unemployment benefits, and retraining-redeployment programs are being developed to ease the social costs of privatization.

7.      The formerly socialist economies should privatize in all possible ways that encourage competition, and they should experiment with all available methods that go beyond a case-by-case approach to privatization. Since the economic and social importance of SOEs is far greater there than in the rest of the world, flexibility is in order--not because privatization is less necessary, but because it is more so. Rampant institutional and policy deficiencies require experimentation with a wide set of privatization tactics. These include share give-aways (or mass privatization schemes), state-assisted financing methods, free or low-cost shares to employees in privatized firms, and new types of investment-management companies to run groups of companies and diversify risk.

8.      In changing the public-private mix in any type of economy, privatization will sometimes be less important than the emergence of new private business. Countries can freeze or restrain the expansion of public enterprises and encourage the growth of a dynamic private sector through free entry, as happened in Korea and appeared to have happened in China and Vietnam.

Types and Techniques of Privatization

A variety of alternatives service delivery techniques can be employed to maximize efficiency and increase service quality. Some methods will me more appropriate than others, depending on the service. In searching for ways of cutting costs and increasing service delivery, one or a combination of these techniques can be safely considered:

1. Contracting Out ( or Outsourcing)

The government competitively contracts with private organizations for profit or non-profit to provide a service or part of a service. In other words, the government hires the private sector firms or non-profit organizations to provide goods or services for the government. Under this approach, the government remains the financial, and has managerial and policy control over the type and quality of goods or services to be provided. Thus, the government can replace contractors that do not perform creditably well.

2. Management Contracts

The operation of a facility is contracted out to a private company. Facilities where the management is frequently contracted out include: airports, wastewater plant, arena and convention centres.

3. Public-Private Competition(or market testing or managed competition)

When public services are opened up to competition, in-house public organizations are allowed to participate in the bidding process.

4. Franchising

A private firm is given the exclusive right to provide a service within geographical area. Franchising is of two types:( i ) Franchising external services- here, the government grants a concession or privilege to a private sector entity to conduct business in a particular market or geographical area, for example, operating concession stands, hotels, and other services provided in certain parks. The government may regulate the service level or price, but users of the service pay the provider directly. (ii) Franchising internal services –here, the government agencies provide administrative services to other government agencies on a reimbursable basis. Franchising gives agencies the opportunity to obtain administrative services from another governmental entity, instead of providing them for themselves.

5. Internal Market

Departments are allowed to purchase support services such as printing, maintenance, computer repairs and printing from in-house providers or outside suppliers. In-house providers of support services are required to operate as independent business units competing against outside contractors for departments’ business. Under Such a system, market forces are brought t bear with an organization. Internal customers can reject the offerings of internal service providers if they do not like their quality or if they cost too much.

6. Vouchers

Government pays for the service; however, individuals are given are given redeemable certificates to purchase the service on the open market. These subsidize the consumer of the service, but services are provided by the private sector. In addition to providing greater freedom of choicer, vouchers bring consumers pressure to bear, creating incentives for consumers to shop around for services and for service providers to supply high-quality, low-cost services.

7. Commercialization (or service shedding)

Government stops providing a service and lets the private sector assume the function.

8. Self-help (or transfer to non-profit organization)

Community groups and neighbourhood organizations take over a service or government asset such as local park. The new providers of the service are also directly benefitting from the service. Government increasingly are discovering that by turning some non-core services- such as zoos, museums, fairs, remote parks, and some recreational programmes- over to non-profit organizations, they are able to ensure that these institutions do not drain the budget.

9. Volunteers

Volunteers are used to provide all or part of a government’s service. Volunteers activities are conducted through a government volunteer programme or through a non-profit organization.

10. Corporatization

Government organizations are reorganized along business lines. Typically, they are required to pay taxes, raise capital on the market (with no government backing-explicit or implicit) and operate according to commercial principles. Government corporations focus on maximizing profits and achieving a favourable return on investment. They are freed from government procurement, personnel and budget systems.

11. Asset sale (or Long-Term Lease)

Government sells or enters into long term leases for assets such as airports, gas utilities or real estate to private firms, thus turning physical capital into financial capital. In a sale lease-back arrangement, government sells the asset to a private sector entity and the then leases it back. Another asset sale technique is the employee buy-out. Existing public managers and employees take the public unit private, typically purchasing the company through an Employee Stock Ownership Plan (ESOP).

12. Private Infrastructure Development and Operation

The private sector builds, finances and operates public infrastructures such as roads, and airports, recovering costs through user charges. Several techniques commonly are used for privately built and operated infrastructure. With Build-Operate-Transfer (BOT) arrangements, the private sector designs, finances, builds and operates the facility over the life of the contract. At the end of this period, ownership reverts to the government. A variation of BTO model, under which title transfers to the government at the time construction is completed. Finally, with Build-Own-Operate (BOO) arrangements, the private sector retains permanent ownership and operates the facility on contract.

13. Divestiture

This involves the sale of government-owned assets or commercial-type functions or enterprises. After divestiture, the government generally has no role in the financial support, management, regulation or oversight of the divested activity.

The pros and cons of Privatization

Having explained the meaning of privatization,  evidence of how it works, its types and techniques, it is imperative to also look at the pros and cons (merits and demerits) on the economies of Russia, Vietnam and China- the countries in focus by this presentation.

Pros (Advantages)

• It stops loss-making public sector enterprises from adding to government debts;
• It depoliticizes public sector enterprises remove, governmental pressures for over-manning and the sub-optimal use of resources;
• It gives new owners a strong incentive to turn around failing public sector enterprises into successful businesses;
• It gives new businesses access to investment capital that government cannot provide;
• It raises more money for government through taxing former public sector enterprises;
• Government can raise funds to pay off other debts fast because of relieve from financial burden of the public sector enterprises being privatized;
• Profit incentive may deliver better outcomes, for example, staff down-sizing to increase efficiency, more staff motivation, and cheaper prices to be competitive.
• If floated on the stock exchange at a good price, investors can make a lot of money through increased business revenue, efficiency and profitability.
• It removes government’s monopolistic status and inability to be responsive to citizens' needs, resulting in inefficient, one-size-fits-all services.
• In practice, all levels of government, seeking to reduce costs, have begun turning to the private sector to provide some of the services that are ordinarily provided by government. The spread of the privatization movement is grounded in the fundamental belief that market competition in the private sector is a more efficient way to provide these services and allows for greater citizen choice.
• With privatization solidly on ground, costs will be reduced at the long run.
• Public sector workers are not harmed by privatization. Displaced workers can be hired by contractors or transferred to other government positions.

Cons (Disadvantages)

• Government no longer receives profits (if it was previously profitable), therefore, the revenue accruing to the government from public sector enterprises becomes shortened as a result of privatization.
• Privatization may decrease safety due to greater profit incentives.
• In extremely unavoidable cases, staff down-sizing could result to workers lay-off, and then unemployment rises. This aptly results to more crimes and social vices because ‘an idle hand is a devil’s workshop’.
• Prices may actually rise if the service was previously subsidized by the government. This is a common experience after a successful privatization process. This becomes imperative in a bid to provide qualitative service, improve efficiency and profitability.
• Privatization alone may not lead to better quality or cost reduction in public service delivery.
• The standard economic measures used to make privatization decisions fail to accurately assess the real costs and benefits of care.
• A major concern to the organized labour is the impact of privatization on job security and employment. Workers layoffs, erosion of wages and benefits, and decreased levels of union membership could be parts of labour’s setbacks for embracing privatization.
• There are concerns that constitutional protections of citizens may suffer a setback

as a result of privatization which may threaten citizens’ constitutional rights.

• One of the disadvantages is that the privatized company will no longer operate in the public interest. While a state-owned company primarily serves the citizens of the state, the primary goal of a privately operated company is to make profit. It may make these profits at the expense of its customers without serving them properly. For example, it may choose the market which is most profitable to operate in and leave less wealthy customers without a service.

Conclusion

The conclusion is straightforward: privatization, when done right, works well.

Privatization is not a blanket solution for the problems of poorly performing public sector enterprises. It cannot in and of itself make up totally for lack of competition, for weak capital markets, or for the absence of an appropriate regulatory framework. But where the market is basically competitive, or when a modicum of regulatory capacity is present, private ownership yields substantial benefits. The success of any privatization arrangement, whichever technique is adopted, will be dependent on the sincerity of government to pursue it with unblemished policy implementation, support, co-operation and understanding of the citizenry. At the onset, privatization bites very hard, but at the long run, the benefits are multifarious and immeasurable.