Political Realism: Machiavelli

PRIVATIZATION HAS BEEN LONG OVERDUE IN DEVELOPING COUNTRIES AND HAS BEEN UNAMBIGUOUSLY SUCCESSFUL. DISCUSS.

1. HISTORICAL FACTS IN PRIVATIZATION PROCESS

Following the Depression, World War II and the end of colonial rule, government ownership was perceived as necessary to promote growth and ensure certain basic services, such as water supply, electricity, gas, telecom, and air and rail transportation. Ignited by the Margaret Thatcher government in the mid-1980s, privatization started to proliferate in both the developing and developed world. [Megginson and Netter, 2001; Kikeri and Kolo, 2005]. While, in recent years, the rate at which this process has taken place within developing countries has been consistently higher than in the past, state ownership represents about 10 percent of GDP in developing countries on average, suggesting there are still a lot of assets in state hands [Economic Reform Today, No. 1, 1998].

The idea behind the privatization of SOEs was to raise revenue for the state, reduce the economic distortions caused by their existence [Shirley and Walsh, 2000] and to reform those companies, which were generally non-profitable and inefficient because they had conflicting objectives. Converting these companies to private entities meant exposure to the vigilance of capital markets, alignment of management incentives, separation of ownership and control [Shirley and Walsh, 2000], and last but not least, competition. Additional objectives of privatization included broader social reforms--redistribution of income and rents within society and the promotion of popular capitalism [Boubakri and Jean-Claude Cosset, 1998]. Normally, a company that is profitable is privatized only if the government wants to open the market from a monopoly, but this process is not always easy, which is why privatization needed to be accompanied by different reforms within the legal and political arena in order to have the right social impact. Since developing countries were further behind on the development of their legal and political systems, the privatization process in developing countries tended to be less efficient than privatization in developed ones [Shleifer, 1998].

2. WHAT DOES "SUCCESSFUL" PRIVATIZATION MEAN?

When we talk about the success or failure of privatization, we need to decide first which factors to take into account to analyze the process and the fate of companies that are the offspring of privatization. The following factors could be used to measure the "success" of privatization: 1) Profitability improvement; 2) Consumer benefit, access and reach; 3) Efficiency of operations and allocation of resources; 4) Income and wealth redistribution.

3. PRIVATIZATION IS NOT UNAMBIGUOUSLY SUCCESSFUL IN DEVELOPING COUNTRIES

Empirical research is inadequate

Research on the impact of privatization on financial and operating performance, labour, fiscal balances and distributional equity largely confirms the view that privatization can be beneficial for firms operating in a competitive market structure in middle-income countries. But there are important caveats. First, the near absence of empirically rigorous studies on the non-efficiency aspects of privatization highlights the low priority given to these areas by researchers. Second, there are no comprehensive databases or studies on the longer term evolution of employment pre- and post-privatization. Limiting the time frame to three years before and after divestiture cannot give a full picture of the economic changes associated with a change in ownership [Chang, Ha-Joon and Ajit Singh, 1992]. Third, projecting the long-term outcomes of privatization based on the actual outcomes for the first few years after privatization assumes that the short term gains will be sustained. Fourth, they ignore the trajectory of the business, i.e. if a business is already following a positive growth trend, then a mere increase in revenue or profit does not necessarily signify successful privatization.

The widely publicized World Bank study by Galal and others in 1994 that showed the superior performance of privatized firms looked at 12 firms headquartered in upper-middle-income economies and one industrialized economy. The sample was not picked randomly. Therefore, the results from such a small non-random sample cannot be generalized to other developing countries. The problems of post-privatization regulation and competition policy as well as implementation and political constraints are strongest among the poorest countries. The absence of certain economic conditions--developed capital markets, competitive goods and services markets, and effective regulatory capacity--makes privatization difficult. Constraints on privatization result from a low-income country's economic structure. No study to date has looked at pre and post-privatization performance comparing the experiences of middle income with low-income economies. Boubraki and Cosset (1998) came close, but they lump together the low-income and middle-income economies. They use only three countries for their low-income category, and all are from South Asia. Even in this case, increases in profitability prove to be insignificant for this subsample.

"Other" Factors

The effects of privatization programs cannot be distinguished from those of the other reforms implemented simultaneously with privatization (Adam, Cavendish and Mistry, 1992). Other factors--trade policy reform and domestic price liberalization--often accompanied privatization. The developing countries that are often used as success cases underwent substantial macroeconomic changes. Similarly, capital market development has resulted to a large extent from financial liberalization and broader economic deregulation. More generally, the fact that many countries were undergoing structural adjustment programmes meant that the broader economic framework in which privatization took place was changing and this was an important contributing factor to successful privatization. Where this broader macroeconomic framework has not changed, it is unclear whether privatization can enhance SOE performance. In addition, although some studies attempt to control for exogenous factors such as GDP growth rate and conditions in international markets, most studies fail to do so.

Privatization is not a "catch-all" solution

There are cases in which it makes sense for some companies, regardless of their financial situation, to remain as public companies. Such is the case of railroad companies, in which the biggest part of the business