Privatization

Privatization, also spelled privatisation (in British English), may have several meanings. Primarily, it is the process of transferring ownership of a business, enterprise, agency, public service, or public property from the public sector (a government) to the private sector, either to a business that operates for a profit or to a nonprofit organization. It may also mean the government outsourcing of services or functions to private firms, e.g. revenue collection, law enforcement, and prison management.

Privatization has also been used to describe two unrelated transactions. The first is the buying of all outstanding shares of a publicly traded company by a single entity, making the company privately owned. This is often described as private equity. The second is a demutualization of a mutual organization or cooperative to form a joint-stock company.

Forms of privatization

There are four main methods of privatization:

1. Share issue privatization (sip) - selling shares on the stock market
2. Asset sale privatization - selling an entire organization (or part of it) to a strategic investor, usually by auction or by using the Treuhand model
3. Voucher privatization - distributing shares of ownership to all citizens, usually for free or at a very low price.
4. Privatization from below - Start-up of new private businesses in formerly socialist countries.

Choice of sale method is influenced by the capital market, political, and firm-specific factors. SIPs are more likely to be used when capital markets are less developed or under developed and there is lower income inequality. 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 privatization has mainly occurred in the transition economies of Central and Eastern Europe, such as Russia, Poland, the Czech Republic, and Slovakia. Additionally, Privatization from below is/has been an important type of economic growth in transition economies.

A substantial benefit of share or asset-sale privatizations is that bidders compete to offer the highest price, creating income for the state in addition to tax revenues. Voucher privatizations, 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.

Secured borrowing

Some privatization transactions can be interpreted as a form of a secured loan and are criticized as a "particularly noxious form of governmental debt". In this interpretation, the upfront payment from the privatization sale corresponds to the principal amount of the loan, while the proceeds from the underlying asset correspond to secured interest payments – the transaction can be considered substantively the same as a secured loan, though it is structured as a sale. This interpretation is particularly argued to apply to recent municipal transactions in the United States, particularly for fixed term, such as the 2008 sale of the proceeds from Chicago parking meters for 75 years. It is argued that this is motivated by "politicians' desires to borrow money surreptitiously", due to legal restrictions on and political resistance to alternative sources of revenue, viz, raising taxes or issuing debt.

Etymology

The Economist magazine introduced the term in the 1930s in covering Nazi German economic policy.

History

See also: List of privatizations

The history of privatization dates from Ancient Greece, when governments contracted out almost everything to the private sector. 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.

Perhaps one of the first ideological movements towards privatization came during China's golden age of the Han Dynasty. Taoism came into prominence for the first time at a state level, and it advocated the laissez-faire principle of Wu wei (無為), literally meaning "do nothing". The rulers were counseled by the Taoist clergy that a strong ruler was virtually invisible.

During the Renaissance, most of Europe was still by and large following the feudal economic model. By contrast, the Ming dynasty in China began once more to practice privatization, especially with regards to their manufacturing industries. This was a reversal of the earlier Song dynasty policies, which had themselves overturned earlier policies in favor of more rigorous state control.

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. 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. Notable privatizations in the UK under Thatcher included Britoil (1982), Amersham International PLC ( 1982), British Petroleum (gradually privatized between 1979 and 1987), British Aerospace (1985 to 1987), British Gas (1986), Rover Group (formerly British Leyland; 1988), British Steel (1988), British Telecom (1984), Sealink ferries (1984), Rolls-Royce (1987) and the regional water authorities (mostly in 1989). After 1979, council house tenants in the UK were given the right to buy their homes; one million had done so by 1986.

In the UK this culminated in the 1993 privatization of British Rail under Thatcher's successor, John Major; British Rail having been formed by prior nationalization of private rail companies.

Privatization in Latin America flourished in the 1980s and 90's as a result of Western liberal economic policy. Public resources, including water management, transport systems and national telecommunication companies, were sold off to the private sector more rapidly than in almost any part of the world. In the 1990s, privatization revenue from 18 Latin American countries totalled 6% of gross domestic product or GDP. Private investment in infrastructure, between 1990 and 2001, reached $360.5 billion, $150 billion more than the next emerging economy. While the evaluation of privatization in Latin America by economists is generally favourable, opinion polls and public protests across the country suggest the vast majority of citizens are dissatisfied with or have negative views of privatization in the region.

Significant privatization of state owned enterprises in Eastern and Central Europe and the former Soviet Union was undertaken in the 1990s with assistance 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. Japan Post 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. Japan Post was thought to be inefficient and a source for corruption. In September 2003, Prime Minister Junichiro 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 privatization, Koizumi scheduled nationwide elections for September 11, 2005. He declared the election to be a referendum on postal privatization. Koizumi subsequently won this election, gaining the necessary supermajority and a mandate for reform, and in October 2005, the bill was passed to privatize Japan Post in 2007.

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

In 1988, the Perestroika policy of Mikhail Gorbachev started allowing private enterprise in the previous centrally-planned and government-owned economy of the Soviet Union. This began a massive privatization of the Soviet economy over the next few years as the country dissolved. Other Eastern Bloc countries followed suit after the Revolutions of 1989 brought them non-Communist governments.

The United Kingdom's largest public-share offerings were privatizations of British Telecom and British Gas during the 1980s under the Conservative government of Margaret Thatcher, when many state-run firms were sold off to the private sector. This attracted very mixed views from the public and parliament, and even a former Conservative prime minister, Harold Macmillan, was critical of the policy; likening it to "selling the family silver". There were around 3,000,000 shareholders in Britain when Thatcher took office in 1979, but the subsequent sale of state-run firms saw the level of shareholders double to 6,000,000 by 1985 and by the time of her resignation as prime minister in 1990 there were more than 10,000,000 shareholders in Britain.

The largest public-share offering in France was France Télécom.

Egypt undertook widespread privatization under President Hosni Mubarak. After his overthrow in the 2011 revolution, the association of the newly private businesses with the crony capitalism of the old regime along with the new look at long-festering labor and police-state issues have led to calls for re-nationalization.

Results

Literature reviews find that in competitive industries with well-informed consumers, privatization consistently improves efficiency. The more competitive the industry, the greater the improvement in output, profitability, and 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. Although typically there are many costs associated with these efficiency gains, many economists argue that these can be dealt with by appropriate government support through redistribution and perhaps retraining. Yet, some empirical literature suggests that privatization could also have very modest effects on efficiency and quite regressive distributive impact. In a first attempt at a social welfare analysis of the British privatization program under the Conservative governments of Margaret Thatcher and John Major during the 1980s and 1990s, Massimo Florio points to the absence of any productivity shock resulting strictly from ownership change. Instead, the impact on the previously-nationalized companies of the UK productivity leap under the Conservatives varied in different industries- in some cases it occurred prior to privatization, and in other cases it occurred on privatization or several years afterwards.

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. A 2009 study published in The Lancet medical journal estimated that as many as 1,000,000 working men died as a result of economic shocks associated with mass privatization in the former Soviet Union and in Eastern Europe during the 1990s.

In Latin American, there is a discrepancy between the economic efficiency of privatization and the political/social ramifications that occur. On the one hand, economic indicators, including firm profitability, productivity and growth, project positive microeconomic results. On the other hand, however, these results have largely been met with a negative criticism and citizen coalitions. This neoliberal criticism highlights the ongoing conflict between varying visions of economic development. Karl Polanyi emphasizes the societal concerns of self-regulating markets through a concept known as a "double movement". In essence, whenever societies move towards increasingly unrestrained, free-market rule, a natural and inevitable societal correction emerges to undermine the contradictions of capitalism. This was the case in the 2000 Cochabamba protests.

Privatization in Latin America has invariably experienced increasing push-back from the public. Some suggest that implementing a less efficient but more politically mindful approach could be more sustainable.

In India, a survey by the National Commission for Protection of Child Rights (NCPCR) —Utilization of Free Medical Services by Children Belonging to the Economically Weaker Section (EWS) in Private Hospitals in New Delhi, 2011-12: A Rapid Appraisal—indicates under-utilization of the free beds available for EWS category in private hospitals in Delhi, though they were allotted land at subsidized rates.

Opinion

Arguments for and against the controversial subject of privatization are presented here.

Support

Studies show that private market factors can more efficiently deliver many goods or service than governments due to free market competition. Over time this tends to lead to lower prices, improved quality, more choices, less corruption, less red tape, and/or quicker delivery. Many proponents do not argue that everything should be privatized. According to them, market failures and natural monopolies could be problematic. However, anarcho-capitalists prefer that every function of the state be privatized, including defense and dispute resolution.

Proponents of privatization make the following arguments:

• 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.
• Increased efficiency. Private companies and firms have a greater incentive to produce more goods and services for the sake of reaching a customer base and hence increasing profits. A public organization would not be as productive due to the lack of financing allocated by the entire government's budget that must consider other areas of the economy.
• Specialization. A private business has the ability to focus all relevant human and financial resources onto specific functions. A state-owned firm does not have the necessary resources to specialize its goods and services as a result of the general products provided to the greatest number of people in the population.
• 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 state-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) in a state-run corporation affects the ongoing asset stream and company performance, whereas any corruption that may occur during the privatization process is a one-time event and does not affect ongoing cash flow or performance of the company.
• 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, often due to the sensitivity of job losses, when economically, it may be better to let the business fold.
• 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 behavior 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.
• Job gains. As the economy becomes more efficient, more profits are obtained and no government subsidies and less taxes are needed, there will be more private money available for investments and consumption and more profitable and better-paid jobs will be created than in the case of a more regulated economy.

Opposition

Opponents of certain privatizations 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). There is a positive externality when the government provides society at large with public goods and services such as defense and disease control. Some national constitutions in effect define their governments' "core businesses" as being the provision of such things as justice, tranquility, defense, and general welfare. These governments' direct provision of security, stability, and safety, is intended to be done for the common good (in the public interest) with a long-term (for posterity) perspective. As for natural monopolies, opponents of privatization claim that they aren't subject to fair competition, and better administrated by the state. Likewise, private goods and services should remain in the hands of the private sector.

Although private companies will provide a similar good or service alongside the government, opponents of privatization are careful about completely transferring the provision of public goods, services and 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 to 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.
• 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.
• 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. The more necessary a good is, the lower the price elasticity of demand, as people will attempt to buy it no matter the price. In the case of a price elasticity of demand of zero (perfectly inelastic good), the demand part of supply and demand theories does not work.
• Privatization and poverty. It is acknowledged by many studies that there are winners and losers with privatization. The number of losers — which may add up to the size and severity of poverty — can be unexpectedly large if the method and process of privatization and how it is implemented are seriously flawed (e.g. lack of transparency leading to state-owned assets being appropriated at minuscule amounts by those with political connections, absence of regulatory institutions leading to transfer of monopoly rents from public to private sector, improper design and inadequate control of the privatization process leading to asset stripping).
• Job loss. Due to the additional financial burden placed on privatized companies to succeed without any government help, unlike the public companies, jobs could be lost to keep more money in the company.
• Reduced wages and benefits. A 2014 report by In the Public Interest, a resource center on privatization, argues that "outsourcing public services sets off a downward spiral in which reduced worker wages and benefits can hurt the local economy and overall stability of middle and working class communities."
• Inferior quality products. Private, for-profit companies might cut corners on providing quality goods and services in order to maximize profit.

Economic theory

In economic theory, privatization has been studied in the field of contract theory. When contracts are complete, institutions such as (private or public) property are difficult to explain, since every desired incentive structure can be achieved with sufficiently complex contractual arrangements, regardless of the institutional structure (all that matters is who are the decision makers and what is their available information). In contrast, when contracts are incomplete, institutions matter. A leading application of the incomplete contract paradigm in the context of privatization is the model by Hart, Shleifer, and Vishny (1997). In their model, a manager can make investments to increase quality (but they may also increase costs) and investments to decrease costs (but they may also reduce quality). It turns out that it depends on the particular situation whether private ownership or public ownership is desirable. The Hart-Shleifer-Vishny model has been further developed in various directions, e.g. to allow for mixed public-private ownership and endogenous assignments of the investment tasks.

See also

• Corporatization
• Deprivatization
• Deregulation
• Marketization
• Private sector development
• Privatization of British Rail
• Privately owned public space
• Private prison
• Special Economic Zone
• Structural adjustment

References

• Alexander, Jason. 2009. Contracting Through the Lens of Classical Pragmatism: An Exploration of Local Government Contracting. Applied Research Project. Texas State University. http://ecommons.txstate.edu/arp/288/.
• Dovalina, Jessica. 2006. Assessing the Ethical Issues Found in the Contracting Out Process. Applied Research Project. Texas State University. http://ecommons.txstate.edu/arp/108/.
• Segerfeldt, Fredrik. 2006. Water for sale: how business and the market can resolve the world’s water crisis. Stockholm Network. http://www.stockholm-network.org/downloads/events/d41d8cd9-Amigo%20Segerfeldt.pdf
• Bernard Black et al., 'Russian Privatization and Corporate Governance: What Went Wrong? (2000) 52 Stanford Law Review 1731
• Feghali, Khalil.(2013). "La privatisation au Liban:allocation des ressources et efficacité de la gestion". L'Harmattan, Paris, ISBN 978-2-343-00839-4
• Hart, Oliver, Andrei Shleifer, and Robert W. Vishny (1997). "The Proper Scope of Government: Theory and an Application to Prisons." Quarterly Journal of Economics 112: 1127-1161. doi:10.1162/003355300555448.
• Hoppe, Eva I. and Patrick W. Schmitz. (2010). "Public versus private ownership: quantity contracts and the allocation of investment tasks." Journal of Public Economics 94: 258-268. doi:10.1016/j.jpubeco.2009.11.009.
• Kemp, Roger L. (2007). "Privatization: The Provision of Public Services by the Private Sector," McFarland & Co., Inc., Publishers, Jefferson City, North Carolina, USA and London, England, UK. (ISBN 978-0-7864-3250-9)

Unindexed

• Bel, Germà (2006), "The coining of `privatisation´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 Privatisation" London and New York: Routledge, ISBN 0-415-12705-X
• Juliet D’Souza, William L. Megginson (1999), "The Financial and Operating Performance of Privatised Firms during the 1990s", Journal of Finance August 1999
• von Hayek, Friedrich, (1960) The Constitution of Liberty
• Roger L. Kemp, PhD, "Privatization: The Provision of Public Services by the Private Sector," McFarland & Co., Jefferson, NC, USA; and London, UK., 2007.
• Kosar, Kevin R. (2006), "Privatisation and the Federal Government: An Introduction", Report from the Congressional Research Service
• Mayer, Florian (2006) Vom Niedergang des unternehmerisch tätigen Staates: Privatisierungspolitik in Großbritannien, Frankreich, Italien und Deutschland, VS Verlag, Wiesbaden, ISBN 3-531-14918-0
• Megginson and Netter, From state to market: A survey of empirical studies on privatization, Journal of Economic Literature 39(2), June 2001, 321-89.
• Nico Perrone (2002), Economia pubblica rimossa, Milan, Giuffrè ISBN 88-14-10088-8
• Smith, Adam (1776) The Wealth of Nations
• Jeb Sprague, 2007. Haiti: Workers Protest Privatisation Layoffs. Inter Press Service.
• Stiglitz, Joseph Globalization and its Discontents
• von Weizsäcker, Ernst, Oran Young, and Matthias Finger (editors): Limits to Privatisation. Earthscan, London 2005 ISBN 1-84407-177-4
• Wolin, Sheldon S. (2008) Democracy Incorporated: Managed Democracy and the Specter of Inverted Totalitarianism (Princeton University Press, 2008). ISBN 978-0-691-13566-3 (Trad. esp.: Democracia S. A., Buenos Aires/Madrid, Katz editores S.A, 2008, ISBN 978-84-96859-46-3)
• Zullo, Roland. (2009). Does Fiscal Stress Induce Privatization? Correlates of Private and Intermunicipal Contracting, 1992-2002. Governance 22.3 (July): 459-481.

External links

• Privatization's Rise from the Dean Peter Krogh Foreign Affairs Digital Archives
• Reports of the Public Services International Research Unit at the University of Greenwich Research database with many articles on the effects of privatization
• Privatization Blog is a resource dedicated to recent developments in privatization.

(P)