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Privatization
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Privatization is the incidence or process of transferring ownership of business from the public sector (government) to the private sector (business). In a broader sense, privatization refers to transfer of any government function to the private sector including governmental functions like revenue collection and law enforcement.
The term "Privatization" also has been used to describe two unrelated transactions.
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Encyclopedia
Privatization is the incidence or process of transferring ownership of business from the public sector (government) to the private sector (business). In a broader sense, privatization refers to transfer of any government function to the private sector including governmental functions like revenue collection and law enforcement.
The term "Privatization" also has been used to describe two unrelated transactions. The first is a buyout, by the majority owner, of all shares of a public corporation or holding company's stock, privatizing a publicly traded stock. The second is a demutualization of a mutual organization or cooperative to form a joint stock company.
Origin of the term
It has been claimed that the term was first used in the 1930s by The Economist in covering German economic policy.
History
In Ancient Greece, the government contracted out almost everything to private sector.
In Roman Republic, private individuals and companies supplied nearly everything, including tax collection, supply the army, religious sacrifices and construction. However, Roman Empire 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 Roman Empire.
Churchill's government privatized British steel industry in the 1950s. West Germany's government started a large-scale privatization, including selling its Volkswagen majority share to small investors in a public share offering in 1961.
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 of privatization.
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 (e.g. underpricing required) may be higher. For this reason, many governments elect for listings in the more developed and liquid markets. Euronext, and the London, New York and Hong Kong Stock Exchanges 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 privatizations, 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 by what companies are offering.
Arguments for and against privatization
Pro-privatization
Proponents of privatization believe that private market factors can more efficiently deliver many goods or service than government due to free market competition. In general, it is argued that 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. According to them, market failures and natural monopolies could be problematic. However, some Austrian school economists and anarcho-capitalists would prefer that everything 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.
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 can be reversed easily 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, 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.
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.
Furthermore, large corporations can pay public relations professionals to convince decision-makers that privitazation is a sensible idea, whether or not this is actually the case. Corporations typically have far more resources for expert testimony, advertisements, conferences and other propaganda efforts than anti-privatization advocates. Of course, this fact has no bearing on the merits of privatization itself.
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 organization 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 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.
- 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.
- Privatisation 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.
Outcomes
Literature reviews find 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, 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. 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 liberties, 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.
With recent cost increases in some industries people are beginning to question whether privitisation is good value for the money. With the cost of certain services increasing rapidly but the service provided either staying constant or even decreasing the cost increase is not justified.
Alternatives to total privatization
Public Utility
The enterprise can remain as a public utility.
Non-Profit
The enterprise could be managed by a private non-profit organization.
Municipalization
Transferring control to municipal government
Outsourcing or 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 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.
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 spiraling 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.
In some instances of partial privatization of contracted services, provision of some portion(s) of the state-owned service are provided by private-sector contactors, but the government retains the capacity to self-operate at contract intervals, if it so chooses. An example of partial privatization would be some forms of school bus service contracting, such as arrangements where equipment and other resources purchased with government capital funds and/o those already owned by a governmental entity are used by the contractor for a period of time in providing services, but ownership is retained by the governmental unit. This form of partial privatization eases concerns that once an operation is contracted, the government may be unable to obtain sufficient competitive bids, and be subjected to terms less desirable than the prior operation under state-ownership. Under that scenario, a reverse privatization would be more feasible for the government. (see section below)
See also Public-private partnership.
Notable privatizations
The largest privatization in history was Japan Post. It 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.
The Prime Minister Junichiro Koizumi wanted to privatize it because it was thought to be an inefficient and a source for corruption. In September 2003, 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 privatization was rejected by upper house, Koizumi scheduled nationwide elections to be held on 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 was 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.
The United Kingdom's largest public share offerings were privatizations of British Telecom and British Gas. The largest public share offering in France was France Telecom. Privatization in Europe has led to genuine competition: 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.
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 (e.g. 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.
Reverse privatization
A reversion from contracted ownership of an enterprise and/or services to governmental ownership and/or provision is called reverse privatization or nationalization. Such a situation most often occurs when a privatization contractor fails financially and/or the governmental unit has been unable to purchase satisfactory service at prices it regards as less than state-ownership or self-operation of services. Another circumstance may occur when greater control than viable under privatization is determined to be in the governmental unit's best interest.
National security concerns may be the source of reverse privatization actions when the most likely providers are non-domestic or international corporations or entities. For example, in 2001, in response to the September 11th attacks, the then-private airport security industry in the United States was nationalized and put under the authority of the Transportation Security Administration.
When a state-owned enterprise or service has been nationalized or privatized, and then is reverted to state-ownership or service provision, the process of reverse privatization may be called denationalization.
See also
Unindexed
- Kosar, Kevin R. (2006), , Report from the Congressional Research Service
- Bel, Germà (2006), , 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), , 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* von Weizsäcker, Ernst, Oran Young, and Matthias Finger (editors): Limits to Privatization. Earthscan, London 2005 ISBN 1-84407-177-4
External links
- Research database with many articles on the effects of privatization
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