Privatization

From Bvio.com

Privatization (sometimes: denationalization, privatisation or — especially in India — disinvestment) is the economic process of transferring property, from public ownership to private ownership. An opposite process is nationalization. In theory, privatization helps establish a "free market", as well as fostering capitalist competition, which its supporters argue will give the public better choices. Conversely, socialists view privatization negatively, arguing that entrusting private businesses with control of essential services reduces the public's control over them, and will result in unemployment and corruption.

In general, nationalization was common during the immediate post-World War 2 period, but privatization became a more dominant economic trend (especially within the United States and the United Kingdom) during the 1980s and '90s. This trend of privatization has often been characterized as part of a "global wave" of neoliberal policies, and some observers argue that this was greatly influenced by the policies of Reagan and Thatcher. The term "privatization" was coined in 1948 and is thought to have been popularized by The Economist during the '80s. Perhaps the most discussed privatization case has been the Privatization of British railways.

Privatization is frequently associated with industrial or service-oriented enterprises, such as mining, manufacturing or power generation, but it can also apply to any asset, such as land, roads, or even rights to water. In recent years, government services such as health, sanitation, and education have been particularly targeted for privatization in many countries.

Arguments for privatization

The basic argument given for privatization is that governments have few incentives to ensure that the enterprises they own are well run. On the other hand, private owners, it is said, do have such an incentive: they will lose money if businesses are poorly run. The theory holds that, not only will the enterprise's clients see benefits, but as the privatized enterprise becomes more efficient, the whole economy will benefit. Ideally, privatization propels the establishment of social, organizational and legal infrastructures and institutions that are essential for an effective market economy.

Advocates of privatization argue that governments run businesses poorly for the following reasons:

They may only be interested in improving a company in cases when the performance of the company becomes politically sensitive.
Conversely, the government may put off improvements due to political sensitivity — even in cases of companies that are run well.
The company may become prone to corruption; company employees may be selected for political reasons rather than business ones.
The government may seek to run a company for social goals rather than business ones (this is conversely seen as a negative effect by critics of privatization).
It is claimed by supporters of privatization, that privately-held companies can more easily raise capital in the financial markets than publicly-owned ones.
Governments may "bail out" poorly run businesses with money when, economically, it may be better to let the business fold.
Parts of a business which persistently lose money are more likely to be shut down in a private business.
Nationalized industries can be prone to interference from politicians for political or populist reasons. Such as, for example, 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; it is argued that such measures can cause nationalized industries to become uneconomic and uncompetitive.

In particular, the first and last reasons are held to be the most important because money is a scarce resource: if government-run companies are losing money, or if they are not as profitable as possible, this money is unavailable to other, more efficient firms. Thus, the efficient firms will have a harder time finding capital, which makes it difficult for them to raise production and create more employment.

Another argument for privatization is, that to privatize a company which was non-profitable (or even generated severe losses) when state-owned means taking the burden of financing it off the shoulders and pockets of taxpayers, as well as free some national budget resources which may be subsequently used for something else. Especially, proponents of the laissez-faire capitalism will argue, that it is both unethical and inneficient for the state to force taxpayers to fund the business that can't work for itself. Also, they hold that even if the privatized company happens to be worse off, it is due to the normal market process of penalizing businesses that fail to cope with the market reality or that simply are not preferred by the customers.

Furthermore, it is argued that an unprofitable public company may become profitable in private hands. An example cited by proponents is Deutsche Post, once part of the German postal service, which began generating profits after it became a part of the international corporation TNT Worldwide Express.

Many privatization plans are organized as auctions where bidders compete to offer the state the highest price, creating monetary income that can be used by the state.

The state can also allow foreigners to buy privatized enterprises, which allows an outside investor to supply the capital needed to upgrade and modernize the firm. Many Polish companies were sold to outside investors, among them the Kwidzyn paper factory, which became a successful firm after its purchase by International Paper.

Arguments against privatization

Opponents of privatization dispute the claims made by proponents of privatization, especially the ones concerning the alleged lack of incentive for governments to ensure that the enterprises they own are well run, on the basis of the claim that governments must answer 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, under this argument, do have an incentive to maximize efficiency in nationalized companies, due to the pressure of future elections.

Furthermore, opponents of privatization argue that it is undesirable to let private entrepreneurs own public institutions for the following reasons:

Private companies do not have any goal other than to maximize profit.
The public does not have any control or oversight of private companies.
A centralized enterprise is generally more cost effective than multiple smaller ones. Therefore splitting up a public company into smaller private chunks will reduce efficiency.
Privatization will not result in true competition if a natural monopoly exists.
Profits from successful enterprises end up in private pockets instead of being available for the common good.
Nationalized industries are usually guaranteed against bankruptcy by the state, they can therefore borrow money at a lower interest rate to reflect the lower risk of loan default to the lender.
In cases where public services or utillities are privatized, it can create a conflict of interest between profit and maintaining a sufficient service. A private company may be tempted to cut back on maintenance or staff training etc, to maximize profits.
A public service may provide public goods that, while important, are of little market value, such as the cultural goods produced by public television and radio.

In practical terms, there are many pitfalls to privatization. Privatization has rarely worked out ideally because it is so intertwined with political concerns, especially in post-communist economies or in developing nations where corruption is endemic. Even in nations with advanced market economies like Britain, where privatization has been popular with governments (if not all of the public) since the Thatcher era, problems center on the fact that privatization programs are very politically sensitive, raising many legitimate political debates. Who decides how to set values on state enterprises? Does the state accept cash or for government-provided coupons? Should the state allow the workers or managers of the enterprise to gain control over their own workplace? Should the state allow foreigners to buy privatized enterprises? Which levels of government can privatize which assets and in what quantities?

In the short-term, privatization can potentially cause tremendous social upheaval, as privatizations are often always accompanied by large layoffs. If a small firm is privatized in a large economy, the effect may be negligible. If a single large firm or many small firms are privatized at once and upheaval results, particularly if the state mishandles the privatization process, a whole nation's economy may plunge into despair. For example, in the Soviet Union, many state industries were not profitbale under the new system, with the cost of inputs exceeding the cost of outputs. After privatization, sixteen percent of the workforce became unemployed in both East Germany and Poland. The social consequences of this process have been staggering, impoverishing millions, but to little social benefit in many post-Communist countries. In the process, Russia has gone from having one of the world's most equal distributions of wealth in the Soviet era to one of the least today. There has been a dearth of large-scale investment to modernize Soviet industries and businesses still trade with each other by means of barter.

In speaking about the transformations in the post-communist countries, however, one must take into account the specifics of the communist and socialist regime which ruled those countries for decades. There are no easy answers regarding those issues. Some argue that it was the cumulation of mismanagement and inattention to the market realities that lead to such fatal consequences, given that most of the assets of those companies had not renovated for decades and their technology was outdated. Further, opening of the markets for import of the products which, in many cases, offered higher quality or lower prices, has given the consumers new array of choices to compete with the old national industries.

Privatization in the absence of a transparent market system may lead to assets being held by a few very wealthy people, a so-called oligarchy, at the expense of the general population. This may discredit the process of economic reform in the opinion of the public and outside observers. This has occurred notably in Russia, Mexico, and Brazil.

Moreover, where free-market economics are rapidly imposed, a country may not have the bureaucratic tools necessary to regulate it. This has been a pertinent problem in Russia and in many South American countries, although some other Eastern European countries, such as Poland and the Czech Republic, fared better in this respect, partly through the support of the European Union. Paradoxically, while Britain has long had a market economy, it also faced this issue after it privatized utilities in the Thatcher era; Britain's utilities regulator was often criticized as being ineffective.

Most economists argue that if a privatized company is a natural monopoly, or exists in a market which is prone to serious market failures, consumers may be worse off when the company is in private hands. This seems to have been the case with rail privatization in the UK and in New Zealand; in both countries, public disaffection has led to government intervention. In cases where privatization has been successful, it is because genuine competition has arisen. A good example of this is long-distance telecommunications in Europe, where the former state-owned enterprises lost their monopolies, competitors entered the market, and tariffs for international calls fell dramatically.

British Rail is an example of privatization program that has been deemed a failure and largely abandoned. The track-owning company has been effectively repossessed by the British government, and many of the train-running companies are at risk of having their concession removed on the grounds that they fail to provide adequate services. One of them, Connex, actually had its franchise cut short in June 2003 by the government for what the Strategic Rail Authority called "poor financial management." However, in other cases, particularly in poor countries, privatized enterprises cannot be renationalized so easily. These governments do not have the the political will to do it, and there is strong pressure exerted by international lending agencies to maintain the privatization.

If the privatization does not fully transfer property rights to the newly private firm, there may be disincentives for the firm to make capital investments. This was a particular problem in the case of the privatized rail track-leasing company in the United Kingdom.

Many have argued that the strategy of privatization in Russia differed from those seen in more successful post-communist economies such as Hungary and Poland. The defects of the process in Russia, combined with capital market liberalization and failure to establish institutional infrastructure, have led to incentives for capital flight, contributing to post-communist economic contraction in Russia.

Likewise, countries such as Argentina, which embarked upon far-reaching privatization programs, selling off valuable, profitable industries such as energy companies, have seen the rapid impoverishment of their governments. Revenue streams which could previously be directed towards public spending suddenly dried up, resulting in a severe drop in government services.

Privatization can also have a ripple effect on local economies. State-owned enterprises are often required by law to patronize national or local suppliers. Privatized companies, in general, do not have that restriction, and hence will shift purchasing elsewhere. Bolivia underwent a rigorous privatization program in the mid 1990s, with disastrous impact on the local economy.

The Wall Street Journal has reported that the World Bank, historically a supporter of denationalization in developing countries, has also begun to voice concerns over privatization. It no longer believes that privatization should be recommended in all cases. Nobel Prize winner Joseph Stiglitz has written a book on the subject called Globalization and its Discontents. Mexico's President Vicente Fox has come under criticism for his plans to privatize Mexico's electrical power generating industry.

Finally, it has been argued that the Chinese economic reform has illustrated that economic reform can take place in the absence of large-scale privatization.

The above arguments have centered on whether or not it is practical to apply privatization in the real world, but some reject the profit incentive, the theoretical basis for privatization, itself. Some opponents of privatization argue that because the driving motive of a private company is profit, not public service, the public welfare may be sacrificed to the demands of profitability. There is no definitive answer, but it is very often argued that essential services, such as water, electricity, health, primary education, and so forth, should be left in public hands. This argument, of course, relies on the view on state one holds, regarding what it should or should not be obligated to do. What is seen as desirable by a socialist may not be by a supporter of capitalism, and vice versa.

Recently, LIBM theory has provided a new perspective on issues relating to privatization.

Corporatization

New Zealand has experienced the privatization of its telecommunication industry, its railway system and part of its electricity market. The process of privatization was halted in 1999 when the New Zealand Labour Party won the election. Although most of the electricity generation and the electricity transmission system remain state owned, the government has corporatized this sector as well as New Zealand Post, the Airways Corporation and other smaller state-owned enterprises (SOEs).

The effect of corporatization has been to convert the state departments into public companies and interpose commercial boards of directors between the shareholding ministers and the management of the enterprises. To some extent, this model has enabled efficiencies to be gained without ownership of strategic organizations being transferred. This has been the policy of the People's Republic of China.

Partial list of privatizations

Australia

Qantas
Commonwealth Bank of Australia
Telstra (49% privatised; remaining 51% to be privatised soon)
Commonwealth Serum Laboratories
Commonwealth Industrial Gases
Commonwealth Oil Refineries
Electricity and gas supplies in Victoria
State-owned betting agencies in most States
Many long-distance and urban passenger railway services
All freight railway services except Queensland Rail
Most State-owned banks
Government Printing Service (New South Wales)
Government Cleaning Service (New South Wales)
Government Insurance Office in New South Wales
All public transport in Melbourne
Sydney Airport

Canada

Air Canada
Canadian National Railway
Petro-Canada
Telus - In the province of Alberta, formerly Alberta Government Telephones
Uranium Industry in Saskatchewan
Canadian National Railway
Teleglobe - An international telco carrier.
Saskatchewan Wheat Pool
Nova Scotia Power

Finland

Finnair
Sonera (former Telecom Finland)

Germany

Deutsche Bundespost became
- Deutsche Post AG
- Deutsche Telekom AG
- Postbank AG
Deutsche Bundesbahn became Deutsche Bahn AG

India

One of the few countries where privatization and globalization efforts have been carried out at the same time, and quite successfully, within a short span of a little over a decade. These efforts are ongoing and will continue over the next several years.
Maruti
BSNL