Development Brief Number 1
October 1992

Private beats public 11--1

Ownership matters. But so does policy. In and of itself, the act of divestiture can be beneficial, but intelligent accompanying policies increase the likelihood and magnitude of the benefits

Developed and developing countries alike are selling their public enterprises, but the Bank is supporting divestiture in most of its borrowing countries. Yet, systematic evidence has been lacking on whether divestiture is advantageous to society. Or on who wins and who loses in the process. And on what makes divestiture benefit society.

The World Bank hosted a conference in Washington, DC, in June to address these questions. Presentations drew on the findings of a two-year research project, sponsored and conducted by the Country Economics Department. One hundred senior policymakers, representatives of international organizations, researchers, and academicians from around the world participated.[1]

Was divestiture good for society? Yes.

In Chile, Malaysia, Mexico, and the United Kingdom, divestiture enhanced domestic and world welfare in 11 of the 12 firms analyzed, mostly in utilities---the exception was Mexicana airlines. The magnitudes of the gains were substantial: they averaged 26 percent of the company's predivestiture annual sales.

The sources of the gains varied. They stemmed primarily from:

• Higher investment, especially where public enterprises had left demand unmet because of tight budgets. A striking example is Chile, where the telephone company (CTC) doubled its capacity in the four years after divestiture.
• Higher productivity, thanks to a smaller work force, improved labor-management relations, better incentives, and internal reorganizations---as in Malaysia's Container Terminal, Mexico's Telmex and Aeromexico, and Chile's CTC. Improved productivity also came about from output diversifying into activities previously unexplored, because public enterprise managers either had no incentive to pursue them, or were blocked by bureaucratic restraints from doing so. British Telecom and Chile's CTC now provide a wide range of new value-added services.
• Higher output prices, which had been artificially low in relation to the scarcity value of resources under public ownership. But effective regulation prevented privatized monopolies from exploiting their market power---except British Airways, which was able to charge consumers higher fares by merging with British Caledonian after divestiture.

Who were the winners and losers?

Workers did not lose---and sometimes won. When the compensation payments are taken into account, divestiture in no case made workers of the divested firms worse off. Workers---as participants in the equity of divested firms---made substantial gains in the United Kingdom's National Freight, Mexico's Telmex, and Chile's electricity distribution company, ENERSIS.

Consumers often won---but not always. In the majority of cases, consumers were as well or even better off after divestiture---thanks to competition and effective regulation. In five cases, however, consumers as a group ended up worse off. For example, consumers of telecommunication services in Mexico now pay higher prices because tariffs were previously too low to cover costs and allow for expansion. ENERSIS of Chile is a special case. After divestiture, the company reduced theft of electricity significantly, which hurt those who got free power, but allowed lower prices to paying consumers.

Foreigners did well---but so did nationals. Foreigners profited from divestiture in all but one of the cases where they were involved (Mexicana airlines is the exception). But they were not the only winners---national economies gained as well, because these investors brought in much-needed fresh capital to meet excess demand and growth. This is true, for example, in Mexico's Telmex and Chile's CTC.

Buyers did well---but so did governments. Buyers, including many small shareholders in the United Kingdom and participants in pension funds in Chile, came out ahead in every case except Mexicana airlines. But so did governments in the majority of cases---meaning that the Treasury received more after divestiture in sale proceeds and the discounted stream of taxes than it would have received in dividends and taxes had public ownership continued. Only in three cases did governments lose (two in Chile) and then only by small amounts.

Policy implications

The evidence clearly shows that ownership matters. For countries to achieve maximum gains from divestiture, they should:

Adopt appropriate regulations before selling natural monopolies. Good regulation provides incentives to producers to reduce their cost and a stable environment to expand. Simul- taneously, it safeguards against potential exploitation of consumers. The best examples here are the United Kingdom and Chile---in tele-communications and in electricity.

Divest some ownership if full divestiture cannot be pursued at once. In Malaysia, partial divestiture was more than a cosmetic change. The government retained control of the Malaysian Airline and Kelang Container Terminal. But the partial sale of shares led the government to exercise its control function differently, and the results were important gains in productivity and welfare.

Give no concessions to sweeten the deal. Governments can hold the private sector to investment commitments to meet pending demand, in return for which they will need to commit themselves to a credible policy environment.

Relevance elsewhere

The sample covers only one industrial and three middle-income countries. But many countries around the world resemble Chile, Malaysia, Mexico, and the United Kingdom. Thus, the gains from divestiture can be expected in many countries.

The benefits from divestiture in relatively poor and formerly centrally planned economies can be even more substantial, because they are likely to go beyond turning divested firms around.