Outreach #3
Policy Views from the Country Economics Department
July 1992

Privatization: eight lessons of experience

Privatization is on the rise. More than 8,500 state-owned enterprises (SOEs) in over 80 countries have been privatized in the past 12 years, 2,000 in countries that borrow from the World Bank.

Not only is the pace of sales accelerating, the size and value of divested firms are also increasing. Close to 30 very large SOEs with a gross value of more than $19 billion have been sold in developing countries in the past two years. Thousands of smaller enterprises are also on the sales block around the world.

It is hard to find a country without a privatization program, or a sector of activity not susceptible to private management if not ownership. Malaysia has sold its National Lottery, Buenos Aires its zoo, Czechoslovakia the guest house of the Communist Party.

Ownership matters

Why privatize? Because ownership is a significant determinant of enterprise performance. In both developed and developing countries, good SOE performance has been very difficult to bring about--and even harder to sustain. Governments facing financial crisis often try to improve performance by bringing in new and dynamic managers, and paying them incentive salaries. And they grant managers autonomy to set prices and hire and fire--and agree to overdue tariff increases and payment of past due bills. These measures often have a positive effect. But as the crisis dissipates, so does political resolve.

Political interference, a common and deadly disease of SOEs, tends to re-emerge--and painfully achieved SOE reforms tend to backslide. SOEs thought to be well on the road to recovery have either stopped improving performance or suffered deterioration. In Korea, where reform short of ownership change ended losses in a group of SOEs for three years in the mid-1980s, large deficits have since reappeared. In New Zealand and Japan, SOE reforms began to bite only when done in conjunction with privatization.

Recognition that SOE reforms are limited and unsustainable, coupled with the fiscal burden of subsidizing loss-makers, has led financially hard-pressed governments to opt for privatization.

Privatization works: the evidence

Privatization--properly structured --yields substantial and enduring benefits. A detailed and rigorous Bank examination of 12 privatizations in four countries found that divestiture was good for the economy as a whole--and led to higher productivity and faster growth in all but one case (see chart and the box on the back page). The Chilean telephone company doubled its capacity in the four years after sale. The privatized telephone company in Mexico reduced its per-unit labor costs sharply.

Another study found that 41 firms privatized by public offerings in 15 countries--Jamaica, Chile, Singapore, and Mexico among them--increased returns on sales, assets, and equity, raised internal efficiency, improved their capital structure, and increased capital expenditures. They also expanded their workforces by small margins. Privatization often is accompanied by layoffs, but this is not always so--jobs increased after privatization in divested firms in the Philippines, Tunisia, Mexico, and Chile.

Most privatization success stories come from high-income and middle-income countries. Privatization is easier to launch and more likely to produce positive results when the company operates in a competitive market, and when the country has a market-friendly policy environment and a good capacity to regulate. The poorer the country, the longer the odds against privatization producing its anticipated benefits, and the more difficult the process of preparing the terrain for sale.

Nonetheless, successes can be found in low-income countries, too. Privatization turned around an almost moribund textile firm in Niger, helped revive a defunct development finance corporation in Swaziland, and revitalized an agro-industrial firm in Mozambique. The Mozambiquan firm diversified into new products, began servicing its debts, and increased production fivefold.

The conclusion is straightforward: privatization, when done right, works well.

How to do it right

There are eight key lessons.

1. Privatization works best when it's part of a larger program of reforms promoting efficiency. New Zealand, the U.K., Mexico, and Chile are all successful privatizers. Their privatizations were accompanied by reforms to open markets, remove price and exchange rate distortions, and encourage the development of the private sector through free entry. Revenue maximization should not be the primary goal of privatization. Far better to eliminate monopoly power and unleash potentially competitive activities than to boost the sales price by divesting into protected markets. Also far better to create regulations to protect consumer welfare than to maximize price by selling into an unregulated market.

2. Regulation is critical to the successful privatization of monopolies. In the sale of Chile Telecom, everybody won--consumers, labor, government, buyers--and the productive efficiency of the company increased as a result of a well-developed, well-administered regulatory framework.

3. Countries can benefit from privatizing management without privatizing the ownership of assets. Management contracts, leases, and concessions have been successfully used the world over, particularly in sectors where it is difficult to attract private investors. In Côte d'Ivoire, the leased water company improved technical efficiency, increased new connections, became more efficient in billing and collection of receivables --and reduced the number of expatriate employees by 70%. But because a change in ownership is usually needed to lock in performance gains, private management arrangements are likely to work best when they are a step toward full privatization.

4. The sale of large enterprises requires considerable preparation. Successful privatizations of large enterprises have entailed breaking them into competitive and marketable units (in east Germany, Argentina, and Mexico), bringing in dynamic private sector managers (in many telecom and airline sales around the world), settling past liabilities, and shedding excess labor (in steel and railways in Argentina). Successful privatizing governments also assiduously avoided large new investments for plant modernization and equipment, since getting the private sector to finance and manage these investments was itself a major reason for privatization.

5. Transparency is critical for economic and political success.Mexico and the Philippines made the sale of enterprises transparent by adopting competitive bidding procedures, developing objective criteria for selecting bids, and creating a clear focal point with minimal bureaucracy to monitor the overall program. A lack of transparency can result in political backlash, as in the early days of privatization in Poland, or even bring the process to a halt, as in Guinea.

6. Governments must pay special attention to developing a social safety net. In Tunisia, generous severance packages encouraged voluntary departures and reduced the need for outright dismissals. In many countries--most recently in Eastern Europe and Central Asia--employee ownership schemes, unemployment benefits, and retraining-redeployment programs are being developed to ease the social costs of privatization.

7. The formerly socialist economies should privatize in all possible ways that encourage competition, and they should experiment with all available methods that go beyond a case-by-case approach to privatization. Since the economic and social importance of SOEs is far greater there than in the rest of the world, flexibility is in order--not because privatization is less necessary, but because it is more so. Rampant institutional and policy deficiencies require experimentation with a wide set of privatization tactics. These include share give-aways (or mass privatization schemes), state-assisted financing methods, free or low-cost shares to employees in privatized firms, and new types of investment-management companies to run groups of companies and diversify risk.

8. In changing the public-private mix in any type of economy, privatization will sometimes be less important than the emergence of new private business. Countries can freeze or restrain the expansion of public enterprises and encourage the growth of a dynamic private sector through free entry, as happened in Korea and appears to be happening in China.

So...

Privatization is not a blanket solution for the problems of poorly performing SOEs. It cannot in and of itself make up totally for lack of competition, for weak capital markets, or for the absence of an appropriate regulatory framework. But where the market is basically competitive, or when a modicum of regulatory capacity is present, private ownership yields substantial benefits.

Sunita Kikeri
John Nellis
Mary Shirley

Count your blessings

The staff debate

Done right, private beats public 11-1


Readings

Kikeri, Sunita, John Nellis, and Mary Shirley, Privatization: The
Lessons of Experience, World Bank, June 1992.
Bishop, Matthew, and John Kay, Does Privatization Work? Lessons from
the UK, London: London Business School, 1988.
Ott, Attiat F., and Keith Hartley, eds., Privatization and Economic
Efficiency: A Comparative Analysis of Developed and Developing
Countries, Brookfield, VT: Edward Edgar, 1991.
Veljanovski, Cento. Privatization and Competition: A Market
Prospectus, London: Institute of Economic Affairs, 1989.
Vickers, John, and G. Yarrow. Privatization: An Economic Analysis,
Cambridge: MIT Press, 1988.