Journal Issue

Privatization: Expectations, Trade-offs, and Results

International Monetary Fund. External Relations Dept.
Published Date:
January 1993
  • ShareShare
Show Summary Details


In view of the seemingly chronic ills that plagued state-owned enterprises around the world, a resurgence of economic liberalism during the 1970s resulted in the dismissal of economic models based on public monopolies. By the end of the decade, a sweeping privatization program was under way in the United Kingdom, and in the early 1980s, a new administration in the United States was pushing a broad deregulatory agenda. Soon, privatization programs followed worldwide. Privatization activity sharply increased over the past five years (Table 1), particularly in developing countries, raising total privatization proceeds from $2.5 billion in 1988 to $23.2 billion in 1992 (not counting privatizations in former East Germany).

Table 1Sharp increase in privatization activityMajor worldwide sales of state-owned enterprises and state participations
Number of transactionsMillion dollarsNumber of transactionsMillion dollarsNumber of transactionsMillion dollarsNumber of transactionsMillion dollarsNumber of transactionsMillion dollars
Industrial countries36,7733920,94517,99731.05824,398
New Zealand61,8463B6973.60351,052
South Africa31.435
United Kingdom14.500148,69910,850719,34851,038
Developing countries2,457203,817357,33717.42423.260
Puerto Rico1142
South Korea12,100
Sri Lanka113’—
Total worldwide39,2305924,76225,33448,48247,658
Source: Privatisation International.* Number not available because of block sales ot small enterprises or government participtions… Indicates data not available.— Indicates no privatizations occurred.
Source: Privatisation International.* Number not available because of block sales ot small enterprises or government participtions… Indicates data not available.— Indicates no privatizations occurred.

Notwithstanding the perils on the road to a market economy, privatization has become a key part of economic reform and adjustment policies, and a prime mover of the economic transition of Eastern Europe. Often, though, an initial wave of unconditional enthusiasm generated by those who touted privatization as a nostrum for all economic ills has gradually given way to a more realistic view that not only identifies the economic benefits of privatization, but also recognizes the trade-offs and compromises that have to be made to obtain particular benefits.

Why privatize?

Economic theory recognizes public ownership as a response to the failure of private markets to secure efficient and equitable outcomes. Still, when the vast majority of enterprises is state owned, the framework that stimulates competition and efficiency may be missing. While the key objective of private enterprises is profit maximization, state-owned enterprises have to contend with multiple objectives that often

conflict with profit maximization. These include general economic objectives—including control of strategic resources, delivery of essential goods and services, employment policies, and price control—and noneconomic objectives, ranging from social obligations to political patronage. Not surprisingly, then, when public and private sectors are compared in terms of the cost of producing similar outputs in a competitive environment, the private sector usually outperforms the public sector. Often, state-owned enterprises need to be kept afloat at taxpayers’ expense, either through explicit government subsidies, such as direct cash grants, or through implicit subsidies, such as subsidized credit, guaranteed sales to the government at fixed prices, reductions of tax liabilities, government equity injections, or preferential exchange rates.

While there are different ways to improve the management of state-owned enterprises, for example by subjecting enterprises to market pressures, privatization is often seen as the best means to enforce market discipline and promote an efficient allocation and use of resources. But just privatizing enterprises is not enough: entire industries have to be restructured to ensure competitiveness if efficiency gains are to materialize; even for natural monopolies it will be necessary to introduce regulation and supervision to reproduce effective competition. Otherwise, privatized enterprises may be able to reap substantial monopoly profits, leaving consumers worse off. Hence, improvements in efficiency do not follow from privatization per se, but from the benefits that increased competition can bring to the marketplace if it is accompanied by industrial restructuring.

Trade-offs and constraints

Privatizing state-owned enterprises usually involves a number of economic, financial, and legal hurdles, as well as conflicting goals and interests that frequently impose constraints and make trade-offs inevitable.

Budgetary trade-offs. Economic theory tells us that privatization without efficiency gains does not improve a country’s fiscal stance. This is because when a state-owned enterprise is sold at a fair market price, the value of sales proceeds should more or less equal the net present value of future after-tax earnings. Hence, when a profitable state-owned enterprise is privatized, the state obtains sales proceeds but forgoes future earnings; the opposite is true when a loss-making state-owned enterprise is privatized. In either case, all that takes place is a trade-off between current and future net proceeds. In government accounts, net proceeds from privatization should preferably be treated as a loan repayment, but, alternatively, may be treated as capital revenue. Depending on what the government actually does with these proceeds, that is, whether—in the case of positive net proceeds—it reinvests them, uses them to retire outstanding public debt, or simply uses them as an opportunity to increase government spending or reduce taxes, the fiscal stance would at best be unaffected.

Policy trade-offs and constraints. What, then, should governments be expected to achieve by privatizing state-owned enterprises? While the potential for efficiency gains from private ownership usually provides the rationale for privatization, available evidence, particularly from large-scale privatization programs like the ones undertaken in Eastern Europe, suggests that these improvements in the allocation and use of resources may have to be obtained at the expense of privatization proceeds. This would imply that the fiscal stance may not improve even when efficiency is enhanced.

In practice, policymakers wish to achieve a broad number of policy objectives, which may or may not be compatible with enhancing efficiency. Such objectives include privatizing the economy in the shortest possible time; maximizing privatization proceeds; selecting the “right” buyers; safeguarding employment; and obtaining investment guarantees. To meet all five objectives—speed, proceeds, ownership, employment, and new investment—the number of independent policy tools should equal the number of policy goals. Clearly, not all objectives can be achieved at once, and trade-offs and compromises are inevitable. For example, when a policy decision is made to privatize a given number of state-owned enterprises as quickly as possible—perhaps to obtain fast improvements in efficiency—any constraint imposed on the other four objectives will tend to slow down the process of privatization and limit the actual extent of efficiency gains.

Table 2The Treuhandanstalt: a look at a successful privatization agency

(billions of DM)
Total income1.607.7411.59
From privatization1.527.419,47
Other income0.080.332.12
Total expenditures5.8927.6241.19
Administrative expenses0.140.881.42
interest expenditures9.868.27
Legally mandated expenditures4.351.578.55
Deficit (-)-4.29-19.88-29.60
Guarantees issued28.4030.2326.52
(percent of GDP;
Total income0.070.300.42
Total expenditures0.241.061.50
Guarantees issued1.171.160.96
(other privatization results)
Enterprises privatized (cumulative)5.210.011,043.0
Completely privatized408.02.700,05,251.0
Partially privatized2,510.05,792.0
Remaining to be privatized5,706.02.575.0
Guarantees obtained (cumulative)
Employment guarantees (thousand)201.0930.01,401.0
Investment guarantees (billion DM)42.9114,0169,5
Memorandum item
GDP (West Germany only, billion DM)2.417,82,612.62,750.0
Source: Treuriandansialt.… Indicates data not available.
Source: Treuriandansialt.… Indicates data not available.

The case of Germany

Germany provides a good example of the policy trade-offs inherent in all privatization schemes. The German privatization agency, the Treuhandanstalt (THA), was founded in March 1990 by the government of former East Germany as a fiduciary trust for state property. On July 1, 1990, the date of economic, monetary, and social union between East and West Germany, THA was instructed to demonopolize East Germany’s industrial structure, privatize as many enterprises as possible, maintain a maximum of jobs, and seek new jobs for those who would lose their former jobs as a result of restructuring or privatization. This broadly defined mission seemed somewhat at odds with common tasks of a privatization agency, and in October 1990 when THA came under the control of West German managers and officials, the philosophy of the institution was streamlined to encompass “privatizing as quickly as possible, restructuring resolutely, and liquidating as carefully as possible,” as described by THA’s former president. This has been the philosophy of the institution ever since. It must be noted that THA has no explicit revenue objectives. In practice, the speed of privatization is clearly important; the decision to sell depends as much on the price that is offered as it depends on restructuring plans, particularly on promises of investment and job guarantees potential buyers are willing to give. With the focus on long-term benefits, the approach has meant that heavy short-term losses from privatization had to be tolerated.

THA’s deficit grew from below 0.2 percent of GDP in 1990 to over 1 percent of GDP in 1992 (Table 2). In addition, during 1990-92, THA incurred contingent liabilities of around 1 percent of GDP in the form of state guarantees that were issued. The upside of what appears to be a serious financial problem is that THA has managed to privatize or partially privatize over 11,000 enterprises during 1990-92, obtain employment guarantees for over 1.4 million jobs, and secure investment guarantees amounting to DM 169.5 billion, or over 6 percent of the 1992 GDP of West Germany. Still, the restructuring plans that have to be presented create some rigidities, and it remains to be seen whether private buyers will actually follow through on employment and investment guarantees. However, there are stiff financial penalties for defaulting, and THA has taken to court companies that default on guarantees, thereby providing a clear signal that no reneging will be tolerated. Hence, to the extent that defaults on guarantees do occur, privatization-related proceeds are likely to increase.

Policymakers in Germany certainly had more freedom to select their desired policy approach among the available options than policymakers in many other countries, particularly in developing countries and in Eastern Europe. Few other countries would be able to finance privatization-induced deficits of the size of Germany’s, at least not in a noninfla-tionary way. This is particularly true for countries with embryonic financial markets. Hence, countries with severe domestic financing constraints will be forced to pay more attention to privatization proceeds. This is likely to reduce the extent of efficiency gains, since it slows down the process of privatization and excludes a number of policy tools and strategies from being applied, most notably mass privatization. To prevent undue reductions in speed from limiting the extent of efficiency gains, a strong case may be made for broad international financial support of privatization and restructuring efforts in developing countries and in Eastern Europe.

Some emerging trends

How have policymakers responded to these various constraints and trade-offs? While countries have reacted quite differently, some common trends are emerging.

One common trend, which is particularly pronounced in countries where the private sector had long been stifled, is that privatization has been embedded in a program of broad liberalization and reform. These measures have ranged from creating the foundations of private sector development, such as legalizing private ownership and enacting bankruptcy laws, to measures indirectly related to privatization, such as reforming the banking sector and liberalizing the current and capital accounts of the balance of payments, thereby allowing for freer trade and foreign capital flows. Rapid progress in these areas is as important to the development of a vibrant private sector as privatization itself.

In Poland, for example, where progress on privatization has been relatively slow and reprivatization—that is, restitution of nationalized property to their former owners—remains undecided, the private sector accounted for close to 60 percent of employment and almost 45 percent of GDP in 1992, compared with less than 30 percent of GDP in 1989. In the former Czechoslovakia, where the private sector was only legalized in late 1990, but which has emphasized rapid and extensive privatization and reprivatization, the private sector accounted for 16-20 percent of GDP, compared with about 10 percent in 1991. In many other countries, including many of the states of the former USSR, privatization policies are implemented more slowly, and private sector growth has often proceeded independent of explicit privatization measures. Still, this growth is concentrated in specific sectors, such as retail trade and construction, but not in industry, where state ownership remains dominant.

A second trend, particularly pronounced in countries where policymakers want to pursue a range of policy objectives simultaneously, is to divide state-owned enterprises into different groups, and to pursue separate and specific privatization goals for each group of enterprises. Poland’s privatization program, for example, aimed at, inter alia, being a key mover of a rapid transition to a market-based economy, while preventing sales at unduly low prices; enhancing corporate governance and the efficiency of labor, capital, and management skills; improving the fiscal stance; ensuring a wide diffusion of private ownership; and being a key element of the program of debt equity swaps. While some of these objectives have since been modified or dropped altogether, others have been added, such as the need to give specific consideration to various population groups, including workers, pensioners, and state employees. This is not unlike other countries’ experiences where privatization is, implicitly or explicitly, becoming part of a broader discussion on distributional questions. In general, the more objectives that have to be satisfied, the more compartmentalized privatization schemes become in practice. As a result, in Poland, as in many other countries, privatization schemes have evolved into highly differentiated multidimensional arrangements, where new owners are carefully selected for some enterprises, prices are maximized for others, a strict time frame is pursued for yet another group, and investment guarantees or employment is safeguarded in yet a further group.

A third trend, and largely a corollary to the first two, is the broad mix of privatization tools used by most countries. This includes special programs for small enterprise privatization, enterprise liquidation schemes with asset sale or auction, leasing arrangements for state assets, management/employee buyouts/buy-ins, direct sales via trade sale or a public share offering to foreign or domestic investors, restitution to previous owners, and mass privatization. Usually, these tools are tailored to match particular privatization objectives. One-by-one asset auctions, for example, are most appropriate when policymakers wish to maximize privatization proceeds; special employee or management buy-out or leasing schemes target specific groups of potential buyers; mass privatization, designed to spread ownership rights of a large number of enterprises among the population, clearly emphasizes speed as a primary objective. Since mass privatization schemes eventually involve distributing a large number of ownership titles to the population, they are likely to work best in countries with developed domestic capital markets. Given the small size of their domestic capital markets, even countries like the former

Czechoslovakia, which emphasized speed as a primary objective and therefore selected mass privatization as a key policy tool, had to adopt a diversified approach to privatization that included many different tools.

A caveat is in order, however. While designing various tools and techniques has helped to tailor privatization schemes to particular groups of potential buyers, it has also complicated them, and, sometimes, the multiplication of tools has not been well controlled by governments, allowing insiders, usually company managers, to exploit the privatization process for their personal gain.


Privatization results have fallen short of expectations, particularly with respect to privatization proceeds; but, more likely, expectations were exaggerated to begin with. Evidence suggests that efficiency gains that are needed for improving a country’s fiscal stance will only materialize if privatization is accompanied by extensive industrial restructuring. Since this is costly, efficiency gains may only be achieved at the expense of net proceeds from privatization. In addition, policymakers may wish to pursue a broad range of policy objectives and, hence, may need different tools to tailor privatization to investors’ needs and ease some of the trade-offs. The range of possibilities is usually constrained by the availability of domestic financing, and, in the absence of international support, policymakers may have to give priority to budgetary considerations.

For a more detailed discussion, see Gerd Schwartz, “Privatization: Trade Offs, Experience, and Policy Lessons from Eastern European Countries,” in Vito Tanzi’s (ed.), Transition from Central Planning to Market Economies: Case Studies in Fiscal Reform(IMF, May 1993), and Paulo Silva Lopes, “Privatization, Indebtedness, and Fiscal Performance: A Budgetary Model and Recent Experience in Developing Countries” (IMF Working Paper, forthcoming).

Other Resources Citing This Publication