The word “privatization” entered popular usage only recently, and certainly the activity with which privatization has become most closely associated—the sale of public sector assets—is a distinct phenomenon of the 1980s. However, like the word itself, the various activities that have been described as privatization can claim a longer history.1 Policies designed to stimulate the substitution of private for public provision of various goods and services are not a recent innovation. But the wide range of public sector activities that are now being considered for privatization, the various methods being suggested to achieve this objective, and the enthusiasm with which privatization policy is in some cases being pursued distinguishes current privatization efforts from previous ones.
The growing appeal of privatization, especially in industrial countries, can in part be traced back to economic developments in the mid-1970s. Rapid public sector expansion in the 1960s and early 1970s was, at the time, seen as a major contributor not only to economic growth but also to social and political stability. The expanding role of the public sector in the economy was rarely challenged. But the situation changed drastically in the mid-1970s, when the inability of economies to adjust to external price shocks—in particular, the first round of oil price increases—led to a marked deterioration in macroeconomic performance. Subsequent recovery was slow, and part of the blame was leveled at large public sectors, which, it was argued, robbed the economy of the flexibility it needed to achieve the necessary adjustment. At the same time, both the efficiency and effectiveness of public sector activities began to be questioned seriously. In a number of countries—most notably the United Kingdom and the United States—the backlash against the public sector was given additional impetus by the election of governments pledged to reducing the size and scope of government. To varying degrees, and in all its forms, privatization was expected to play a significant role in achieving such a reduction.
Privatization has also been frequently recommended for developing countries, where the industrial sector and, occasionally, key elements in the commercial sector, are heavily dominated by public enterprises. Loss-making enterprises have, for many years, been a drain on government resources in these countries. Such enterprises have required direct budgetary transfers or have relied on government-guaranteed borrowing to finance their cash operating losses. Recently, the wider macroeconomic problems that have afflicted developing countries have forced them to reconsider their strategies for dealing with public enterprises. In particular, many of the countries that have adopted Fund-supported adjustment programs have been trying to address the problems that give rise to the need for financial support of public enterprises, and privatization has, in a number of cases, been considered as a way of relieving governments of their heavy involvement in industry and commerce.2
This paper will examine the role that privatization can play within a wider strategy designed to overcome the problems associated with public enterprises. For this purpose, privatization is defined as a transfer of ownership and control from the public to the private sector, with particular reference to asset sales. It is therefore equated with total or partial denationalization. The paper will for the most part skirt the detail of privatization initiatives in various countries—many of which have been reviewed elsewhere (see Berg (1983) and (1985))—and try to address some general issues that arise in evaluating the potential role of privatization. Section II briefly reviews the arguments used to support public production and nationalization, discusses the performance of public enterprises, and identifies the problems to which privatization can be seen as a direct response. These problems include the tendency for politicians to interfere in public enterprise operations; the inability of politicians and civil servants to monitor enterprise managers effectively; inappropriate managerial incentives; and the availability of financial support from the government with only limited constraints. As a consequence, public enterprises are often inefficient and incur losses. Advocates of privatization claim that it will lead to improved economic performance as the scope for political interference is limited, the discipline of the private capital market is imposed, and managerial incentives are improved. It is also claimed that privatization will reduce the budgetary cost associated with inefficiency; in addition, any sale proceeds will directly benefit public finances. Section III outlines these and other arguments used in support of privatization, while also focusing on techniques of privatization and problems of implementation, in particular, asset valuation, marketing, and financing. These problems are illustrated with country experiences, especially the ambitious program of asset sales under way in the United Kingdom and France.
Sections IV and V examine, in analytical terms, the likely impact of privatization. While changes in ownership can lead to increases in productive efficiency (that is, to lower production costs), the paper points to the possibility that such increases may be only modest. Significant gains in efficiency are most likely to result from the privatization of some of the major public monopolies, but only if this results in their being exposed to competition. The transfer of a public monopoly to the private sector, with its monopoly power left intact, may achieve only limited increases in productive efficiency. Moreover, it is unlikely to increase allocative efficiency—that is, to lead to a structure of output more highly valued by consumers given social costs of production. If the opportunity to secure economic efficiency—that is both productive efficiency and allocative efficiency—is to be fully exploited, privatization should be accompanied by liberalization, to foster competition, and by regulation, to prevent anticompetitive practices.
In economic terms, the scope for effective privatization in the public enterprise sector depends upon a number of considerations: whether private sector managers have a greater incentive than public sector managers to seek out opportunities to improve efficiency; the number of public enterprises facing national or international competition; the extent to which public monopolies should be regarded as “natural”; and the importance of social and other non-commercial (such as macroeconomic) objectives. In view of such considerations, privatization is not likely to be extensive relative to the size of public enterprise sectors in either industrial or developing countries. As a result, the improvement of incentive mechanisms and statutory and administrative procedures currently employed to secure economic and financial control of public enterprises, as well as the search for alternatives to privatization, will need to be given a high priority. Regarding public finances, it is argued that changes in ownership alone offer few lasting budgetary benefits unless privatization is associated with increased efficiency.
Section VI discusses the implications for adjustment policies arising from the principal conclusions of this paper. Privatization should be encouraged to the extent that it fosters more active competition and improves existing incentive and control mechanisms for public enterprises. It should be noted, however, that if privatization involves no more than a transfer of activities from the public to the private sector, it may yield only limited gains.
The words “privatize” and “privatization” appeared for the first time in the 1983 edition of the Webster’s Ninth New Collegiate Dictionary, where their earliest recorded use is given as being in 1948. However, S.H. Hanke claims responsibility for popularizing these words while serving on the U.S. President’s Council of Economic Advisers in 1981 and 1982 (Washington Post, January 13, 1986).
See International Monetary Fund (1986) for a listing of Fund supported adjustment programs for the period 1980-84 containing references to privatization.