Benefits

Privatization is seen primarily as a means of improving the efficiency of enterprises. Because it is believed to limit the scope for political interference in decision making, to increase managerial incentives by making managers responsible to shareholders who will monitor their performance better than governments, and to impose the financial discipline of private capital markets (including the market for corporate control), there is likely to be an incentive to seek productive efficiency, and fewer barriers to attaining it.

Other benefits are also claimed. Through privatization, an enterprise can gain access to private sector financing, and private owners may bring access to new markets. If the sale of public sector assets can be made attractive to small investors, this will broaden share ownership, which may be thought desirable. Privatization may also spur the development of domestic capital markets, and, it has been argued, lead to a reduction in public sector deficits, especially if the government can dispose of loss-making enterprises. In addition, it may disarm public sector trade unions that are abusing a monopoly position. Advocates of privatization also tend to associate it with increased competition and hence improvements in allocative efficiency.

Privatization may also benefit enterprises that remain within the public sector. For these enterprises, increased efficiency will result principally from improvements to existing incentive and control mechanisms. If a significant number of public enterprises can be transferred to the private sector, the government should be better placed to focus on the objectives, conduct, and performance of those enterprises that it remains responsible for. There is also a potential role for such privatization techniques as contracting out and franchising, which fall short of total or even partial denationalization.

The main arguments made in support of privatization are discussed later in the paper. In particular, Section IV examines efficiency issues while Section V analyzes the impact of privatization on government finances. The remainder of this section focuses on techniques of privatization, national experiences and prospects, and practical problems of implementation.

Techniques

The term “privatization” has been used to refer to any shift in activity from the public to the private sector. This could involve no more than the introduction of private capital or management expertise into a public sector activity. For the moment, however, we will concentrate on the transfer of ownership of public enterprises to the private sector.⁶ Ownership can be transferred in a variety of ways. An enterprise may be sold in its entirety to a buyer in private industry engaged in a similar activity or seeking to diversify; to the management and employees; or to the public through a share issue. Alternatively, a part of the whole may be sold, probably to a private buyer with a related interest. This may be appropriate where the enterprise as a whole is not attractive to a private buyer—because some of its activities are heavily regulated, for example—but where other activities can be separated from the whole and run independently. Where salable parts cannot be identified, a proportion of the whole can be sold, the exact percentage depending upon how much control the government wishes to retain over the enterprise.

A change in ownership need not involve a sale. An enterprise can be privatized by handing over ownership by means of, say, a nominal sale to a private individual, to a private concern, or to a particular interest group, most likely the management or employees of an enterprise. Such a “giveaway” may be appropriate where heavy losses, massive debts, or a history of labor troubles make an enterprise unattractive to a specific buyer or to the wider public. As a final resort, an enterprise can simply be liquidated, and its plant and equipment sold off to the private sector. There are many other privatization techniques—Pirie (1985) identifies over twenty—but they do not involve changes in ownership.

Once privatization is adopted as a policy, a number of practical problems, such as asset valuation, marketing, and financing, have to be addressed before it can be implemented. The following section reviews recent privatization developments and what is in immediate prospect. It cites specific examples of the problems associated with privatization, particularly in the United Kingdom, where sales of public sector assets have been extensive. This review serves to illustrate some of the problems that are then discussed.

Experiences and Prospects

The United Kingdom

As of April 1987, the United Kingdom had raised £12.0 billion through a privatization program that commenced in 1979. The sale of a majority stake in British Telecom yielded £4.1 billion, while the sale of British Gas (the largest share issue ever made), which so far has generated £1.8 billion, will eventually yield £5.1 billion. Details of the major enterprise sales are shown in Table 1.⁷ In each case, sale was by one of two methods or a combination of both, namely, the sale of equity by tender and offers for sale at a fixed price. The latter has been the more common. Both types of sale presented problems, with tenders failing to reach reserve prices and, most notably, offers being oversubscribed, the market initially establishing large discounts, with the offer price significantly below the subsequent market price.

Table 1.

United Kingdom: Privatization of Major Public Enterprises, February 1981 to January 1987

Source: Yarrow (1986), Table 1; and data provided by the United Kingdom authorities.

¹Dates shown indicate initial offering.

²Of which £334 million in 1982/83 and £293 million in 1983/84.

³Of which, £1,352 million in 1984/85, £1,246 million in 1985/86, and £1,084 million in 1986/87. Also included is £408 million generated by the sale of British Telecom stock and preference shares.

⁴Total estimated proceeds are £5,090 million, with the second installment having been due in June 1987 and the third installment due in April 1988. In addition, £750 million of British Gas debt was redeemed in May 1987.

⁵Total estimated proceeds are £825 million, with the second installment paid in August 1987.

Table 1.

United Kingdom: Privatization of Major Public Enterprises, February 1981 to January 1987

Date1	Enterprise	Proceeds (In millions of £)
February 1981	British Aerospace	43
October 1981	Cable & Wireless	181
November 19832	Britoil	627
December 1983	Cable & Wireless	263
June 1984	Enterprise Oil	382
July 1984	Jaguar Cars	297
November 19843	British Telecom	4,090
May 1985	British Aerospace	346
August 1985	Britoil	426
December 1985	Cable & Wireless	571
December 19864	British Gas	1,796
January 19875	British Airways	415

Source: Yarrow (1986), Table 1; and data provided by the United Kingdom authorities.

¹Dates shown indicate initial offering.

²Of which £334 million in 1982/83 and £293 million in 1983/84.

³Of which, £1,352 million in 1984/85, £1,246 million in 1985/86, and £1,084 million in 1986/87. Also included is £408 million generated by the sale of British Telecom stock and preference shares.

⁴Total estimated proceeds are £5,090 million, with the second installment having been due in June 1987 and the third installment due in April 1988. In addition, £750 million of British Gas debt was redeemed in May 1987.

⁵Total estimated proceeds are £825 million, with the second installment paid in August 1987.

View Table

Table 1.

United Kingdom: Privatization of Major Public Enterprises, February 1981 to January 1987

Date1	Enterprise	Proceeds (In millions of £)
February 1981	British Aerospace	43
October 1981	Cable & Wireless	181
November 19832	Britoil	627
December 1983	Cable & Wireless	263
June 1984	Enterprise Oil	382
July 1984	Jaguar Cars	297
November 19843	British Telecom	4,090
May 1985	British Aerospace	346
August 1985	Britoil	426
December 1985	Cable & Wireless	571
December 19864	British Gas	1,796
January 19875	British Airways	415

Source: Yarrow (1986), Table 1; and data provided by the United Kingdom authorities.

¹Dates shown indicate initial offering.

²Of which £334 million in 1982/83 and £293 million in 1983/84.

³Of which, £1,352 million in 1984/85, £1,246 million in 1985/86, and £1,084 million in 1986/87. Also included is £408 million generated by the sale of British Telecom stock and preference shares.

⁴Total estimated proceeds are £5,090 million, with the second installment having been due in June 1987 and the third installment due in April 1988. In addition, £750 million of British Gas debt was redeemed in May 1987.

⁵Total estimated proceeds are £825 million, with the second installment paid in August 1987.

Determining the market price of a public enterprise in advance of a sale is difficult since there is very little information on which to base an estimate. Selling by tender would, therefore, seem to be logical, especially where the enterprise has no private sector comparator. However, this has been regarded as too complex a method of sale to secure the participation of small investors, which is an objective of privatization policy in the United Kingdom. Offers for sale have met with some or all of the problems mentioned above. For example, in the case of Amersham International, a small radionics firm, an offer for sale of 100 percent of equity in 1982 was oversubscribed 25 times. The sale yielded £64 million. Subsequent trading established an immediate discount of over 30 percent on the sale and most of the original 65,000 shareholders sold out to the large institutions at a considerable profit.

This is not an isolated example. Mayer and Meadowcroft (1985) report continued oversubscription and an average discount of 26 percent on a range of sales between 1979 and 1985.⁸ They also report that in most cases subsequent trading resulted in a large reduction in the number of people holding shares in the enterprises concerned. Only in the case of Britoil did the number of shareholders subsequently increase, but the sale by tender of the first tranche of Britoil shares was initially unattractive to small investors. In the case of British Telecom, the government took a number of measures to encourage share purchases, and persuade shareholders to hold on to their initial allocation. These efforts appear to have succeeded, despite an immediate discount of almost 100 percent, and a larger subsequent discount. The original 2.3 million shareholders have only fallen to about 1.7 million. More extensive measures accompanied the sale of British Gas, and these resulted in over 4 million successful applications for shares. These measures, combined with a relatively modest discount of about 20 percent appear to have persuaded shareholders, on the whole, to retain their initial allocations.

The experience in the United Kingdom with other forms of asset transfer is limited. There have been a number of instances of complete parts of a whole enterprise being sold—for example, the sale of hotels and the cross-Channel ferry service run by British Rail, a communications subsidiary of British Airways, and a subsidiary of the British Steel Corporation. The National Freight Company and the Redheads ship repair yard were sold to their workforces. And, in one case, an operation—the cross-Channel hovercraft service run by British Rail—was given to its workforce.

Notwithstanding the problems associated with offers for sale, recent figures suggest that privatized enterprises have improved their profits and the managers of some of these enterprises attribute the improvement mainly to the freedom to pursue commercial objectives unhampered by government interference in decision making.⁹ It is important to note, however, that much of the improvement in profitability occurred over a period when the economy was recovering from a major recession. In many cases profits were increasing prior to privatization, and enterprises that remained in the public sector were also reporting bitter financial results. It is therefore not clear what part privatization has played in this improvement.¹⁰ The only failure in this respect has been the Redheads ship repair yard, which was in severe financial trouble less than two years after privatization and was subsequently taken over by another ship repair yard. This was not wholly unexpected, and should not be regarded as reflecting badly on the privatization strategy; since an objective of privatization is to separate those commercial enterprises that can compete in the private sector from those that cannot, it represents a successful aspect of the strategy.

While there must remain some uncertainty as to the overall economic impact of the U.K. Government’s privatization program, it has clearly caught the imagination of the British public (of whom eight to nine million were shareholders in privatized enterprises in 1987) and created interest throughout the world. The U.K. Government has recently announced plans to privatize the British Airports Authority; attention is then expected to turn to the electricity supply industry, with the nationalized steel, coal, railway, and water supply sectors representing possible but less likely candidates for privatization.

France

The French Government announced a five-year privatization plan in mid-1986. Sixty-five enterprises and subsidiaries—including major banks, insurance companies, financial holding groups, and industrial groups—were covered by the plan. Considerable progress has been made by way of implementation. Beginning in October 1986, 13 enterprises had been sold by June 1987 with proceeds of over FF 55 billion; the major sales are listed in Table 2. The investment banking group Suez was due to be sold in October 1987, with five other major privatizations, including leading insurance companies and banks, planned to take place before mid-1988.

Table 2.

France: Major Privatizations, November 1986 to June 1987

Source: Data provided by the French authorities.

Table 2.

France: Major Privatizations, November 1986 to June 1987

Date	Enterprise	Proceeds (In billions of FF)
November 1986	St. Gobain	8.2
January 1987	Paribas	12.6
April 1987	Crédit Commercial de France	2.0
May 1987	Compagnie Générale d’Electricité	10.0
May 1987	Havas	2.5
June 1987	Société Générale	17.0
June 1987	TFI (television station)	4.5

Source: Data provided by the French authorities.

View Table

Table 2.

France: Major Privatizations, November 1986 to June 1987

Date	Enterprise	Proceeds (In billions of FF)
November 1986	St. Gobain	8.2
January 1987	Paribas	12.6
April 1987	Crédit Commercial de France	2.0
May 1987	Compagnie Générale d’Electricité	10.0
May 1987	Havas	2.5
June 1987	Société Générale	17.0
June 1987	TFI (television station)	4.5

Source: Data provided by the French authorities.

Some of the problems associated with privatization in the United Kingdom have been largely avoided in France. Except in the case of the glassmaker St. Gobain, market discounts appear to have been small, reflecting the relative ease of valuation given the smaller size of the enterprises involved and the existence of national and international competitors. Partly reflecting the smaller discounts, shareholders have also tended to retain their initial share allocations; as a result, the number of individual shareholders in France has increased fourfold since the privatization program commenced and there has been a substantial mobilization of savings for investment in the stock market. The fact that the proceeds of the sales are to be used to repay debt and to increase the capital of other public enterprises has been particularly welcomed.

Other Countries

Information about privatization in countries other than the United Kingdom and France is mostly sketchy. Table 3 summarizes recent developments in selected countries, focusing on asset sales; other forms of privatization, including the award of foreign management contracts, leasing, and liquidation are more widespread but still remain relatively infrequent events. It appears that only a small number of countries have made significant advances, and that so far privatization is mainly an industrial-country phenomenon. In addition to the industrial countries referred to in Table 3, Canada, the Netherlands, and Spain have privatized some public enterprises. Among developing countries, the achievements of Chile, Malaysia, and Niger appear to be the most extensive in their respective geographical regions. Other countries that have started implementing a privatization strategy include Brazil, Mexico, Côte d’Ivoire, Senegal, Zaïre, Bangladesh, the Philippines, Singapore, and Sri Lanka. Perhaps the main feature of privatization in countries other than the United Kingdom is the concentration of sales in the industrial and service sectors, with the traditional public enterprises, and in particular the public utilities, remaining largely unaffected. The partial privatization of the Japanese telecommunications company, NTT, and the Malaysian national airline, MAS, represent notable exceptions.

Table 3.

Privatization in Selected Industrial and Developing Countries¹

Sources: Berg (1985); “Privatization: Everybody’s Doing it Differently,” The Economist (London), December 21, 1985; “Private Affair in Asia,” Far Eastern Economic Review (Hong Kong), July 25, 1985, supplemented with material from periodicals, newspapers, wire services, and various unpublished reports.

¹A forthcoming World Bank report on privatization will contain a more detailed review of privatization initiatives in industrial and developing countries.

Table 3.

Privatization in Selected Industrial and Developing Countries¹

Chile

In the mid-1970s a large number of enterprises taken over by the Allende—Popular Unity—Government were denationalized. More recently, in 1983 the government intervened to prevent bank failures. Two of these banks, Concepción and Internacional, were capitalized and sold to the private sector in 1986. A third, Colocadora, was merged with Banco de Santiago. All shares in Banco de Santiago and Banco de Chile, were sold to over 57,000 shareholders. By end-1986, CORFO, the Chilean Development Corporation and its affiliates, sold over 50 percent of the shares of the following enterprises: CHILMETRO (urban transport-metro), CHILQUINTA (electricity distribution), SOQUIMICH (nitrates), and CAP (iron ore). Shares in CTC (domestic telecommunications), ENTEL (international telecommunications), CHILGENER (electricity generation), IANSA (sugar), and LAB Chile (airline), were also sold, although private sector holdings in these companies remain below 50 percent of the total. Shares in the power company, CHILECTRA, have been on sale since 1985.

Federal Republic of Germany

After a number of small sales, in 1984 the Government received about DM 800 million from the sale of a 14 percent stake in the energy and chemicals conglomerate VEBA. In 1986 it received DM 50 million from the sale of 40 percent of VIAG, the aluminum and chemicals group, and DM 163 million from the sale of 45 percent of IVG, with interests in transportation and property. The remainder of the Government’s holding in VEBA was sold in 1987, for DM 2.4 billion. Forthcoming sales include the Government’s 16 percent share of Volkswagen, more than half its 95 percent share of Prakla-Seismos, an oil and gas exploration company, and some financial institutions.

Italy

In response to widening deficits, a program to strengthen the finances of the major state holding companies—IRI, ENI, and EFIM—was commenced in 1982. Privatization forms part of this program. Thus between 1983 and September 1986 IRI divested itself of enterprises valued at Lit 775 billion, with five banks being sold for Lit 610 billion and an additional Lit 165 billion being raised from the sale of 23 smaller industrial enterprises. Since 1985, IRI has sold holdings in a number of larger enterprises—including STET and SIRTI (telecommunications), SIP (telephone utility) and ALITALIA (airline)—raising Lit 3,410 billion. In addition to selling shares on the domestic stock market, funds have also been raised on London’s Euro-equity market and from IRI employees.

Japan

In 1985 Nippon Telegraph and Telephone (NTT) was recast as a private stock corporation. Half the total shares (about 6 billion) are in the process of being sold, the completion date for the sale being 1989. The sale proceeds are being used to repay government debt and to finance public investment. The Japan Tobacco Industry became a private stock corporation at the same time, but there are as yet no plans to sell shares. In April 1987, Japan National Railways (JNR) was broken up into several regional companies, in preparation for privatization. In September 1987, a bill to privatize Japan Air Lines (JAL) was approved by the Diet, and the Government’s 43.5 percent shareholding will be sold by the end of the year.

Malaysia

Since 1985, the Malaysian Government has sold a 49 percent of its holding in Malaysian Airline System Berhad, a 17 percent holding in the Malaysian International Shipping Corporation, and half of its holding in the Port Kelong container terminal. There have also been a number of smaller sales. The Telecommunications Department is being prepared for sale over the next two to three years. In addition, the Malayan Railway, the National Electricity Board, and the Postal Department are listed among candidates for future sale.

Niger

A number of enterprises were privatized in recent years. These include SONIDEP (petroleum distribution), SONITEXTIL (textiles), SOTRAMIL (millet processing), RINI (rice milling), SNCP (hides and skins), LEYMA (insurance), NITRA (freight forwarding), and INN (government printing office). Some sales have been made to Nigerian interests.

Turkey

In 1984/85, TL 50 billion (US$114 million) was raised by selling certificates entitling holders to a share of the revenue from the Bosphorus Bridge (34 percent) and the Keban Dam (22 percent). A new dam is being financed in a similar way. In 1987, the Government began to sell its minority interest in a number of small private companies. More extensive privatization is planned, with the petrochemical producer, Petkim, the hotel chain, Turban, and parts of Turkish Airlines among the likely sales.

Sources: Berg (1985); “Privatization: Everybody’s Doing it Differently,” The Economist (London), December 21, 1985; “Private Affair in Asia,” Far Eastern Economic Review (Hong Kong), July 25, 1985, supplemented with material from periodicals, newspapers, wire services, and various unpublished reports.

¹A forthcoming World Bank report on privatization will contain a more detailed review of privatization initiatives in industrial and developing countries.

View Table

Table 3.

Privatization in Selected Industrial and Developing Countries¹

Chile

In the mid-1970s a large number of enterprises taken over by the Allende—Popular Unity—Government were denationalized. More recently, in 1983 the government intervened to prevent bank failures. Two of these banks, Concepción and Internacional, were capitalized and sold to the private sector in 1986. A third, Colocadora, was merged with Banco de Santiago. All shares in Banco de Santiago and Banco de Chile, were sold to over 57,000 shareholders. By end-1986, CORFO, the Chilean Development Corporation and its affiliates, sold over 50 percent of the shares of the following enterprises: CHILMETRO (urban transport-metro), CHILQUINTA (electricity distribution), SOQUIMICH (nitrates), and CAP (iron ore). Shares in CTC (domestic telecommunications), ENTEL (international telecommunications), CHILGENER (electricity generation), IANSA (sugar), and LAB Chile (airline), were also sold, although private sector holdings in these companies remain below 50 percent of the total. Shares in the power company, CHILECTRA, have been on sale since 1985.

Federal Republic of Germany

After a number of small sales, in 1984 the Government received about DM 800 million from the sale of a 14 percent stake in the energy and chemicals conglomerate VEBA. In 1986 it received DM 50 million from the sale of 40 percent of VIAG, the aluminum and chemicals group, and DM 163 million from the sale of 45 percent of IVG, with interests in transportation and property. The remainder of the Government’s holding in VEBA was sold in 1987, for DM 2.4 billion. Forthcoming sales include the Government’s 16 percent share of Volkswagen, more than half its 95 percent share of Prakla-Seismos, an oil and gas exploration company, and some financial institutions.

Italy

In response to widening deficits, a program to strengthen the finances of the major state holding companies—IRI, ENI, and EFIM—was commenced in 1982. Privatization forms part of this program. Thus between 1983 and September 1986 IRI divested itself of enterprises valued at Lit 775 billion, with five banks being sold for Lit 610 billion and an additional Lit 165 billion being raised from the sale of 23 smaller industrial enterprises. Since 1985, IRI has sold holdings in a number of larger enterprises—including STET and SIRTI (telecommunications), SIP (telephone utility) and ALITALIA (airline)—raising Lit 3,410 billion. In addition to selling shares on the domestic stock market, funds have also been raised on London’s Euro-equity market and from IRI employees.

Japan

In 1985 Nippon Telegraph and Telephone (NTT) was recast as a private stock corporation. Half the total shares (about 6 billion) are in the process of being sold, the completion date for the sale being 1989. The sale proceeds are being used to repay government debt and to finance public investment. The Japan Tobacco Industry became a private stock corporation at the same time, but there are as yet no plans to sell shares. In April 1987, Japan National Railways (JNR) was broken up into several regional companies, in preparation for privatization. In September 1987, a bill to privatize Japan Air Lines (JAL) was approved by the Diet, and the Government’s 43.5 percent shareholding will be sold by the end of the year.

Malaysia

Since 1985, the Malaysian Government has sold a 49 percent of its holding in Malaysian Airline System Berhad, a 17 percent holding in the Malaysian International Shipping Corporation, and half of its holding in the Port Kelong container terminal. There have also been a number of smaller sales. The Telecommunications Department is being prepared for sale over the next two to three years. In addition, the Malayan Railway, the National Electricity Board, and the Postal Department are listed among candidates for future sale.

Niger

A number of enterprises were privatized in recent years. These include SONIDEP (petroleum distribution), SONITEXTIL (textiles), SOTRAMIL (millet processing), RINI (rice milling), SNCP (hides and skins), LEYMA (insurance), NITRA (freight forwarding), and INN (government printing office). Some sales have been made to Nigerian interests.

Turkey

In 1984/85, TL 50 billion (US$114 million) was raised by selling certificates entitling holders to a share of the revenue from the Bosphorus Bridge (34 percent) and the Keban Dam (22 percent). A new dam is being financed in a similar way. In 1987, the Government began to sell its minority interest in a number of small private companies. More extensive privatization is planned, with the petrochemical producer, Petkim, the hotel chain, Turban, and parts of Turkish Airlines among the likely sales.

Sources: Berg (1985); “Privatization: Everybody’s Doing it Differently,” The Economist (London), December 21, 1985; “Private Affair in Asia,” Far Eastern Economic Review (Hong Kong), July 25, 1985, supplemented with material from periodicals, newspapers, wire services, and various unpublished reports.

¹A forthcoming World Bank report on privatization will contain a more detailed review of privatization initiatives in industrial and developing countries.

Despite only limited progress, interest in privatization is clearly worldwide. In many countries a principal motive behind actual and planned privatization is to reduce the government resources flowing to the enterprise sector (the Federal Republic of Germany, Spain, Senegal, Niger); a need for additional revenue to secure a reduction in budget deficits is also apparent (Canada, the Netherlands); improving efficiency through promotion of the private sector is often mentioned (Malaysia, Sri Lanka); and in some cases the objective is to reprivatize failing enterprises that have been taken over by the government (Bangladesh, Chile, the Philippines). In several countries the World Bank Group has promoted privatization as part of its structural adjustment programs. Elsewhere the impetus has been provided by the United States Agency for International Development. While the Fund has supported adjustment programs which refer to privatization, the Fund has not used conditionality as a means of promoting privatization as such.

Notwithstanding the motivation behind privatization and the external support it attracts, there remains a marked divergence between stated intentions and follow-up action. Rather stark examples of this are provided by countries such as Kenya, Jamaica, and Peru, where negligible progress has been made in implementing relatively large programs. Such divergence reflects a variety of factors, including the inevitable gap between ideological rhetoric and a real intention to act. But in many cases it is probably too early to assess the true divergence, since the typical lead time has yet to be established. Seemingly overambitious plans may yet come to fruition, and initiatives being formulated by other countries may also take time to implement. In this respect, practical problems that need to be overcome before a privatization program can be successfully implemented should not be underestimated, especially in developing countries.

Problems of Implementation

The U.K. experience shows that even in a sophisticated financial environment, where shares are routinely traded in large volume and high quality advice can be readily obtained, it is difficult to establish the market value of an enterprise before its sale. A number of factors contribute to this difficulty: the size of the enterprise being sold; the uncertainty regarding the structure of the market in which an enterprise will operate; the impact of any regulatory control that will accompany privatization; and the extent to which the private sector sees opportunities to improve the efficiency of privatized enterprises that the public sector ignores. Undervaluation of assets can be costly. For example, the British Telecom sale may have cost the U.K. Government as much as £3—4 billion in forgone sale proceeds.¹¹ But with the smaller underpriced issues, the loss has been correspondingly smaller, suggesting that where large share issues are involved, the risk of underpricing can be reduced by selling in small lots to establish a trading price before the majority of shares is placed on the market. This practice is to be adopted when the U.K. Government sells the British Airports Authority: a quarter of the shares are to be sold by tender and then the remaining three quarters will be offered for sale at a price reflecting that established in the sale by tender.

In the case of enterprises that are too small to market in parts, or where an enterprise will be sold directly to a single buyer, valuation will remain difficult. However, one possibility would be to yield control while selling in several phases, with the sale being structured so that long-term financial performance forms the basis for a final valuation, while an interim sale price is based on short-term performance. This would certainly make it easier to sell loss-making enterprises, since no initial sale price need be stated at the time of a change in management, and the ultimate price could take into account any turnaround in performance under private management. If such an arrangement is attractive, there is in fact no need to contemplate changing ownership until an enterprise has spent an extended period under private management. For example, a government could enter a management contract with the private sector, or lease an enterprise to the private sector, for a number of years prior to sale.

Valuation problems are compounded in developing countries. In many cases neither the private sector of the economy nor the capital market is sufficiently developed to yield even an approximate valuation. While international markets could help in this respect, the restrictions that are often placed on the involvement of foreigners and nonresident nationals limit this possibility. And even where a market value can be established, the thinness of domestic capital markets necessarily places limits on the ability to finance privatization from domestic resources. In the United Kingdom and other industrial countries there are large, well-established capital markets. Many developing countries, particularly in Africa, do not have a stock market, and those that do exist are often very small.¹² In Peru, for example, the privatization program was never implemented because the planned asset sales (equivalent to about 3 percent of GDP in the early 1980s (Berg, 1983) were too large in relation to available private sector resources.

In this respect, an advantage of privatization, by necessity only on a small scale initially, is that it may promote the development of indigenous capital markets. Any increase in the range of assets available to domestic savers may lead to increased saving and to the substitution of shares in privatized enterprises for cash holdings, and real and foreign assets. In Turkey, for example, the sale of bonds secured by revenues from the Bosphorus Bridge and the Keban Dam, financed largely by gold sales, is claimed to have been a major influence on the growth of the capital market. As in the Turkish case, a minimum income may have to be guaranteed to shareholders to induce them to participate in a market where the availability of, and access to, information is necessarily limited. This is especially important in developing countries where there is the risk that profits will be squandered rather than distributed to shareholders.

If the domestic capital market cannot be sufficiently developed, other alternatives will have to be explored. For example, an often neglected source of finance is the workforce of an enterprise. A privatization package could be set up allowing workers to receive shares in an enterprise in return for agreeing to repay the government, or to relinquish a claim against it. In practice, this could mean that a share of wages would go to the government for a specified period. In effect, the government would be bearing part of the operating risk even after privatization—it would not receive full payment if the enterprise failed—and this could be seen as a way of compensating for informational inadequacies. Alternatively, workers could give up their termination benefits or part of their accrued pension rights, which in many cases would be greater than if they had worked in the private sector.

Debt-to-equity conversions also offer a potential source of finance. A number of Latin American countries, most notably Argentina, Brazil, Chile, and Mexico, are allowing foreign banks to exchange debt for equity. Typically, the foreign creditor will sell debt to a third party seeking an equity position in the country concerned. The debt is sold at a discount in the secondary market, but a participating bank benefits because it divests itself of a possibly trouble-some loan and can reorganize its portfolio. The debtor government will convert the debt into domestic currency as long as the proceeds are used to finance approved local investment; this will directly serve growth and other development objectives. Such a procedure also reduces a country’s external debt burden without drawing on scarce foreign exchange. The investor—often a multinational company—also benefits from the reduced effective exchange rate at which local assets are acquired. These advantages—which may or may not wholly materialize—combined with the fact that public enterprise debt forms a large share of total external debt in developing countries, can facilitate the privatization process.

One of the objectives of privatization in the United Kingdom has been to widen the ownership of shares, so the issue of proper marketing is important. As indicated above, the initial results of the U.K. Government’s attempts to encourage share ownership by individual investors were poor as individuals sold out their holdings mainly to the financial institutions. In part, this reflects the bias of the U.K. tax system against individual saving and in favor of collective saving (see Kay and King (1983)). But it is mainly a reflection of the profits to be made by purchasers as a result of the underpricing of shares. Despite continued underpricing, privatization has recently achieved greater success in securing wider share ownership as shareholders have responded to incentives designed to discourage quick sales. Moreover, in the 1986 budget, the U.K. Government introduced a personal equity plan giving tax incentives to hold shares.

Many developing countries, by contrast, wish to limit participation to particular groups of shareholders and, to this end, exclude potential buyers. In addition to foreigners and nonresident nationals, ownership by certain ethnic or social groups is often unacceptable. This may be a principal reason why privatization is proceeding so slowly. Brazil, Kenya, and Malaysia are countries where restrictions on desirable shareholders have been a major impediment to privatization. But these restrictions are not found exclusively in developing countries. For example, Japan is not allowing foreign purchases of shares in the telecommunications company, NTT. Also, both the British and French privatization programs have, formally or informally, imposed restrictions on foreign ownership.