Abstract

This paper has argued that privatization should be assessed in terms of its effect on economic efficiency. Economic efficiency is not only the key to improving the performance of the public enterprise sector, but is also the source of other gains often attributed to privatization, in particular, its favorable budgetary impact. Many of the other benefits ascribed to privatization—for example, reducing the power of public sector unions and widening share ownership—are unlikely to be related to efficiency gains. And if they are indeed desirable, they can probably more effectively be achieved by other policies, such as trade union reform and tax incentives to promote saving.

This paper has argued that privatization should be assessed in terms of its effect on economic efficiency. Economic efficiency is not only the key to improving the performance of the public enterprise sector, but is also the source of other gains often attributed to privatization, in particular, its favorable budgetary impact. Many of the other benefits ascribed to privatization—for example, reducing the power of public sector unions and widening share ownership—are unlikely to be related to efficiency gains. And if they are indeed desirable, they can probably more effectively be achieved by other policies, such as trade union reform and tax incentives to promote saving.

To public enterprises that are subject to national or international competition, privatization offers the possibility of increased productive efficiency as government financial backing is withdrawn and bankruptcy and take-over become possibilities. But if a public monopoly is transferred to the private sector with its monopoly power intact, there may be little additional incentive to improve efficiency, although the risk of bankruptcy and takeover may prevent excessive inefficiency in small monopolies. Far more success can be expected if privatization is accompanied by increased competition, and privatization of public monopolies will lead to more competitive or contestable markets only if accompanied by active competition policy. Privatization is neither necessary nor sufficient to create a competitive or contestable market.

The question does arise, however, whether privatization facilitates the promotion of competition. Recent discussions of privatization have certainly increased awareness of competition policy issues. From a political point of view, it may also be easier to liberalize in the context of a privatization strategy. In this context, though, it is necessary to warn against the temptation (observed in some cases) to restrict competition—for example, to make public sector assets more attractive to private buyers—and to note that market failure may prevent the emergence of competition, while in other cases competition may be inappropriate or difficult to enforce. The impact of privatization on economic efficiency in one of the few countries with sufficient history of privatization—the United Kingdom—is difficult to assess. For example, Brittan (1986) concludes that the choice is between “slightly better than nothing” and “slightly worse than nothing.” His own verdict is the former, based upon his observation that “faced with the charge of simply creating private monopolies, the Government is impelled to introduce some competitive elements… Some moves to promote competition are better than none at all” (p. 38). Does this conclusion necessarily extend to privatization in general, and the impact of privatization in developing countries in particular?

The admissibility and desirability of privatization, as well as what types of enterprise should be privatized, ought to be determined by similar considerations in both industrial and developing countries. However, given the different structure and objectives of the public enterprise sector in developing countries, the character of any privatization program is likely to be very different from that of the United Kingdom, or those programs contemplated by other industrial countries.21 The excesses of the public enterprise sector—political interference, gross mismanagement, and the proportion of resources devoted to its support—are far greater in developing countries than in industrial countries. Many enterprises are simply not viable and should be disposed of, while a significant proportion of commercial enterprises face or could face competitive pressures, but currently benefit from budgetary support or artificial barriers that protect them from competition, in particular trade restrictions. Unless a strong case, based on social or other noncommercial objectives, can be made for retaining such enterprises in the public sector, privatization, accompanied by the elimination of protection, would appear appropriate. On these grounds, the scope for efficiency-enhancing privatization therefore appears to be greater in developing countries than elsewhere.

As regards public monopolies, privatization is appropriate to the extent that competition can be effectively introduced and private shareholders can motivate managers better than governments. Private ownership is usually presumed to be more efficient, and the evidence, which principally relates to industrial countries, does not contradict this view. In developing countries, however, market failure is usually more prevalent than in industrial countries, and greater importance is attached to social and other noncommercial objectives; hence, the relatively large public sectors found in many of these countries. There is only limited scope for privatizing natural monopolies and other enterprises owing their existence to market failure. Also, where enterprises have been used to meet social and other noncommercial objectives, it is unlikely that privatized enterprises can be required to operate according to market criteria without sacrificing some of the more compelling objectives. These considerations would seem to suggest that privatization may be less appropriate in developing countries than in industrial countries.

Whatever the merits of privatization, and the scope for its implementation, it seems inevitable that public enterprise sectors will remain large in both industrial and developing countries and, where opening up the public sector to domestic or international competition is judged difficult or inappropriate, inefficiency will continue to be a problem. In such cases, efficiency can be increased only if enterprises are substantially freed from political interference and existing incentive and control mechanisms are directed toward requiring enterprises, as far as their social and other noncommercial objectives permit, to function along commercial lines and to become financially independent. This will continue to be the main thrust of public enterprise policy.

Privatization and Adjustment Programs

Privatization has been mentioned as an element in the structural adjustment efforts of many countries, and to varying degrees this has been addressed in a number of recent programs of the Fund and Bank. Yet it was noted above that, except for the United Kingdom and France, little privatization in general, and denationalization in particular, has actually occurred. Questions therefore arise as to whether privatization should be advocated more forcefully.

This paper has argued that while the economic impact of privatization may be beneficial its net effect, unless measures are taken to promote competition, is probably small. Privatization is therefore likely to be dominated in economic terms by other policies, in particular liberalization and regulation, and more effective variants of the incentive systems and control mechanisms, both statutory and administrative, currently in place. The merits of privatization are thus likely to be influenced by the economic, social, and political factors that are appropriate to the country concerned.

The conclusions of this paper point to the issues that ought to guide national authorities in their discussions of privatization. In particular, one should stress the importance of competition policy and the modest efficiency gains that could result from privatization alone. Where competition already exists, the presumption should be that privatization is appropriate. For public monopolies, the key issue is the extent of the market failure being compensated for. The potential for increased competition, the way in which it is to be secured, and, in particular, the extent to which privatization is consistent with increased competition need to be assessed on a case-by-case basis. It is also important to recognize that privatization ought to reflect a fundamental change in attitude to the conduct of industrial policy.

Privatization, especially in industrial countries, is currently being facilitated by favorable economic developments. By its nature, privatization will result in enterprises having to respond to market forces. Thus, in the event of an economic downturn, the government should be prepared to accept the employment losses, bankruptcy or takeovers that result. If the government instead responds to pressures for intervention (and possibly renationalization), it may find itself in a position where it is bearing costs associated with privatization, in particular sale proceeds that do not reflect the profit forgone in good years, while paying for rescue operations in bad years. Thus the need to ensure that privatization extends beyond a transfer of ownership, and that potential improvements in efficiency are indeed realized, is again emphasized.

Notwithstanding the above reservations and qualifications, privatization should be supported, in all its forms, as a positive step toward dealing with the problems of public enterprises. But to repeat the main point of this paper, privatization must be accompanied by other policies—to promote competition and to improve the efficiency of enterprises that must remain within the public sector—if a significant turnaround in the performance of public enterprises, and the productive sector of the economy as a whole, is to be achieved.

21

The issue of priorities is further discussed in general terms by Paul (1985) and in some detail in the United Kingdom context by Beesley and Littlechild (1983).

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