Privatization

Source: AlexaLaw

Privatization is the incidence or process of transferring ownership of a business, enterprise, agency or public service from the public sector (the state or government) to the private sector (businesses that operate for a private profit) or to private non-profit organizations. In a broader sense, privatization refers to transfer of any government function to the private sector - including governmental functions like revenue collection and law enforcement.
The term "privatization" also has been used to describe two unrelated transactions. The first is a buyout, by the majority owner, of all shares of a public corporation or holding company's stock, privatizing a publicly traded stock, and often described as private equity. The second is a demutualization of a mutual organization or cooperative to form a joint stock company.

Origin

Edwards states that The Economist coined the term in the 1930s in covering Nazi German economic policy.
The Oxford English Dictionary notes usage dating from 1942 in Econ. Jrnl, 52, 398.

History

This section requires expansion. A long history of privatization dates from Ancient Greece, when governments contracted out almost everything to the private sector[5]. In the Roman Republic private individuals and companies performed the majority of services including tax collection (tax farming), army supplies (military contractors), religious sacrifices and construction. However, the Roman Empire also created state-owned enterprises — for example, much of the grain was eventually produced on estates owned by the Emperor. Some scholars suggest that the cost of bureaucracy was one of the reasons for the fall of the Roman Empire.
In Britain, the privatization of common lands is referred to as enclosure (in Scotland as the Lowland Clearances and the Highland Clearances). Significant privatizations of this nature occurred from 1760 to 1820, coincident with the industrial revolution in that country.
In more recent times, Winston Churchill's government privatized the British steel industry in the 1950s, and West Germany's government embarked on large-scale privatization, including selling its majority stake in Volkswagen to small investors in a public share offering in 1961[5]. In the 1970s General Pinochet implemented a significant privatization program in Chile. However, it was in the 1980s under the leaderships of Margaret Thatcher in the UK and Ronald Reagan in the USA, that privatization gained worldwide momentum. In the UK this culminated in the 1993 privatization of British Rail under Thatcher's successor, John Major; British Rail having been formed by prior nationalization of private rail companies.
Significant privatization of state owned enterprises in Eastern and Central Europe and the former Soviet Union was undertaken in the 1990s with assistanced from the World Bank, the U.S. Agency for International Development, the German Treuhand , and other governmental and nongovernmental organizations.
A major ongoing privatization, that of Japan Post, involves the Japanese post service and the largest bank in the world. This privatization, spearheaded by Junichiro Koizumi, started in 2007 following generations of debate. The privatization process is expected[by whom?] to last until 2017.


Types

There are four main methods[citation needed] of privatization:
Share issue privatization (SIP) - selling shares on the stock market
Asset sale privatization - selling an entire organization (or part of it) to a strategic investor, usually by auction or by using the Treuhand model
Voucher privatization - distributing shares of ownership to all citizens, usually for free or at a very low price.
Privatization from below - Start-up of new private businesses in formerly socialist countries.
Choice of sale method is influenced by the capital market, political and firm-specific factors. SIPs are more likely to be used when capital markets are less developed and there is lower income inequality. Share issues can broaden and deepen domestic capital markets, boosting liquidity and (potentially) economic growth, but if the capital markets are insufficiently developed it may be difficult to find enough buyers, and transaction costs (e.g. underpricing required) may be higher. For this reason, many governments elect for listings in the more developed and liquid markets, for example Euronext, and the London, New York and Hong Kong stock exchanges.
As a result of higher political and currency risk deterring foreign investors, asset sales occur more commonly in developing countries.
Voucher privatization has mainly occurred in the transition economies of Central and Eastern Europe, such as Russia, Poland, the Czech Republic, and Slovakia. Additionally, Privatization from below is/has been an important type of economic growth in transition economies.
A substantial benefit of share or asset-sale privatizations is that bidders compete to offer the highest price, creating income for the state in addition to tax revenues. Voucher privatizations, on the other hand, could be a genuine transfer of assets to the general population, creating a real sense of participation and inclusion. If the transfer of vouchers is permitted, a market in vouchers could be created, with companies offering to pay money for them.


Differing views

Supporting

Proponents[who?] of privatization believe that private market factors can more efficiently deliver many goods or service than governments due to free market competition. In general, it is argued that over time this will lead to lower prices, improved quality, more choices, less corruption, less red tape, and quicker delivery. Many proponents do not argue that everything should be privatized. According to them, market failures and natural monopolies could be problematic. However, some Austrian school economists[who?] and anarcho-capitalists[who?] would prefer that every function of the state be privatized, including defense and dispute resolution.
The basic economic argument given for privatization states that governments have few incentives to ensure that the enterprises they own are well run. One problem is the lack of comparison in state monopolies. It is difficult to know if an enterprise is efficient or not without competitors to compare against. Another is that the central government administration, and the voters who elect them, have difficulty evaluating the efficiency of numerous and very different enterprises. A private owner, often specializing and gaining great knowledge about a certain industrial sector, can evaluate and then reward or punish the management in much fewer enterprises much more efficiently. Also, governments can raise money by taxation or simply printing money should revenues be insufficient, unlike a private owner.
If private and state-owned enterprises compete against each other, then the state owned may borrow money more cheaply from the debt markets than private enterprises, since the state owned enterprises are ultimately backed by the taxation and printing press power of the state, gaining an unfair advantage.
Privatizing a non-profitable state-owned company may force the company to raise prices in order to become profitable. However, this would remove the need for the state to provide tax money in order to cover the losses.
Proponents of privatization[who?] make the following arguments:
Performance. State-run industries tend to be bureaucratic. A political government may only be motivated to improve a function when its poor performance becomes politically sensitive, and such an improvement can be reversed easily by another regime.[citation needed]
Increased efficiency. Private companies and firms have a greater incentive to produce more goods and services for the sake of reaching a customer base and hence increasing profits. A public organization would not be as productive due to the lack of financing allocated by the entire government's budget that must consider other areas of the economy. (Note: However according to the Samuelson Condition, public organizations tend to produce more of a public good or service. Also, since private firms provide goods and services according to the marginal private benefit curve, private firms have an incentive to produce less.)
Specialization. A private business has the ability to focus all relevant human and financial resources onto specific functions. A state-owned firm does not have the necessary resources to specialize its goods and services as a result of the general products provided to the greatest number of people in the population.
Improvements. Conversely, the government may put off improvements due to political sensitivity and special interests — even in cases of companies that are run well and better serve their customers' needs.
Corruption. A state-monopolized function is prone to corruption; decisions are made primarily for political reasons, personal gain of the decision-maker (i.e. "graft"), rather than economic ones. Corruption (or principal-agent issues) in a state-run corporation affects the ongoing asset stream and company performance, whereas any corruption that may occur during the privatization process is a one-time event and does not affect ongoing cash flow or performance of the company.
Accountability. Managers of privately owned companies are accountable to their owners/shareholders and to the consumer, and can only exist and thrive where needs are met. Managers of publicly owned companies are required to be more accountable to the broader community and to political "stakeholders". This can reduce their ability to directly and specifically serve the needs of their customers, and can bias investment decisions away from otherwise profitable areas.
Civil-liberty concerns. A company controlled by the state may have access to information or assets which may be used against dissidents or any individuals who disagree with their policies.
Goals. A political government tends to run an industry or company for political goals rather than economic ones.
Capital. Privately held companies can sometimes more easily raise investment capital in the financial markets when such local markets exist and are suitably liquid. While interest rates for private companies are often higher than for government debt, this can serve as a useful constraint to promote efficient investments by private companies, instead of cross-subsidizing them with the overall credit-risk of the country. Investment decisions are then governed by market interest rates. State-owned industries have to compete with demands from other government departments and special interests. In either case, for smaller markets, political risk may add substantially to the cost of capital.
Security. Governments have had the tendency to "bail out" poorly run businesses, often due to the sensitivity of job losses, when economically, it may be better to let the business fold.
Lack of market discipline. Poorly managed state companies are insulated from the same discipline as private companies, which could go bankrupt, have their management removed, or be taken over by competitors. Private companies are also able to take greater risks and then seek bankruptcy protection against creditors if those risks turn sour.
Natural monopolies. The existence of natural monopolies does not mean that these sectors must be state owned. Governments can enact or are armed with anti-trust legislation and bodies to deal with anti-competitive behavior of all companies public or private.
Concentration of wealth. Ownership of and profits from successful enterprises tend to be dispersed and diversified -particularly in voucher privatization. The availability of more investment vehicles stimulates capital markets and promotes liquidity and job creation.
Political influence. Nationalized industries are prone to interference from politicians for political or populist reasons. Examples include making an industry buy supplies from local producers (when that may be more expensive than buying from abroad), forcing an industry to freeze its prices/fares to satisfy the electorate or control inflation, increasing its staffing to reduce unemployment, or moving its operations to marginal constituencies.
Profits. Corporations exist to generate profits for their shareholders. Private companies make a profit by enticing consumers to buy their products in preference to their competitors' (or by increasing primary demand for their products, or by reducing costs). Private corporations typically profit more if they serve the needs of their clients well. Corporations of different sizes may target different market niches in order to focus on marginal groups and satisfy their demand. A company with good corporate governance will therefore be incentivized to meet the needs of its customers efficiently.
Job gains. As the economy becomes more efficient, more profits are obtained and no government subsidies and less taxes are needed, there will be more private money available for investments and consumption and more profitable and better-paid jobs will be created than in the case of a more regulated economy.[unreliable source?]
Opposing

Opponents of privatization[who?] dispute the claims concerning the alleged lack of incentive for governments to ensure that their public services are well run, on the basis of the idea that governments are proxy owners answerable to the people. It is argued[by whom?] that a government which runs nationalized enterprises poorly will lose public support and votes, while a government which runs those enterprises well will gain public support and votes. Thus, democratic governments do have an incentive to maximize efficiency in nationalized companies, due to the pressure of future elections.
Opponents of certain privatizations believe that certain public goods and services should remain primarily in the hands of government in order to ensure that everyone in society has access to them (such as law enforcement, basic health care, and basic education). Likewise, private goods and services should remain in the hands of the private sector. There is a positive externality when the government provides public goods and services to society at large, such as defense and disease control. As for natural monopolies they are by their nature not subject to fair competition and better administrated by the state.
The controlling ethical issue in the anti-privatization perspective is the need for responsible stewardship of social-support missions. Market interactions are all guided by self-interest, and successful actors in a healthy market must be committed to charging the maximum price that the market will bear. Privatization opponents believe that this model is not compatible with government missions for social support, whose primary aim is delivering affordability and quality of service to society.
Many privatization opponents[who?] also warn against the practice's inherent tendency toward corruption. As many areas which the government could provide are essentially profitless, the only way private companies could, to any degree, operate them would be through contracts or block payments. In these cases, the private firm's performance in a particular project would be removed from their performance, and embezzlement and dangerous cost-cutting measures might be taken to maximize profits.
Furthermore, large corporations may pay public-relations professionals to convince decision-makers that privatization is a sensible idea. Corporations typically have far more resources for expert testimony, advertisements, conferences and other propaganda efforts than anti-privatization advocates.
Some[who?] would also point out that privatizing certain functions of government might hamper coordination, and charge firms with specialized and limited capabilities to perform functions which they are not suited for. In rebuilding a war torn nation's infrastructure, for example, a private firm would, in order to provide security, either have to hire security, which would be both necessarily limited and complicate their functions, or coordinate with government, which, due to a lack of command structure shared between firm and government, might be difficult. A government agency, on the other hand, would have the entire military of a nation to draw upon for security, whose chain of command is clearly defined. Opponents would say that this is a false assertion: numerous books refer to poor organization between government departments (for example the Hurricane Katrina incident).
Although private companies will provide a similar good or service alongside the government, opponents of privatization are careful about completely transferring the provision of public goods, services and assets into private hands for the following reasons:
Performance. A democratically elected government is accountable to the people through a legislature, Congress or Parliament, and is motivated to safeguarding the assets of the nation. The profit motive may be subordinated to social objectives.
Increased Market Efficiency for Public Goods and Services. A public organization tends to produce more of a public good or service according to the Samuelson condition and Marginal Social Benefit curve. This results in a better positive externality for society. On the other hand, a private firm does not provide sufficient public goods and services, because it provides them on the marginal private benefit curve or private demand curve. A private firm provides less in order to make more profit. Therefore the public goods and services are provided more efficiently for society as a whole by a public organization. (Any market is more efficient for society when marginal social benefits equals marginal social costs, MSB=MSC.)
Improvements. the government is motivated to performance improvements as well run businesses contribute to the State's revenues.
Corruption. Government ministers and civil servants are bound to uphold the highest ethical standards, and standards of probity are guaranteed through codes of conduct and declarations of interest. However, the selling process could lack transparency, allowing the purchaser and civil servants controlling the sale to gain personally.
Accountability. The public does not have any control or oversight of private companies.
Civil-liberty concerns. A democratically elected government is accountable to the people through a parliament, and can intervene when civil liberties are threatened.
Goals. The government may seek to use state companies as instruments to further social goals for the benefit of the nation as a whole.
Capital. Governments can raise money in the financial markets most cheaply to re-lend to state-owned enterprises.
Strategic and Sensitive areas. Governments have chosen to keep certain companies/industries under public control because of their strategic importance or sensitive nature.
Cuts in essential services. If a government-owned company providing an essential service (such as the water supply) to all citizens is privatized, its new owner(s) could lead to the abandoning of the social obligation to those who are less able to pay, or to regions where this service is unprofitable.
Natural monopolies. Privatization will not result in true competition if a natural monopoly exists.
Concentration of wealth. Profits from successful enterprises end up in private, often foreign, hands instead of being available for the common good.
Political influence. Governments may more easily exert pressure on state-owned firms to help implementing government policy.
Downsizing. Private companies often face a conflict between profitability and service levels, and could over-react to short-term events. A state-owned company might have a longer-term view, and thus be less likely to cut back on maintenance or staff costs, training etc., to stem short term losses. Many private companies have downsized while making record profits.
Profit. Private companies do not have any goal other than to maximize profits. A private company will serve the needs of those who are most willing (and able) to pay, as opposed to the needs of the majority, and are thus anti-democratic. The more necessary a good is, the lower the price elasticity of demand, as people will attempt to buy it no matter the price. In the case of price elasticity of demand is zero (perfectly inelastic good), demand part of supply and demand theories does not work.
Privatization and Poverty. It is acknowledged by many studies that there are winners and losers with privatization. The number of losers —which may add up to the size and severity of poverty—can be unexpectedly large if the method and process of privatization and how it is implemented are seriously flawed (e.g. lack of transparency leading to state-owned assets being appropriated at minuscule amounts by those with political connections, absence of regulatory institutions leading to transfer of monopoly rents from public to private sector, improper design and inadequate control of the privatization process leading to asset stripping.[7]
Job Loss. Due to the additional financial burden placed on privatized companies to succeed without any government help, unlike the public companies, jobs could be lost to keep more money in the company.
Intermediate views

Others don't dispute that well-run for-profit entities with sound corporate governance may be considerably more efficient than an inefficient governmental bureaucracy or NGO, however many implementations of privatization can - in practice - lead to the fire sale of public assets, and/or to inefficient or corrupt - for profit management.

Developed or minimally corrupt economies

A top executive can readily reduce the perceived value of an asset – due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative (e.g. pessimistic) estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce sale price. (This is again due to information asymmetries since it is more common for top executives to do everything they can to window dress their earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates.
When the entity gets taken private - at a dramatically lower price - the new private owner gains a windfall from the former top executive's actions to (surreptitiously) reduce the sales price. This can represent 10s of billions of dollars (questionably) transferred from previous owners (the public) to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the fire sale that can sometimes be in the 10s or 100s of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives).
When a publicly held asset, mutual or non-profit organization undergoes privatization, top executives often reap tremendous monetary benefits. The executives can facilitate the process by making the entity appear to be in financial crisis - this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell.
Ironically, it can also contribute to a public perception that private entities are more efficiently run reinforcing the political will to sell of public assets. Again, due to asymmetric information, policy makers and the general public see a government owned firm that was a financial 'disaster' - miraculously turned around by the private sector (and typically resold) within a few years.

Underdeveloped or highly corrupt economies

In a society with substantial corruption, privatization allows the government currently in power and its backers to siphon a large portion of the entire net present value of state assets away from the public and into the accounts of their favored power brokers. Without privatization, corrupt officials would have to slowly harvest their corrupt earnings over time. As such, efficient privatization depends on their being a very low of current corruption among the current government officials since it allows for far more 'efficient' extraction of corrupt rents.
Of course, corrupt governments can also extract corrupt rents quite efficiently in other ways - particularly by borrowing extensively to engage in spending on overly favorable contracts with their backers (or on tax shelters, subsidies or other giveaways). Generations of subsequent taxpayers are then left with paying back the debt incurred for corrupt transfers made decades previously. Naturally, this may lead to the sale of public assets....
In the end, the public is left with a government that taxes them heavily, and gives them nothing in return. Debt repayment is enforced by international agreements and agencies such as the IMF. Infrastructure and upkeep is sacrificed - leading to a further decay in the economic efficiency of the country over time.


Outcomes


Literature reviews find that in competitive industries with well-informed consumers, privatization consistently improves efficiency. Such efficiency gains mean a one-off increase in GDP, but through improved incentives to innovate and reduce costs also tend to raise the rate of economic growth. The type of industries to which this generally applies include manufacturing and retailing. Although typically there are social costs associated with these efficiency gains[10], many economists argue that these can be dealt with by appropriate government support through redistribution and perhaps retraining.
In sectors that are natural monopolies or public services (such as, say, passenger rail in the United States), the results of privatization are much more mixed, as a private monopoly behaves much the same as a public one in liberal economic theory. The government is actually seen as a more natural provider of public goods and services. However, the efficiency of an existing public sector operation can be put into question requiring changes to be made. Changes may include, inter alia, the imposition of related reforms such as greater transparency and accountability of management, an improved cost-benefit analysis, improved internal controls, regulatory systems, and better financing, rather than privatization itself.
Regarding political corruption, it is a controversial issue whether the size of the public sector per se results in corruption. The Nordic countries have low corruption but large public sectors. However, these countries score high on the Ease of Doing Business Index, due to good and often simple regulations, and for political rights and civil liberties, showing high government accountability and transparency. One should also notice the successful, corruption-free privatizations and restructuring of government enterprises in the Nordic countries. For example, dismantling telecommunications monopolies has resulted in several new players entering the market and intense competition with price and service.
Also regarding corruption, the sales themselves give a large opportunity for grand corruption. Privatizations in Russia and Latin America were accompanied by large-scale corruption during the sale of the state-owned companies. Those with political connections unfairly gained large wealth, which has discredited privatization in these regions. While media have reported widely the grand corruption that accompanied the sales, studies have argued that in addition to increased operating efficiency, daily petty corruption is, or would be, larger without privatization, and that corruption is more prevalent in non-privatized sectors. Furthermore, there is evidence to suggest that extralegal and unofficial activities are more prevalent in countries that privatized less.


References

Alexander, Jason. 2009. Contracting Through the Lens of Classical Pragmatism: An Exploration of Local Government Contracting. Applied Research Project. Texas State University. http://ecommons.txstate.edu/arp/288/.
Dovalina, Jessica. 2006. Assessing the Ethical Issues Found in the Contracting Out Process. Applied Research Project. Texas State University. http://ecommons.txstate.edu/arp/108/.
Segerfeldt, Fredrik. 2006. Water for sale: how business and the market can resolve the world’s water crisis. Stockholm Network. http://www.stockholm-network.org/dow...Segerfeldt.pdf
Bernard Black et al., 'Russian Privatization and Corporate Governance: What Went Wrong? (2000) 52 Stanford Law Review 1731