FREE ESSAY ON PRIVATIZATION

PRIVATIZATION

Privatization
What is Privatization?
Privatization is the process of transferring productive operations and assets from the
public sector to the private sector. Broadly defined in this fashion, privatization is
much more than selling an enterprise to the highest bidder, as it includes contracting
out, leasing, private sector financing of infrastructure projects, liquidation, mass
privatization, etc. My testimony will argue that there is no single best approach to
privatization; the appropriate privatization path depends on the goals that the
government is seeking to attain, the individual circumstances facing the enterprise and
the economic and political context of the country. 
It should be noted that privatization is fundamentally a political process as well as a
commercial and economic process. Privatization changes the distribution of power within a
society, as it diminishes control of the economy by the state and government- appointed
managers. Workers often feel threatened by the potential changes inherent in
privatization, although employees frequently benefit from the process. As a result,
public support is a major consideration in any privatization program and many of the
choices made in designing and implementing transactions reflect the need for such
support. Two consequences flow from this factor. 1) choices of approaches are sometimes
altered due to political considerations, meaning that equity must be promoted in the
privatization strategy, and 2) program implementation must be objective and fair to avoid
adverse publicity.
What are the goals of privatization?
Many goals are often pursued through privatization programs. These goals often fall along
two principal dimensions: 1) broad social or macro economic goals, and 2) enterprise
specific or macro economic goals. 
Macro economic goals are numerous. Fundamentally, privatization is advocated as a means
to reduce the governments role in the economy, partly as a philosophical matter (as in
the UK) but principally because governments have performed badly in that role. Many
countries can attribute substantial portions of their external debt to liabilities of
state-owned enterprises and significant portions of government budgets are devoted to
paying subsidies or otherwise assisting loss-making State-owned enterprises. Government's
objectives in these situations are often simply to extricate themselves from these
financial commitments, and focus scarce resources instead on education, infrastructure,
and social welfare. 
A second macro economic goal of privatization is to promote the development of the
private sector by leveling the playing field and ending subsidized competition from
state-owned enterprises. There is a danger in some countries that emerging private
businesses face unfair competition from state enterprises that have access to credit and
other inputs at below market rates and better access to government distribution channels.
In order to give the private sector a fair opportunity to compete and thrive, state-owned
enterprises are privatized. 
A third goal of privatization's to obtain the sales proceeds and use them to finance
shortfalls in the government's budget or retire some of the public sector debt. While it
is widely recognized that focusing on sales proceeds may be shortsighted and ignore other
important outcomes of privatization, it is a fact that many governments are strongly
influenced by the availability of funds from privatization. 
A fourth goal is to broaden share ownership so that the public has mechanisms for saving
money and participating in the economies of their countries. 
The macro economic goals of privatization focus mostly on the potential improvements that
private sector operators will bring to an enterprise to improve this performance and
increase chances of survival. These goals recognize the need to improve enterprise
efficiency by introducing new technology and financing sources, improving the quality of
the product, enhancing marketing-especially in the international market, providing
information systems, and generally improving the management of the enterprise. Obviously
successful changes of this nature, when applied to a number of individual enterprises,
will have significant macro economic implications as well. 
The final goals of privatization is to note that in most countries privatization is but
one part of a broad program of structural reform. This is most evident former Communist
country, where privatization is an element of the process of developing a market economy
and its associated financial institutions. In such cases, the privatization program
designed should take into account the broader economic goals that are being pursued, as
well as the goals specific to the enterprise.
What types of privatization techniques can be used?
There are a variety of techniques that can be selected to use in privatizing state-owned
enterprises of activities. These techniques include the following: Small business
auctions--A normal procedure for privatizing small businesses is to auction them to the
highest bidder. Especially when dealing with truly small businesses, such as sole
proprietorships and small partnerships, it is advantageous to sell to a single bidder.
Given the size of the enterprises, elaborate bid evaluations and valuations are not
appropriate and will only serve to delay the process. Auctions also create a dramatic
setting to promote the visibility of privatization and allow for broad participation, and
they are truly transparent, in the sense that all participants can see for themselves how
the process was conducted and identify the high bidder. 
Auctions are generally not appropriate for larger enterprises because the bids will not
be as readily comparable. The quality of the new ownership group becomes important--what
technology will it bring, is it well financed, what investments will it commit to making,
where will it market the product, will it close the business to limit competition? 
Strategic investors--Larger enterprises are often sold on a case- by-case basis, by
soliciting technically and financially capable investors to acquire the enterprise. In
soliciting the investors, the seller normally conducts a thorough review of the business
and prepares material describing the business and it's equipment, workforce, financial
condition, markets, and prospects. This information is circulated to a group of candidate
investors that express initial interest in the business. These investors then submit bids
outlining the terms under which they would purchase shares of the enterprise. 
Trade sales have significant disadvantages in that they can take a long period of time
and substantial expense to conduct. Because of the substantial amount of negotiation
often involved, they also have the aura of back room deals being conducted and are
susceptible to complaints from bidders that the decision process was unfair--
particularly when the bids are structured very differently. 
Initial Public Offerings (IPOs)--Initial Public Offerings are the sale of shares directly
to the public. Most of the privatization conducted in the United Kingdom during the
1980's was done through IPOs. Because the potential buying public includes a large number
of unsophisticated investors, relatively more information and higher quality information
needs to be prepared to conduct an IPO. A valuation of the enterprise is prepared and a
pricing strategy is developed that reflects the valuation, but seeks to ensure that the
offer is sufficiently attractive that the shares available can be sold. IPOs have the
virtue of stimulating interest among the general public in financial markets and
increasing share ownership in society. 
The disadvantages of IPOs are that they do not bring new capital to the enterprise and do
not bring in new managerial talent or resources. As a result, IPOs should only be used if
the performance of existing management is satisfactory. In addition, IPOs are very time
consuming and expensive to conduct, and they generally require the existence of a formal
stock exchange and broker network or other distribution mechanism to be implemented
effectively. 
Joint Ventures--A common form of privatization in some parts of the world--especially
China--is the joint venture. Under a typical joint venture, an investor approaches the
government and offers to contribute something of value to an enterprise, such as capital,
management, or technology, and in return receives a share of the ownership of the newly
constituted business. Joint ventures are often attractive to governments that are not
fully supportive of privatization because the government does not give up all control of
the enterprise. Over time, and with new investments, it may be possible to minimize
government control by diluting its ownership interest. 
There are several significant disadvantages to joint ventures as a form of privatization.
Because of the government's continued involvement, many of the goals of privatization
stated above are not met. The government remains involved in management and it's
liability for poor performance is retained. 
Mass Privatization Programs--One of the significant innovations in privatization
techniques during the last few years is the development of mass privatization programs.
In concept, mass privatization programs avoid the time and expense of case-by-case
transactions and involve the general public by distributing shares for free or in
exchange for specially created privatization vouchers. The mechanics of mass
privatization programs are similar to IPOs, except that vouchers are used to purchase
shares, rather than cash. As a result, significantly less analytical time is required and
disclosure requirements are greatly reduced. 
The disadvantages of the mass privatization programs lie principally in the diffusion of
owner-ship across broad groups and in the critical role that management is able to play
in the privatization process. It is argued that subsequent restructuring of enterprises
will be more difficult due to these factors. Offsetting this argument to some degree is
the fact that potential investors in these enterprises can negotiate with the new
owners--rather than the government--and can make investments into the enterprise in
return for shares, rather than have their funds go into the state treasury.
Build-Own-Operate/Build-Own-Transfer Programs--Governments facing severe needs for
infrastructure investments increasingly turn to the private sector to finance, build, and
operate the needed facilities. In return, the government gives certain assurances to the
investor and pays fees for the services provided. This technique has proved useful in
attracting additional capital into infrastructure investments and alleviating critical
shortages of power and transportation, especially in Asia. 
The disadvantages of these programs are that they are often very difficult and time
consuming to negotiate and structure. Because these programs are relatively new and
involve financing of new projects not assets that are already existing--many difficult
issues emerge that have not previously been confronted. 
Liquidation--State-owned enterprises with very limited prospects for survival are
sometimes liquidated and there assets auctioned to the private sector. Sometimes these
liquidated enterprises continue as going concerns; in other cases their assets are sold
separately. Liquidation ends the government's commitment to support an enterprise and
lays the groundwork for private sector investment, if the product has a market and it can
be manufactured efficiently. Liquidation is normally a last resort, used when the
government has no realistic alternatives. 
In practice, many transactions do not fit neatly into these defined categories. In most
of these transactions the government initially sells a minority of shares to a qualified
international operator through negotiated trades sales. The evaluation criteria for this
bid depend on the purchase price and on the commitment of the operator to expand service
coverage and quality significantly. Following one or more years of performance and
improvements by the operator, the balance of the government's shares are sold through
several rounds of public offerings, involving both domestic and international
shareholders.
What is the process of privatization?
Regardless of the privatization technique that is selected, the process of privatization
is relatively standardized. Governments generally follow several steps in privatizing
enterprises. First, the target companies are reviewed to understand, in a very general
way, their characteristics, markets, and prospects. Second, a privatization plan is
prepared to guide the implementation. This plan should match the goals of the government
and the characteristics of the enterprise to determine the approach that will be taken.
Third, the company is marketed, whether to core investors or the public, depending on the
path chosen. Fourth, if necessary, the terms of the transaction are negotiated and the
legal documentation prepared. Finally, the transaction is closed. 
Throughout this process, several factors are critically important to the success of the
privatization program. First, speed is absolutely essential. During the period that
governments are deciding to privatize, until the point that new owners are recognized,
the enterprise is essentially under control of its management. Few true ownership
interests are represented and the interests of capital-- whether of maintaining existing
capital or investing new capital are ignored. Great potential exists for asset-stripping
or other misappropriation of assets. 
Second, the transparency of the privatization process must be preserved and publicized.
Any questionable ethical conduct has the potential to destroy the integrity of the
process and erode political support. 
Finally, the privatization program must be implemented professionally. If it is not, the
enterprises, investors, and the public could be discouraged from participating--with
disastrous consequences.
Privatization Developments around the World
Privatization is moving forward very quickly in many countries throughout the world. In
contrast to several years ago, when privatization was much discussed and the U.S.
government was actively promoting the concept of privatization, the rationale for
privatization is now widely accepted. Issues now concern the implementation of
privatization and the appropriate techniques to use, whether in the wealthier countries
of Latin America or the poorest countries of Africa. In this section our group briefly
reviews recent privatization developments in each major region of the developing world,
Africa, Eastern Europe, Middle East and Latin America. International and International
Privatization Group estimates. Latin America has led the developing world in terms of the
pace of its privatization, although central and Eastern Europe and the former Soviet
Union have recently begun to implement massive programs. In 1992, transactions in Latin
America accounted for about one-third of the developing world's total, up from less than
10% in 1988. Latin American governments see privatization as a quick means of economic
reform, specifically, as a means of attracting foreign investment and fostering economic
liberalization. Progress in this region has been mixed, as some countries have several
years of success behind them while others are only beginning. 
The predominant method of privatization in the region is trade sales of enterprises,
conducted on a case-by-case basis. In addition, there have been several significant
public offerings. 
Chile is nearing the end of its privatization cycle. By 1991, it had privatized the
financial sector, nearly all the manufacturing sector, and much of its transport and
communications. While the state sector in 1973 accounted for 40 per cent of Chile's gross
domestic product (with over 375 enterprises), Chile's military rulers distributed to
general investors shares in state run companies, mostly in insurance firms and utilities.
Other state firms were auctioned off or sold to individual shareholders. As a result of
this massive privatization effort, the Chilean government sold 24 state enterprises,
between 1985 and 1989, raising $1.7 billion. 
Mexico has been one of the leaders in the area of privatization in the Latin America. As
of mid-1990, the government claimed to have sold, merged or liquidated 750 public
enterprises out of a total 1,155. 
The Argentine government took in revenues of $7.6 billion from the sale of more than 200
companies by 1992. Investments in privatized companies are expected to total $36 billion
by the year 2000. Excluding the petroleum sector, the new owners invested nearly $8
billion in the last three years. Once the railroad proper-ties are fully disposed of,
outflow to state enterprises will amount to only about $200 million.
Nicaragua successfully divested itself of 237 companies from its targeted 350 through the
end of 1992. Bolivia and Ecuador have just recently begun their privatization programs,
though neither had established specific timetables for privatization and privatized only
on a case-by-case basis. Bolivia has announced an
innovative program, combining features of trade sales and mass privatization. 
The expansion of investment for modernization and the development of local capital
markets were significant during 1992. Within the realm of emerging stock markets, Latin
America captured 33% of global market capitalization. 
Governments in Latin America permit employee participation when conducting the sale of a
state owned company, allowing employees to be the first to make bids on shares to be
sold. Venezuela and Panama stipulated in their privatization laws that initial offers of
shares were to be extended to the company's employees prior to accepting bids from
outside investors. In some cases, preference for share purchase was also extended to the
company's suppliers and customers before allowing other investors to make bids. In
general, employees were permitted to purchase a minimum of 5% of the company and a
maximum of 20%. 
The role of foreign investor participation varied within the region, though there existed
a desire for increased foreign investment in order to enhance capital market development.
The future of privatization in Latin America has a positive outlook, particularly with
growing support for the program. Privatization in Brazil will be back in full swing once
the government has made final revisions. Argentina and Mexico will carry on as leaders of
privatization in the region, even though both countries plan to complete their programs
in the near future. 
The nations in Asia have made significant progress toward achieving their privatization
goals and are now beginning to privatize larger state-owned enterprises (SOES) and public
utilities. According to International Privatization Update (Jan/Feb 1993), annual
privatization activity, measured in dollar volume, has increased 70% from its 1991 level.
Privatization through public offering is the most common method of privatization in Asia.

There is an increased emphasis on infrastructure privatization as power generation
facilities, rail lines, roads, airports, and seaports are now candidates for private
sector involvement. These SOES, usually government monopolies in sectors such as
petrochemicals, air transport, or steel, enjoy a domestic market with few competitors,
but the rigors of international competition necessitates their privatization. 
Malaysia has already raised $3 billion, and is planning transactions for another 50 firms
by 1996. The stock exchange in Kuala Lumpur increased its capitalization and its
listings. A large number of state-owned enterprises were sold in industries such as
automobile manufacturing and pharmaceuticals for a total of 5 major transactions.
Malaysia has also authorized an ambitious privatization program to be implemented over
the next six years. 
Sri Lanka's privatization initiative yielded positive results as well. Nearly 50 SOEs
have been transferred from the government to the private sector. Sri Lanka also had
success in its efforts to attract foreign capital as foreign investment increased by 75%
in 1992. 
Privatization efforts have commenced in China with several high publicity initial public
offerings (IPOS) on regional stock exchanges. Additionally, state governments in China
were directed to list local agencies suitable for privatization. These are China's first
serious steps toward large-scale privatization. To date, most private sector involvement
has been in the form of joint ventures with foreign partners. 
Bangladesh has been putting far greater reliance on the private sector since the late
1970s and has sold state equity in numerous companies in chemical, textile and jute
industries. Within two years of privatization, the textile mills in question have been
turned around and are making substantial profits compared with heavy losses previously. 
Taiwan authorized an enormous $303 billion six-year plan designed to develop the
country's infrastructure. The program includes an initiative that will involve the
private sector in infrastructure development. The government also conducted studies on
the feasibility of privatization in certain sectors, but has not yet initiated the
privatization process. 
The Philippines has made impressive progress by privatizing several large enterprises and
is now completion of the portfolio of state assets held by the Asset Privatization Trust.

Privatization is new to Thailand and Vietnam and their governments have not developed
long-standing commitment to the process. In Thailand, SOEs account for a large portion of
government revenues. Vietnam has recently initiated a privatization program, but until
recently officials in that country have been most concerned with attracting capital, in
the form of aid and investment, from foreign sources. 
In the years to come, Asian privatization will be funded by regional leaders such as
Japan, Hong Kong, Taiwan, and Singapore. These countries will be the leading investors in
China, Vietnam, Indonesia, and the Philippines. The political will to continue
privatization remains strong, but Asian governments have entered a more difficult stage
as they attempt to privatize larger enterprises and infrastructure. 
Privatization and private sector development were relatively insignificant in Africa just
a few years ago. They are now a prominent part of the economic reform programs of most
African countries, very often the mainstays of broader economic reform programs.
Adjustment programs, becoming more common in the region, usually stipulate some adherence
to private sector development and public sector reform. Few countries seem able to move
beyond the planning stages or even sustain successful programs once implemented.
Countries in this region have so far approached privatization hesitantly, mostly as a
revenue-enhancing measure or to relieve the budget of the strains of debts incurred by
state-owned enterprises. 
Of all the countries in the region, several have established and maintained successful
privatization programs capable of carrying out transactions on a sustained basis. These
countries-Chate d'lvoire, Egypt, Ghana, Zambia, and Nigeria--are continuing programs of
moderate success from previous years. Morocco and Egypt have probably been most
successful in making the recent transition from the planning stage to implementation. 
Political stability is a precursor for the initiation and implementation of a
privatization program. Governance issues are particularly prominent in the preparation
stage, while meeting training and technical objectives become more important as the
process nears the transaction stage. In Africa, a shortage of capital has been the
primary problem, slowing the progress to economy-wide transaction implementation, a fact
reflected in part by the distribution of countries on either end of the privatization
process. 
Privatization is often adopted because it is seen as a method to quickly convert to a
market economy. Nowhere has this been demonstrated better than in the former socialist
countries of Central and Eastern Europe and the former Soviet Union. These newly
independent countries have undertaken the most extensive privatization programs in the
world, adopting almost every method of privatization available. Both the scope of
transaction activity and public participation have been impressive. Hungary, the Czech
Republic, and Poland lead this region in terms of implementing and carrying out
successful privatization transactions. In each of these countries, the private sector now
controls the majority of the economy. Russia has developed an innovative mass
privatization program that has divested thousands of enterprises and served as a model
for other countries in the region. In many parts of the region, successful programs to
auction small businesses have been conducted.
Privatization in Eastern and Central Europe and the Newly Independent States(NIS) of the
former Soviet Union led the rest of the developing world, both in innovative approach and
overall volume of transactions. Regional privatization activity generated approximately
$18.0 billion in transactions during 1992, including
nearly $12.0 billion handled by Germany alone. Programs in Czechoslovakia, Hungary, and
Poland progressed the furthest in 1992, having privatized between one-quarter and
one-half of their economics by the end of the year. Other countries, including Russia and
some of the Newly Independent States, are rapidly implementing mass privatization
programs. 
The United States economy is substantially in the private sector, with state-owned
enterprises comprising a small share of national income, relative to other countries. In
the United States, privatization debates focus on the more exotic forms of privatization,
such as schools and prisons, or on private provision of infrastructure. With the
exception of a few very large enterprises-- such as the Tennessee Valley Authority,
Bonneville Power Administration, and the US Postal Service-there are no candidates for
privatization that are widely discussed. Experts say the sale of federal assets could
raise large sums. The sale of federal energy projects including the Tennessee Valley
Authority could bring $30 billion. Congress has already approved the sale of the federal
government's oil and gas reserves at Elk Hills, California, which could bring $1.6
billion. Sale of the nation's Strategic Petroleum Reserve could generate $13 billion.
Auctioning off drilling rights to federal lands and offshore fields controlled by the
government might bring in as much as $420 billion. 
Hydroelectric and petroleum properties are not the only assets belonging to the federal
government. It owns one-third of he land area of the U.S. Sale of timber lands owned by
the Forest Service and grazing lands under the auspices of the Bureau of Land Management,
a total of 351 million commercial area, could fetch $160 billion, according to Reason
Foundation estimates. Many urban buildings and properties owned by the federal government
across the country are not needed and could be sold. The U.S. also owns $12 billion in
foreign real estate -- some of which could be sold off.
US role in promoting and assisting privatization in other countries has been significant.
The US Agency for International Development has played a critical role in providing
needed technical assistance to governments around the world in developing privatization
programs. This technical assistance has helped to develop the infrastructure needed for
privatization programs, promoted better policies and broader marketing of companies, and
provided the expertise needed to facilitate informed, confident decision-making by
governments in developing countries. This assistance in many countries has made a
positive contribution toward speeding and sustaining the privatization process. 
Trends In Developing Countries 
According to World Bank data, privatization has become increasingly popular in developing
countries over the past 10 years. In 1992, completed privatization in developing
countries numbered in the thousands -- raising $23.1 billion. The number of privatizing
countries rose from 12 in 1988 to 43 in 1995. The value of the sales as a proportion of
the gross domestic product (GDP) of the privatizing countries has remained fairly stable
at about 0.5 percent from 1988 to 1995. The World Bank data cover 88 countries that sold
$135 billion worth of assets in 3,801 transactions of more than $50,000 over the
1988-1995 period. 
Privatization have a particularly strong influence over decisions to invest, and each
dollar of privatization revenue generates an extra 38 cents in new investment -- with
financial and infrastructure privatization having the most positive effect on other
foreign direct investment.