Selected Issues In Privatization

Privatization is carried out for many reasons, some of the most important of which are decreasing the burden on the government's budget, bringing into the firms more skilled management and improved technologies, and attracting private investment. Improvements in the performance of an enterprise after its privatization do not necessarily arise from the nature of ownership per se, but rather because:

the switch from public to private ownership results in more precise, and more measurable, objectives on the part of the owners which then create the environment and incentives to monitor and control management more effectively. An important additional aspect of this argument is that, under private ownership, firms will only remain in existence as long as they are viable. If they are not their resources will be re-allocated (through the market mechanism) to more efficient uses. In contrast, un-economic State-owned enterprises (SOEs) are frequently long-lived, maintained as a result of access to soft credit combined with political and other non-economic pressures which, in additional to constituting a drain on

Private ownership itself makes a difference. Some State-owned enterprises have been efficient and well managed for some periods, but government ownership seldom permits sustained good performance over more than a few years. The higher probability of efficient performance in private enterprise needs to be considered in choosing whether to invest public funds in SOEs or in health, education and other social programs. (S. Kikeri, J. Nellis, and M. Shirley, Privatization: The Lessons of Experience, The World Bank, Washington, DC, USA, 1992, p. 1.)

the financial resources of governments, also constrain efficient allocation of scarce financial, and especially human, resources.22

Apart from ideology, one of the common motives for not privatizing has been fear of potentially monopolistic behavior on the part of firms that are transferred to private ownership. In short, the fundamental reasons for privatization are the fiscal cost of maintaining SOEs -although it should be remembered that improving the net flow of revenues to the Treasury, including taxes, requires improvement in the profitability of the privatized entity - and the need to improve the enterprises' productivity and economic growth performance. The basic counterargument is the concern about creating a non-competitive market structure. In agro-industry, such a concern is, concretely, that monopolistic or oligopolistic processing firms will offer lower prices to producers and charge higher prices to consumers.

Many SOEs around the world have performed well for considerable periods of time, but it is difficult to sustain that performance indefinitely. One of the reasons is that government committees or Ministers may control investment decisions, rather than the enterprise itself. Another is that selection of managers is not always carried out on grounds of technical competence, while a

third reason is that rates of staff remuneration are often not linked to performance.

On the other hand, privatization carried out improperly can lead not only to the ills of market concentration but also to windfall gains for the new owners or managers, fueling social discontent with a policy of opening toward the market. At stake here is the nature of the distribution of wealth in society, and how privatization policy may affect it. Kikeri et al. consider that satisfaction of two fundamental conditions can make privatization work well: existence of a reasonably competitive market, and a capacity in the government to regulate industry. Only if the market is truly competitive can the regulatory capacity factor be ignored.23

These guidelines may be applicable in many parts of the world, but in countries where State ownership has been extensive, as in Eastern Europe and the Former Soviet Union countries, experience suggests that perhaps the drawbacks of non-competitive market forms are not as damaging to the economy as the inefficiencies of continued State ownership:

Comparative analysis of the Czech and Slovak, Polish, Russian and Lithuanian mass privatization models indicate that during the initial steps of privatization it is better to run the risks of imperfect competition and markets, and to accelerate the process, than it is to delay and possibly derail privatization.24

The same authors point out, however, that in such cases privatization must be followed by structural reform: 'Even where mass privatization occurs and the sell-off process is accelerated . . . there is clear recognition that this is only the first phase of structural reform. Where privatization occurs with little else in the way of structural reform, as it has in Russia, the process is vulnerable to charges that it has failed. . . . post-privatization structural change and adjustment issues will require careful thought and prudent planning' (op. cit., p. 47).

Finally, Lieberman et al. emphasize that 'privatization needs to be viewed as part of a more comprehensive reform program' to 'create the base for a market economy' (ibid). This is perhaps the most fundamental objective of privatization programs.

In practice, the operational question often is not so much whether to privatize as how to privatize. For agricultural storage and processing facilities, it can be a choice between a strategy to attract the investor with the deepest pockets versus one oriented at encouraging a broad base of ownership through creating widely dispersed shareholdings. The former is often the aim of privatization conducted via public auctions, and the latter is accomplished through special legislation which defines the types of shares and their rules for distribution and sale.

If there are concerns about potential monopoly power, sale to a single bidder is likely to exacerbate them. In contrast, sale of shares to, say, a large number of farmers would tend to prevent their being exploited by the newly-privatized agro-processing enterprise. On the other hand, in principle sale at public auction is the only way to guarantee that the asset being sold commands a market price, that is, a price which reflects its true economic value.

If it is anticipated that privatizing State grain silos will lead to reinforcement of an existing oligopoly in domestic grain trade, is it preferable to sacrifice the theoretical advantages of selling the facilities at public auction, in favor of a direct sale to groups of farmers? If so, are subsidized sales terms justified as a way to end the continuing annual subsidy in the State's operation of the silos? The conceptual literature offers no firm guidance on such questions. In the blunt words of Stanley Fischer, 'Given the magnitude of the task [of privatization], it would be a mistake to discourage any potentially viable form of privatiza

23. S. Kikeri, J. Nellis and M. Shirley, Privatization: The Lessons of Experience, The World Bank, Washington, DC, USA, 1992, p. 5.

24. I. W. Lieberman, A. Ewing, M. Mejstrik, J. Mukherjee and P. Fidler (Eds), Mass Privatization in Central and Eastern Europe and the Former Soviet Union, A Comparative Analysis, Studies of Economies in Transformation, No. 16, The World Bank, Washington, DC, USA, 1995, pp. 47-48.

tion that is not theft'.25 In Honduras in the early 1990s, policy makers opted for sale of silos to large numbers of producers, at a subsidized price, and the experience was considered a success. In that case, it was clear that sale of the facilities to the highest bidder would indeed have resulted in reinforcing an existing oligopoly in grain trade.

One of the keys to success of privatization is building adequate regulatory institutions and capacity. In the words of Pranab Bardhan:

While the process of deregulation should continue [in agricultural reform programs], in some respects the regulatory powers of the State have to be enhanced, for example, in ensuring the implementation of the avowed purpose of reforms to increase competition. Otherwise privatization often involves replacement of a public monopoly by a private monopoly.26

Desirable as privatization may be in many cases, implementing it is not necessarily a simple task. For assets which are divested at public auction, it is essential to take pains to ensure that the process is transparent, and that the winning bid is honored.

An issue which sometimes arises is that the domestic private sector may not have the managerial capacity or financial depth to take over ownership of a significant number of facilities. This problem has arisen in acute form in Malawi,27 Mozambique, Guyana and other countries where the State has had a preponderant role in managing the economy until recent years. Francesco Goletti and Philippe Chabot have commented on this issue for the privatization of agricultural marketing, in the Central Asian context:

If market reforms are undertaken, a thriving and efficient private sector will not necessarily develop and engage in those functions previously performed by the public sector. In the presence of market failures and infrastructure bottlenecks, the effects of market reforms on agricultural marketing may be adverse. Sometimes, governments give exclusive rights to one major private or domestic firm, limiting the access of technology to farmers, and institutionalizing barriers to entry. In other cases, imports are limited to particular brands, resulting in a restricted access by farmers to the broader range of choices available in the international markets. The private sector may not have an incentive to participate in the marketing of agricultural inputs because of thin markets or lack of credit. In the Central Asian case, the major impediments seem to be regulatory and physical (i.e., the presence of large grain elevators and cotton ginneries inherited from the Soviet era).28

The alternative of allowing foreign capital to acquire most of the privatized facilities is not always considered acceptable. One solution is to provide generous terms on which new shareholders may acquire their participation in facilities, but it cannot be a complete solution since one of the aims of privatization is to bring in significant amounts of new capital. An optional solution is to combine foreign and domestic shareholding, by auctioning a given portion of the enterprise's assets and using a formula for dis

25. Stanley Fischer, 'Privatization in Eastern European Transformation', Working Paper IPR6, Institute for Policy Reform, Washington, DC, USA, March, 1991.

26. Pranab Bardhan, 'Institutions, reforms and agricultural performance', in Kostas G. Stamoulis (Ed.), Food, Agriculture and Rural Development: Current and Emerging Issues for Economic Analysis and Policy Research, Economic and Social Department, Food and Agriculture Organization of the United Nations, Rome, 2001, p. 155.

27. For comment on this issue in the case of Malawi, see C. Adam, 1994, pp. 150-151.

28. Reprinted from Food Policy, 25(6), Francesco Goletti and Philippe Chabot, 'Food policy research for improving the reform of agricultural input and output markets in Central Asia', pp. 675-676, Copyright (2000), with permission from Elsevier.

tributing another portion of them among the domestic public. An Eastern European solution has been to foster the creation of holding companies, by providing the general public with tradeable privatization vouchers, and allowing them to be used for investing in the holding companies, or funds, instead of directly in the privatized facilities.

Privatization issues are pervasive in the agricultural sectors of many countries. Creating security of land tenure, of one form or another, for private farmers is still a challenge throughout the world. Farmer participation in irrigation systems also can involve considerations of privatization. It now is widely accepted that management of such systems should be devolved to the local level, generally to groups of irrigation users. They often are required to finance part or all of the maintenance costs through fees levied on themselves for that purpose. The two central ideas are straightforward, namely (a) that farmers will be more willing to pay maintenance fees if they can manage the corresponding expenditures themselves, and thus be reassured that the fees go to the intended purpose in an efficient manner, and (b) maintenance is likely to be more effective if it is carried out by those who have the most direct interest in the system's long-term viability.

An issue that is not recognized as often is who should be the owner(s) of the system - national government, local government, farmers or someone else? It can be argued that as long as farmers are not full owners of the system, their interest in its maintenance will not be a strong as it could be. If farmers were shareholders in the system (main canals, pumps, etc. - all components excepting the canals within each property), then they could sell their shares along with their land, in the event of a decision to leave farming or leave the area. Equally, their children could inherit their shares. Hence they would have an interest in the potential capital gains of the system as well as in its year-to-year functioning for irrigating their fields. This additional interest would be expected to increase their commitment to the system's proper maintenance and management.

Nevertheless, the most typical policy is to leave system ownership in government hands and require users to shoulder the burden of system maintenance. Since this kind of arrangement leaves incomplete the incentives for maintenance, there would appear to be grounds for considering alternative approaches. This question is discussed in Chapter 6 where examples of farmer ownership of irrigation systems are given.

Privatization considerations can be extended to the area of farm services as well, and they are very relevant to questions of the structure of the agricultural financial sector. These issues are also considered in subsequent parts of this volume.

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