Sat, Apr 07, 2007
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Accelerating Privatization
Pros and Cons
State-owned industries must compete with demands from other government departments and special interests.
A financial crisis occurs when money demand instantly rises relative to the money supply. Until a few decades ago such a disaster equalized a banking crisis.
Today it also takes the form of a currency crisis.
Many economists have discovered theories on how a financial crisis develops and ways to prevent it. However there is no consensus on it and financial crises continue to be a regular phenomenon, especially in progressive nations.
Many developing states have been experiencing financial crises over the past few years. These crises have undermined the investment capacity of their governments and state-run economic agencies, reported the Persian daily Donyaye Eqtesad.
In many such countries, nearly all the economy is government-controlled with a negative financial balance.
Only privatization in these nations could produce the expected results once money needed for investment by the private sector is secured by the state-run sector.
But if privatization must succeed, conditions such as a liberalized trade regime, sustainable and predictable environment for investment, as well as the necessary capacity and institutionalized rules and regulations must exist.
Market conditions also play a major role in making a privatization scheme successful.

Recently the World Bank (WB) conducted a research on the outcome of privatization schemes before or after it occurred.
According to the WB, reforms happen when some kind of political and economic stability in any given developing nation exists.
Therefore, the pros and cons of privatization must be considered before executing the plans.
Economic crises serve as a perfect excuse to initiate privatization schemes; however, privatization in such circumstances might not necessarily produce the desired results.
Privatization is a tool in the government’s hand to hit their targets. In fact state-run economic agencies were specifically established for this purpose in many countries.
It should not then be surprising if privatization appears more difficult in places where conditions which helped create vulnerable private sectors in the first are unchanged.
Experiences in many developing nations suggest that privatization drive has proved successful, especially when governments have been unable to provide necessary finance for major development projects.
Proponents of privatization say private marketers can deliver goods or service more efficiently than the government due to free market competition.
Generally, this leads to lower prices, improved quality, more choice, less corruption, less red tape and quicker delivery over time.
But many proponents still disagree that everything should be privatized; problems such as market failures and natural monopolies may limit this, while some think that everything can be privatized, including the state itself.
The basic economic argument for privatization is that governments have few incentives to ensure that the enterprises they own are well run.
One problem is lack of competition in state monopolies. It is difficult to know whether or not an enterprise is efficient without competitors.
Another drawback is that the central government administration, and the voters who elect them, have problems evaluating the efficiency of every enterprise.
A private owner, often specializing and gaining greater 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 banknotes in case of insufficient revenue, unlike a private owner.
If both private and state-owned enterprises compete against each other, then the state-owned company can borrow money at low interest rate from debt markets than from private enterprises.
Because state-owned enterprises are ultimately backed by the taxation and printing press power of the state, gaining an unfair advantage.
Privatizing a non-profitable company which was state-owned may force the company to raise prices to become profitable. However, this would remove the need for the state to provide tax money to cover the losses.
Usually, state-run industries tend to be bureaucratic. Conversely, the government may put off improvements due to political sensitivity and special interests.
A monopolized function is prone to corruption; decisions are made primarily for political reasons, personal gains of decision-makers, rather than economic ones.
Privately-owned companies’ managements are accountable to their owners/shareholders and to the consumer and only thrive where needs are met. Managers of such companies are required to be more accountable to the broader community and to political stakeholders.
This reduces their ability to directly and specifically serve the needs of their customers, and can bias investment decisions from otherwise profitable areas.
It is easier for privately-held companies to raise investment capital in financial markets when such local markets exist and are suitably liquid.
Since profit rates for private companies are often higher than for government debt, it promotes efficient investments while restraining cross-subsidizing with the overall credit-risk of the country.
Investment decisions are governed by market profit rates. State-owned industries must compete with demands from other government departments and special interests.
In either case, for smaller markets, political risks may add substantially to the cost of capital.
Governments have the tendency to bail out poorly-run businesses often due to the sensitivity of job losses, when economically it is better to fold the business.
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 able to take greater risks and then seek bankruptcy protection against creditors if those threats turn unpleasant.
Private companies make profits by attracting consumers to buy their products rather than from their competitors. Such enterprises are typically profitable if they serve the needs of their clients well.
Different sized companies target diverse market niches to focus on marginal groups and satisfy their demand.

Opponents of privatization dispute claims concerning the alleged lack of incentive for governments to ensure that the enterprises they own are well run. This is based on the idea that governments are proxy owners answerable to the people.
They argued that a government which runs nationalized enterprises poorly lose public support and votes, and vice versa.
Thus, democratic governments do have an incentive to maximize efficiency in nationalized companies, due to the pressure of future elections.
Opponents of some privatizations say certain parts of the social terrain should remain closed to market forces to protect them from unpredictability of the market.
Others argue that some utilities provided by the government benefits the entire society, and are indirect and difficult to measure or unable to produce a profit, such as defense.
Still others say natural monopolies are by definition not subject to competition and are better managed by the state.
The controlling ethical issue from the anti-privatization perspective is the need for responsible stewardship of social support missions. All market interactions are guided by self-interest, and successful performers in a healthy market must be committed to charge the maximum price that the market will bear.
Privatization opponents believe that this model is incompatible with government missions for social support, whose primary aim is delivering affordability and quality of service to society.
As many areas which the government provides 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 routine, and embezzlement and other cost-cutting measures would be taken to maximize profits, such as labor layoffs.
Some also say privatizing certain functions of government might hamper coordination and charge firms with specialized and limited capabilities to perform duties which are unsuitable for them.
Furthermore, they argue that it is undesirable to transfer state-owned assets into private hands for the following reasons:
A democratically elected government is accountable to the people through a legislature or parliament, and is inspired to safeguarding national assets. The profit cause may be subordinated to social objectives.
The government is motivated to performance improvements as well run businesses that contribute to the state revenues.
Government ministers and civil servants must uphold the highest ethical standard. Such 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 make personal gains.
The public does not oversee or have any control of private companies.
The government may use state companies as instruments to advance social goals for the benefit of the nation. It can raise money in the financial market on low profit to re-lend to state-owned enterprises.
Governments have chosen to keep certain companies/industries under public ownership because of their strategic importance or sensitive nature.
If a government-owned company providing an essential service-such as water supply-is privatized, it could lead the new owner to abandon the social obligation of supplying to those who cannot afford to pay or to regions where this service is unprofitable.
Privatization will not result in true competition if a natural monopoly exists. Profits from successful enterprises end up in private, often foreign hands instead of being available for the common good.
Governments easily exert pressure on state-owned firms to help implement government policies. 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 is thus less likely to cut back on maintenance or staff costs, training, to stem short-term losses.
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 to pay, as opposed to the needs of the majority.
Privatizing a non-profitable company which was state-owned may force the company to raise prices to become profitable.
Countries with poor income need a healthy environment to succeed in their privatization drive.
In most cases, reforms have been mentioned as the only way to resolve the issue, with emphasis to speed up the process of privatization of the state-run sectors.
Political interferences in the performance of state-owned economic agencies serve as a perfect reason to privatize them. However, privatization can still pave the way for corruption.
For instance, corruption during the privatization process can result in significant under-pricing of the asset. This allows for more immediate and efficient corrupt transfer of value, not just from ongoing cash flow but from the entire lifetime of the asset stream. Often such transfers are difficult to reverse.
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.
Many examples support such a claim, but above all it is important that there should transparency when ceding shares of the state-owned enterprises to the private sector.