Privatization Solution Worse than Problem

By Jomo Kwame SundaramReprint | |

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In order to make the case for privatizing state-owned enterprises, their real problems were often exaggerated in order to make the case for privatization from the 1980s.

KUALA LUMPUR, Malaysia, May 14 2019 (IPS) - Privatization has not provided the miracle cure for the problems (especially inefficiencies) associated with the public sector. The public interest has rarely been well served by private interests taking over from the public sector. Growing concern over the mixed consequences of privatization has spawned research worldwide.

Jomo Kwame Sundaram

Adverse economic consequences
Both Bretton Woods institutions have long been aware of the adverse impacts of privatization. For example, IMF research acknowledged that privatization “can lead to job losses, wage cuts and higher prices for consumers”. Similarly, World Bank research on Argentina, Bangladesh, Chile, Ghana, Malaysia, Mexico, Sri Lanka and Turkey found huge job losses when big SOEs were privatized.

In the United States, the United Kingdom, Canada, Chile, Sweden, Russia, Poland, Ukraine, Bulgaria, China, Hong Kong, Malaysia, the Philippines, South Korea, Sri Lanka and Bangladesh in 1999-2004, privatization more adversely affected women workers. IMF and World Bank safety net or compensation proposals were either too costly for the public treasury or too administratively burdensome.

Diverting private capital from productive new investments to buy over existing state-held assets has actually slowed, rather than accelerated economic growth. This significantly diverts funding from productive new investments, augmenting economic capacities, to instead buy over already existing assets. Instead of contributing to growth, this simply changes asset ownership.

Listing privatized SOEs on the stock market subjects them to short term managerial considerations, typically to maximize quarterly firm earnings, thus discouraging productive new investments for the longer term. This short-termist focus tends to marginalize the long-term interests of the enterprise and the nation.

Thus, stock market listing implies the introduction, perpetuation and promotion of a short-termist culture. This is often inimical to the interests of corporate and national development more generally, and improving economic welfare more broadly.

Private ownership not in public interest
Both evenly distributed as well as concentrated share ownership undermine the corporate performance of the privatized enterprise, whereas SOE ownership could overcome such collective action problems. Where the population has equal shares following privatization, such as after ‘voucher privatization’, no one has any particular interest in ensuring the privatized company is run well, worsening governance problems.

Thus, public pressure to ensure equitable share ownership may inadvertently undermine corporate performance. As shareholders only have small equity stakes, they are unlikely to incur the high costs of monitoring management and corporate performance. Thus, nobody has an incentive to take much interest in improving the corporate operations.

This ‘collective action’ problem exacerbates the ‘principal-agent’ problem as no one has enough shareholder clout to require improvements to the management of the privatized enterprise due to everyone having equal shares and hence modest stakes. Conversely, concentrated share ownership undermines corporate performance for other reasons.

Fiscal challenge
Privatization may postpone a fiscal crisis by temporarily reducing fiscal deficits with additional ‘one-off’ revenues from selling public assets. However, in the long-term, the public sector would lose income from profitable SOEs and be stuck with financing and subsidizing unprofitable ones. More resources would also be needed to finance government obligations previously cross-subsidized by SOE revenue streams.

As experience shows, the fiscal crisis may even deepen if new owners of profitable SOEs avoid paying taxes with creative accounting or due to the typically generous terms of privatization. For example, Sydney Airport paid no tax in the first decade after it was privatized even though it earned almost A$8 billion; instead, it received tax benefits of almost A$400 million!

Typically, investments in SOEs do not show up as government development expenditure or debt. Instead, they are hidden away as government-guaranteed debt, which accrue as ‘contingent liabilities’. Thus, the government remains ultimately responsible. Problems arise when government ministers force SOEs to undertake projects, make investments, or buy overpriced equipment or services, especially when not even needed.

Adverse public welfare impacts
Privatization tends to stoke inequality. Due to the macroeconomic consequences of privatization, reduced investments in the real economy would mean less job growth, stagnant wages, or both.

Diversion of available funds to buy existing assets diminishes resources available to expand real economic capacities and capabilities. Thus, by diverting private capital from productive new investments to privatize existing public sector assets, economic growth would be slowed, rather than enhanced.

Privatization gives priority to profit maximization, typically at the expense of social welfare, equity and the public interest. In most instances, such priorities tend to reduce jobs, overtime work opportunities and real wages for employees besides imposing higher user fees or charges on customers or consumers. Thus, privatization, tends to adversely affect the interests of public sector employees and the public, especially poorer consumers.

Short-termist developmentalism?
Investments by the new private owners are typically focused on maximizing short-term profits, and may therefore be minimized. Profit-maximizing commercial or ‘economic’ costing has generated various problems, often causing services and utilities, such as water and electricity, to become more inferior or expensive.

Without subsidies, privatized companies typically increase living costs, e.g., for water supply and electricity, especially in poorer, rural and more remote areas. Thankfully, technological change has reduced many telecommunication charges, which would otherwise have been much higher due to privatization.

Privatization was supposed to lead to fair competition, but private owners have an interest in retaining SOEs’ privileges. Hence, there has been concern about: (i) formal and informal collusion, including cartel-like agreements; (ii) privileged bidding for procurement contracts and other such opportunities; and (iii) some interested parties enjoying special influence and other privileges.

Costs of living have undoubtedly increased for all. Privatization has often resulted in dualistic provision of inferior services for the poor, and superior services for those who can afford more.

The implications of dual provision vary greatly, and may well be appreciated by those who can afford costlier, but better, privatized services, especially as many resented cross-subsidization of services to the needy.

Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.