Privatizing the public sector

Transferring ownership of state property to the private sector, generally by selling it to business interests at a reduced price.

In order to maintain the credibility and the sustainability of the privatization process, increasing public awareness of its objectives, transparency and accountability play a critical role. It is particularly important to enter into consultations with all groups involved in, or affected by, privatization to ensure their participation and that the design of the privatization process would maximize social welfare gains. Socially-related support measures may be needed to help cushion the potential hardships caused by privatization, such as social compensation and safety net measures and employment creation.

Special conditions are sometimes attached to sales, such as the retention of a special or "golden share" by the government in order to protect the business from an unwelcome take-over, for example on national security grounds, or to provide an opportunity for the management to adjust to the private sector culture.

Privatization activities have increased considerably around the world in the post-Cold War era. Governments in several industrial countries and in a large number of developing countries are divesting themselves of part or all of their ownership in some state-owned enterprises, typically telecommunications. If the enterprise is financially sound and can attract a large number of local investors, then public offerings have been made, partly to develop domestic capital markets. But the primary form of divestiture in most developing countries is by private offering and is likely to remain so. It may include the outright sale of enterprise assets. In cases where the enterprise is unsuitable for divestiture because it is not financially viable once protection and subsidies are removed, liquidation may be the only feasible course of action. Small, unviable enterprises have been closed or liquidated in several countries, including Guinea, Mali, Mexico and Venezuela.

The privatization of infrastructure may involve the sale of the infrastructure or sale of the infrastructure company through public offering of shares or to a private investor. Such sales involve far more complex and costly operations than that of privatizing a trading company, for example. Questions such as valuation, enterprise restructuring and industrial segmentation in order to enhance competition, method, sequencing, timing and transparency of sale, underwriting, participation of foreign and "strategic" investors, safeguards (through, for example, the use of "golden shares") against undesirable corporate activity such as hostile takeovers and the concerns and interests of particular social groups (for example, rural populations) assume great importance and call for particular attention. The treatment of large accumulated debts of infrastructure companies, for example, those of railways in Germany and Japan, also raises particular problems. In Japan, in addition to the restructuring of the national railways, a Settlement Corporation has been established to take over the railway's long-term debt which could not be transferred to the regional companies, which would be repaid from the sale of land no longer needed by the industry and of the shares of the regional companies, as well as to help retrenched workers to find new jobs. In addition, there may be environmental aspects to be considered. At the same time, because of their importance in the national economy and of the vital economic and social services which they provide, there is greater pressure than in a commercial privatization to show the benefits of privatization, as reflected in the supply and quality of services, their prices and in their economic impact (for example, on communications and other enterprise costs).

In view of the size of the transactions involved relative to the size of the domestic capital markets or of domestic savings, some countries may find it difficult to transfer full or majority ownership of infrastructure companies to the private sector through public offerings. However, there are other options, including minority ownership transfer, commercialization, corporatization, the granting of an operation and maintenance contract or joint ventures. Where there is genuine competitive bidding for the franchises, contracting out can provide periodic competition for the industries concerned. A non-divestiture option, which can also serve as a preparatory step to divestiture, is corporatization; such an option has been used effectively in some developed and developing countries (Australia, Malaysia, New Zealand and the UK) in order to prepare public utilities for their successful transfer to private ownership.

Another option still is the sale of development and operating rights through build-operate-transfer schemes. While such an option can provide a number of benefits, e.g. new sources of capital, reduced time and cost to develop new infrastructure, improved operating efficiency and responsiveness to customers, efficient pricing of infrastructure services, and new tax revenues, there can be major obstacles, including the reluctance of financial markets to finance infrastructure projects without government financial support or guarantees, lack of sophistication on the part of public managers to attract privately-financed infrastructure projects, and local opposition and environmental regulation. The latter affect both public and private projects. Although infrastructure development is costly, the cost of under-supply of a vital service like electricity, when translated into macroeconomic constraints to growth, may be much higher.

Governments may thus have to assume some of the risks and offer incentives to the private investor by providing a long-term contractual concession and, where necessary, monopoly power during the period of the concession, in order to attract financing for infrastructure development. Alternatively, governments may choose a method whereby the risks are assumed by the private investor and are reflected in the tariffs. If subsidies are to be granted, they should be provided in a transparent manner. Loan guarantees from multilateral agencies or the sponsoring government may also be necessary in order to obtain the necessary financing.

Economic regulation is needed both to protect consumer welfare and to provide a guarantee and financial stability to the private sector developer/operator. Where the regulatory capacity is inadequate or is subject to political interference, a negotiated contractual concession, by covering the life cycle of the project, may be preferable to the private sector developer/operator than price or rate of return regulation. Such a contractual agreement between shareholders and the government can stipulate allowable rates of return; it can provide for re-negotiations where the stipulated rates of return are not sufficient, as well as for penalties, for example when there are quality shortfalls.

Competitive bidding is necessary for the award of concessions. For this purpose, pre-selection of bidders is essential. There may be a role for the donor community to reimburse partially the pre-selected bidders for their bidding costs and to co-finance the cost of feasibility studies in order to enhance the participation of bidders in developing countries.

This practice generally refers to industrial enterprises, banks, land and stock shares. For example, enterprises built at state expense in the UK and the USA to produce war material during World War II were sold to industrialists after the war. More recently, in the 1990s most industrialized countries have engaged to some degree in a process of privatizing state utility companies and public services.

The forms of privatization range from management privatization through commercialization and corporatization to capital privatization. Commercialization and corporatization have been applied generally to medium or LSEs. Public enterprises may be commercialized (Nigeria, United Republic of Tanzania) or corporatized (Finland) without leading to divestiture. Some corporatized public enterprises have the right to raise capital on the private capital market (Finland, the Netherlands) Further, some public enterprises are able to involve the private sector in the increased capitalization of their enterprises (Senegal, Tunisia) or to acquire shares of private companies (Morocco), giving rise to some form of "rolling privatization". Capital privatization may also be preceded by management privatization, generally in the case of small and medium enterprises (Ghana, Morocco and Senegal). However, management privatization may be used as an end in itself (Côte d'Ivoire, Ghana, Niger, Senegal, Sri Lanka, Togo). It is an important tool for the contracting out, sometimes combined with the private development, of public utilities (Argentina, Colombia, Côte d'Ivoire, Malaysia, Thailand, the USA). In general, the technique chosen depends on the enterprise needs in terms of new capital, management know-how, technology, market contacts and incentives of ownership, including good corporate governance.

The government's practice of keeping a "golden share" in the telecommunications industry after privatization has been adopted in a number of countries (as in New Zealand, Turkey and the UK). In France, for reasons of national interest, the government can take a particular action ("golden share") which would give the state the possibility, after a privatization exercise, to authorize any participation exceeding 10% of the shares. After the modifications introduced in 1993, the share of control may be less than 10%. However, the state retains the right to name one or two non-voting members to the board of directors of the company or to oppose any transfer of assets likely to jeopardize national interests. In the case of public enterprises operating in the area of health, security and defence, any participation exceeding 5% of the share capital is subject to the approval of the Minister of the Economy.

Other similar measures allow the government to place a state-appointed director in a privatized company (Portugal, Turkey). In the Republic of Korea, in order to prevent investors from monopolizing the financial sector, ceilings are placed (maximum of 5% for firms, maximum of 5,000 shares for individual investors) on the ownership of shares in the privatized banks. In the United Kingdom, any individual holding of shares of privatized utilities is limited to 15%, regarded as the threshold for material influence on a company. Certain countries also place a limit on foreign equity participation (France, 20%, but not applicable to EEC/EU nationals; Malaysia, 25%). In addition, as indicated above, social conditions such as employment protection schemes are attached to sales in certain countries. Other conditions applied by certain Eastern and Central European countries include the development of export markets and share retention by the buyer for a specified period in order to prevent the buyer from quickly turning over the enterprise to another party. Likewise, in Sri Lanka, foreign investors are not allowed to transfer a recently-acquired enterprise to another foreign investor without government approval.

In New Zealand, in order to promote widespread ownership and to avoid situations where minority shareholders of companies would object to their sale (as was the case with the Bank of New Zealand and the Petroleum Corporation), new owners are required to float shares as a condition of sale. For example, in the case of the Telecommunications Corporation, now privately owned, 40.1% of the shares had to be floated by the new owners within three years of the sale. Similarly, a public flotation of 30% of the shares was part of the Air New Zealand deal in l988.

Denationalization forces enterprises to confront the rigours of competition.

Denationalization can result in the failure of enterprises which cannot compete.