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Privatisation and public good

InpaperMagzineSeptember 6, 2010

The privatisation of state owned enterprises has been done to raise capital for cash-starved governments,

curtail fiscal deficit by selling inefficient and unprofitable units, raise investment level and thus spur economic

activity.

It is designed to improve the working of the sold-out units by transferring their control and management to

private sector.

According to official statistics, so far some 166 privatisation transactions have yielded Rs475 billion. These

transactions have taken two forms: transfer of ownership through majority or 100 per cent shares, and sale

of minority shares in the stock market. In one instance— PTCL`s privatisation —the government transferred

control of an enterprise to a private company by selling it 26 per cent shares.

Privatisation is useful if it promotes competition resulting into supply of quality goods at low price toconsumers. However, the same purpose may be achieved not by selling SOEs but to remove barriers to

entry and exit in the given industry. If such barriers exit, privatisation will not promote competition, rather 

there will only be a change of ownership from the state to the private sector. A state monopoly will be

replaced by a private sector one.

The point to note is that allocative efficiency is promoted not by privatisation per se but by competition. For 

instance, telecommunication and electronic media sectors have fairly improved not because of privatisation

but because of entry of several firms in both sectors, which have given consumers greater choice, while the

KESC`s privatisation has not resulted into improved power supply in Karachi, because a public sector 

monopoly was replaced with a private sector one.

Political corruption has been used as an argument for privatisation. The state-owned banks were often

forced to dole out loans to rulers and their cronies who misused credit provided to them. The problem of bad

debt made a strong case for privatisation of the banks, which, by and large, have performed significantly

better under the new management.

The problem here however is essentially not of inefficiency per se but of having a corrupt

political/bureaucratic culture. In such a culture, privatisation itself presents an opportunity for corruption and

lack of transparency. Public assets may be sold at less than market price to the cronies of decision-makers

or to those who lack the expertise to run these units in a competitive manner. One may not forget the

Supreme Court`s landmark decision in 2006 against the privatisation of the Pakistan Steel Mills.

Another argument for privatisation is that working and decision-making in SOEs is not market-based making

them inefficient. The SOEs may be over-staffed or forced to charge a price much lower than the market

price. This problem has much to do with the nationalisation programme of 1970s. The argument is sound but

only partly. The government, no doubt, has to provide huge subsidies to keep such `inefficient` enterprises

working, which tells upon public finances. However, market price is not always the right price. Provision of 

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basic services like health and education needs to be subsidised, otherwise those at the lower end of the

social stratum are not likely to have adequate access to them.

Public schools and hospitals providing subsidised services suffer losses but society as a whole gains.

Similarly, while it may not be economical to locate certain projects in far-flung areas, the need to develop

and alleviate sense of deprivation in those regions makes a strong case for undertaking the economic

activity.

Privatisation of such SOEs will have enormous social, political and economic costs. The benefits of 

allocative efficiency to be obtained through privatisation may be at the expense of already vulnerable

segments of society. A disregard of the vital needs, such as health and education, of such segments means

that society will be deprived of a potentially useful large human capital not only leading to an inefficient

outcome but also breeding social discontent, which is also not conducive to optimal working of the economy

There can be a case for privatising chronically unprofitable SOEs, which are not providing basic or strategic

services. For instance, there is a stronger case for privatising the Pakistan International Airlines (PIA),whose services are consumed by the affluent section of society, than for privatising the Railways, which is

the preferred means of transport for low-income commuters. But even in such cases importance needs to be

given to the privatisation`s effects on competition, transparency, and the managerial and technical expertise

of the bidders in providing such goods or services.

Privatisation can be used to attract domestic and foreign investment and thus to accelerate the economic

activity and create jobs. However, such purpose can be served only if the new management has the

capacity and the intention to make their newly acquired assets work.

In several cases, firms which bought privatised units were interested only in their land, which they got at

lower than the market price, and used them as real estate rather than to produce the goods or services they

were meant for. Such rent-seeking behaviour of private entrepreneurs needs to be checked.

Finally, the sale of SOEs can be used as a cash cow for the government. The Privatisation Commission

Ordinance 2000 provides that 90 per cent of privatisation proceeds are to be utilised for debt retirement and

10 per cent for poverty alleviation. However, this is a use of, rather than justification for, privatisation.

Besides, there is one major problem with such use of privatisation: the sale of inefficient enterprises will not

yield the desired amount of money and the sale of profitable units for injecting cash to the public exchequer 

is not a sound approach as the potential cons may outweigh the intended pros.