Public Sector Reform – Privatisation (Dr. Christopher Gan)

Public Sector Reform –

Privatisation

(Dr. Christopher Gan)

Why Involve the Private Sector?

The Problem Chronic poor performance is the rule

rather than the exception in many publicly run municipal services

many households lack good access to services (especially the poor)

service is often of poor qualityservice delivery is inefficient

(Source, Penelope Brook, the World Bank)

What is Privatisation?

According to the World Bank, privatisation “is the transfer of

ownership of State Owned Enterprises (SOEs) to the private sector by sale (full or partial) of

going concerns or by sale of assets following their liquidation”


Privatisation helps establish a free market, as well as fostering capitalist competition, which its supporters argue will give the public greater choice at a competitive price

Privatisation embraces denationalisation or selling-off state-owned assets, deregulation (liberalisation), competitive tendering, as well as the introduction of private ownership and market arrangements in the ex-socialist states

Privatisation is a political process and, therefore, requires political will, commitment and clarity


Consider University education: Nationalization implies public good

Assumes a constituent policy: Equity before efficiency

Everyone pays the cost, because everyone is better off

Privatization implies private good Assumes a distributive policy: Everyone pays the cost, benefits flow to only a few Admin students moving to Alberta?

Therefore, efficiency-based, user-pays model Includes higher-tuition Academic-based/merit funding only

If the Objective is Achieving Maximum Asset Value

Grant an exclusivity period before the introduction of competition

Don’t limit foreign investment Minimise the obligations on the

incumbent (e.g., for network roll-out, price cap tariff control)

Sell the company in several stages including and IPO (timing is important)

(Source: Kelly, 1999)

If the Objective is Maximising Consumer Welfare

Introduce competition at the earliest opportunity in all parts of the Sector

Sell the company as quickly as possible, including employee share options

Put Universal Service Obligations into license of incumbent and its competitors

Pro-competition regulation during early years

(Source: Kelly, 1999)

Privatization Benefits

The global trend toward state-sector privatization is driven by the recognition that market-based economies are better suited to maximizing societal wealth than nationalized industries and planned economies Industry privatization and deregulation are

necessary steps toward free market competition Eliminates conflicts of interests resulting from state

ownership: political versus economic objectives Promotes efficiency gains through the introduction

of competition (Source: AEAC, 2002)


Economics Benefits Raising revenue for the pursuit of other public

policies through divestiture of government owned enterprises

Raising external investment capital for the energy sector

Establishing the basis for growth in taxable income Efficient allocation of resources (labor, natural

resources, and capital) The promotion of efficiency and productivity gains

(Source: AEAC, 2002)


Social Benefits: Commercial control over enterprise

(more disclosure) ‘Private – dividend’ more public money

for programs and services (Source: AEAC, 2002)

Privatization Benefits(Source: Bleas, Estache Kaufmann)

Fiscal Benefits

Improved Efficiency

Improved Access


Form and extent of private involvement

Market structure and competition

Regulatory approach

Extent of benefits depends on policy choices on three main issues (Source: Bleas, Estache

Kaufmann)

Arguments Against Privatisation

Democratic Government Incentive pressure of future elections

Public Interests Vs Profit Max satisfy needs of the majority as instrument to implement government policy

Essential Services Availability socially necessary but unprofitable services


Profit Contribution To The State Revenuemotivation for the government to

improve the performanceprofits directly into common wealth

of the whole country - better equity

Consumer Interest Protection low competition, infrequent choices

and lack of expertise


Costs of Privatization: Economic Costs:

Loss of annual government revenue Social Costs:

Loss of ‘guaranteed’ jobs Loss of government influence in market

outcomes (Public Interest) Loss of government control over

provision of public goods and services

Why Privatisation Fails?

Lack of strong high-level political commitment to the privatisation program

Inappropriate design of privatisation strategy (in terms of scope, technique, sectors and institutional capability of the government)

Unclear and weak institutional framework: decentralized (ministerial/ provincial level) or centralized (such as an independent privatisation committee under the head of state)

Poor preparation of enterprises for privatisation or divestiture (such as inadequate accounting and auditing, treatment of losses, or social and environmental safety nets)

Why Privatisation Fails?

Insufficient transparency and flexibility in terms of the method of privatisation, balancing ownership and control (corporate governance)

Vested interests of managers, employees and customers

Lack of appropriate legal frameworks (e.g., property rights, foreign ownership, bankruptcy laws)

Underdeveloped capital markets

Preconditions for Privatisation

Irreversible political commitment to economic stabilization and liberalization

The accomplishment of necessary legal and regulatory reforms, such as the establishment of property rights, streamlined investment laws, and enforceable bankruptcy laws

Structural reforms across all economic sectors

Privatization Methods

Service contract Management contract Lease build-operate-transfer (BOT) Concession Divestiture Direct selling of assets Voucher program (Source: AEAC, 2002)

Service Contracts

Definition: specific tasks are contracted to the private

sector, but overall utility management remains with the public sector

Typical duration: 6 months - 2 years Pros: can inject good technical expertise Cons: unlikely to improve performance

greatly where overall management is weak

(Source: Penelope Brooks, World Bank)

Management Contract

Definition: a private company is paid a fee to

operate a set of municipal services Typical duration: 3 to 5 years Pros: gains in managerial efficiency Cons: gains can be difficult to

enforce; city remains responsible for investment


Example: Solid Waste Collection

Management contracts for waste collection are common

Caracas, Seoul, Bangkok, Jakarta, Lagos Contractors are often medium-size

enterprises 100 contractors in Lagos, 85 in Seoul

Cost savings can be significant US data - private sector is 10-30% cheaper UK & Canada data - private sector is 20-40%

cheaper (Source: Brooks, World Bank)

Lease

Definition: a private company leases the assets of a utility,

and maintains and operates them, in return for the right to revenues

Typical duration: 10 to 15 years Pros: commercial risk borne by the private

sector, giving strong performance incentives Cons: administratively demanding;

government remains responsible for investments


Build-Operate-Transfer

Definition: private sector develops, finances and

operates bulk facilities Typical duration: 15 to 30 years Pros: good way of getting efficient

delivery of bulk services, with private investment

Cons: not a good solution if supporting distribution systems are in bad shape, or traffic levels are uncertain

(Source, Penelope Brook, the World Bank)

Example: Solid Waste in Hong Kong

DBO (Design-build-operate) for refuse transfer stations and a chemical waste plant

for waste plant, capital cost paid over 5 years in monthly installments

DBO for landfills (including restoration and aftercare)

capital costs paid in lumpsums at milestones

(Source: Brooks, World Bank)

Concession

Definition: city owns the assets, but contracts with

the private sector for operations, maintenance and investment

Typical duration: 25 to 30 years Pros: potential for high efficiency in

operations and investment Cons: requires considerable

commitment and regulatory capacity (Source: Brooks, World Bank)

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Example: Water & Sanitation in Manila

A 25-year water and sewerage concession began in Manila in 1997

– requires increase in water connections from 65% to 100% of households within 10 years

– requires increase in sewerage connections from 8% to 83% of households within 25 years

– requires decrease of technical and commercial loss from over 60% to 25% within 25 years

– projected to involve total investments in excess of $7 billion

(Source: Brooks, World Bank)

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Divestiture

Definition: the assets of a municipal utility are sold

to the private sector Typical duration: indefinite, but may

be limited by a license Pros: potential for high efficiency

gains Cons: requires credible regulatory

framework (Source: Brooks, World Bank)

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Voucher Programs

In much of Eastern Europe, the only politically feasible alternative to auctioning off SOEs was to effectively give the SOEs directly to the nation's citizens by giving them the exclusive right (and the means) to purchase shares

These voucher programs had the virtues of speed and perceived fairness: literally thousands of firms were privatized in five years or less, and the non-discriminatory nature of these voucher distribution programs ensured their popularity

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Voucher Programs

The principal drawbacks are threefold:

Voucher programs do not raise cash for the SOE or the government

Voucher privatizations do not result in an

infusion of new technology or managerial expertise.

Vouchers do nothing to establish an effective monitoring mechanism for newly privatized firms, and the ownership structure that results from their exercise is usually highly flawed

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Direct Selling of Assets

In a direct sale, all or part of an SOE is auctioned, either to an existing company (foreign or domestic) or to a group of investors

They bring in significant revenue for the government; they frequently inject new technology and expertise into the SOE's operations; and they solve the monitoring problems that an atomistic ownership structure creates

Asset sales also compare favorably with SIPs in terms of the speed with which direct sales can be arranged, the ability of governments to sell SOEs piecemeal, and the fact that the direct sale format means that buyers are obliged to commit to certain operating standards of their acquired firms

Other Privatization Methods

Contracting Out/Outsourcing The state enters into agreements with private

vendors to provide services. The state pays contractors to provide the services

Public-Private Partnerships The state conducts projects in cooperation with

private vendors, relying on private resources instead of tax revenue

Examples - Management contract, Leases, Concession, Divestiture, Build-Operate-Transfer (BOT)

Privatization - Conclusions

Do privatised enterprises improve performance in terms of profitability, efficiency and investment?

Does privatisation improve government finances?

What is the social impact for consumers and employees?

What are the overall effects on the economy?

How do different approaches to privatisation affect end results, and what lessons can be learned?

References

AEGIS Energy Advisors Corp. (AEAC), “State Oil Company Privatization, “ November 8, 2002

Isabelle Bleas, Antonio Estache, and Daniel Kaufmann, “Public-Private Partnership in Infrastructure and Poverty,” World Bank Institute

Penelope Brook, “Private Sector Roles in Delivering Public Services: Policy Options for Developing Cities, “ the World Bank

Tim Kelly, “Process and impact of commercialisation/privatisation: Worldwide trends,” CTO Senior management seminar: Telecoms restructuring and business change, Malta, 17-21 May, 1999

Public Sector Reform – Privatisation (Dr. Christopher Gan)

Documents

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