Privatization and Equity

PRIVATIZATION AND EQUITY Privatization, as with any economic policy, creates gainers and losers. Increasingly, governm...

Author: V. V. Ramanadham

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PRIVATIZATION AND EQUITY

Privatization, as with any economic policy, creates gainers and losers. Increasingly, governments—particularly those in developing countries—are coming to realize that privatization can have a very severe economic impact and raise problems of equity. Yet remedial actions are often inadequate and unsystematic. In Privatization and Equity, the authors look at some of the problems brought about by the change to private ownership. The book provides an overall analysis of the issues concerning the impacts of privatization on equity. The authors first identify and examine the means through which privatization may have an unfair effect on some sectors, from new market structures to foreign ownership and operating policies. Second, they discuss the interrelationships between privatization and the national economic parameters, which, apart from the profits raised by privatized enterprises, imply many equity considerations. Third, they highlight the consequences for privatization of disregarding these effects, from reversal of policy to problems of credibility in public perception. These issues are explored across a broad range of developing countries by contributors who have a wide experience of privatization. They include policy makers, professionals and academics from both the developed and developing world. Professor V.V.Ramanadham is Coordinator of the UNDP Interregional Network on Privatization. He has been engaged in research in the field of public enterprise, privatization and industrial economics for over forty-five years, and has numerous publications in the area. Recent books include Public Enterprise and Income Distribution, The Economics of Public Enterprise, Privatization in the UK (ed.), Privatization: A Global Perspective (ed.) and Constraints and Impacts of Privatization (ed.). He is an Associate Fellow of Templeton College, Oxford, and the Founder-Director of the Institute of Public Enterprise, India.


Edited by V.V.Ramanadham

London and New York

First published 1995 by Routledge 11 New Fetter Lane, London EC4P 4EE This edition published in the Taylor & Francis e-Library, 2002. Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 © 1995 Interregional Network on Privatization (UNDP) All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library. Library of Congress Cataloging in Publication Data A catalogue record for this book has been requested. ISBN 0-415-11898-0 (Print Edition) ISBN 0-203-21424-2 Master e-book ISBN ISBN 0-203-21436-6 (Glassbook Format)

CONTENTS

List of figures List of tables Contributors Preface

vii viii x xi

1 The impacts of privatization on distributional equity V.V.Ramanadham

1

2 The distributional impact of privatization in developing countries: who gets what and why Paul Cook and Colin Kirkpatrick

35

3 The impacts of privatization on distributional equity with special reference to East Germany Dieter Bös

49

4 Privatization and distributional equity in Poland Ryszard Rapacki

68

5 The impacts of privatization on distributional equity in the Philippines Leonar Magtolis Briones

83

6 The impacts of privatization on distributional equity in Thailand Kraiyudht Dhiratayakinant

99

7 The impacts of privatization on distributional equity in Malaysia Ismail Muhd Salleh

118

8 The impact of privatization on distributional equity: the case of Sri Lanka Saman Kelegama

143

v

CONTENTS

9 The impacts of privatization on distributional equity in Bangladesh Muzaffer Ahmed

181

10 The distributional implications of privatization: the case of India’s divestment programme Sunil Mani

193

11 The impacts of privatization on distributional equity in Nigeria J.J.Bala

207

12 The impacts of privatization on distributional equity: the Chilean case, 1985–9 Cristián Larroulet

226

13 The impacts of privatization on distributional equity in Guyana Carl B.Greenidge

241

14 Concluding review V.V.Ramanadham

270

Index

280

vi

FIGURES

1.1 1.2 3.1 3.2 3.3 3.4 8.1 8.2 8.3 8.4 8.5 8.6

Impacts on the public exchequer The distributional impacts of privatization Lorenz curves of equivalence incomes Lorenz curves of satisfaction with household income Incomes of people in unemployed households Satisfaction of people in unemployed households Provincial distribution of employment in PVEs Sectoral distribution of employment in PVEs Ethnic/religious distribution of shareholders (percentage according to the number of shareholders) Distribution of compensation Utilization of compensation Distribution of income-generating activity

vii

11 23 56 57 59 59 150 151 152 158 160 160

TABLES

1.1 2.1 2.2 2.3 2.4 3.1 3.2 3.3 4.1 5.1 5.2 6.1 6.2 6.3 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 8.1 8.2 8.3

Source and incidence of distributional equity Forms of privatization and degree of control Foreign exchange as a share of total revenue Foreign direct investment in privatizations, 1988–92 Pattern of external finance to developing countries Incomes, employment and productivity in West and East Germany Reduction in employment in THA-owned firms Cumulated welfare effects of alternative tax policies The poverty level in Poland, 1985–90 Disposed assets, by industry List of competitor-buyers The performance of the state-owned enterprise sector Privatization before 1986 Privatization activities since 1980 Growth of public enterprises Federal loans to statutory bodies, government-owned companies, and state governments as a percentage of total government outstanding debt Consolidated public sector finances 1970–90 and public sector employment List of privatized projects as at 1 May 1992 Estimate of revenue generated and forgone by the government from floating of MAS, MISC, Tradewinds and Sports Toto Outstanding government debt Summary of savings in BOT projects Potential reductions in employment in privatization projects Summary indicators of Masterplan programme Public ownership of some privatized SOEs SLTB commuter fare subsidy scheme Schedule of privatizations viii

5 41 42 43 44 55 58 63 77 97 97 114 115 116 136 137 137 138 139 139 140 140 141 153 168 176

TABLES

8.4 10.1 10.2 10.3 10.4 10.5 10.6 11.1 11.2 11.3 11.4 11.5 11.6 11.7 12.1 12.2 12.3 12.4 12.5 12.6 12.7 12.8 12.9 12.10 12.11 12.12 12.13 13.1 13.2 13.3 13.4 13.5

Privatized enterprises by July 1993: price per share and employment levels Divestments of PSE shares The favourable and unfavourable effects of divestiture Employment consequences of closure of chronically sick PSEs List of PSEs offered for divestment The extent of loss to the government on account of PSE share divestment Chronically sick PSEs under SICA Privatization Commercialization Sale of assets Share distribution of some privatized firms in Nigeria Summary of valid applications on Union Bank Plc offer FMNL Plc ordinary shares allotted to the general public Post-privatization shareholding structure of United Nigerian Insurance Company Ltd Data on the Chilean economy, 1984–9 Exports during 1983–9 Savings, investment and employment, 1984–9 Involvement of the state in the economy Bank statistics, 1984–7 Participation of foreign investors, up to 1988 Employment in privatized companies Growth in telecommunications service Gross domestic investment Distribution of shareholdings following privatization (1985–8) Chile: income distribution, 1985–90 Number of shareholders in privatized public companies Percentage control by ten major shareholders Income distribution of wage earners by sector, 1992 Significance of enterprises privatized, 1984–92 Relative impact of government share flotations on shareholding by the public Allocation of shares: selected privatizations Privatization of public enterprises, 1984–8 and 1989–92

ix

178 195 196 198 200 202 203 220 221 221 222 224 224 225 227 228 228 229 230 232 234 234 234 236 236 237 237 243 244 259 260 264

CONTRIBUTORS

Muzaffer Ahmad Professor of Management and Economics at Dhaka University, Bangladesh; formerly, Adviser (Minister) for Industries. J.J.Bala Director of Research, Technical Committee on Privatization and Commercialization, Nigeria. Dieter Bös Professor of Economics, University of Bonn, Germany. Leonar Magtolis Briones Professor, College of Public Administration, University of the Philippines; President of Freedom from Debt Coalition. Paul Cook Professor, University of Manchester, UK. Kraiyudht Dhiratayakinant Director, Social Research Institute, Chulalongkorn University, Bangkok, Thailand. Carl B.Greenidge Deputy Secretary General, ACP Group, Brussels; formerly Finance Minister, Guyana. Saman Kelegama Fellow at the Institute of Policy Studies, Colombo, Sri Lanka. Colin Kirkpatrick Professor, Project Planning Centre for Developing Countries, University of Bradford, UK. Cristián Larroulet Executive Director of Instituto Libertad y Desarrollo, Santiago, Chile; President of the Council of Directors of Universidad del Desarrollo. Sunil Mani Faculty Member, Centre for Development Studies, Trivandrum, India; author of Foreign Technology in Public Enterprises. V.V.Ramanadham Coordinator, Interregional Network on Privatization; formerly, Professor and Dean at the Osmania University, Hyderabad, India, founder-director of Institute of Public Enterprise, and staff member of the United Nations. Ryszard Rapacki Professor, Warsaw School of Economics. Ismail Muhd Salleh Deputy Director General, Institute of Strategic and International Studies, Kuala Lumpur, Malaysia.

x

PREFACE

Most of the papers included in this volume were first presented at the Expert Group Meeting held at New Delhi during 20–4 September 1993 on the Impacts of Privatization on Distributional Equity—a subject that has not yet received due attention from privatizing governments. The meeting was sponsored by the Division for Global and Interregional Programmes (DGIP) of the United Nations Development Programme (UNDP). It constituted a major part of the work programme of the Interregional Network on Privatization during 1993. I express my gratitude to the contributors, to Mr Timothy Rothermel, Director, and Mr Philip Reynolds of DGIP (UNDP) for their guidance in the conduct of this activity and to Dr S.R.Mohnot for his collaboration. V.V.Ramanadham Coordinator Interregional Network on Privatization New York

xi

1 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY V.V.Ramanadham INTRODUCTION The purpose of this introductory paper is to provide an overall analysis of the issues concerning the likely impacts of privatization on distributional equity. At certain places illustrations are drawn from the experience of different countries. Full country-specific reviews are covered by the country papers. The plan of the paper is as follows. This first section deals with the connotation of the two terms ‘privatization’ and ‘distributional equity’, relevantly to our purpose, and offers some introductory observations on developing countries. There then follows a discussion of the many ways in which privatization may have impacts on distributional equity. A further section considers the policy options open to governments in dealing with such impacts. Finally, some conclusions are set out. Privatization In tracing the nature and magnitude of the impacts of privatization, one has to be clear about the connotations of the term. Privatization represents a conceptual continuum,1 ranging broadly over divestiture and non-divestiture options. It is useful to keep in mind the distinction between the two categories, which can have different impacts on distributional equity. Divestitures, for instance, are accompanied by effects relating to the ownership of capital and the enjoyment of profits, for there will be new, private-sector owners replacing the government. Non-divestiture options, on the other hand, do not alter the fact of government ownership; nor do they imply any change in the accrual of profits (or losses) to the government. The distributional effects of non-divestiture options will be confined to the nature of marketization introduced in the operations and the organization of a continuing public enterprise, whereas in the case of a divestiture ownership effects also follow. Moreover the precise effects of non-divestiture marketization depend on the nature and scope of the option as employed in a 1


given case; and the distributional impacts vary correspondingly from case to case—for instance, as between a management contract arrangement and a restructuring that involves a break-up of supra-optimal units into independent entities which would be likely to compete with one another. For full clarity of the implications, it is helpful to distinguish among certain situations of privatization which do not involve divestiture. These may be described as efforts at privatizing the economy in the broad sense of the term. First, there is the case of the induction of private capital into an existing public enterprise—not the soliciting of public deposits, but the acceptance of equity capital from non-government sources, as (at the time of writing) was contemplated by the Shipping Corporation of India Ltd. Here distributional effects flow from the fact that ownership begins to be shared by both government and non-government investors. That is, the taxpayer shares in— but has no monopoly of—the net returns. Second, a new joint venture may be set up between the government and private capital. Third, a private enterprise may be set up in a sector long reserved for, or traditionally supposed to be the domain of the government. In Malaysia, for example, the new highway concessions exclusively involving private capital are taken to be a part of the privatization process; so are the build-and-operate and build-operate-and-transfer projects.2 The most important among the distributional effects in these cases stem from the private-sector model of operations and investment decisions. We cannot talk of distributional ‘changes’, since these enterprises are not those that existed in the public sector, with their own distinctive distributional implications. There is one ‘change’ possibility, however. Their operations might influence those of the existing public enterprises, if any, in the sectors concerned—e.g., in the electricity sector—such that the latter are forced to effect changes in their own input and output policies; and these could trigger some redistributions. Distributional equity Let us turn to the more difficult term, ‘distributional equity’. Malaysia’s government speaks of emphasis being placed on targeting the programmes for the ‘hard-core poor’, such that the incidence of poverty as a whole might decline from 17.1 per cent in 1990 to 11.1 per cent in 1995 (and for Sabah, from 34.3 per cent to 25.6 per cent).3 And Argentina’s slogan is ‘humanized and social capitalism’.4 It is not easy to be prescriptive of an ideal distributional pattern in precise terms, yet a close look at public policies in various countries suggests the following elements as generally considered to promote distributional equity: (a) Helping the relatively poor sections of the community, the unemployed, and any identified groups of handicapped persons or of persons 2

IMPACTS ON DISTRIBUTIONAL EQUITY

segmented by tradition of isolated into the backwaters of development— e.g., hill tribes. (b) Raising the share of national income of the lowest-income brackets. (c) Raising the share of wealth owned by the poorest groups. (d) Controlling ‘excessive’ flows of income and capital outside the country. Translating these notions into flesh and blood entails making value judgements which are specific to time, country and the government. The effect of privatization in terms of any of these notions might be established, even if rather imprecisely. The question also arises as to how acceptable a privatization might be from the equity standpoint. This involves many value judgements. The disparate distributional effects in a given case—e.g., when a privatized enterprise attains internal efficiency through measures that cost jobs and raise prices—can only be adjudged properly if the desideratum in the case of each effect is known through some public policy statements and if we have an acceptable technique of evaluating trade-offs among different redistributions (which are unlikely to be unidirectional). A primary component of the redistributions implicit in privatization is that which occurs as between the taxpayer and the rest of the interest groups associated with the enterprise. The next section will examine this issue in detail. At this stage it may be mentioned that, by and large, privatization options and techniques which shift profits to the private sector might be to the taxpayer’s disadvantage, while those that imply economic prices on the part of a continuing public enterprise (which has been losing or making low profits) are in the taxpayer’s favour. Then there are groups associated with an enterprise undergoing privatization, which experience redistributions. The most obvious among them include the consumers who are affected by changes in output and pricing policies, the employees who are affected by the recruitment policies and methods of wage remuneration, and the suppliers of inputs from the small industry sector who might experience changes in the procurement policies and production techniques of the privatized enterprise. In several instances of non-divestiture options, the taxpayer’s interests might be adversely affected as any of these groups improves its own interests, upon privatization; and vice versa. It is also possible that the interests of one or some of these groups might be affected adversely as some others gain an advantage; and in the course of the mutual effects among these groups, the taxpayer’s interests might sometimes remain unaffected. The point to note is that the redistributions which privatization in a given case produces are wide ranging and call for an intensive analysis of which group benefits and at whose expense. The distributional impacts of privatization on different groups might vary over time. The immediate impacts might not be the ones that will remain in the long run. This issue will be taken up later with particular reference to the public exchequer, employment, and the consumer. While the immediate effects can be identified, the 3


subsequent trends and the long-run effects can only be speculated about analytically. That would not be easy; but such an attempt is worth undertaking. It helps us explore the right course of policy actions to deal with the impacts which are likely to be unfavourable. It would not be wise to avoid such an analysis on the plea that not enough time has elapsed yet after privatization. The distributional impacts of privatization may be analysed with reference, first, to a single enterprise; second, to a whole sector of enterprises—e.g., fertilizers or banks; or third, to the totality of privatized enterprises. Broadly, the differences between the three perspectives are as follows. (a) In the first case, the size of distributional impacts would be narrower than in the other two cases, since we deal with a single enterprise. The impacts essentially consist of those on employment and on the public exchequer. Investor-financing costs borne by the government are a special source of the impacts in the latter case, in certain circumstances. Redistributions through changes in price structures would be somewhat limited, if we assume that there are other enterprises, public or private, in the sector concerned, and that any changes introduced by the privatized enterprise would entail minimal deviations from the price circumstances already prevailing in the market. However, where the privatized enterprise happens to be the only or the most dominant enterprise in the sector, e.g., in the case of British Gas, changes that occur in its price structures are, of course, likely to bring about redistributions affecting the consumers. (b) Where an entire sector is privatized, the impacts are likely to be considerable as well as multidirectional. In particular there might be material changes in the operating practices of the enterprises. These refer to the procurement of inputs as well as to the selling of outputs. In all likelihood, public policy objectives which might have applied to them would be scaled down, implying an almost obvious series of redistributions, subject to any specific compensations devised by the government to moderate the effects. One other impact, which has a potential for redistributions, may be derived from the changes likely to occur in the inter-industry relations involving the privatized sector. For example, if the privatized electricity enterprises withdraw price subsidies on sales to small industry in general, or to a given industry such as aluminium or to agriculture, there are bound to be distributional effects on the investors, employees and consumers of the affected activities. (c) When we look at the totality of privatizations, two additional aspects assume importance. One refers to the changing profile of the public exchequer as privatizations proceed. This can be a source of redistributions, in favour or disfavour, primarily, of the taxpayer and, secondarily, of the beneficiaries of specific government expenditure decisions. The other aspect—somewhat distinct from the first—is the transfer of profit-earning opportunities to the private sector. Equally importantly, they might lead 4


to skewness in wealth and income distribution. Later sections go into this question in more detail. The source of impacts and the incidence discussed above may be presented in the matrix form shown in Table 1.1. Table 1.1 Source and incidence of distributional equity

Developing countries In concluding this section, we may summarize the setting of the developing countries, which is relevant to the present analysis, in the following terms. These apply to them as a cross-section, though there might be individual differences in magnitude. (a) The proportion of people below the poverty line is rather high—e.g., about 30 per cent in heavily populated India. In Eastern Europe, ‘in every country for which data are available, the proportion of the population living in poverty has increased’.5 As per the UNDP’s Human Development Report 1993, 70 per cent of the total population of the least developed countries are ‘people in absolute poverty’.6 It would be considered unethical to let these numbers rise. (b) Unemployment is severe. At the time of writing the East European countries, for example, presented alarming unemployment figures.7 Developments which were to inflate these figures would be far from appealing to the generality of the population, as well as to governments. There are particularly serious problems in respect of certain depressed country regions and certain precarious occupations like agricultural labour. (c) Certain groups of people merit description as ‘backward classes’. The criteria might be ethnic, locational, or peculiarly circumstantial. Hill tribes in India are one example. It may be considered politically appropriate to insulate them from total exposure to market forces. (d) There is wide skewness in the patterns of income and wealth distribution. It is feared that over time, the disparities have been growing, rather than declining. It is said of Brazil that the top 20 per cent of the population earn twenty-six times what the bottom 20 per cent earn.8 Another interesting example may be 5


drawn from the ASN unit of the Permodalan Nasional Berhad of Malaysia, an institution focused on encouraging share ownership by Bumiputreas, the indigenous ethnic group in the country. In 1991, some 60.3 per cent of the unit holders accounted for 1.4 per cent in value of the units, while 0.85 per cent of the unit holders held 45.8 per cent of the value.9 (e) There are extremely wide variations in the per capita incomes of different regions in large-sized countries. There is impressive evidence of this from India and Malaysia.10 (f) The tax systems are characterized by elements of severe regressivity. Sri Lanka’s tax system, for instance, depends heavily on production and trade taxes;11 many of these are likely to be regressive. To cite another example, most of the increase in the Malaysian federal government’s revenue in 1992 was expected to be from indirect taxes.12 (g) A number of public-sector enterprises owe their origins to the prevalence of public policy objectives which entail the subsidizing of certain groups or regions in some way. The public distribution systems, which often run parallel to market systems, are an obvious illustration. Further, the operating practices of many public enterprises have been deliberately influenced by such objectives. The most conspicuous effect is the carrying of surplus manpower. The former socialist countries nearly attained full employment in this way, regardless of the productivity implications. These characteristics represent a selected excerpt from the socio-economic scenario of developing countries and the centrally planned economies in transition. They have to be constantly kept in mind while analysing the distributional impacts of privatization and more certainly when one wants to arrive at policy measures appropriate to identified impacts. One final observation of an introductory nature is that the distributional impacts of privatization are particularly significant and warrant analysis in countries where: (a) public enterprise has been large in relation to the national economy, and privatization has touched a high proportion of it; (b) the social returns traceable to the enterprises have been, or have been perceived as, substantial; (c) the market forces are unlikely to make up for the initial losses of benefit (or income) sustained by certain groups consequent on privatization; and (d) the socio-economic or political scenario of the country is too brittle to relegate the impacts to inattention. To express these ideas differently, the analysis gains in importance in countries where the objectives of privatization go beyond ‘internal efficiency’ on the part of individual privatized enterprises and extend significantly to the area of the external economies or social returns associated with the enterprises concerned. There are indications of concern along these lines even in advanced market economies, like the 6


UK.13 These are expressed in regulatory structures which, in the final analysis, duly emphasize the concept of returns from the enterprise’s operations to others than the investors concerned, without neglecting the interest of the latter. It is interesting to note Dieter Bös’s statement that ‘economists believe that efficiency aspects of privatization are more important than the distributional aspects.’ ‘However,’ he concedes, ‘both in “the West” and in economies in transition, distribution problems have been high on the political agenda.’14 In fact, in developing countries and in the economies of transition, distribution problems tend to be high, not merely on the political agenda, but genuinely on the agenda of public economic policy. THE DISTRIBUTIONAL IMPACTS This section is devoted to the delineation of the distributional impacts of privatization on different groups—taxpayers, employees, investors and consumers. The discussion will be in the context of divestiture in the main. References to the non-divestiture options will be made at the end of the section. Divestiture Impacts on taxpayers The impacts of divestiture on the public exchequer may have results from which the taxpayer either gains or suffers. And they may be either immediate or more long term—i.e., either as a divestiture takes place or in the course of the developments that follow. The most significant factor is divestiture pricing, i.e., the level of price at which an enterprise is sold off. Obviously the seller—i.e., the government or the taxpayer—loses if the price is ‘low’, while the buyer gains. And there is a redistribution which tends to be to the taxpayer’s disadvantage. The price — may be said to have been ‘low’ in the following circumstances: (a) where the price actually received is lower than what could have been obtained; (b) where the price received is lower than is justified by the estimated future earning power of the enterprise. Neither condition is easy to prove conclusively, though a discerning analysis of the relevant circumstances offers a clue to the answer. For example, the price accepted from the preferred buyers—e.g., locals as against foreigners —may be demonstrably lower; the price realized from an employee buy-out may be definitely lower than what the government could have realized by selling the enterprise on the open market; and so on. As regards the second circumstance mentioned above, there can be serious problems of valuation, 7


especially in the case of an enterprise whose track record has not been good, or whose future prospects in terms of markets, technology and the government’s sectoral policies are difficult to judge. Many enterprises in developing countries and centrally planned economies in transition come under this description. In the generality of cases, their shares are not quoted on the stock exchanges (assuming that the latter exist); thus one important means of knowing the investor market’s judgement of the worth of the enterprise is absent. It is far from being the purpose of this paper to go into valuation per se. However, two points need notice. First, many public enterprises have incurred heavy costs of development, including R. & D. Such investments would be at varying stages of fruition at the point of divestiture. Full credit must be given to the size and time-frame of the inflow of net benefits from such expenditures. The point has great relevance in developing countries, where notable technology developments have largely been initiated in the public sector. Second, the balance sheets of some public enterprises are unrealistic. They include many fictitious assets, along with highly doubtful debts. These balance sheets have to be reconstructed in order to establish a reasonably reliable profile of the enterprises. It is in terms of that profile that one should estimate the price that can be expected or asked. The actual price received may be compared with this value, before a conclusion is derived on whether the price received is relatively low. (This issue will be picked up later, in a slightly different context.) Our discussion on low divestiture prices is purposeful, in view of the bulk of evidence on underpricing in many countries. Studies by the UN Centre on Transnationals suggest that many sales in eastern Germany, for instance, have been ‘at very low prices, based upon the valuation of individual assets and liabilities’.15 Rapid privatization has usually resulted in ‘imprecise and frequently low values’.16 ‘Where the goal is complete divestiture as soon as possible, valuation and equity considerations are neglected’.17 There is evidence from the UK too (through reports of the Committee on Public Accounts and the National Audit Office) of ‘windfall gains for the investor at public expense’.18 It was concluded by researchers in Malaysia that divestitures in the case of MAS, MISC, Tradewind and Sports Toto were underpriced very heavily, judged by the opening trade price.19 Divestitures in many countries have been described in a UNDP study as ‘a garage sale’ of public enterprises to favoured individuals and groups.20 Perhaps the underpricing of divestitures will continue for quite some time, if for no other reason than that there is an oversupply of divestitures the world over, and the ‘foreign capital’ which is frequently the target of divestiture has a plentiful choice. If we add to this the mistakes in logistics and the possible irregularities in finalizing the sale transactions, there is clearly extensive scope for outcomes which are to the taxpayer’s disadvantage. 8


The disadvantages of relatively low capital incomes occur in several ways. They limit the government’s ability to retire public debt or to incur capital expenditures in the course of its budget policies; or they raise the need for increased public borrowing. (Where the government looks to privatization incomes even to bridge current deficits in the budget—as in India—the disadvantage is even more marked.) There is a continuing disadvantage to the taxpayer where the enterprise divested has hitherto been a highly profitable one. The profits, over and above the interest costs to be serviced in respect of the investments concerned or the public debt that corresponds to the investments, will be lost to others. In estimating the potential loss to the taxpayer, due consideration should be given to the factor of deferred expenditures, or expenditures whose potential rewards are likely to accrue in the future—a point mentioned earlier. The situation would be different where the enterprise divested is a lossmaking one. However, there are three qualifications. (a) In a significant number of cases, the enterprises are loss making because of the public policy objectives implemented through their operations. If we assume that such objectives are to continue, following privatization, the government will have to devise a mechanism under which the new private-sector owners will continue to maintain the non-commercial operations concerned, in return for compensation from the public exchequer (or a local authority). Thus the basic cause of what appear to be losses on the part of several public enterprises does not alter. There is, of course, some likelihood of the public policy objectives coming under rigorous scrutiny and the quantum of compensations aggregating to a figure below the current losses. (b) The precise character of the losses shown in the accounts of many public enterprises needs to be established. They are largely traceable to the fact that there are significant accumulated losses which are financed by loans on which interest costs are incurred. Accumulated losses do not necessarily imply that the current operations of the enterprise are unprofitable, yet they might wipe out whatever profits arise out of current operations, necessitating huge debits under the head of interest charges. The lesson is simple: the accumulated losses—a fait accompli—should be written off, the balance sheet should be cleaned up, and the enterprise should be offered conditions under which current operations are likely to be commercially viable. However, where the enterprise cannot be viable even after such financial restructuring, the enterprise may be clearly termed a loss-making enterprise for purposes of the present argument. (c) The argument, in fact, can be extended to the debate on restructuring in general. The merely financial exercise mentioned above may provide an enterprise with a clean balance sheet, but not necessarily with the conditions for future viability. The latter may only be possible, in some cases, through 9


a thorough restructuring, entailing technological and organizational changes. These cost fresh money. If this is calculated to produce a net profit on the total investment including the costs of restructuring—but not the accumulated losses—the enterprise should not be considered as a losing enterprise. Its likely profits, in excess of the bare interest cost of the total investment, would represent a potential stream of loss which the taxpayer sustains on privatization. Unfortunately none of the qualifications cited above is given due consideration by many governments, partly because of the pressure to divest rapidly and without any kind of restructuring. And the argument that lossmaking enterprises are best divested gains popularity. Whether the taxpayer really gains in every case depends on a careful assessment of these qualifications. Taking the two factors together—the divestiture price and the net results status of the enterprise—we may postulate that the taxpayer’s disadvantage would be at the maximum where the divestiture price is low, the enterprise is profitable, and its profitability is expected to improve further in the course of time. The disadvantage is smaller where the divestiture price is high and the profit prospect of the enterprise is not one of spectacular improvement in the future. The taxpayer gains most from the divestiture where the divestiture price is high, the enterprise is loss-making and its future prospects are not particularly bright. (This would be an uncommon case.) The discussion so far has been in terms of individual divestitures. It is necessary to look at how the taxpayer fares under a series of divestitures. Basically the impacts depend on the magnitude of the divestitures and the profile of the public enterprises that remain unsold in the public sector. Assuming that the more profitable enterprises are the first to be divested, the government may find itself stuck with the loss-making enterprises. The net effect on the public exchequer or the taxpayer would be a combination of forgone profits and continuing losses. If the divestiture prices are, on the whole, relatively low, the disadvantage is aggravated by the fact that a part of the interest burdens attributable to the public debt of the divested enterprises continues to haunt the exchequer. The relative importance of the low-profit or loss-making enterprises staying in the public sector for a long time may be illustrated by two examples. In Nepal the public-sector enterprises include Nepal Electricity, Nepal Water Corporation, Agricultural Inputs Corporation, Nepal Food Corporation, Nepal Oil Corporation, R.B. Bank, Agricultural Development Bank and Nepal Television. These account for about 80 per cent of the total losses sustained in the public sector. In Hungary, as many as 143 enterprises are expected to stay in the public sector for a long while. In fact a new holding corporation has been set up to take charge of them. The above phenomena may be illustrated as shown in Figure 1.1. 10


Figure 1.1 Impacts on the public exchequer

Assume that the government initially receives a profit, after interest, of OP from its profitable enterprises and sustains a loss of OL, after interest, from its loss-making enterprises. As divestitures take place, the profit income declines as per PP2, while the losses perhaps stay as they were as per OL 1 or, with performance-improvement programmes, tend to be somewhat lower as per OL2. The original excess of profit over loss (i.e., OP minus OL) gradually contracts to the space between OO1 and PP2, minus that between OO1 and LL1 or LL2. The net effect on the exchequer is an annual loss in income. This begins to translate itself into tax measures that hurt the taxpayer. There is another important factor which determines the impacts on the taxpayer, namely the way in which the divestiture incomes are utilized. Practices vary among countries. The UK used them for income tax reductions in the early years, though gradually they have supported substantial reductions in public borrowing. France used them substantially in public debt reduction. Hungary used about 50 per cent of the divestiture income for public debt reduction in 1991, while some 33 per cent went into the current budget.21 The German Treuhand agency makes use of the divestiture incomes for restructuring the enterprises under divestiture. In Nigeria the funds are unused, pending decisions on how to use them. 11


If such funds are used for paying off public debt, the budget enjoys the recurring advantage, year after year, of reduced debt servicing charges. This is particularly welcome, since the profit earnings from investments financed from public debt resources decline as divestitures advance. Whether the gain through reduced interest burdens is higher than, equal to, or lower than the profits forgone depends on the twin considerations of divestiture price and enterprise profitability, as noted already. The budget experiences a net impact correspondingly. This eventually passes on to the taxpayer, assuming that the government proceeds to effect tax changes in response to the new budget situation. If the divestiture proceeds are used for fresh commercial investments, what takes place is a rotation of government investments. That is, as earlier investments are transferred to the private sector, new investments are made in the public sector. There could be valid reasons for this approach in many developing countries, even if in joint venture with private capital, domestic or foreign. The infrastructural sector such as electricity, water or transport might be a suitable focus for such investment. Now the impact on the taxpayer depends on the degree to which the operations of such enterprises are run along commercial lines. It is possible to insist on their working on the private-sector model, in which case the eventual effect on the taxpayer need not be unfavourable. If the divestiture incomes are used for social expenditures or for infrastructural expenditures not intended to work on the private-sector model, the impact on the taxpayer would be that of a budget gap, other things being equal. However, there can be certain redistributions through the availability of social or infrastructural outputs in favour of the regions or of population groups coming within the purview of such expenditures. What the taxpayer, on an average, loses, the general public, even if only in specific areas or sectors of activity, gains. There is a trade-off here. The propriety of it has to be judged on the canons applicable to taxation and public expenditure decisions. If the government views the divestiture incomes as a godsent opportunity to indulge in wasteful expenditures—e.g., building prestigious buildings or a new capital city—the impact on the taxpayer tends to be disadvantageous. Where divestiture incomes are utilized for purposes which are of utility principally to the richer sections of the population, the generality of the public derive no distributional advantage. Let us now look at the special situation where there is no divestiture income, as in the case of divestiture through free vouchers. Here the impacts work themselves out in a complex manner. At the outset, the public exchequer derives no capital income; hence there is no question of recurring streams of income from the use of a divestiture resource. This disadvantage to the budget is compounded by the fact that the public debt remains intact, and the cost of servicing it will be a continuing burden. Radical changes in tax structures will be called for, in order to create fresh avenues of recurring incomes for the public exchequer. In the centrally planned economies in transition (where the voucher method of privatization has been adopted) there will be a need to 12


introduce several kinds of direct taxes, the more so as some individuals, unlike in the past, begin to accumulate sizeable incomes. The distributional impacts really stem from the nature of the equation as between direct and indirect taxes and from the precise composition of the indirect taxes. (Certain other distributional aspects of the voucher method will be considered at a later stage in this section.) Investors Divestitures occasion some degree of redistribution among the investors. Such redistribution will be at a minimum if all persons have equal shares in the divested enterprises. In practice this hardly happens, even in countries where equal values of free shares are offered to all citizens. ‘Unexpected’ concentrations of privatized assets are already occurring in the Czech and Slovak republics, where the nine largest investment funds (among more than 400) control about half of the aggregate investment points. ‘By contrast, direct investment by individuals accounts for only 25 per cent of the vouchers.’22 Almost every privatizing government has expressed its preference for the widest possible distribution of ownership of privatized enterprises. In many cases this is, in fact, mentioned as one of the objectives of privatization. In practice, however, divestitures have tended to have a bias for ownership concentration, partly as a result of prevailing inequalities in income and wealth— the relatively rich would naturally be the first to own privatized capital. That apart, many of the divestiture techniques adopted by governments have had a built-in bias for concentration. In many countries, trade sales and negotiated transfers have been quite common. (For example, forty out of sixty-three reprivatizations in the Philippines were in the nature of negotiated sales.23) The ‘block’ ownership formula pursued in some countries favours concentrated ownership in the hands of large buyers. (In Sri Lanka, in almost every case currently, 60 per cent of the shares have been sold to a core investor.) Selling a large-sized enterprise without disaggregating it into smaller, but economic, units is another common practice. This again works in favour of large buyers. In many countries, there is a dearth of effective stock exchange activity; hence public flotations are not easy. (For instance, public share flotations accounted for only a fifth of the total divestiture proceeds realized in Sri Lanka during 1989–93.24) There has been a quest for managerial capability on the part of the new owners. Likewise there are urgent needs of technological upgrading. Above all, there is an emphasis on speed in privatization, and on attracting foreign capital. There is, thus, a bias in favour of large owners. Attempts are no doubt made to encourage a spread of share ownership among a large number of people. These broadly fall under the following categories: 13


(a) Allocation of a certain proportion of privatized shares in small lots, so that there will be a large number of small allottees. (b) Preferential allotments to employees. (c) Support for employee buy-outs. (d) Provision of financial aids to small investors. Let us focus on the distributional implications of these measures, leaving aside their implications for managerial efficiency. Under the first category of efforts, there can be a large number of small shareholders, but they account for a very minor proportion of the share capital. (For instance, about 98 per cent of the 338,350 shareholders in British Airways, owning between one and 1,000 shares each, together held only about 10 per cent of the share capital in 1989.)25 In Sri Lanka, shareholders with less than 500 shares each accounted for only 5 per cent of the capital in the recently privatized Pugoda Textiles Lanka Ltd.26 If the real substance of ownership consists of the power to influence managerial behaviour, and the power to enjoy high rewards of profit, it is the others—not the tens of thousands of small shareholders—that hold these powers. There is the argument that the major shareholders are not individuals, but institutions—e.g., pension funds, mutual funds, investment trusts, insurance companies, building societies and banks. Apparently the benefits of concentrated ownership vest in the institutions. In practice, however, the profits and other benefits of the institutions reach their owners or clientele, who might themselves belong to the richer sections of the community. Thus, although the benefits seem to reach a large mass, there is considerable skewness in the pattern of their distribution—as mentioned earlier, in the case of the Permodalan Nasional Berhad. The other point worth noting is that, while at the time of share allotment the number of small shareholders may be quite large, as time passes many are induced to sell their shareholdings, either because the share market prices are attractive—as has happened in the UK27 —or because they are in need of liquid cash—a common phenomenon in most developing countries. It is said that in Sri Lanka, transport workers who received sizeable quantities of free shares started selling them off. A similar outcome is on record in the case of Malaysia.28 Looking at such evidence, one may speculate that the special emphasis that privatizing governments place on developing a large mass of shareholders gets gradually blunted, particularly in developing countries, by share transfers characteristic of capitalism. The second category—preferential allotments to employees—is one of the most common features of privatization round the globe. For example, in 1984 the British government offered fifty-four free shares to each eligible employee in British Telecom. There was a matching offer of two shares for one, up to seventy-seven per employee, and a discount of 10 per cent was offered up to 1,000 shares per employee purchased under the priority 14


arrangements. There has been a loyalty bonus of one free share for every ten kept by the employees until 31 July 1990, subject to a maximum of 200 shares, in the case of BAA Plc.29 In France, employees were offered special share prices and one free share for every ten shares purchased; employees could defer payment for three years. In Poland, there were substantial reductions in the prices of shares purchased by employees. In Sri Lanka, 10 per cent of privatized shares have been offered free to employees; in the road transport sector, 50 per cent of the mobile assets were passed over free. Such generosity might have a strong justification in weakening employee opposition to privatization, but it raises questions concerning distributional equity. The argument may be advanced in a two-pronged manner. First, public enterprise employees do not necessarily constitute the lowest-income brackets in developing countries—on the contrary, their emoluments (though not at the very top managerial levels) are far higher than those of their counterparts in the private sector. And in general they have not been threatened by the risk of job losses, unlike in sizeable segments of small-scale industry which are perennially exposed to business losses leading to loss of employment on a reasonable wage. Offering ownership concessions to public enterprise employees is good for them, but has limited justification in the context of the overall distributional pattern of the economy. This comment might have less force with reference to centrally planned economies in transition, where almost everyone was previously an employee in the public sector. Second, ownership benefits offered to employees accrue to them unequally; this applies even to centrally planned economies in transition. Employees who are situated in relatively profitable enterprises receive far higher ownership benefits than those placed in less profitable or loss-making enterprises.30 (The latter enterprises might in fact be loss-making as a result of public policy objectives, and not necessarily because of the inefficiency of the employees.) Employees working in enterprises which are retained in the public sector on grounds of strategic interest or unsaleability are denied the kind of ownership benefits that their brethren in other enterprises receive. The third category—employee buy-outs—has varying degrees of success as a divestiture technique. Eastern Germany has probably had the largest number of MBOs (or MEBOs). There, the Treuhand has helped the evolution of MBOs in many ways: all unnecessary assets of the enterprises have been stripped off, so as to keep the divestiture price low; in some cases, land is only leased out on a long-term basis; the Treuhand agrees that future investments will come from the internal resources of enterprises, rather than from the investors’ own resources; and the purchase price may be paid up to the extent of 50 per cent after three years, the balance being paid later in instalments.31 Employee buy-outs have the distributional merit of preventing concentrated ownership of enterprises by wealthy individuals outside the enterprises concerned. While they present the possibility of a wide spread of the share capital among the employees of such enterprises, there are bound to be severe 15


disparities within the ownership structure of an employee buy-out, in the course of time or even to start with. There is also the possibility of the employees manipulating the divestiture price in their own favour, and gaining extremely valuable concessions in the process of share acquisition. In Slovenia, employees can acquire up to 60 per cent of the shares in an employee buy-out on very favourable terms (e.g., 20 per cent or more free of charge in exchange for ownership certificates, and up to 40 per cent through a general programme of internal buy-out, under which 20 per cent is paid in cash at once, with a discount of 25 per cent; and seller financing for four years at a real interest rate of 2 per cent is available.32 To the extent that divestitures occur by means of employee buy-outs, there is the distributional implication that certain persons (i.e., those within the enterprises concerned) enrich themselves as preferred buyers in a process that excludes others (i.e., those outside the enterprises) from bidding. The last category, concerning the offer of financial aids to small buyers, has not proved popular in practice, since it involves finding the resources necessary for the purpose. There are traces of such aids being used in the divestiture processes applicable to employees, considered above—for example, the loyalty bonus shares in the UK, and the 2 per cent rate of interest on deferred payments in Slovenia. Once again we should not gloss over the fact that, though schemes involving seller finance might help in creating a large body of shareholders initially, the continuance of such a pattern of shareholding is not guaranteed in the circumstances of poverty in developing countries. In any case, employees might account for only a minor portion of the share capital of the enterprises concerned. We shall now turn to certain other aspects of distributional implications of divestitures: foreign ownership, ethnic background of new owners, regional patterns of new ownership, and managerial compensation arrangements. Foreign investors have played a significant role in the privatization processes of several countries. For example, about 72 per cent of the divestiture incomes in Hungary during 1991 were from foreign sources,33 as were about a third in Sri Lanka during 1989–93.34 There are two points of particular relevance to our discussion. First, the larger the proportion of foreign involvement in privatized ownership, the wider the scope for foreign exchange outflows. There would be no problem in this, in theory, if the outflows represent no more than reasonable profits which are not far in excess of the normal profit returns enjoyed by other investors in the country, on an average, and if the outflows of external remittance are totally free from malpractice by the foreign investors. Such malpractice can include irregular practices in transfer pricing and in the accounting of import and export transactions. Second, foreign investors would be likely to invest only in the most profitable among the enterprises being offered for privatization. Thus the opportunity to make big profits goes disproportionately to the benefit of foreign investors. 16


The ethnic implications of privatization have assumed importance in some countries. Malaysia, for instance, provides an instance of how privatization has been directed by the government to ensure that a target group, in this case the indigenous Bumiputeras, has been the major beneficiary.35 For instance, the shares initially taken by the Permodalan Nasional Berhad eventually found their way into the hands of the Bumiputeras. In certain other countries, the ownership patterns in the aftermath of privatization have proved somewhat unpalatable to the government and the indigenous people. In Kenya, Tanzania and Uganda, for example, some divested enterprises have ended up in the hands of Asian capitalists—a development resented by the indigenous populations. Equally, one can point to other African examples where dominant ownership by certain tribes (such as the Kikuyus in Kenya) has given rise to social tensions. Likewise, divestitures might result in relative concentration of ownership in a few regions of a country, provoking displeasure elsewhere. In cases where there are relatively backward regions in a country, with relatively low per capita incomes, the problem of regional disparities in ownership tends to gather momentum. An interesting example may be drawn from Nigeria, where privatized capital has been heavily subscribed for by the inhabitants of a few states like Lagos (which indeed has had an overwhelming share), Ogun, Bendel, Kane and Imo, as against states like Soketo and Plateau, whose shares in privatized share subscriptions have been extremely low.36 Managerial emoluments tend to be higher in the privatized sector, as even the UK experience has revealed.37 The initial justification often lies in the fact that management pay levels were relatively low when the enterprises were in the public sector. We do not have enough data to take a view on whether the nature of share distribution could have any clear impact in this respect. Where shares are thinly spread over a large mass of shareholders, the managers could expropriate for themselves powers of crucial decision-making, including those on managerial compensation. But even in situations where there are large ‘core’ investors, they might feel no great concern over this issue as long as the profit results of the enterprise are good. One conclusion seems possible: in the absence of public regulation of managerial compensation, this is determined in the light of the circumstances of profit and of directorial attitudes. Where these conditions are favourable, the compensation tends to be high. Employees Perhaps the most feared impact of privatization is that it is followed by employee lay-offs. The fear is justified by the fact that in many countries, public enterprises carry excessive labour forces. When they are exposed to the conditions of the market-place, suddenly without governmental protection against bankruptcy, the newly privatized concerns have to reorganize their production functions 17


in such a way that they will earn a satisfactory profit. This may compel them to retrench their labour forces suitably. For example, there have been redundancy rates of 20 to 55 per cent in Ethiopia. There are several qualifications to this conclusion, however, for the determining circumstances of different enterprises are likely to differ. (a) Assume that the enterprise has a large market to which it was unable to cater fully while in the public sector, because of the inability of the government to provide it with the necessary investment. As a privatized enterprise, it is free to formulate and implement its own investment plans. In the course of expanding its production activity for a larger market, it might be free from the need to retrench its workforce. (b) There is a special version of the above scenario, in the context of the situation in many developing countries. Assume that the enterprise had been unable to take full advantage of the markets, because of the lack of foreign exchange needed for introducing suitable adjustments in the production structure. When privatized, however, the enterprise enjoys greater freedom to solicit foreign investment. Where it already has a foreign component of investment, acquiring further foreign exchange might be relatively easy. Once the enterprise is appropriately modernized with the technologies that the foreign resources make possible, it might be able to serve expanded markets and find itself capable of retaining the existing labour force. (c) The enterprise, when privatized, will be in a position to reorganize the deployment of its workforce and to introduce appropriate retraining of spotted talent. As a public enterprise, it might have found this difficult to implement due to bureaucratic hurdles. It will now experience improvements in productivity and be able to operate with more economical cost structures than before. These may have favourable effects on output expansion. There may then be no need for retrenchment. (d) Where the enterprise is so privatized that it has the facility of operating as a monopoly, it does not necessarily have to undertake retrenchment, if it finds it easy to make a profit whatever its productivity and cost structures. This, in a way, is a negation of the basic objective of privatization. Besides, if there is an effective regulatory framework, it is certain to induce the enterprise to improve its operating efficiency. On the whole, except in such circumstances as mentioned above, privatized enterprises effect lay-offs to some extent. How severe the distributional disadvantage of this is tends to depend on a macro factor: the capacity of the rest of the economy to provide employment for the displaced workers. In countries like Bangladesh and India, where unemployment is already very high, the scope for absorbing the newly laid-off might be no better than that in relation to the stock of the unemployed themselves. It is possible, however, 18


that coming with some skills and probably accustomed to the disciplines of the workplace, the laid-off workers might pick up employment more easily than the others. There might also be schemes for re-employing the displaced workers in preference to the others, and it is also possible that many of them would try to set up their own businesses on a small scale, with technical and financial assistance from their former employers, in some cases. We sometimes come across the argument that, as privatization makes the economy as a whole more efficient, employment opportunities expand in such a way as to cushion the initial impact of lay-offs. The validity of this argument is country-specific. In most countries, such self-balancing will take a long time. In some it might be no more than wishful thinking. Our discussion so far has been in terms of numbers. There is another dimension from the distributional angle. In the cross-section of public enterprises, wages and incentive payments are not strictly related to one’s productivity; where there is some semblance of a connection, the norms are often far too generous. Besides, a majority of public enterprises—especially the large ones—offer their employees a wide variety of social benefits, such as education, health care, recreation, housing, transport, and retail shopping. These benefits are heavily subsidized; in some cases they are free. (In the central government enterprise sector in India, the ‘social expenditure’ per employee exceeded 10 per cent of the wage income in certain sectors (like steel, chemicals, heavy engineering and transport) in certain years.)38 Privatized enterprises tend to scale down their social expenditure—this constitutes a particular problem in the centrally planned economies in transition; or they begin to charge their employees ‘economic’ prices for the services received by them, or make the eligibility rules more stringent. In all these ways, the continuing employees of privatized enterprises experience some unfavourable distributional changes. Whether these are justifiable from the national standpoint of income distribution is another question. One has to take note of the redistributions which occur in favour of the consumers, as employees are laid off in the interest of efficiency which ultimately leads to price reductions. Here is a trade-off which warrants evaluation. Consumers The distributional impacts of privatization on the consumers are enterprisespecific. Let us, therefore, look at the varying scenarios in which public enterprises are transformed into private enterprises. (a) Where an enterprise enjoying monopoly powers and making high profits is privatized as an undisturbed monopoly, there might be no improvement 19


(b)

(c)

(d)

(e)

(f)

(g)

in the consumers’ deal. In fact, this might become worse, unless the regulatory framework imposes changes in its pricing and effectively limits the profits it can earn. Where an enterprise enjoying monopoly powers, yet making losses or low profits through inefficiency, improves its efficiency and reduces its cost structures on privatization, it might make satisfactory profits without raising its prices. The consumers will experience no disadvantage, unless the enterprise begins to exploit its monopoly position by hiking up the prices. Where an enterprise enjoying monopoly power, yet making losses or low profits because of public policy objectives in favour of all consumers, or certain groups of consumers, is privatized, consumers will experience an unfavourable change in their position as the enterprise begins to raise its prices. Specific groups who previously enjoyed subsidized services will lose that benefit, while those who suffered from subsidizing prices might, though not necessarily, gain relief. Where a monopoly is transformed into a competitive structure in the course of privatization, consumers can hope to gain benefits from price reduction, as well as freedom from the consequences of cross-subsidies in prices. In the latter case, certain consumer groups who were paying high prices to subsidize some other groups enjoy a benefit, while the latter suffer. (Whether they deserve to is another issue. Some of them might in fact represent groups whom the subsidized prices were not intended to benefit.) Where a privatized enterprise is exposed to competition from imports through policies of trade liberalization, the results will be similar to those in the preceding case. This warrants distinct mention, because in several small-market economies there might be less scope for domestic competition than for import liberalization. Where an enterprise which is making losses through inefficiency is privatized, the new owners will try to introduce ‘economic prices’, while making an effort all round to be efficient. The consumers will lose their former (undeserved) benefit of low prices. It is equally possible that, without sizeable price hikes, improved efficiency by itself is sufficient to make the enterprise profitable, in which case no disadvantage will be experienced by the consumers. While a public enterprise might have been making investment decisions in the context of an uncommercial product mix, remote areas of operation and over-fast expansion, the new owners will seek to minimize such decisions; the potential benefits of certain consumer groups will be affected correspondingly.

Several points of analytical interest may be deduced from the above propositions. First, the immediate effects might change in the long term; the 20


enterprises are likely to attain new levels of efficiency as time goes by. Second, the unfavourable impacts suggested above are likely to be subject to regulation over the privatized enterprises, aimed at mitigating such impacts. Third, some of the redistributions might in fact be desirable on the basis of macro considerations. That is, the price benefits that prevailed in the pre-privatization era might not have been ideal—this has been a major problem in many developing countries. Finally, by freeing enterprises from the constraints imposed on them by virtue of their being instruments of distributional policy, the government is then in a position to shift such policies to the right political levels and on to the government budget. The next section will pick up some of these issues. Non-divestiture options We shall wind up this section with some specific references to non-divestiture privatization options which are currently prominent in many countries, either as a provisional measure of policy pending divestiture, or on grounds of the strategic importance of the enterprises concerned. Taxpayers Since non-divestiture options do not involve the sale of an enterprise, the impacts traceable to the nature of the divestiture price, discussed earlier, will be absent. In general, the impacts on the taxpayer are likely to be favourable, since the driving motivation here is efficiency improvement. A management contract may result in a higher net revenue for the exchequer than before. A lease arrangement may bring in a higher income than the earlier profit income. A performance contract or a memorandum of understanding with a public enterprise may have the effect of progressively enhancing the weight of profit in the criteria mix set for its operations. Restructuring enables the enterprise to operate with improved efficiency and to raise higher profits than before. There can be another significant and favourable impact on the taxpayer. When the enterprise is put up for sale at some time in the future, the chances of securing a relatively high divestiture price will be better. However, due caution has to be exercised to prevent a management contractee or a lessee— where these options are pursued—from running down the assets or otherwise artificially creating a picture of low value for the enterprise, with the motive of grabbing it at a relatively low price. Investors There is little to say under the head of distributional impacts on investor groups, since the government continues to be the investor under non-divestiture options. 21


Employees As the main thrust of non-divestiture options consists of efficiency improvement within an undisturbed ownership structure, employee lay-offs, if necessary, cannot be ruled out. Management contracts and leases would encourage the new managers to take hire-and-fire decisions to their commercial advantage. The anxiety to achieve good results during the tenure of the contract prompts them to be relatively short-termish in their outlook and to adopt techniques of maximizing employee productivity. To the extent permitted, they also scale down the expenditures on social amenities provided to the staff. Restructuring will have two opposing effects. One is retrenchment where the workforce is excessive—as in some of the UK nationalized industries in the 1970s. The other consists of well-planned, full utilization of the workforce through technical and marketing changes that create enough work for all the employees. The actual impact on employees will depend on the interaction of these two factors. Performance contracts, in principle, are expected to facilitate the application of proper norms of productivity. In many cases this is likely to cause some lay-offs. Further wage and incentive rewards begin to be linked with performance. As a result, some of the easy benefits to which the employees might have been accustomed will thin out gradually. Consumers As the general direction of non-divestiture options is towards operational efficiency, there will be an emphasis on economic pricing, as we have already witnessed in the case of fertilizers, transport and electricity in many countries. In that process not only does the price level rise in several cases, but cross subsidies get ironed out to some extent. These might impact unfavourably on the consumers concerned. But, as mentioned earlier, such impacts might in fact be desirable on macro grounds. The additional revenues that the public exchequer raises through economic prices in the public enterprise sector can be a source of substantial distributional benefits, making properly targeted social expenditures possible, keeping down regressive tax enhancements, and moderating the need for public borrowing. POLICY MEASURES Let us now consider the options open to governments in trying to moderate the rigours of the distributional impacts of privatization. The broad spectrum is presented in Figure 1.2. There are three caveats in selecting the right policy option and in deciding on how far to go in pursuing it. First, the benefits which it confers on a target 22

Figure 1.2 The distributional impacts of privatization


group might be qualified by disadvantages to some other group(s). It is, therefore, necessary to make an assessment of the net benefit. To some extent this involves a value judgement. Second, the efficacy of a policy option depends on the resource potential supporting it, in terms of technical skills and finance. These resources have high opportunity costs in developing countries and former socialist countries. Third, since privatization aims at establishing a market economy, some of the policy options should be conceived in a timefinite manner. In other words, they should be treated as exceptions to the general market forces, considered necessary within limits of time and range. This proposition applies to the different options with unequal force. For example, compensation arrangements for producers, or safety nets, might be for definite durations with reference to a given target group, whereas general legislation and progressivity in tax structures are likely to be continuing phenomena, without particular reference to privatization. The value of the policy options depends on how well the lessons of the three caveats are effectively kept in mind while pursuing them. Divestiture techniques Without repeating the preceding section, let us look at how the divestiture techniques themselves may be designed so as to minimize the prospect of unfavourable redistributions. (a) Divestitures should be effected through public flotation rather than through private sales, as far as possible. (b) Public flotations may be qualified by allotment decisions in favour of relatively small investors. (c) Prior to divestiture, enterprises may be broken up into non-monopolistic units, subject to criteria of optimal size. (d) Concessional share allotments may be subject to restrictions on resale within a set period. (e) Divestiture agreements may contain claw-back provisions in favour of the government or the consumer, in the event of high capital gains accruing from asset stripping, within a specified period. (f) Divestiture agreements may stipulate that there can be no retrenchment for a specified number of years. These techniques might be effective in minimizing the unfavourable distributional impacts on taxpayers, consumers or employees. Yet they might also make divestitures difficult, depriving the economy of efficiency gains in enterprise operations and of the benefits which arise from governmental withdrawal from entrepreneurship. Such disadvantages have their own equity implications for the taxpayer and the consumer. 24


Regulation From the equity standpoint, the purpose of regulating privatized enterprises would be to ensure that the new owners do not operate in a way which is to the disadvantage of the consumers or the employees. Where competition is effective in the sector in which a privatized enterprise operates, no regulation would be necessary, except where specific price benefits for given groups of consumers, which the free markets do not offer, are deemed necessary, given a public policy objective. This issue will be picked up later in this section, under ‘Subsidies’. Where competition is not effective, regulation would be necessary so as to induce efficiency on the part of the enterprise and to protect the interests of the consumer. Considering the extensive range of monopoly elements in a large number of markets in developing countries and centrally planned economies in transition, governments have to give serious thought to the introduction of an effective regulatory framework.39 Its scope may be as follows: (a) Prices may be regulated under a formula such as the British ‘RPI minus X’ (where RPI refers to the retail price index and X represents the pressure on the enterprise to be efficient). (b) The enterprise may be encouraged or required to disaggregate itself into separate businesses for accounting purposes, so that inter-consumer subsidies can be minimized. (c) Some mechanism, the X factor being one, may be designed so as to contain the profits earned by the investors.40 (d) ‘Windfall gains’, arising on the sale of assets within a specified period after privatization, may be clawed back through an appropriate formula (which is additional to the capital gains tax laws). The formula might be in the taxpayer’s interest, where the gains are syphoned into the public exchequer, or in the consumer’s interest, where they are applied to price reductions.41 We should not lose sight of the fact that certain parts of the overall legislative framework of the country themselves take care of some of the factors contributing to inequity: for example, anti-monopoly laws, pro-competition laws, laws relating to wages, bonuses, retrenchment and retraining, and foreign exchange controls. Where they do not exist, they have to be established and made effective, so that regulatory arrangements concerning privatized enterprises tend to be supplementary and specific, as dictated by clear need, case by case. Budget policies Some of the distributional impacts which are considered to be inequitable may be addressed by a series of policy measures at the level of the government 25


budget. There are two points of special interest here. The measures can be targeted precisely towards persons who are exposed to a loss of income or to a disadvantageous redistribution; and the meausres are presumably based on public sanction, which the budget implicitly carries. Safety nets The most prominent impact attracting government attention is that affecting employment. Restrictions to inhibit retrenchment can only be a temporary measure. In fact they go against the very objective of efficiency underlying privatization. Freedom concerning labour practices should be the long-term goal. In the interim, however, safety nets may be devised so as to provide the laid-off persons with some income during a short period while they look for alternative employment opportunities. Where the numbers involved are large and where, privatization apart, there is already a huge army of the unemployed in the country, the problem has to be addressed as one intrinsic to the country’s economic system. It is just possible that the government will be forced to offer some kind of a dole to them, even if there are restrictive conditions of eligibility. This is a cost which the economy bears as a whole. Privatized enterprises bear their share of the cost too, but not the entire cost of maintaining the total number laid off by them individually. Every enterprise in the economy contributes to the national fund out of which the safety nets are financed. Under this approach, enterprises can be prepared for divestiture by reducing their manpower to the necessary levels, with productivity in mind. Divestitures become easier to effect, since the problem of excess manpower ceases to be a disincentive to buyers and since the agreements of sale would be nearly free from restrictive employment conditions. The prospect of efficiency gains improves, since enterprises can choose the production functions that most suit them. Effective safety nets are a major guarantee of success for non-divestiture options, especially for the device of performance contracts applicable to enterprises which remain in the public sector for some reason. It would not be easy, in developing countries, for such enterprises to undertake the severe manpower planning that is warranted, unlike in the UK where British Airways and British Steel went through considerable readjustment and retrenchment before divestiture. And the efficacy of the non-divestiture option would be at stake. If safety nets emerge from budget policies, this option can offer hope of success. The distributional disadvantage following retrenchment would not be a drag on their pursuit of marketization in operations. The policy option of safety nets subsumes measures of retraining which improve the opportunities of re-employment for the initially laid-off workers. There is another dimension to it: the persons laid off may be offered financial aid or some other form of assistance which eases their path to establishing small businesses for themselves. This point will be picked up in the next part of this section. 26


Subsidies Certain distributional inequities are best dealt with by means of discreet subsidies from the government budget. Such a policy has several merits. It is likely to be rigorously economical, under the constraints of fiscal stringency in many countries; it is most likely to be narrowly, i.e., precisely, targeted to the benefit of those affected by privatization; it leaves the producer free to act on commercial criteria; and it relieves consumers of the inequity of crosssubsidizations at the discretion of the producer. The option of budget subsidies is amenable to a four-fold classification, in terms of whom they reach. First, the government may identify and subsidize the affected consumer at the point of purchase of a given product or service. (We do not go into the logistics of the measure here.42) This subsidy may take the form of cash, a card entitling the bearer to make a purchase at below market prices, or a direct payment to the producer on behalf of the consumer when a bill relating to the purchase is presented by the enterprise to the government. The precaution necessary in the choice of this tool is to ensure that the subsidy, which is intended to offset an unfavourable redistribution suffered by a consumer, is not abused by others who do not deserve it. Leakages should be minimized. An appropriate example would be a non-transferable electricity coupon which the subsidized consumer can present to the supplier of electricity in part payment of a bill. Conditions may be defined, if necessary; for example, that the coupon is worth so much, or a given proportion of the actual bill, whichever is less. Further, the value of such subsidies (or coupons) may be scaled down over time, the more so when the purpose is to soften the initial impact of privatization, rather than to stand in the way of economic prices in the course of time. Many instances of agricultural consumption of electric power in India come within this description. Second, it may be more convenient to direct the subsidies towards the producer in certain cases. Where a privatized enterprise has no interest in maintaining outputs which are uneconomical, the consumers concerned may suffer an unfavourable redistribution. If the government considers it worth helping them out, it may encourage, induce or require the enterprise to continue to provide the outputs in return for what may be termed a ‘compensation’. Uneconomic bus services in remote, rural areas are an example. The burden on the government may be minimized through a tendering system, under which potential providers are asked to bid to offer the subsidized operations. This modality, in principle, may be applied to the product mix (of which the above is in fact a special case) or to closures of productive capacity (for example, a coal-pit or a food store in a large chain or a rural bank office). It is useful to think of such examples in the context of developing countries. The current scenario of banks in India, with a large number of small and 27


uneconomical offices and innumerable loans which have no chance of being recovered, is worth scrutinizing in this context. Third, the central or federal government may offer subventions to the provincial governments or local authorities, specifically for the purpose of subsidizing certain consumer groups. These funds are purpose-specific and the policy rests on the belief that the funds will be utilized more efficiently by decentralized levels of the administration. Fertilizer subventions which the central government offers to the states in India are an example of how the initial inequities of a new policy—in this case, de-administered fertilizer prices —are sought to be moderated. Fourth, budget measures may be designed to counter certain distributional inequities of privatization at the level of ownership. Concessions may be offered to small subscribers of shares in privatized enterprises, especially the employees. Low-interest credit may be offered to them, and also to retrenched employees interested in establishing their own businesses. The E-credits now in vogue in Hungary are an example of this. They attract interest rates about half the level of the market rates.43 The much-publicized announcement of the President of Poland to offer $10,000 to every citizen to buy into privatization represents an extreme illustration under this head of public exchequer policies. It also has the merit of highlighting the major limitation of this option. Can the public exchequer afford the costs involved? If it cannot, the initial impacts of redistributions continue unabated in varying degrees and the government loses credibility in the eyes of the affected groups. If it can afford the costs, that can only be through increased taxation or reduced expenditure; and these have their own distributional effects on the taxpayers and the public in general, as we shall see in the following paragraphs. Tax structures Two categories of possible tax measures may be distinguished. The first relates to the tax reliefs that may be offered to failing enterprises in the privatized sector, on the assumption that these will have a favourable effect on their cost burdens and stimulate their viability. (There have been several examples of requests for such tax benefits, in Guyana and Sri Lanka.) This would be a controversial measure, however. It would be unfair to other enterprises in the same sector. Besides, market forces might justify the liquidation of the units concerned, either because there is no demand for the products in question or because those units are unable to market their products competitively against those of other suppliers in the field. The distributional benefit sought to be conferred on the employees and the investors of the non-viable units has, therefore, to be weighed against the opposite effects on the investor and employee groups in the other enterprises operating in related markets. In any case, such a dole should be time-finite. It would be preferable to offer it, at 28


least partially, as a loan to be paid back when the enterprise survives and prospers. The other tax option relevant to distributional equity borders on the concept of progressivity in the tax structure. As profit incomes and enterprise ownership be concentrated disproportionately in small groups, income taxes, wealth taxes and inheritance (or estate) duties may be designed in a suitably progressive manner. This device has to be wielded cautiously to avoid impeding entrepreneurial initiative, and would be a part of the general tax laws of the country. Expenditures The expenditure policies of the government may be so formulated as to moderate the disadvantageous elements in the redistributions caused by privatization. Three categories may be distinguished. (a) Bailing-out expenditure Privatized enterprises which fail and whose disappearance can only be prevented by their being bailed out by the government through injections of cash, offer of easy loans for modernization and technological improvements, or even equity subscriptions, might lobby for being bailed out. This is a facet of history all too familiar in the area of public enterprise—from Italy to India.44 It is not impossible that history should repeat itself, subject to the hard conditionalities imposed by international financial agencies. There are already examples from Bangladesh of the government having taken over shares in some privatized concerns. (b) Capital expenditure The government may focus on capital expenditure in the social sector, while relinquishing its role in entrepreneurial expenditure in the economic sectors, through a variety of privatization options. This represents a case of specialization in a direction in which the government has a comparative advantage. Several governments have in fact been expanding their poverty-targeted programmes in recent years—e.g., the ‘Janasaviya Programmes’ of Sri Lanka, the ‘Development Programmes for the Poorest’ in Malaysia, and the poverty alleviation programmes of the Philippines. The relevance of such expenditure policies to privatization is twofold. First, where privatization involves localized hardship through unemployment or the loss of incomes, public expenditure policies may be initiated to provide the infrastructure for facilitating the emergence of new income opportunities; for example, where a coal-pit or steel mill is closed. Second, divestitures bring in incomes to the public exchequer. A part of these may be allotted to social expenditure projects whose impact on poverty alleviation may be high. In general a whole group of people 29


or a whole region becomes the beneficiary, not just those who have been exposed to a distributional disadvantage from particular privatizations; however, the latter may be included as beneficiaries, in some cases a major part. The scope for such benefits (to the poor) depends on the size of the divestiture incomes which are available for social expenditure—e.g., on schools, hospitals and public sanitation. It must not be forgotten that repayments of public debt are a major competitor for the funds, justifiably so in the generality of situations. (c) Current expenditure Current social expenditure, in principle, belongs to the above category. However, it would be smaller in size and, strictly speaking, the commitments are subject to revision from year to year. The most relevant aspect of privatization, especially in the former socialist countries, concerns the extraordinary assumption of social services (for the benefit of their employees) by enterprises in the preprivatization era.45 The new owners wish to shed this function as fast as possible; in fact, the divestitures might even exclude their transfer along with the assets of the enterprises. It may seem proper for governments to step in and fill the vacuum, so that the erstwhile beneficiaries do not suddenly lose the benefit of free or extremely cheap social services. Summing up, the aim of most of the policy measures discussed in this section is to mitigate the ruthlessness of a sudden distributional disadvantage, but not to underwrite, for all time, the income benefits that every specific group (of consumers or employees) used to enjoy in the pre-privatization era. The option of budget policies entails costs which the public exchequer, already under strain in most countries, may find too burdensome. Two further problems present themselves. Once initiated, a budget policy measure might prove difficult to discontinue, for political reasons. Again on political grounds the size and range of budget-sponsored benefits to the affected expand progressively from year to year and might even be abused by persons who did not constitute the main target. Finally, the further the government goes in using the budget as an ameliorative means, the greater will be the eventual burden on the taxpayer. If the tax system of the country tends to be regressive, the tax burden will be disproportionately inequitable to the poorer sections of the population. CONCLUSION The need for improved performance of public enterprises is particularly great in developing countries and centrally planned economies in transition. However, severe distributional impacts accompany the reform measures, particularly divestiture. 30


Some of the redistributions involved are basically in the right direction, but their suddenness, coupled with the fact that large groups of people, e.g., employees and consumers, have long been used to certain patterns of benefits, complicates public perceptions and introduces socio-political tensions. It is necessary to introduce proper measures of easing the changes, consistent with a country’s political and economic circumstances. Some impacts are rather fundamental, especially those sustained by the taxpayer, the more so the larger the divested sector in relation to the economy as a whole. It is necessary to attempt a clear estimation of the consequences of divestiture for the public exchequer, as a result of which taxpayers eventually might suffer unequally. On the whole, privatization strengthens the forces of ownership concentration, which is a particular problem in economies that are already characterized by the predominance of a few family groups at the helm of ownership and entrepreneurship. Income disparities are aggravated, and skewness in the distribution of wealth is worsened. These features are not born out of privatization, but are features of capitalism and free-market economies. Privatization serves the purpose of aggravating them, in easy ways in the circumstances in which it is implemented. Assuming that there is a case for privatization, and that income and wealth concentrations are nearly inherent in the process, one has to look for the right remedy in budget policies, based on progressivity in taxation and social expenditures targeted at the relatively poorer sections and regions of the country. It is also helpful to devise means of clawing back windfall gains which new owners amass within a specified period after they have taken over a privatized enterprise. This deals with the problem of honest underpricing of enterprise sales, to some extent, and helps counter the forces of easy enrichment of the new owners. The inequity of unemployment apparently caused by privatization is, in most cases, a fundamental national legacy. The aim should be to allow enterprises to operate with an efficient input structure and to meet the problem of unemployment through national solutions; the cost is best met through the public exchequer. Raising the necessary resources will be a challenging problem, of course. Consumers are likely to be at a disadvantage in several sectors of activity in developing countries, where monopoly conditions might persist after privatization, and policies of import liberalization might be neither effective nor politically feasible. Here again, what is needed is effective regulation of privatized enterprises in the interests of consumers. One final word. So far, we have scrupulously kept fraud and corruption in privatization processes outside our discussion. Experience suggests that in many countries, divestitures have been replete with such malpractice. The consequence, at the minimum, is that opportunities of making easy money in 31


a big way are seized by those responsible for privatizing and those buying the enterprises. Issues of distributional equity in the context of privatization are so important for the developing world and centrally planned economies in transition that early efforts should be made to analyse their nature in the specific situation of a country, with a view to arriving at the most acceptable balance between the fundamental needs of improved economic performance and those of equity. Such an analysis brings to the fore situations where not all redistributions are uniformly favourable. Deliberate value judgements on acceptable trade-offs will be called for. Ignoring the problem of distributional equity does not eliminate it. It simply becomes progressively more serious. NOTES 1 For a full description, see United Nations Development Programme (1991) Guidelines on Privatization, New York, p. 8. 2 As per the ‘List of Privatized Projects’ (dated 7 January 1993) produced by the Economic Policy Unit of the Prime Minister’s Office, Kuala Lumpur, Malaysia. 3 Sixth Malaysia Plan 1991–1995 (1991), Kuala Lumpur, p. 31. 4 The Economist, London, 16 January 1993, p. 56. 5 UNDP Human Development Report 1993, New York, p. 47. 6 Ibid., p. 171. 7 The rates of unemployment in September 1993 were 12.9 per cent in Hungary, 15.4 per cent in Poland, 9.3 per cent in Romania and 17.3 per cent in Croatia. (Source: Economic Commission for Europe and national statistics, as cited in Transition, World Bank, vol. 4, no. 9, December 1993, p. 2.) 8 New York Times, 25 July 1993, p. 10L. 9 Permodalan Nasional Berhad, Annual Report 1991, Kuala Lumpur, p. 7. 10 Economic and Political Weekly, Bombay, 5–12 December 1992; Sixth Malaysia Plan 1991–1995, Kuala Lumpur, 1991, p. 38. 11 Public Investment, 1992–96, Colombo: Government of Sri Lanka, p. 24. 12 Permodalan Nasional Berhad 1991, Kuala Lumpur, p. 27. 13 For instance, the water companies in the UK argued for ‘a rate of return of some 9.5 per cent after inflation’, compared with the suggestion of the Director-General of OFWAT, of ‘between 5 and 6 per cent’. OFWAT (1993) Annual Report 1992, London, p. 5. 14 Dieter Bös (1993), ‘Privatization in Europe: A comparison of approaches’, Oxford Review of Economic Policy, vol. 9, no. 1, p. 106. 15 Accounting Problems Arising during Privatization in Germany, Report of the SecretaryGeneral, E/C/10/Ac.3/1992/5/Add.3, 16 January 1992, p. 24. 16 Identification of Accounting Problems Arising during Privatization and their Solution, Report of the Secretary-General, E/C/10/Ac.3/1992/5, 17 January 1992, p. 5. 17 Review of Important Current Developments at the Global Level in the Field of Accounting and Reporting by Transnational Corporations, Report of the Secretary-General, E/C/10/ Ac.3/1992/2, 23 December 1991, pp. 35–6. 32


18 For example, Second Report from the Committee of Public Accounts, Session 1985–86, Departments of Transport, Trade and Industry and Energy (1985), Sale of Subsidiary Companies and Other Assets, London: HMSO, note 5, vii; note 2, xiv; and note 3, vi. 19 Ismail Muhd Salleh and Lee Tin Hui (1990), Privatization: The Process So Far, Kuala Lumpur: ISIS, p. 4. 20 UNDP (1993), Human Development Report, New York, p. 49. 21 Gusztav Bager (1993) in V.V.Ramanadham (ed.) Constraints and Impacts of Privatization, London: Routledge. 22 Jan Vanous, President of Plan Economics, cited in Financial Times, London, 30 March 1993. 23 Committee on Privatization (1991) 1991 Annual Report, Manila. 24 As per list of divestitures prepared by the Ministry of Finance, Commercialization Division, Colombo, 1993. 25 British Airways Plc (1989) Annual Report and Accounts, London, p. 45. 26 Pugoda Textiles Lanka Ltd. Annual Report for the period ending 31st March 1991, Colombo, p. 6. 27 For instance, the number of shareholders holding less than 100 shares in British Aerospace Plc fell from 44,062 to 3,279 within a year after flotation. (Tenth Reports of Public Accounts, Session 1981–2, Sales of Shares in British Aerospace, 189, London: HMSO, 1982, p. 15.) 28 Privatization Master Plan, Kuala Lumpur: Government of Malaysia, p. 28. 29 Privatization: The Facts, London: Price Waterhouse, 1989, pp. 18 and 59. 30 For interesting comments in this regard, see Andreja Bohm and Marko Simoneti (eds) (1993), Privatization in Central and Eastern Europe 1992, Ljubljana: Central and Eastern European Privatization Network, p. 230. 31 Ibid., p. 31. 32 Ibid., p. 230. 33 Gusztav Bager, op. cit. Some recent instances of foreign buying are as follows: In Hungary, South African Breweries take a 75 per cent holding in the brewery Kobanyai Sorgyan, worth $100 million; Universal Leaf Tobacco of USA is to take a 76 per cent stake in Nyireghaza Tobacco Fermentation. In Poland, 70 per cent of Polgaz Koccian (Gas) was sold to AGA (a Swedish-based company); and five other industrial gases producing companies were sold to BOC of Britain and Liquid Carbonic from USA. The German firm H.Bahlsens Keksfabrik KG acquired an 80 per cent share in the Skawina biscuit enterprise near Cracow. This was the third firm in the sector to be sold to foreign investors, after Wedel, the chocolate-maker, was sold to Pepsi Co. Food International and Olza in Cieszyn to Jacobs Suchard. In the Czech Republic, Ford of USA has concluded negotiations for the purchase of AutopalNovy Jicin, a car parts manufacturer. In Bulgaria, 81 per cent of the food processor Tsarevchni Produkti was sold to Amylum NV of Belgium. (These facts are derived from Press Clippings on Privatization, Price Waterhouse, New York, May 1993 and June 1993.) 34 Ministry of Finance, Colombo, op. cit. 35 Sixth Malaysia Plan 1991–1995, Kuala Lumpar, 1991, p. 49. 36 V.V.Ramanadham (ed.) (1993). Privatization: A Global Perspective, London: Routledge, p. 364. 37 The pay rises in many privatized enterprises in the UK were criticized by the 33


Chancellor of the Exchequer as ‘excessive and unjustified’ (Daily Telegraph, London, 28 June 1991, p. 13). 38 Bureau of Public Enterprises, Annual Reports, New Delhi: Government of India. 39 For a full discussion on regulation, see the Report on the Monitoring and Regulatory Aspects of Privatization, UNDP, New York, September 1993. 40 For instance, OFGAS has among its objectives in setting the price formula the securing of ‘a fair price for consumers’, while allowing British Gas ‘to earn a reasonable rate of return’ (OFGAS (1993) 1992 Annual Report, London, p. 9). OFWAT’s strategy is ‘to protect consumers against excessive prices’ (OFWAT (1993) Annual Report 1992, London, p. 45). 41 For example, under the UK system of regulation of privatized water companies, condition K of the licence requires that ‘half of the retention on land sales must go to water consumers through a reduction in prices’ (OFWAT (1991) Annual Report 1990, London, p. 21). 42 For a discussion, see V.V.Ramanadham (1988) Public Enterprise and Income Distribution, London: Routledge, chapter 3. 43 Andreja Bohm and Marko Simoneti, op. cit., p. 26. 44 The best illustrations of this are IRI of Italy and the National Textile Corporation of India. 45 Human Development Report (UNDP 1993, p. 49) observes:

State-owned enterprises used to distribute most social benefits, from child care to health care and pensions. But over the past three years, these widespread automatic benefits have been dramatically curtailed and are being replaced by ‘social safety nets’ whose services are targeted much more narrowly—and thus risk missing millions of people in desperate mood.

34

2 THE DISTRIBUTIONAL IMPACT OF PRIVATIZATION IN DEVELOPING COUNTRIES Who gets what, and why Paul Cook and Colin Kirkpatrick INTRODUCTION Privatization has been at the forefront of economic policy debates worldwide, during the past decade. With the resurgence of economic liberalism in the 1970s, economic models based on an interventionist role of the state in the economy were replaced by market-oriented policies and development strategies. Privatization was a key component of the new market orthodoxy. By the late 1970s the United Kingdom had embarked on an ambitious programme of selling state-owned enterprises to the private sector, and other market economies soon followed with similar privatization measures. The break-up of the socialist bloc and the efforts to establish a capitalist economic system extended the coverage of privatization to Eastern Europe and Central Asia. In the developing countries the transfer of public enterprises to private ownership began more slowly, but activity increased sharply in the second half of the 1980s, with total privatization proceeds in LDCs increasing from £2.5 billion in 1988 to $23.2 billion to 1992 (Schwartz and Lopez 1993). These global indicators disguise the wide variations in objectives and experience. Privatization programmes have been made to meet a range of objectives. In the ex-socialist economies the overwhelming aim has been to establish a critical mass of privately owned assets, to form the basis of a market economy. In the developed market economies the push to privatize has been driven largely by an ideological desire to reduce the role of the state, and by public sector budgetary considerations. For the developing countries, the espousal of privatization has frequently been propelled by the need to correct serious macro imbalances in the public sector and balance of payments accounts. The forms of privatization adopted have been equally varied— ‘there are at least 57 varieties of privatisation’ (The Economist, 21–7 August 1993) —reflecting differences in economic and political conditions, and in the structural characteristics, of each economy. 35


The multiplicity of objectives and forms of privatization complicates the task of analysing the impact of the various programmes that have been implemented. Furthermore, since privatization is a comparatively recent phenomenon in most countries, the available evidence is limited to a relatively short period of time. Not surprisingly, therefore, empirical analysis of the impact of privatization is still in its infancy. The focus of this paper is on the distributional impact of privatization in developing countries. The analysis is developed within a broad political economy framework, where we attempt to identify the beneficiaries and losers, the relationship between these groups and the policy decision-makers, and the effect which these links may have on the privatization policy-formulation process. We begin with a discussion of the main components of the analytical framework. This construct is then used to develop a number of general hypotheses relating to the content and implementation of privatization policy in developing countries. The paper goes on to present some empirical evidence on the distributional impact of privatization measures, which is interpreted as being consistent with the hypotheses derived from the political economy perspective. Finally, there is a summary and conclusions. THE IMPACT OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY—SOME PRELIMINARIES ‘Privatization’ and ‘distributional equity’ are open to wide ranges of interpretation. Privatization can be used to refer to any measure of public sector reform which has the effect of increasing the influence of the market mechanism on the allocation and utilization of resources. In this paper, it is defined in the narrow sense of a change in the ownership of an enterprise, from public to private sector. Private ownership of a privatized enterprise may be partial, however, and can be associated with varying degrees of control. We do not attempt to define distributional equity; instead we use the more neutral concept of distributional impact. Any policy change affects various parties and interests differently: some gain from the change, others are made worse off. Privatization, as with any other economic policy change, generates losers and gainers. The aim of the distributional impact analysis is to identify the final incidence of these often complex and interrelated effects. Privatization is used as a policy instrument to advance a range of objectives. Often, these goals can conflict, and trade-offs are required. The most commonly encountered privatization trade-off is between economic efficiency and public sector revenue needs. An improvement in the privatized enterprise’s economic performance will frequently depend upon greater competition in the market, which constrains the enterprise’s opportunity for monopolistic pricing behaviour. But the price that a private party is willing to pay for the enterprise will vary inversely with the degree of market competition and deregulation. 36

THE IMPACT IN DEVELOPING COUNTRIES

Privatization proceeds may have to be sought, therefore, at the expense of improvements in the allocation and use of resources. Policy-makers in developing countries will often wish to achieve additional objectives, which may not be compatible with either enhanced economic efficiency or sales revenue. These may include extending the scope of the private sector as quickly as possible, safeguarding employment, or selecting the ‘right’ buyers for the enterprise to be privatized. In resolving the dilemma of multiple objectives and trade-offs, the policymaker is required to apply an implicit set of relative social values or weights. In analysing this policy choice, economists have traditionally taken economic efficiency as the primary objective of economic policy. Where other objectives are allowed for, their ‘costs’ are assessed in terms of forgone economic efficiency gains. In empirical analysis, it is common practice to examine the efficiency impact alone, with the distributional effects being left to the ‘political process’ to resolve. From a political economy perspective, the distributional objective is central to the policy process. As Grindle (1991:45) argues: A model of policy making relevant for this era of economic crisis and political upheaval would be one…[which] would accept politics, not as a spanner in the economic works, but as the central means through which societies seek to resolve conflict over issues of distribution and values. Governments are seldom indifferent to the distributional impact of privatization transactions. Indeed, the choice of privatization instrument is often determined by the government’s intentions to effect a particular redistribution of ownership. By concentrating their analytical attention on ‘technical’ matters of economic efficiency performance, and neglecting the ‘political’ issues of distributional impact of policy change, economists have encouraged acceptance of the convenient, but in our view, mistaken, assumption that resource allocation and use objectives dominate distributional objectives in the policy-makers’ prioritization of policies. Here, we argue that the reverse is the case, that the distributional impact of a particular policy change is of major concern to the policy-maker. In the context of privatization, the question of ‘to whom should firms be sold’ will be at the forefront of governments’ policy formulation processes. PRIVATIZATION AND DISTRIBUTIONAL IMPACT: A POLITICAL ECONOMY APPROACH How is economic welfare affected by privatization, and how is this change distributed between different groups or interests in the economy? Following Jones et al. (1991) we can link the effects of divestiture with the behavioural 37


changes which result from the fact that the enterprise performs differently before and after privatization. The change in welfare (∆W) associated with the changes in the enterprise’s conduct after privatization can be separated into a change in consumer surplus (∆S), a change in the rents received by providers of inputs (∆I) (principally labour), and a change in enterprise profits (∆P). ∆W=∆S+∆I+∆P The change in consumer surplus is positive to the extent that greater efficiency or competition reduces prices. The change in factor rents is most commonly negative to the extent that the privatized enterprise reduces rents received under public ownership in the form of above-market-level wages, or overpayments for material inputs. The change in profits (discounted present value of future profit stream) is positive, in so far as the privatized enterprise’s financial performance improves under private ownership. The distribution of ∆P between the seller and buyer will be determined by the negotiated price at which the enterprise is sold. The private purchaser gains to the extent that his maximum willingness to pay (based on the net present value of the future stream of profits) exceeds what he actually pays. To carry out a full analysis of the distributional impact of privatization, it would be necessary to allow for different social weighting of ∆S, ∆I and ∆P, and also of the relative social value of resources available for use in the private and public sectors. Here, we narrow the focus of our analysis to the asset-ownership component of the welfare change, i.e. ∆P. We further assume that the government receives a price for the privatized enterprise which is equivalent to its ‘as it is’ value. In other words, the whole of the profits which result from the change in enterprise performance subsequent to privatization will accrue to the private-sector owners. How then do the ‘purchasers’ fit into the government’s distributional objectives? If we turn to the new political economy literature, we find that policy-making is explained in terms of rational self-interested choices on the part of the politicians, bureaucrats and administrators who shape policy. The economist’s usual representation of the policy-maker as the platonic guardian of the public interest is replaced by a passive policy-maker who is dependent upon societal and state-centred forces, all of which seek to advance their own interests by influencing the policy-making process (Meier 1993). By endogenizing the policy-maker, the new political economy attempts to explain economic distortions and inefficient policy choices in terms of rational selfinterest choices by sectional interests. The state becomes a passive agent of various interest groups, engaged in the transfer and redistribution of income or wealth between different factions. Evidence of the inefficiencies and distortions associated with the public enterprise sector in LDCs provided the basis for economists’ advocacy of privatization as a means of improving enterprise performance. The various 38


distortions associated with public ownership were often attributed to selfinterest behaviour on the part of those who influenced public enterprise policy. Thus, public enterprises were seen as important instruments of political patronage, as means of redistributing rents to favoured suppliers of inputs, or as vehicles for supplying subsidized enterprise output to particular user groups. When we turn to privatization, therefore, we encounter an apparent paradox within the new political economy perspective. For it would seem irrational for those controlling the policy process, having gained control over the economic benefits deriving from the public enterprise sector, to wish to reduce that control by a process of privatization (Milne 1993). This paradox is neatly presented in the following quote: Privatization requires politicians and government officials to relinquish assets valuable to their careers without receiving any visible reward. It is only to be expected that they will try to retain control. (Walters 1985, quoted in Milne 1993) There are a number of ways, however, in which this paradox can be at least partly resolved. First, the change from public to private ownership need not be associated with a significant shift in control. The policy-makers often do not constitute a separate interest group, but constitute the private sector’s interests within the polity. Privatization may simply represent a change in the means of distributing gain to a particular interest group, rather than a redistribution between groups. Second, it needs to be recognized that the new political economy (NPE) approach provides an incomplete perspective of the policy-making process in developing countries. In particular, the NPE ‘is weakened as an approach to understanding policymaking in developing countries and as a policy analytic tool by the assumption that politics is a negative factor in attempting to get policies right’ (Grindle 1991:44). Hence, the NPE fails to explain how ‘good’ economic policy decisions come to be adopted. Here, the literature on the developmental state, which focuses on the independent influence of a technocratic group on the policy-making process, is illuminating (Onis 1991). Drawing particularly on the experience of the Asian newly industrializing economies, it is argued that a group of enlightened technocrats, independent of and isolated from sectional interests and pressures, helped in pursuing economically rational policies. The significant economic gains accruing from the rapid economic growth engendered by these policies provided the necessary ex-post political validation of policy choices. A similar view, which allows for the adoption of ‘sensible’ economic policy choice, is expressed by Bagwati (1988:41, quoted in Meier 1993), who observes: 39


Many developing countries learned [the policy lessons] the hard way; by following import substituting industrialization (ISI) policies too long and seeing the fortunate few pursuing the export promotion (EP) strategy do much better. Perhaps learning by others’ doing and one’s own undoing is the most common form of education! Hence, enlightened economic policy-making may be adopted as the policymakers try to emulate policies that have been demonstrated to be successful in other countries (Meier 1993:386). A third explanation of the ‘privatization paradox’ relates to the influence of other economic factors on the privatization policy-making process. The existence of multiple economic objectives and constraints inevitably forces the policy-maker into trade-off or compromise decisions with respect to the distributional objective. This trade-off is most evident in the case of revenue and ownership objectives. By increasing the transparency of the sales process and opening the sale to multiple bidders, the government increases the potential revenue yield. But at the same time, it reduces its capacity for transferring the assets to a particular purchaser. There is little doubt that in many developing countries, privatization programmes have been adopted during periods of macroeconomic crisis, reflected in fiscal and balance of payments disequilibria. Many observers have attributed causality: The fact that so many countries showed signs of [divestiture]…in the early 1980s, we believe, was a reflection largely of the drying up of cash in that period, a reaffirmation of the soundness of Samuel Johnson’s observation that the prospect of being hanged in a fortnight wonderfully concentrates the mind. The pronounced slowdown in the growth of the world economy at that time, when coupled with the drying up of the international credit markets, provided the functional equivalent of a sentence of hanging. (Vernon 1988:19, quoted in Jones et al. 1991) The influence of the macro-disequlibria imperative on governments’ privatization distributional objectives is seen most clearly in the increasing reliance upon foreign capital in privatization sales. As we shall see in the following section, foreign capital has financed approximately 25 per cent of all privatization sales in developing countries. Foreign ownership is the antithesis of the domestic redistribution objectives of privatization. As UNDP (1992:50) notes: Distributional impacts of privatization, whether measured in terms of income or power, may also have an international dimension. Foreigners may acquire assets and control cheaply, particularly in disturbed economic conditions, thus transferring resources and power out of the domestic economy. If it is assumed that the most 40


profitable segments of the divested enterprises happen to be the ones to which foreign capital is most attracted, the transfer of benefits to foreigners is particularly open to notice and criticism. Alternative forms of domestic privatization have differing implications for the government’s capacity to ‘control’ the distributional impact of the sales. Generally, the wider and more transparent the divestitive process, the more diffused the asset redistribution effect. A stock market flotation is likely to increase the potential revenue yield, but will allow the government no control over who purchases the shares. Hence, it is not unusual for governments to influence the equity allocation, by providing for allocations at fixed prices to employees or managers, or by selling substantial blocks of shares to a single party or interest group. ‘Closed’ trade sales are the least transparent form of privatization, and allow governments considerable scope for influencing the asset redistribution outcome. The hypothesized link between the form of privatization adopted and the degree of control over the distributional outcome in terms of asset ownership is represented in Table 2.1. This representation is highly stylized, and excludes several important factors. Clearly, as we have already discussed, the choice of privatization mode is determined by a variety of competing objectives. Similarly, the level of economic developments, particularly of the financial markets, may limit the range of privatization methods that can be used. Also, the relative weight attached to the distributional objective vis-à-vis efficiency or fiscal objectives will vary between countries, and over time within a particular economy. Table 2.1 Forms of privatization and degree of control

In the next section of the paper we attempt to provide some empirical evidence relating to the use of privatization as an instrument of distributional policy. PRIVATIZATION AND DISTRIBUTIONAL IMPACT: INTERNATIONAL DIMENSION Over the period 1988–92 the number of privatizations grew rapidly—from fifty-eight to over 450—generating a total revenue of almost $185 billion in a 41


total of over 1,000 transactions.1 (These figures exclude privatizations in the former East Germany, which have added an additional $106 billion in investment commitments.) The main boost in privatization activity has occurred in the developing countries, where revenues increased from $2.6 billion in 1988 to $23.1 billion in 1992. In 1992, for the first time, the total sales volume in developing countries exceeded the revenues generated in industrialized countries—$17.3 billion. Over the period 1988–92, developing countries accounted for 27 per cent of all privatization sales, by value. The level of privatization activity has varied quite significantly across the developing country regions. By far the most active region within the developing world has been Latin America and the Caribbean, accounting for 70 per cent of all LDC privatizations, followed by Europe and Central Asia with 18 per cent, and Asia with 12 per cent (World Bank 1993). Sub-Saharan Africa has not participated to any significant extent in the recent upsurge of privatization, accounting for a meagre 0.3 per cent of total sales revenues in the developing world. In terms of economic sectors, privatizations in infrastructure dominated, accounting for about 35 per cent of total revenues for the developing world as a whole. Industrial production, comprising chemical production, heavy industry and manufacturing was the second most important sector, generating a fifth of total revenues. Foreign investment has accounted for an increasing share of privatization sales in LDCs. Sader (1993) estimates that while foreign investors only participated in seven such operations in 1988, they were involved in 191 by 1992 and in a total of 375 over the period 1988–92. A total of $18 billion in foreign exchange was generated during this period, contributing on average about 30 per cent of total revenue (Table 2.2). Table 2.2 Foreign exchange as a share of total revenue (per cent)

Source: Sader (1993)

Foreign direct investment (FDI) has been the most common means of foreign participation in privatization transactions in the developing countries. Of the total foreign exchange contribution to privatization of $18.5 billion, some $14.5 billion (78 per cent) was in the form of FDI. Investment in privatizations accounted for about 10 per cent of all FDI flows to LDCs over the 1988–92 period (Table 2.3). 42


Table 2.3 Foreign direct investment in privatizations, 1988–92

Source: Sader (1993)

The other form of foreign investment in privatization has been portfolio investment. Here, direct portfolio investment in LDCs has been limited, and has occurred through the purchase of equity instruments, traded in international security markets. These instruments have been used extensively in the sale of large Latin American telecommunications companies. The statistics on foreign investment inflows for privatization understate the degree of foreign involvement and control in privatization, in so far as debt-equity swap arrangements have been used. These agreements result in increased foreign ownership of the enterprise, but do not result in an inflow of foreign exchange. A number of Latin American countries has made extensive use of debt-equity swap facilities in their privatization programmes (UN 1992). The involvement of foreign capital in privatization presents the government in many developing countries with a serious dilemma, in so far as attempts to impose restrictions on foreign participation for domestic distributional reasons quickly narrow the range of financing options and the willingness of foreign investors to become involved in the privatization sales. It is impossible to assess, other than in the broadest terms, the extent to which developing country governments have been compelled to compromise on their ownership and distributional objectives in order to secure foreign capital inflows. But it is possible to put forward several arguments to support the general contention that governments have increasingly found it necessary actively to seek foreign participation. 43


Pressure to attract foreign buyers has come from several sources. The first has been the influence of the international financial institutions, and in particular the World Bank, through the conditionality attached to its structural adjustment loans. The World Bank and its sister organizations the IFC and the MIGA have been active in encouraging privatization in developing countries. About 70 per cent of all structural adjustment loans and 40 per cent of sectoral adjustment loans made during the 1980s contained a privatization component. Between 1981 and 1992 the Bank supported 182 privatization operations, in sixty-seven countries (World Bank 1992). Typically, the Bank has encouraged foreign involvement in privatization sales. The reliance on foreign involvement in privatization has also been a response to the shortage of balance of payments finance. With the dramatic decline in commercial bank lending, many LDCs have adopted a more proactive policy stance to foreign investment, and FDI now accounts for a much larger share of external finance flows to developing countries (Table 2.4). As we noted earlier, as much as 10 per cent of FDI inflows in recent years has been linked to privatization. Table 2.4 Pattern of external finance to developing countries (percentage share)

Source: World Bank (1993)

PRIVATIZATION AND DISTRIBUTIONAL IMPACT: THE DOMESTIC DIMENSION Application of the political economy analytical approach to the domestic dimensions of the privatization and distributional impact relationship, of necessity, requires detailed knowledge and familiarity with the particular economy under examination. Here, we confine the discussion to one country, Malaysia, which is used to illustrate the broad contours and dimensions of the political economy approach to the analysis of privatization policy. The picture is painted in broad strokes, and draws on the more detailed and richer literature available elsewhere.2 The Malaysian government was one of the earliest LDCs to embark on a privatization programme. The Prime Minister, Dr Mahathir Mohamad, 44


announced the government’s commitment to privatization in 1983 and this was followed by publication of Guidelines on Privatization in 1985, which outlined policy aims, modes of privatization and the means of privatization. In addition to the standard objectives of reducing the financial and administrative burden on government, promoting efficiency and competition, and stimulating private investment, privatization in Malaysia was also intended to contribute towards meeting the objectives of the New Economic Policy (NEP), especially as Bumiputera entrepreneurship and presence have improved greatly since the early days of the NEP and they are therefore capable of taking up their share of the privatized services. (Guidelines on Privatization 1985) Foreign investment in privatized enterprises was to be limited to 30 per cent. By the end of 1990 there had been seventeen privatizations involving divestment, either by sale of equity or assets to the public or by way of private placement and management buy-out (Jomo forthcoming). Other forms of privatization were also used, including leasing arrangements, management contracts, and ‘build-operate-transfer’ infrastructure contracts. The record in Malaysia suggests that privatization has been used primarily as an instrumentforenhancingthewealthof certaingroupscloselyalliedtothegovernment: ‘as in most of the ASEAN states, connections with the government were an important factor in determining which candidates for taking over state enterprises would be successful’ (Milne 1993:16). Often, privatization has not involved the formalities of an open tender system, an approach sanctioned by the official ‘first come, first served’ policy by which the government has on several occasions justified awarding privatization opportunities to those parties who supposedly first proposed the privatization activity. For example, Sapura Holdings commissioned a major consultancy report in 1983 on the feasibility of privatizing Telekom Malaysia, which was submitted to the government: it is generally acknowledged that Sapura was the main beneficiary of the subsequent privatization of telecommunications in Malaysia (Kennedy 1991, quoted in Jomo forthcoming). The ruling party, UMNO, has control over a sizeable part of the country’s corporate sector through a complex interlinking structure of holding companies and agencies. The privatization process has contributed to the strengthening of UMNO’s corporate interests. The licence to operate the open private television network in Malaysia was issued to the Fleet Group, UMNO’s holding company, on the basis of a working paper submitted by the Group. Malaysia’s largest public works contract, to construct the North-South highway, was awarded to a construction company with little experience in highway construction, which is controlled by a UMNO holding company. Other privatization sales have confirmed the close political connections of the purchasers (Jomo forthcoming). Other aspects of Malaysia’s privatization programme have been more transparent. 45


The government has floated the equity of several major state-owned enterprises on the Kuala Lumpur stock exchange. These have included the national airline, a shipping line, several cement companies and the country’s electricity generating enterprise. However, in the case of the airline and shipping companies, the privatization was only partial, and the government retained majority ownership and control. As stipulated under the country’s Industrial Co-ordination Act, at least 30 per cent of the floated shares are reserved for Bumiputera individuals, or institutions approved by the state to hold shares in trust for the indigenous group (Ng and Toh 1992:50). But with institutions acquiring most of the privatized equity, the contribution of privatization to the development of individual Bumiputera wealth or entrepreneurship has been limited, and instead may have increased intra-Bumiputera inequalities of income and wealth. There is general agreement among commentators on the Malaysian privatization experience that the aims of the ‘New Economic Policy’, which was intended to increase the Bumiputera share of national wealth, have figured prominently in the government’s objectives. Adam et al. (1992), for example, comment that ‘the eventual methods of asset sale employed have tended to emphasize the close link between the objectives of the NEP and the privatization programme’ (p. 227) and argue that: The striking conclusion that emerges from this review of the first decade of privatization in Malaysia is how widespread the subjugation of the objectives set out in the Guidelines is to those of the NEP, and consequently it is difficult to conclude that the privatization process itself has elicited any fundamental efficiency changes. (Ibid.: 255) The distributional implications of the privatization programme can be further disaggregated, however, to show how government has used privatization as an instrument for the distribution of the privatized assets and associated rents to favoured groups close to the government party. SUMMARY AND CONCLUSION The central theme of this paper has been that the process of privatization is innately political in nature. The resolution of distributional conflict is at the core of the political process. Privatization is an instrument through which the government can attempt to advance its distributional objectives, and these distributional objectives are likely to dominate considerations of increased economic efficiency or revenue yield. A political economy perspective views the government’s distributional objective in terms of the promotion of specific groups’ economic interests, rather than the advancement of communal welfare. Privatization is used, 46


therefore, to promote the same interests and groups as were favoured before privatization: the difficulty for government lies in maintaining control of the distribution of the rents created by privatization to the favoured groups. The degree of control that a government can exercise is influenced by the particular method of privatization it uses: in general, the more transparent and open the process, the less control government has over the distributional outcome. In assessing the impact of privatization in developing countries, the principle of comparative advantage has led economists to focus their attention on the efficiency aspects of the post-privatization experience. Yet, it seems clear that distributional considerations have had a major influence on the formulation and implementation of privatization policy. A fuller understanding of the outcome of privatization in developing countries therefore requires more systematic and detailed analysis of distributional issues than has hitherto been the case. NOTES 1 The figures in this section are taken from Sader (1993). Estimates of the volume of privatization transactions by Schwartz and Lopes (1993) and World Bank (1993) give figures of similar order of magnitude. 2 For a more detailed discussion of the Malaysian privatization experience, see Jomo (forthcoming), Milne (1993), Ng and Toh (1992) and Adam et al. (1992).

REFERENCES Adam, C., Cavendish, W. and Mistry, P. (1992) Adjusting to Privatization: Case Studies from Developing Countries, London: James Currey. Bagwati, J. (1988) ‘Export-promoting trade strategy’, World Bank Research Observer, vol. 3, no. 1. Cook, P. and Kirkpatrick, C. (1993) ‘Privatization and public enterprise reform in the transitional economies of Asia: past experience and future prospects’, paper presented at 3rd Asia Pacific Conference of Management Consultants, Managing the Changing Public-Private Sector Relationship, Brisbane, August. Cook, P. and Kirkpatrick, C. (eds) (forthcoming) Privatisation Policy and Performance: International Perspectives, Brighton: Harvester-Wheatsheaf. Grindle, M.S. (1991) ‘The new political economy: positive economics and negative politics’, in G.M.Meier (ed.) Politics and Policy Making in Developing Countries, San Francisco: ICS Press. Jomo, K.S. (forthcoming) ‘Privatization in Malaysia’, in P.Cook and C.Kirkpatrick (eds) Privatisation Policy and Performance: International Perspectives, Brighton: HarvesterWheatsheaf. Jones, L.P., Vogelsang, I. and Tandon, P. (1991) ‘Public enterprise divestiture’, in G.M. Meier (ed.) Politics and Policy Making in Developing Countries, San Francisco: ICS Press. Kennedy, L. (1991) ‘Liberalization, privatization, and the politics of patronage in Malaysian telecommunications’, paper presented at 41st conference of International Communications Association, Chicago, May. 47


Meier, G.M. (1993) ‘The new political economy and policy reform’, Journal of International Development, vol. 5, no. 4. Milne, R.S. (1993) ‘Privatization in the ASEAN states: who gets what, why, and with what effect?’, Pacific Affairs, vol. 10, no. 1. Ng, C.Y. and Toh, K.W. (1992) ‘Privatization in the Asian-Pacific region’, Asian-Pacific Economic Literature, vol. 6, no. 2. Onis, Z. (1991) ‘The logic of the development state’, Comparative Polities, October. Sader, F. (1993) ‘The experience of privatizations in the developing world: 1988–1992, World Bank, International Economics Dept., August, mimeo. Schwartz, G. and Lopez, P.S. (1993) ‘Privatization: expectations trade-offs and results’, Finance and Development, June. United Nations (1992) World Investment Report, 1992, New York: UN Transnational Corporations and Management Division. UNDP (1992) Privatization: Constraints and Impacts, Report of the Expert Group Meeting, Geneva, August. Vernon, R. (ed.) (1988) The Promise of Privatization: A Challenge for American Foreign Policy, New York: Council on Foreign Relations. Walters, A.R. (1985) ‘Privatization: a viable policy option’, in Asian Development Bank, Privatization Policy, Methods, Procedures, Manila: ADB. World Bank (1992) Privatization: The Lessons of Experience, Washington, DC: World Bank, Country Economics Department. —— (1993) Global Economic Prospects and the Developing Countries, 1993, Washington, DC: World Bank.

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3 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY WITH SPECIAL REFERENCE TO EAST GERMANY Dieter Bös INTRODUCTION In all transition economies, distribution problems have been high on the political agenda. The evaluation of these problems is difficult, from both theoretical and empirical points of view. Theoretically, the necessity of interpersonal utility comparisons causes many ‘pure’ theorists to shun topics such as income or wealth distribution. Empirically, lack of data typically makes it impossible to give well-founded evidence on how the transition process influences income or wealth distribution. Only a few realizations of the relevant data are available. Since the process started only in 1989, data on only three years can be reported, and in many cases not even that. Moreover, many of those data are volatile, reflecting short-run transition difficulties rather than long-run trends. Hence, although there is ample and reliable long-run evidence for the years before 1990, evidence for the years since then is lacking.1 ‘Distribution’ in any investigation can have many different meanings. It may refer to the functional or personal distribution of incomes, to the distribution of ownership and of wealth. Moreover, in a country like Germany it may also refer to the contrasting distribution of income, knowledge, wealth etc. between West Germany and East Germany. Hence it would be a difficult task to write a general overview of distributional aspects of the transition from communist planning to market-economic structures. This paper is much more modest in scope. First, I concentrate only on the distributional consequences of privatization, ignoring interesting issues such as price liberalization and income distribution, capital stock obsolescence, employment and distribution, exchange rates and distribution—for instance 49


the East-West mark exchange rates, etc.2 Second, when it comes to empirical analysis, I concentrate only on problems of distribution in Germany. To start off, I begin with some theoretical background on popular capitalism, on employees’ shares and on public enterprises’ pricing policies with distributional objectives. Results are presented which are valid for all economies in transition. Specifically, popular capitalism is of the utmost importance for the Czech privatization process, while employees’ shares have been most intensely discussed in Poland. I then turn to empirical research on German unification. After presenting the most recent data on East German incomes and satisfaction with incomes, I relate these figures and the corresponding unemployment figures to the German privatization policy, before turning from the distribution of incomes to the privatization-induced distribution of property, an issue which is hotly debated between East and West Germans. Finally, I consider the general feedback effects of any fiscal policy measure, specifically the consequences of financing East German privatization with West German taxpayers’ money. THE THEORETICAL BACKGROUND 3 Popular capitalism Popular capitalism means widespread share ownership in privatized enterprises. In capitalist countries4 the concept was mentioned as early as 1947, by Ludwig Erhard,5 with the intention of promoting capitalist spirit in the population by establishing many small shareholders. It was in Austria that the concept was first applied: in 1957, 40 per cent of the shares of the two largest nationalized banks were privatized by selling ‘people’s shares’. West Germany followed in its privatization activities between 1959 and 1965, including the privatization of Volkswagen.6 However, it soon became clear that the small investors sold their shares as soon as possible; in the long run, these shares came into the control of institutional and individual investors (von Loesch 1988). The recent privatizations in the UK and in France once again applied the idea of popular capitalism. So far, the figures have indicated some measure of success, for example, an increase in the number of shareholders by millions. The long-run success of the policy, however, will only be apparent after some ten or twenty years. Of the economies in transition, the Czech Republic and Poland favour the idea of popular capitalism (as do some other post-communist countries). The former Czechoslovakia had already implemented such a policy. Privatization using people’s shares holds particular advantages for economies in transition: it allows rapid privatization and solves the problem of firm valuations as well as that of the lack of purchasing power. Moreover, it seems to guarantee the desired irreversibility of the transition process. On 50

EAST GERMANY

the negative side, giving away shares to the general population neither provides the necessary funds for investment, nor does it create bodies which control the managers. Many proposals exist on how to solve this control problem;7 the Polish national investment funds are a typical example. It is important to note that there is also a political argument which justifies privatization achieved through popular capitalism in economies in transition. It has been argued that it is equitable to grant explicit ownership of firms to the general population, because prior to the transition they implicitly owned the firms (the so-called ‘people’s property’). This was an accepted argument in the former Czechoslovakia; however, in other countries the argument has been rejected, for instance in Germany. Here another legal position was taken.8 In the treaty on German unification, the original owners, whose individual property had been expropriated by either the Nazis or the GDR, were explicitly entitled to plead for restitution in kind. The ‘people’s property’ ceased to exist on the day of German unification, and only the concept of individual property of the original owners now matters from a legal standpoint. If the people’s property no longer exists, then it cannot be a legitimate basis for shares or vouchers. Hence, given the position of the treaty on German unification, there is no argument for a general scheme of people’s shares or vouchers in Germany. After presenting the facts, let us consider the distributional consequences of popular capitalism. In my opinion it is not a good instrument for distributional policy. With such a policy we would like to take from the rich and give to the poor. However, shares are risky investments—they are not a form of savings which the proverbial (riskaverse) man-in-the-street desires. He likes bonds because of the fixed interest rate. Hence, it could be feared that popular capitalism might simply redistribute from the risk-averse to the risk-loving, and since the poor typically cannot afford to take risks, redistribution would go the wrong way. This possibility has been recognized by policy-makers who modify their policy to attract more risk-averse investors by making share ownership less risky: the shares are distributed free of charge, or at such a low price that there is a guaranteed windfall profit. This policy leads to large numbers of investors; however, each will try to realize the profit as soon as possible. Hence, as soon as popular capitalism is modified so as to attract many investors, even those having lower incomes, it becomes an extremely costly instrument: first, investors are attracted by considerable underpricing of the shares; second, special discounts must be conceded to avoid the quick speculative realization of windfall profits.9 Even these discounts do not help in the long run. The Austrian and German experiences do not lend support to the hypothesis that popular capitalism policies necessarily result in a nation of small-scale capitalists.

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Employees’ shares In many post-communist countries, employees claimed that their firm’s value was based only on their own labour and thus they were entitled to the property of ‘their’ firm in the process of transition. This was the basis of many spontaneous privatizations in Hungary; it was also intensively discussed in Poland. To alleviate the political pressure from employee-voters, typical mass privatization programmes have made special provisions for employees’ shares, giving the employees a small percentage of shares free of charge or at a reduced price. Allocation of employees’ shares in this way is not equitable: first, only the employees of the privatized firms are eligible for these shares: what about civil servants who may have worked as intensively as industrial workers, and yet are not entitled to some ‘government shares’? Second, employees in good firms realize high windfall profits, whereas employees in non-viable firms receive nothing, even though the failure of the firm might be due to circumstances beyond their control, for instance, the loss of export markets in the former Soviet Union. Generally, the equitability of employees’ shares is difficult to evaluate because of intricate feedback effects on wages and investment. If employers and trade unions negotiate over the total income of the employees, higher dividend incomes will be offset by lower wage increases. In extreme situations, as modelled by Grout (1988), the employees (as a group) receive the same percentage of the firm’s revenue, regardless of whether they own shares or not: if they do not own shares, they receive this percentage in the form of wages; if they own shares, they receive it as a sum of wages and dividends. This led Grout to the conclusion that employees lose if they buy employees’ shares. He conjectured that the firm’s revenue is constant and argued that employees do not receive more money, but must pay for the shares. Hence, according to Grout, a rational employee never buys employees’ shares, unless a low tax rate on dividend incomes from those shares makes it profitable to change the composition of the employee’s portfolio from assets with highly taxed returns to shares with dividends taxed at a lower rate. However, as shown in Bös and Nett (1991), this conclusion is superficial. When dealing with the negotiations between employers and trade unions, Grout ignores the fact that issuing employees’ shares may increase the level of investment in the firm, because wages to be paid per unit of revenue decrease if employees hold more shares: the employees take over part of the costs, proportionate to their share incomes.10 Hence, even if the employees always receive the same percentage of the firm’s revenue, they may still realize net gains because this revenue increases, such that the constant share of the higher revenue may exceed the amount of money to be paid for the shares. (The case for employees’ shares is even better if there is special tax treatment of the respective dividend incomes.) 52

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Pricing with distributional objectives In contrast to private firms, public enterprises have often been instructed to price according to distributional objectives. This implies charging lower prices for goods which are mainly demanded by lower-income earners.11 In this case the public enterprises rely on internal subsidization, where the internal deficit of the low-priced goods is financed by the internal profits earned from sales to higher-income or business customers. If the privatized firm operates in a competitive market, this internal subsidization becomes impossible and distributional pricing cannot be upheld. This holds for all privatizations of key-sector enterprises where a competitive market develops after privatization. If, however, in some post-communist states this competition does not work, and if there is not even competition from abroad, then there are no market forces to prevent internal subsidization. Unfortunately, this implies that after the abdication of the state as the owner of the enterprise, the state once again enters the scene, namely as the regulator. This is unfortunate, because a priori it is not clear why the state, after failing effectively to run the firm as an owner, should now suddenly have become an efficient regulator. This implies that in post-communist states, regulation should concentrate on encouraging market entry, not on the continuation of distributional pricing of key-sector enterprises. In Western economies a similar problem arises when public utilities are privatized. The government should first attempt to encourage competition, as the UK for instance did with its split of the electricity supply industry into electricity generation (a potentially competitive business) and distribution (where the incumbent monopolist was disaggregated into three firms, one of which remained public, but which do not, however, compete with each other). Typically, there are parts of former public enterprises’ activities where competition can be introduced relatively easily, and other parts where this is not the case. An example of the latter is in the presence of distributional grids with natural-monopoly properties. If the establishment of competition does not work, the government, as a regulator, is still required to cope with the remaining market failures. In Western economies, monopolistic privatized utilities typically are not regulated with the aim of distributional pricing. However, even regulation which is not oriented to distributional objectives may nevertheless favour lower-income earners. As a case in point, consider the UK price-cap regulation, which has become well known under the label of RPI-X: the average price increase of monopolistically supplied goods of the public utility must not exceed the increase of the retail price index minus an exogenously fixed ‘X’, a value which is politically determined, and which is meant to be set on the basis of expected productivity increases. The privatized firm maximizes profits, given the RPI-X constraint. As shown in Bös (1991: 124–34) the resulting price structure favours lower-income earners. It is qualitatively identical to the Feldstein (1972) rule of distributional pricing.12 The reason is that the basket 53


of goods which is used for the calculation of a retail price index is always fixed on the basis of a consumer poll taken at some time in the past. However, empirical studies which are the basis for the regular revisions of cost of living indices show that in a developed and growing economy, the percentage of consumption which is dedicated to necessities falls over time. Hence, a basket of goods chosen at some earlier period always exaggerates the weight of necessities. Regulation on the basis of a retail price index which over-accentuates necessities implies relatively lower prices for these necessities. Hence, RPI-X regulation implies distributional pricing, although the firm is privatized and maximizes profits. EMPIRICAL OVERVIEW OF CHANGES IN THE EAST GERMAN INCOME DISTRIBUTION Comparison of the distribution of incomes and of satisfaction in West and East Germany The following comparisons are based on panel data which resulted from interviews in West Germany in 1989 and in East Germany in June 1990, March 1991 and March 1992.13 We first present the Lorenz curves of equivalence incomes and of satisfaction. The equivalence incomes are calculated by assigning an age—and position—dependent weight to each person in a household and then dividing the nominal household income by the sum of these weights: the head of the household is given the weight of unity, other houshold members are given less weight. Hence the equivalence incomes are larger than per capita incomes which assign the same weight to every member of a household. The degree of satisfaction with one’s income position results from asking the heads of household how content they are with their net income, offering them a scale from 0 (worst) to 10 (bliss). Such a figure of satisfaction measures not only the differences in nominal incomes, but also the shifts in the purchasing power. The latter are most important, because much of the nominal increase in East German incomes has been eaten up by price increases which were caused by the reduction of government subsidies for rental payments, energy and transportation prices. Let us first briefly present some absolute figures on incomes. Nominal wages in East Germany have skyrocketed since unification. Table 3.1 presents the percentage increases of the sum of gross wages and salaries in West and in East Germany. The percentages always refer to the figure of the previous year. The sum of gross wages and salaries is taken from the national accounts —it is not a measure of average wages and salaries, because as a sum of incomes it depends on the number of income earners, that is on the rate of employment. Hence, Table 3.1 includes figures of the annual changes in total employment. Together these figures present clear evidence of the rapid 54

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Table 3.1 Incomes, employment and productivity in West and East Germany

Source: DIW-Wochendienst (Deutsches Institut für Wirtschaftsforschung, Berlin) 18–19/1993, p. 258; and 20/1993, pp. 281–5 (non-adjusted values). Notes: a Lohnstückkosten b Forecast for 1993, quarters I–IV.

increase of East German wages and salaries. The background of this policy is the special German internal migration problem. There are two types of migration which German policy-makers are afraid of: first, a high unemployment migration, brought about by high East German wages; although unemployment benefits are high, East Germans seem to be quite sensitive to lasting unemployment, in spite of the difficulties they face if they move to the West;14 and second, a low wage migration, where the wage differentials between East and West Germany are the main driving force; this makes it difficult to adjust the East German wages to the development of labour productivity. Any policy of moderate unemployment coupled with moderate wage increases was made impossible by the trade unions, who used the argument of imminent high migration to push for a policy of high minimum wages, without any resistance on the employers’ side. The employers were represented by former East German officials and managers, who themselves were interested in high wage increases (which also guarantee higher unemployment benefits). Moreover, the West German employers’ representatives did not interfere, most probably because they had no wish to face low wage competition located within Germany. And the Treuhandanstalt (THA), that is the government trust responsible for privatization, restructuring and liquidation of the former GDR firms, did not interfere either. This is hard to understand, since in 1990 the Treuhandanstalt was the largest employer in East Germany, with approximately 4 million employees. Let us next turn to relative figures on incomes. Taking equivalence incomes, 55


Figure 3.1 Lorenz curves of equivalence incomes Source: DIW Wochenfericht 6/93, p. 56.

a Lorenz-curve comparison is presented in Figure 3.1. This shows that the income distribution in West Germany is less equal than in East Germany. There is a trend of the East German distribution to become less equal; however, this trend is not very marked, as can be seen in the figure. For the absolute figures of satisfaction with net income, recall that 0 is worst and 10 is bliss. The West German figure of 1989 was 6.5. In East Germany, satisfaction sank from 5.5 (1990) to 4.8 (1991), and remained nearly constant at 4.9 (1992). The sharp decline shows the disillusionment which resulted from overly high expectations at the time of unification.15 Relative figures on satisfaction are presented in Figure 3.2. The satisfaction is more equally distributed in West than in East Germany. From 1990 to 1991 the Lorenz curve of East German satisfaction moved away from the West German curve; in 1992 this trend reversed. Whether this is based on a sort of cognitive dissonance may be left open. Privatization In East Germany, 5,168 out of 12,892 key-sector enterprises16 were totally privatized between 3 October 1990 and 31 March 1993; moreover, 5,808 parts of enterprises were privatized (some other parts of the enterprises remaining in Treuhandanstalt (THA) ownership), and in 554 cases enterprises were 56

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Figure 3.2 Lorenz curves of satisfaction with household income Source DIW Wochenfericht 6/93, p. 56.

partially privatized with a minority Treuhandanstalt participation.17 Additionally, 1,274 key-sector enterprises were totally reprivatized, that is, given back to their former owners.18 East German key-sector enterprises are not sold at an auction, but on the basis of negotiations between the Treuhandanstalt and bidders who are willing to take over an enterprise. In these negotiations three basic problems must first be resolved: property rights (is there a claim from a former owner?), disposal of environmental contamination, and the firm’s indebtedness to the state (formerly an important part of financing the government’s budget). The THA either shares the environmental and ownership risks with the investor, or it shoulders the full burden itself. It also enters into an agreement with respect to servicing former company debts. The final payment to the THA may be quite low, sometimes nominal; however, these sales are coupled with investment pledges and job guarantees (with penalties to be paid in the event of failure to abide by the commitments). As a result of this policy, as of 31 March 1993 the THA reported investment pledges of DM176.7 billion and job guarantees of 1.44 million employees. This particular procedure was chosen by the THA to guarantee the development of an industrialized economy in East Germany— it had been feared that West German investors would buy their East German potential competitors, with the intention not of innovating the outdated technology, but of closing down production and using the land for warehouses for their Western products to be sold in East Germany. 57


Privatization and unemployment As already mentioned, the THA has never been involved in wage bargaining: the rise in wages occurred without special reference to privatization. The rapid wage increases, however, have had a direct influence on the number of jobs investors in privatization are willing to guarantee. Hence it seems strange for the THA to have paid lip-service to job security, but not to have pushed for a policy of lower wage increases. The consequence of this policy can be seen clearly in Table 3.2. Only some 40 per cent of jobs in East German key-sector enterprises could be secured when the THA decided on the existence or otherwise of such jobs. Table 3.2 Reduction in employment in THA-owned firms (thousands)

Source: Monthly bulletin of Treuhandanstalt, 31 March 1993. The table is an updated version of Carlin and Mayer (1992:7); based originally on Kühl (1991:682–3).

How low this figure is, can most clearly be seen if it is compared with the percentage of jobs which can be saved if privatization proves impossible and the firm is due for liquidation by the THA. As of 31 March 1993, a total of forty firms had been liquidated and liquidation proceedings19 had been initiated for a further 2,538 keysector enterprises. These cases of liquidation would affect a total of 301,000 jobs; the THA estimated that approximately 27 per cent of these jobs would be saved.20 While on the subject of unemployment arising from privatization, let us deal with the distributional consequences of unemployment in East Germany. Figure 3.3 compares the income positions of persons under the age of fifty-five whose household is hit by the unemployment of at least one member of the household.21 Worst hit are members of households where in both 1991 and 1992 at least one member of the family was unemployed. The further deterioration after 1991 often results from yet 58

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further members of the household becoming unemployed.Less serious is the situation if only in 1991 or only in 1992 some member(s) of the family were unemployed. It is interesting to note that those households which were hit by unemployment already started with a relatively lower household income in the former GDR in 1990. Figure 3.4 shows a similar pattern22 of the satisfaction positions.

Figure 3.3 Incomes of people in unemployed households

Figure 3.4 Satisfaction of people in unemployed households 59


Privatization and the distribution of property East German members of parliament have become increasingly critical of the fact that most purchasers of East German enterprises have been West Germans.24 In response to these complaints, several special forms of restructuring and privatization have been applied, the best known of which are management buy-outs (MBOs)25 and management limited partnerships (Management Kommanditgesellschaften). As of 31 March 1993, a total of 2,009 MBOs had been transacted in East Germany.26 This implies that a fairly high percentage of privatized enterprises have come under East German control. About 65 per cent of enterprises which had been privatized by MBO employed fewer than fifty people (forty employees on average). Many of them are very small companies.27 In most cases, an MBO takes place when there is no other bidder for the firm in question. However, if no other bidder wants to invest in an enterprise offered by the THA, there must be something wrong with the enterprise. Potential investors are experienced enough to estimate the risks they would run by acquiring an enterprise. If they evaluate these risks as being too high, then the enterprise cannot be sold as it is and must be restructured by the THA. Is the manager of the enterprise able to evaluate the risks of running the company on his own account? This question can only be answered positively if the manager is very experienced. The lack of managerial skills, experience and know-how is one of the major hurdles East German business leaders will have to face over the coming years. Hence it seems unlikely that the MBOs which have been transacted because Western bidders shunned the risk will bring about an efficient, competitive East German-owned business sector. Instead, we fear that these MBOs, though formally independent, will remain reliant on assistance from the THA for a long time, otherwise they will go bankrupt. If it is not the THA which takes care of them, then some other governmental or semi-governmental institution such as the capital partnership associations (Kapitalbeteiligungsgesellschaften) will have to support them, financially and technically. Another THA plan for increasing East German participation in the economic activities has been the creation of ‘management limited partnerships’. As of July 1993, the THA spoke of five ‘management limited partnerships’, comprising sixty-nine enterprises. Management limited partnerships are a legally acceptable but controversial form of company where the general partner of a limited partnership is a limited liability company.28 The managing limited liability company is typically run by a director from the THA, the only limited partner of the limited partnership, with two-thirds of the voting rights. Management limited partnerships have the character of a roof organization which combines different enterprises, that is, it operates as a holding company. In an example given by Härtel et al. (1992), a total of nineteen enterprises of a conglomerate structure have 60

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been bundled up in two management limited partnerships which are managed by two business experts, who participate in the returns on privatization of the enterprises belonging to the holding. The THA argues that such a procedure gives enterprises access to management know-how. It is questionable whether this aim will be achieved, however. The existing management partnerships contain, inter alia, an enterprise producing heavy machinery, another producing printing machines, some enterprises belonging to the building and construction sector, one enterprise belonging to the transport sector: in other words, the holdings exhibit a completely heterogeneous pattern. However, it is one thing to run a holding as a manager and another thing to individually manage nineteen different companies. It is not too far-fetched to suppose that the only effect of management partnerships is the artificial disposal of unsold enterprises from THA statistics. Both management buy-outs and management limited partnerships allow East German managers to remain in their companies, together with a higher level of East German involvement in key-sector enterprises. West Germans’ objections against these two models focus on precisely that point. East German managers often lack the knowledge and skills needed to survive and to succeed in a competitive market. Any policy which unduly favours East German bidders or managers neglects the important fact that the sale of key-sector enterprises is a part of the transition to a market economy which must be given priority over regional and psychological considerations. Additionally, it disregards the fact that more than two-thirds of privatizations have taken place through the THA’s regional branches, which exclusively handle sales of smaller units with a strong regional impact, for instance craft enterprises, transport companies, small industrial enterprises and services. There is no evidence that the share of SMEs coming into the hands of East German bidders is significantly smaller than that going to West German investors. Moreover, nearly 100 per cent of the privatized retail and wholesale stores, restaurants and pharmacies, cinemas and smaller hotels have been sold to East German bidders. East Germans, however, are not very impressed by these figures, in particular because they see growing evidence that many of the small units mentioned above are competing unsuccessfully with units run by Western managers. This is clear evidence of managerial deficits which would have made it impossible for privatized key-sector enterprises to have been run by East German managers. At the moment, East German managers in general are still unable to develop a strategic conception for the enterprise they would like to buy—with some notable exceptions, of course. Apart from a lack of business administration skills, they have only sketchy knowledge of Western markets. It will take quite some time until the skills and experiences of East and of West German managers are of comparable levels. 61


The distributional consequences of financing the THA deficit The German policy of privatization has not aimed at government profit, but at investment and job guarantees. Accordingly, the THA is run at a high deficit. The deficit has been financed by borrowing in capital and money markets. According to the treaty on German unification, the borrowing limits for 1990 and 1991 amounted to DM25 billion. For 1992 and 1993 there was an official annual borrowing limit of DM30 billion. Since the THA is a government agency, the federal government is obliged to pay the THA’s deficit. When the THA is wound up, the federal government will become responsible for repayment of the debt principal and interest. There is a legitimate fear that in the next few years, the THA’s deficit will remain in the region of DM30–40 billion. This could be the outcome of political pressure not to liquidate non-viable industrial enterprises, but to keep them artificially alive. The burden of this deficit will ultimately be passed on to the (mainly West German) taxpayer. Different proposals for tax increases have been presented in the political debate, much of which has concentrated on the consequences of tax increases on the distribution of personal income. In the following I shall compare the consequences of four different policies: (a) an increase in the rate of value added tax (typically rejected because of its allegedly regressive effects); (b) a ‘solidarity charge’, that is a surcharge on wages and any other incomes, excluding transfers such as old age pensions; such a charge would be paid by every income or wage taxpayer; (c) a surcharge on the income or wage tax of the better-off, that is taxpayers with an annual household income above DM60,000 for single persons, and above DM120,000 for married couples—once again, excluding transfers (typically such a surcharge has been proposed by social democratic interest groups, because of its progressive effects); (d) a surcharge on capital incomes. It should be mentioned that a surcharge of 7.5 per cent of the income and wage tax liability of the better-off was collected from 1 July 1991 to 30 June 1992; a 7.5 per cent solidarity charge on the income and wage tax liabilities of all taxpayers29 has been planned as part of the so-called ‘solidarity pact’ of the right-wing and left-wing parties and interest groups introduced as of 1 January 1995. The other two proposals have been suggested on several occasions by various politicians and economists. The most sophisticated analysis comparing the distributional consequences of the above four tax policies was presented by Richter and Rose (1993). They investigate the burden which falls on West German taxpayers if an additional DM50 billion must be raised for East Germany. Since it is assumed that the money goes to the East, there is no positive utility-increasing effect in the West. The West only incurs welfare losses from taxation, when alternatively 62

Source: Richter and Rose (1993:28,30)

Table 3.3 Cumulated welfare effects of alternative tax policies (over twenty years) (compared with unchanged tax policy, in DM and in per cent)


facing the four tax policies mentined above. Richter and Rose use an applied general equilibrium analysis, measuring the individual welfare losses by the Hicksian equivalent variation. This measures utility in monetary terms, comparing the household expenditures before and after the tax change. If xi is the quantity of good i bought after the tax change, and xOi the quantity bought before, the equivalent variation can be approximated by ?ipoi, where pOi are the prices before the tax change. Since a general equilibrium model is used, the changes in quantities reflect all economic feedbacks of the tax policy. The results are presented in Table 3.3. Table 3.3 presents the discounted present value of twenty years of welfare effects from alternative tax policies. It is interesting to note that all the policies have progressive effects—the average tax burden increases with net income. As would be expected, the progressivity is most pronounced in the cases of a surcharge on the rich and a surchage on capital incomes. The tax policy with the lowest degree of progressivity is the increase in the value added tax— however, this would still be progressive, and not regressive as often assumed. The simulation analyses show that in the long run, all tax policies reduce labour inputs. However, the effects on capital inputs are quite diverse. Capital inputs decrease in the long run in the case of all policies which negatively affect savings. These are the solidarity charge, the surcharge on the rich and the surcharge on capital incomes. Only the increase of the value added tax has no such negative consequences; it practically leaves the capital inputs unchanged. This also implies a higher national product in the case of an increase of VAT; as a consequence of these higher incomes, in an aggregate evaluation of the various tax policies the VAT comes first: if the individual equivalent variations of each income bracket are multiplied by the number of individuals in that bracket and then added up over the brackets, the total welfare losses by VAT are only 2.08 per cent; all other alternatives lead to higher cumulated welfare losses.30 SUMMARY The theoretical and empirical argumentation of this paper allows us to draw the following conclusions: (a) Popular capitalism is a bad instrument for good types of redistribution (that is, taking from the rich and giving to the poor). It may, however, be a good instrument for bad types of redistribution (that is, favouring particular interest groups).31 (b) Employees’ shares in post-communist countries are not equitable. In general, the increase in the firm’s investments due to employees’ shares can make these shares attractive to employees, although their wages may be reduced because dividend income is included in the negotiations between employer and employees. 64

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(c) If privatization leads to competition, internal subsidization becomes impossible. However, if this is not the case, new regulatory policies become necessary, both in post-communist and in Western countries. From a distributional point of view, the RPI-X regulation is of particular interest because it implicitly leads to distributional pricing. (d) In spite of its concentration on job guarantees, the ‘big bang’ privatization policy in East Germany is one of the major reasons for the East German unemployment which has caused much of the East German dissatisfaction with their present economic situation. (e) Management buy-outs and management limited partnerships are used as instruments to favour East German investors, thus alleviating Eastern resentment against too high a West German share in the distribution of property. However, in most cases they are inefficient instruments. (f) Applied general equilibrium analysis shows that in the long run, an increase of value added tax is the most efficient instrument to finance the deficits which result from the German privatization policy. Unexpectedly, the distributional effects of an increase of value added tax are progressive— absolutely and proportionately, the better-off are burdened to a higher extent than the worse-off. NOTES 1 Atkinson and Micklewright (1992) chose a misleading title of their book. They called it Economic Transformation in Eastern Europe and the Distribution of Income, although the book deals only with the distribution of earnings and income in Eastern Europe before 1990. 2 For Germany, see for instance Kurz (1993). 3 This part of the paper is based on Bös (1993:11–14). 4 Bös (1991:4–5, 11, 24–30). 5 See Hirche (1961:12). 6 For details see, for instance, Hawkins (1991:15–18) and von Loesch (1988). 7 For a good survey of such proposals, see Borensztein and Kumar (1991). 8 For a more detailed discussion of the following, see Bös (1992:7). 9 For typical examples in the UK, see Vickers and Yarrow (1988), chapter 7. 10 Furthermore, the difference between the tax rates on dividends and on wage incomes influences the investment decision. 11 To simplify the text, we have restricted our analysis to linear prices. For two-part tariffs, or other non-linear prices, the argument holds analogously. 12 Maximizing profits, given an RPI-X constraint, leads to exactly the same price structure as minimizing the retail price index, given a revenue-cost constraint. For the latter problem, see Bös (1978), which proves the qualitative equivalence of minimizing RPI and of maximizing a distributionally weighted consumer surplus, in both cases under a revenue-cost constraint. 13 ‘Socio-economic panel’, see Deutsches Institut für Wirtschaftsforschung, Wochenbericht, 6/1993, pp. 55–9. 65


14 According to Akerlof et al. (1991), unemployment is more important than wage differentials for the East-West German migration. 15 See DIW-Wochendienst 6/93. 16 ‘Key-sector enterprises’ is a term which comprises industrial enterprises, docks, transportation, mining, energy, R. & D., newspapers, printing offices, etc. 17 See monthly bulletin of Treuhandanstalt, 31 March 1993, p. 6. 18 These statistics do not include the ‘small’ privatizations of shops, cinemas, libraries, pension houses, etc. In East Germany, within half a year of unification, approximately 17,000 of a total of approximately 30,000 small business establishments were sold. See Bös (1992). 19 Both in the form of ‘Gesamtvollstreckung’ and of ‘liquidation’. 20 Monthly bulletin of Treuhandanstalt, 31 March 1993, p. 20. 21 For the following interpretation, see DIW-Wochenbericht 6/93, pp. 57–8. 22 For reasons of comparison this figure is also restricted to persons under age fiftyfive. 23 This subsection is based on Bös-Kayser (1992). 24 Die Wirtschaft, no. 32/92. 25 Following the THA’s terminology, we speak of management buy-outs only, although it is clear that the THA also subsumes management buy-ins under this category. 26 See monthly bulletin of Treuhandanstalt, 31 March 1993. 27 See Kokalj-Richter (1992). 28 GmbH & Co. KG. 29 No solidarity charge will be imposed below a taxable annual income of DM 12,500 for single persons or DM25,000 for married couples. See Handelsblatt, 13 May 1993. 30 Needless to say, the simple adding-up of individual utility measures implies strong value judgements—hence some readers might prefer to deal only with the disaggregated data. 31 This formulation is due to George Yarrow, who used it at the Geneva UNDP conference, August 1992.

REFERERNCES Atkinson, A.B. and Micklewright, J. (1992) Economic Transformation in Eastern Europe and the Distribution of Income, Cambridge: Cambridge University Press. Borensztein, E. and Kumar, M.S. (1991) ‘Proposals for privatization in Eastern Europe’, Staff Papers, Washington, DC: International Monetary Fund, vol. 38, pp. 300–26. Bös, D. (1978) ‘Cost of living indices and public pricing’, Economica, vol. 45, pp. 59–69. —— (1991) Privatization: A Theoretical Treatment, Oxford: Oxford University Press. —— (1992) Privatization in East Germany, Washington, DC: International Monetary Fund, Fiscal Affairs Department. —— (1993) ‘Privatization in Europe: a comparison of approaches’, Oxford Review of Economic Policy, vol. 9, no. 1, pp. 95–111. Bös, D. and Kayser, G. (1992) ‘The last days of the Treuhandanstalt’, mimeo, University of Bonn. Bös, D. and Nett, L. (1991) ‘Employees share ownership and privatization: a comment’, Economic Journal, vol. 101, pp. 966–9. 66

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Carlin, W. and Mayer, C. (1992) ‘The Treuhandanstalt: privatization by state and market’, mimeo, NBER, Cambridge, MA. Feldstein, M.S. (1972) ‘Distributional equity and the optimal structure of public prices’, American Economic Review, vol. 62, pp. 32–6. Grout, P.A. (1988) ‘Employee share ownership and privatisation: some theoretical issues’, Economic Journal, vol. 98, Supplement, pp. 97–104. Härtel, H.H. et al. (1992) ‘Unternehmenssanierung und Wettbewerb in den neuen Bundesländern’, HWWA-Report, no. 103, Hamburg. Hawkins, R.A. (1991) ‘Privatisation in Western Germany, 1957 to 1990’, National Westminster Bank Quarterly Review, November, pp. 14–22. Hirche, K. (1961) Das Experiment der Volksaktie, Cologne: Bund-Verlag. Kokalj, L. and Richter, W. (1992) Mittelstand und Mittelstandspolitik in den neuen Bundesländern: Privatisierung, Schäffer-Poeschel: Stuttgart. Kühl, J. (1991) ‘Beschäftigungspolitische Wirkungen der Treuhandanstalt’, WSI Mitteilungen, 44, no. 11, Bund Publishers: Cologne, pp. 682–8. Kurz, H.D. (1993) ‘Distributive aspects of German unification’, in H.D.Kurz (ed.) United Germany and the New Europe, Aldershot: Edward Elgar. von Loesch, A. (1988), ‘Die Privatisierungen mittels Volksaktien im Rahmen der Vermögenspolitik 1959 bis 1965’, in H.Brede (ed.) Privatisierung und die Zukunft der öffentlichen Wirtschaft, Baden-Baden: Nomos. Richter, H. and Rose, M. (1993) ‘Steuerfinanzierung eines Solidarprogramms Ost’, Wirtschaftsdienst, vol. 73, no. 1, pp. 22–30. Vickers, J. and Yarrow, G. (1988) Privatization: An Economic Analysis, Cambridge, MA: MIT Press.

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4 PRIVATIZATION AND DISTRIBUTIONAL EQUITY IN POLAND Ryszard Rapacki SETTING THE STAGE By the late 1980s, i.e. at the outset of the transition from a command economy to a market economy, the private sector—outside agriculture— constituted only a fringe of the Polish economy. Altogether private business contributed some 18 per cent of Poland’s GDP, as compared with 15 per cent in Hungary and only 2–4 per cent in other Eastern and Central European countries (Milanovic 1989, Gelb and Gray 1991). Of this contribution, only some 8 per cent came from non-agricultural private activities (handicrafts, repair services, retail trade, restaurants, etc.) while predominantly privately owned agriculture contributed about 10 per cent of the total value added. Since 1989 the country has witnessed a rapid expansion of private enterprise. By the end of 1993 the private sector’s contribution to Poland’s GDP had increased almost three-fold, reaching 50 per cent, while its share of total employment amounted to nearly 60 per cent (Statystyka Polski 1994). The share of the private sector (in terms of output) ranged from 90 per cent in retail trade, to 86 per cent in construction, 80 per cent in road haulage (44 per cent in overall transportation), 60 per cent in wholesale trade, 58 per cent in imports and 37 per cent in industry (CUP 1993, Poland 1994). It was the ‘grass-root’ privatization, i.e. the fast expansion of existing private firms and the entry of new small-scale private businesses, that produced the most visible results in transforming the ownership structure of the Polish economy and generating corresponding efficiency gains (Rapacki and Linz 1992). During the period 1990–3 the number of private proprietorships more than quintupled, from 350,000 to 1.8 million, employing 2.6 million people (23 per cent of total non-agricultural employment). Simultaneously, the number of domestic private companies grew from 33,200 to 66,500, and that of joint ventures with foreign capital equity from 1,600 to 15,100. Altogether, by the end of 1993, these three categories of private firms employed 5.3 million people, or 46.5 per cent of total non-agricultural manpower in Poland (Poland 1994).1 68

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As far as government-conducted (or ‘from above’) privatization is concerned, between August 1990 (i.e. implementation of the Privatization Law) and December 1993, a total of 4,035 stated-owned enterprises (SOEs) — some 46 per cent of their total number in Poland as of end-June 1990—were subject to privatization procedures (Statystyka Polski 1994). Of these, 522 were converted into corporate entities, of which ninety-eight were actually divested through private placements or public offerings. Some 367 former SOEs (this number increased to 460 in May 1994) were selected to enter National Investment Funds within the Mass Privatization Programme. In numerical terms, privatization through liquidation has taken place on a much larger scale. By end-1993, of the 1,998 SOEs targeted for disposal in this way, 691 (in good financial standing) were actually privatized (through leasing, employee/ management buy-outs, sale of assets, etc.), while 191 insolvent firms were liquidated under bankruptcy procedures. As a result of government-led ownership transformations (including the bankruptcy law) the public sector in Poland has substantially shrunk: the number of SOEs declined from 8,770 in June 1990 to 5,924 in December 1993, i.e. by 32.5 per cent (Statystyka Polski 1994; own calculations). In general, however, ‘privatization from above’ has advanced much more slowly than expected and its results have been well below the original government targets. While attempting to study the distributional impacts of the privatization programme being implemented in Poland, one should be aware of several complications that make unambiguous conclusions difficult and subject to many reservations. (a) The qualitative nature of many dimensions of the privatization processes and the lack or inadequacy of crucial data on their distributional implications in a transition economy give rise to severe problems of identification and measurement, as well as of the reliability of available statistics. (b) Privatization is an important process, but only one of the many key components of the complex systemic transformation process underway in Poland. Hence, many identified results may, in fact, stem from a variety of sources that makes it difficult clearly to disentangle different impacts and to attribute these results exclusively to privatization (Ramanadham 1993). To give but one example, changing distributional patterns in the course of 1990–3 in Poland have, apart of privatization, resulted from the implementation of a ‘shock therapy’, liberalization and deregulation of economic activity, including opening up the Polish economy. (c) Due to the initial conditions of ownership transformation in Poland in the late 1980s, and to many interlinkages and feedbacks between government-led and ‘grass-roots’ privatization, the standard notion of privatization (i.e. confined to government-conducted) does not offer an adequate analytical perspective on its distributional impacts. It seems 69


advisable, therefore, to extend the scope of analysis to encompass both dimensions of the Polish privatization process. (d) One of the important side effects of privatization in Poland has been the spontaneous and rapid expansion of the unreported or ‘grey’ economy. Estimates of its actual size range from 5 to 35 per cent of GDP; the most reliable sources place this figure at approximately 20 per cent (CUP 1993). While induced mostly by motives of tax evasion, the development of unreported activities, located at the fringe of private and public sectors, has been conducive to a wide range of redistributional effects. Before embarking on the analysis of distributional implications of Poland’s privatization programme, several methodological remarks seem appropriate. First, the distributional impacts may be assessed in terms of individual firms (microeconomic perspective), their immediate environment (industry, sector, local community, etc.), and the whole economy (macroeconomic spillovers). Second, privatization may give rise to redistributions affecting different social groups (e.g. the owners, the employees, the consumers and the taxpayers). The relevant impacts may be of different strength and diverging directions, thus calling for trade-off judgements (UNDP 1993). Finally, short-run and long-term effects of privatization should be clearly distinguished, the latter presenting particularly difficult problems of identification and measurement. PRIVATIZATION AND UNEMPLOYMENT The emergence and rapid development of a large-scale open unemployment has been one of the heaviest costs of systemic transformation in Poland. It must also have constituted a strong economic, cultural and psychological shock for most people born and brought up under the command economy and used to the constitutionally ensured job security (Rapacki 1993). Simultaneously, growing unemployment has contributed, to a considerable extent, to changing distributional patterns across different social groups, professions and regions. Despite deep-rooted labour-management traditions and strong trade unions, open unemployment has grown quickly during the 1990–3 period; by end1993 Poland’s unemployment rate was the highest in Eastern and Central Europe. Whereas the official unemployment rate in December 1989 amounted to only 0.3 per cent of the registered labour force, a year later it had risen to 6.5 per cent, to almost double in December 1991 (11.4 per cent), and it further grew to 13.6 per cent and 15.7 per cent in December 1992 and 1993, respectively. In absolute terms the latter figure translates into almost 2.9 million people without a job (Statystyka Polski 1994, Rapacki 1993).2 Official statistics provide only an approximate picture of unemployment in Poland, however, and tend to overestimate its actual size. Out of many different 70

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factors contributing to this discrepancy,3 two deserve special mention here. The first one stems from different methodologies applied to monitor developments in the Polish labour market. The official statistics rely on data collected by local and regional labour offices and derive from a very stringent definition of unemployment. Parallel labour market surveys conducted by the Central Statistical Office (GUS) and based on more liberal, international methodological standards (people having only temporary jobs are not counted as unemployed, for instance), indicated that in mid-1993 (August) the number of unemployed totalled 2.3 million, some 560,000 less than suggested by the official statistics, while the rate of unemployment (13.1 per cent) was 2 percentage points below the official level (Rzeczpospolita, 10–11 November 1993). The second factor was due to the fast development of the ‘grey economy’. According to some estimates about one half of the registered unemployed have derived incomes from unreported activities,4 thus providing a cushion against the adverse distributional effects stemming from officially registered unemployment. Unemployment in Poland has displayed large geographical ranges; in some regions (voivodships), in particular in northern, north-eastern and central Poland, the unemployment rates have run at almost double the national average. In December 1993 the highest rates recorded were 28.7 per cent and 28.6 per cent (Koszalin and Suwalki voivodships, respectively). Altogether, in thirteen voivodships out of fifty-one, unemployment exceeded the 20 per cent level. Moreover, in a considerable number of smaller urban and rural areas unemployment has reached the level of social disaster on a local scale, rates approaching 35–40 per cent. At the other extreme, in the high-growth regions, including most of the large cities (Warsaw, Cracow, Gdansk, etc.), unemployment rates have remained in single digits (Statystyka Polski 1994). Unemployment has also tended to be highly concentrated both in terms of age and education. It has mostly affected young people: in end-September 1993 over 35 per cent of all unemployed were below twenty-four years of age, while nearly 30 per cent were between twenty-five and thirty-four years. In this regard Poland exhibited the second-highest (after Spain) share of unemployed youth in Europe (Rzeczpospolita, 13 October 1993, Poland 1992). Simultaneously, unemployment has predominantly affected unskilled and semi-skilled labour. In September 1993 some 30 per cent of all unemployed had only primary education and over 37 per cent had a basic technical background, while only 4 per cent of college and university graduates were among those unemployed (Rzeczpospolita, 13 October 1993). Several other salient features of Polish unemployment deserve mention here. First, the number of long-term unemployed has been on an upward trend. In December 1993 the number of people without a job for more than one year, compared to previous periods, further increased to 1.3 million, that is, 45 per cent of all registered unemployed (Statystyka Polski 1994). 71


Second, more than half (52 per cent at end-December 1993) of the officially unemployed have remained without any source of current income, as they lost their entitlement to unemployment benefits. The problem of economic degradation of a considerable margin of the Polish population, caused by growing unemployment, has been further aggravated by two accompanying phenomena. One was the effect of a ‘discouraged worker’, implying that the actual scale of adverse social and economic consequences of unemployment has been larger than suggested by official data. Parallel to that, in many regions affected by high structural unemployment this phenomenon tended to selfperpetuate in terms of spreading over two or more members of the same family (Zycie Gospodarcze 1992). Hence, if one neglects the offsetting distributional impact of the ‘grey economy’, this might suggest that unemployment directly contributed to produce poverty and pushed a growing number of Polish families below the subsistence level (Rapacki 1993). The exact quantitative influence of privatization on the size, composition and the induced effects of unemployment in Poland is hard to identify and measure, in particular in terms of the short-term macroeconomic consequences of the former. This is due, in part, to the variety of sources that have generated unemployment, and—in part—to the differentiated nature of the mix of impacts privatization itself exerted on the latter. From the data on the labour market trends during 1990–3 it becomes clear that, in particular in 1990–1, i.e. the period of the fastest growth of unemployment, it was not privatization that contributed the most to the emergence of this phenomenon. The major source of open unemployment was the adjustment process in state-owned enterprises and the budget-funded sphere, and the resulting mass lay-offs and redundancies taking place more or less uniformly across the entire public sector. It is worth stressing in this context that this trend was incompatible with the goals of Poland’s transformation strategy, assuming selective lay-offs resulting from the bankruptcies of insolvent firms, and reallocation of resources to more efficient uses (Gomulka 1992). The latter category, i.e. state-owned enterprises selected for liquidation due to their insolvency, comprised by end-1993 1,111 firms of which only 191 (17 per cent) had been actually liquidated (Statystyka Polski 1994).5 On the other hand, the available statistics suggest that in the short run, privatization, and in particular the fast expansion of the new and old private sector, contributed to offset partly the adverse effect of public sector adjustments on unemployment. The rapid development of private proprietorships alone generated some 1.6 million jobs during 1990–36 while the growth of the private corporate sector, including privatization of former SOEs both through capital and (partly) liquidation tracks generated nearly 1.8 million jobs7 (Transforming the Polish Economy 1993). The impact of privatization on unemployment in the short run has taken several diverse courses, and substantially differed in its medium- and long-run 72

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effects. Generally speaking, its short-term contribution to the growth of unemployment in Poland has been relatively small, depending mostly on the privatization technique applied. In the case of privatization based on divestitures (capital track) the immediate effects on unemployment have been negligible, this being true both for former SOEs going public through offerings and for private placements to strategic investors. In the latter instance, many trade sales—in particular to foreign investors—explicitly guaranteed pre-divestiture levels of employment for a certain period (usually two to three years). The effects of privatization through liquidation have been more equivocal. While in some cases (e.g. management/employee buy-outs, leasing to employees) the new companies have tended to continue labour hoarding, the new private owners of former SOEs privatized through the outright sale or contribution of assets to the new company have seemed much more inclined immediately to initiate the scaling-down of employment. It should be stressed, however, that the majority of SOEs privatized through liquidation (68 per cent) have chosen the option of leasing the assets to employees (Statystyka Polski 1994). The impact of privatization from above on the labour market in the medium and long run presents problems in identification and measurement, due in part to the short history of systemic transformation in Poland and the limited availability of relevant data. Nevertheless, the existing evidence allows at least some conclusions to be drawn and some emerging trends to be established. First, as a medium-term adjustment to the new market environment some former SOEs, listed on the Warsaw Stock Exchange, have started programmes of limited lay-offs to tackle the problem of overmanning, inherited from the command economy. In some cases the scale of labour shedding has been around 30 per cent of pre-privatization levels (author’s estimates, based on consulting experience). Second, foreign owners of Polish companies purchased under trade sale agreements (capital track), once the contract shield against unemployment expires (after two to three years), are likely to scale down the prevailing employment levels to achieve their efficiency goals. Third, in the longer run even companies privatized under the leasing/ employee buy-out schemes that at present seem the most reluctant to shed labour, will start feeling the competitive pressure and will have to restructure their employment. This will imply redundancies for at least certain categories of labour (e.g. the less skilled). Fourth, due to the imposed, dependent (or ‘imperial cluster’ type, using Staniszkis’s terminology (Staniszkis 1989)) pattern of development in Poland after the Second World War, the present structure of employment inherited from the command economy displays strong regional and sectoral distortions. Many SOEs in particular regions (towns, industrial zones), first of all in heavy industry, have frequently enjoyed not only a monopoly but simultaneously a monopsony position, being the sole employer in the area (Rapacki and Linz 73


1992). This makes the privatization and/or demonopolization task in such cases extremely difficult and politically sensitive both in the microeconomic (a given firm and the whole monopolized industry) and macroeconomic sense. From the microeconomic angle, if privatized and subsequently embarking on inevitable lay-offs, such SOEs may directly contribute to the collapse of local labour markets and—by the same token— combine to produce adverse multiplier income effects in the entire local community. Thus, postponing necessary decisions concerning restructuring and privatization (or vice versa) of SOEs enjoying local monopoly and monopsony power acts as a time bomb and is bound eventually to affect adversely the labour market and income distribution in particular regions, the size of those impacts being larger the longer privatization decisions are delayed. On the other hand, government-conducted privatization may, in the medium and long run, be conducive to offsetting the initial increases in unemployment. The efficiency gains stemming from privatization are likely to translate into greater growth potential in many new private companies, and hence into expansion of their operations and creation of new jobs. The recent experience of many public companies in Poland, which in 1993–4 have started to raise new share capital through the Warsaw Stock Exchange with a view to financing their expansion/modernization projects, strongly supports this assertion. The same holds true for many foreign-owned companies or Polish companies with foreign equity (e.g. Fiat Poland, Wedel, Zywiec, Unilever or Proctor and Gamble Polska) which have undertaken ‘greenfield’ investments aimed at considerable capacity expansion or/and product diversification, thus providing new job opportunities. To sum up, the forgoing analysis suggests that privatization to some extent may have contributed to the growth of unemployment in Poland; by the same token it has also indirectly affected the distributional equity. From this perspective unemployment can be seen as one of the major sources of the rapidly growing income disparities that emerged in Poland after 1989. Simultaneously, unemployment has displayed a strong correlation with the upward trend in the number of low-income families and poverty, in particular in the regional and sectoral cross-sections where strong multiplier effects, leading to self-perpetuation of poverty, have developed. According to a recent World Bank report, unemployment has been the main cause of poverty in Poland in 35 per cent of cases (World Bank 1994). Unemployment, through increasing income disparities, has also been conducive to changing consumption patterns and the structure of tax burdens, thus affecting both consumers and taxpayers. In the former case, the declining standards of living of those unemployed and their families have resulted in the fall of consumption both in real and physical terms (in particular, consumption of certain higher-quality foodstuffs) and led to a substantial increase in the budget share of food, at the cost of spending on culture, recreation, health care and durables. 74

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Taxpayers, in turn, have suffered from the growth of unemployment in two distinct ways. First, firms—both state-owned and private—have had to contribute an additional 2 per cent of their pre-tax income to the Labour Fund, being the major source of financing active forms of combating unemployment (retraining, start-ups of new small businesses, etc.). This new, hidden tax has brought about hikes of labour costs conducive to higher inflation and making Polish labour less internationally competitive. Second, a shrinking personal income tax base, due to unemployment, combined with the rapidly rising central budget expenditures on unemployment benefits, has led to a substantial (both absolute and relative) shift of the tax burden towards the middle- and high-income groups. In 1993 the government, in an attempt to keep a check on the skyrocketing budget deficit, had to resort to the freezing of nominal tax brackets, thus effectively implementng the fiscal drag (inflation rate in 1993 amounted to 37.6 per cent). In 1994, in turn, marginal tax rates were raised by one, three and five percentage points (i.e. to 21 per cent, 33 per cent and 45 per cent), respectively. PRIVATIZATION AND INCOME DISTRIBUTION The implementation of shock therapy at the start of systemic transformation in Poland has, in the short run, brought about a dramatic fall in the standards of living for most Polish families, at least in statistical terms. The steepest decline took place in the first quarter of 1990; compared to December 1989 the real wages in six major sectors of the Polish economy (excluding agriculture) had plunged in January 1990 by 43.2 per cent, and in February by 47.3 per cent (GUS 1991). Despite some improvement later in 1990 and in 1991, they still remained well below their pre-1990 levels: in December 1990 the real wage index amounted to 70.4, but during the 1992–3 period it further deteriorated (to 65.5 in December 1993) (GUS 1993, Statystyka Polski 1993, Rapacki 1994).8 As a result, the share of wages and salaries in total households’ incomes dropped from 41.2 per cent in December 1989 to 32.4 per cent in December 1991, and further in 1992–3 (Rapacki 1994). Parallel to the fall in real wages, systemic transformation in Poland has also resulted in a dramatic drop in real savings and real money balances, in particular in early 1990. Compared to its end-1989 level, by December 1990 the real savings index had slipped to only 49.7; due to a steady growth of savings afterwards it improved to 65.8 in September 1993, still being, however, much below the pre-1990 level.9 The real money balances held by households have exhibited a similar pattern: after a steep decline in early 1990 (their lowest index—54.1—was recorded in April 1990) they partly rebounded later on, to arrive in September 1993 at 67.5 per cent of their end-1989 levels (GUS 1993, Rapacki 1994). 75


The breakdown of data on real wage performance does not reveal the actual changes in the purchasing power of the Polish population nor in the real consumption. As suggested by official statistics, total consumption in real terms declined in 1990, compared to 1989, by 11.7 per cent, including a 15.3 per cent fall in personal consumption (Czarny and Czarny 1992). Since then, however, this trend has been reversed: during 1991 and 1992 total consumption increased by 3.3 per cent and 2.0 per cent, respectively, while personal consumption rose by 7.4 per cent and 5 per cent. A similar trend can be traced in retail sales: during 1991–3 they went up by 8 per cent, 3.7 per cent and 6 per cent, respectively (GUS 1993, Statystyka Polski 1993). The above data clearly show that—after a dramatic decline in 1990—both consumption and sales have been steadily growing despite the fall in real wages. This may have been due to several reasons, the most important being dissaving, higher indebtedness of households to the banking system, growth of other sources of household income (chiefly social security payments from the government budget and property income in the private sector), and unreported rents extracted from the ‘grey economy’. On this premise and allowing also for the elimination of shortages after 1989, some economists claim that even though statistical real wages have fallen, the living standards may actually have risen and people may on average be better off (Lipton and Sachs 1990). Seen from a different perspective, the negative correlation between real wages, on the one hand, and consumption, savings and retail sales, on the other, may also reflect a growing income concentration and the resulting distributional inequity. In the light of available statistics, this conclusion gains a relatively strong empirical evidence. In terms of major social groups, wage-earners and private farmers can be deemed the main losers in the first stage of systemic transformation in Poland. In 1990–1 the real incomes of the latter fell by 71.2 per cent, while those of the former fell by 35.7 per cent below their 1989 level.10 Those who gained both in absolute and relative terms were the non-agricultural private sector and beneficiaries of social security and other transfer payments. The real incomes of these two groups displayed positive growth rates and so in 1991 exceeded their 1989 levels by 8.5 per cent and 5.3 per cent respectively (GUS 1991, Rapacki 1993). The above cross-sectional data on the changing pattern of relative incomes are to some extent consistent with the statistics on income distribution among different decile groups in Poland. In the first quarter of 1992, compared to the corresponding period of 1991, the share of the highest income group, i.e. the top decile of total income, increased in wage earners’ households from 19.1 per cent to 19.9 per cent. Parallel to this the share of the lowest income group, i.e. the bottom decile, declined from 4.5 per cent to 4.0 per cent. Similar patterns were recorded in pensioners’ households. Simultaneously, the ratio of the average income in the richest 20 per cent to the poorest 20 per cent of 76

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Table 4.1 The poverty level in Poland, 1985–90.

W—wage-earners; W-F—wage-earners-farmers; F—farmers; P—pensioners. Source: Warunki zycia (1991:30).

families of wage-earners and pensioners rose from 3 in 1991 to 4 in 1992 (Statystyka Polski 1992, Zycie Gospodarcze 1992). On the opposite side of the growing concentration of income and wealth, the period after 1989 also witnessed the widening scope of poverty in Poland (Table 4.1). As demonstrated by the data, 1990 saw a dramatic extension of the poverty zone, i.e. the number of people living below the subsistence (low income) level, as determined every year by the Ministry of Labour and Social Policy. Farmer families were the group most severely hit by this phenomenon. This trend continued in 1991 and 1992:35 per cent and 43 per cent respectively of wage-earners’ families slid below the subsistence level, these proportions being even higher in the households of pensioners and farmers. According to the most pessimistic estimates, the number of people living below the poverty line might have reached almost 11 million in 1991 (Zycie Gospodarcze 1992). A more recent World Bank study on poverty in Poland, however, based on a more stringent definition of poverty, estimated that the total number of persons below the subsistence level amounted to 5.5 million, i.e. 14.4 per cent of Poland’s population (World Bank 1994). The cross-sectional data reveal the composition of poverty according to different criteria. Low labour income (wages, salaries) has been the main source (60 per cent) of poverty, followed by unemployment (35 per cent) and old age (5 per cent). In terms of professional origin, the total number of persons living below the subsistence level has been made up mostly of workers (38 per cent), farmers (17 per cent), pensioners (17 per cent) and people on social security benefits (13 per cent). The poverty has been strongly concentrated in rural areas (60 per cent) and in small towns below 100,000 inhabitants (27 per cent). Only 8 per cent and 5 per cent, respectively, of those affected by poverty lived in big cities and medium-sized towns (World Bank 1994). The large aggregates, as those shown above, may, to some extent, conceal the actual differentiation of incomes and wealth, as well as longer-run prospects to improve living standards within each broad category. It seems advisable, therefore, to amend the forgoing discussion on distributional equity with a tentative enumeration of the main losers and gainers in narrower terms. The 77


main losing groups after 1989 include, first of all, employees of SOEs and— in the short run—the budget-funded sphere (except for civil servants in central administration, justice and defence), and in particular (Rapacki 1993): (a) employees of SOEs heavily dependent on the former Soviet market; (b) regions most strongly hit by structural unemployment; (c) sectors and regions worst affected by economic recession of 1990–1 (e.g. the textile industry and the Lodz area); (d) declining industries (e.g. coal mining, metallurgy, and heavy industry in general); (e) employees of state farms; and (f) unskilled and semi-skilled workers, mostly young. On the other hand, those who gained and are bound to gain even more in the longer run comprise, in the most general terms, the non-agricultural private sector (including joint ventures and the growing number of foreign subsidiaries and branches), and in particular: (a) the newly emerging business class, a heterogeneous group encompassing both petty traders and a small number of successful billionaire entrepreneurs; (b) the nascent middle class which will probably incorporate, inter alia, the historically distinct group of intelligentsia; (c) skilled and highly skilled labour in ascending and high-tech industries (e.g. electronics, computers); (d) the financial services sector, including banks and capital markets; (e) accounting and business consulting services; (f) legal services, including real estate business; (g) the mushrooming market for specialized education and training (e.g. private and public business schools, executive management training, foreign languages schools and private tutors); and (h) the most dynamic and entrepreneurial individuals from all social groups and sectors, capable of exploiting income- and wealth-maximization chances created by the new market environment. This applies in particular to certain categories of employees in the generally under-funded budgetary sphere, i.e. people living in metropolitan areas with specific background, skills and experience (e.g. economics and management graduates). While it would be difficult to ascribe precisely each of the above outcomes to one particular explanatory variable out of the multiple determinants entailed by the transition process in Poland, it remains clear that both ‘grass-roots’ and ‘from above’ privatizations have exerted an important impact on many of them and produced important distributional effects. Some of them seem obvious and straightforward—for instance, the case of the newly born business 78

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class and the emerging markets and sectors (banking, brokerage, business consulting and training, etc.). There are also other, less obvious, still equally important impacts on distributional patterns, resulting from a particular systemic endowment Poland inherited from the command economy, that require a special highlighting here. One of the peculiar features of the command economy consisted of the fact that large-sized SOEs used to provide the whole array of social services unrelated to production (health care, housing, recreation, nursery provision, etc.) both to their employees and for entire local communities. In the absence of an immediate alternative for the supply of these services in a transition economy, privatization of such SOEs immediately leads to steep falls in certain categories of consumption and in the general standard of living of those involved (i.e. employees and consumers), thus entailing high short-run economic, social and political costs (Rapacki and Linz 1992). Another command-economy legacy in Poland has been the unique form of labour-management relations, a phenomenon labelled sometimes as the Polish ‘Bermuda Triangle’. It consisted of the actual split of the property rights bundle between workers, management and the government, in the SOEs: workers and managers gained the right to use and benefit from use of enterprise assets while the Treasury as the sole owner retained the right of exchange. As a result, workers’ councils at each enterprise have enjoyed a strong position vis-à-vis managers, as they were empowered with the right to hire and fire plant managers, and to codetermine the current production and investment decisions. This gave rise to frequent wage hikes in excess of productivity increases. Seen from the employees’ perspective, privatization of state-owned enterprises, entailing dissolution of workers’ councils and weakening of the trade unions’ bargaining position, has been generally perceived as producing short-run adverse effects on their wages and—by the same token—on their consumption levels. This prevailing perception may not have necessarily been fully supported by the existing privatization experience, in particular under the liquidation track. Anecdotal evidence during 1990–3 strongly suggests that the fastest growth of wages was recorded in those former SOEs that were privatized under leasing and employee buy-out schemes. To appease the vested interests of employees and to lessen their resistance to divestitures of their firms, the Polish privatization programme provided for several compensation schemes for employees of SOEs being divested through public offerings and the Mass Privatization Programme (capital track). Since the implementation of the privatization programme in August 1990, the employees of SOEs scheduled for divestiture have been offered different options to swap their part in the ‘old’ property rights (as defined above) for ‘new’ ones, i.e. privileged access to the shares of privatized SOEs. Originally (1990–1) employees were granted the right to purchase, at a discounted (50 per cent) price, up to 20 per cent of shares in their companies going public. During the 1992–3 period, in turn, they were offered up to 10 per cent of 79


shares free. Within the framework of the Pact on State-owned Enterprise, a comprehensive economic and social programme elaborated by the previous government of Hanna Suchocka in mid-1993, this ceiling was increased to 15 per cent. A similar scheme has been envisioned under the Mass Privatization Programme (i.e. for some 460 state-owned enterprises) being implemented in 1994. The Programme goes in this respect even further: in addition to 15 per cent of shares for SOEs’ employees, another 15 per cent of equity is to be given away to firms’ subcontractors and suppliers (e.g. farmers) (Law on National Investment Funds 1994). Poland’s experience to date with different forms of employee share plans suggests that in many instances these may have been the source of a sizeable wealth effect in the groups involved. The wealth effect has resulted from two intertwined reasons. The first was the very fact of being given a ‘free lunch’ (free transfer of property rights) or of becoming a shareholder at a discounted purchase price. The second reason was due to large capital gains recorded at the Warsaw Stock Exchange between March 1993 and April 1994 for all listed companies. To give one example, the initial price of Bank Slaski on the secondary market in February 1994 exceeded thirteen-fold its issue price fixed for public offering in December 1993. It is self-evident that this sort of wealth effect has been conducive to important distributional implications and has combined to generate higher consumer spending (increased marginal propensity to consume) coupled with changes in its composition (a switch towards durable goods and real estate). Finally, privatization has produced substantial wealth and distributional effects, not only directly to employees and managements of former SOEs going public but indirectly, i.e. through the emerging capital market in Poland. The unprecedented bull market that has prevailed on the Warsaw Stock Exchange for over one year made many individual investors dramatically better off in a relatively short time. This trend may also be illustrated by the sharp increase in the number of investment accounts in brokerage houses: from below 100,000 in early 1993 to over 670,000 in mid-1994 (Gazeta Wyborcza 1994). NOTES 1 Out of the total labour force in agriculture of 4 million, 3.7 million persons were employed in the private sector (Poland 1994). 2 It is worth mentioning that by end-May 1994 the number of registered unemployed slightly declined (to 2.8 million) thus pushing the unemployment rate down to 15.4 per cent, below the level recorded in Slovakia [Rzeczpospolita 1994]. 3 They are discussed in Rapacki (1994). 4 One of the possible rough measures of the size of the ‘grey economy’ can be deduced from the aforementioned GUS labour market surveys. Based on these surveys it was estimated that in August 1993 at least 365,000 people, i.e. 2.5 per cent of total employment in Poland, were involved in unreported activities (Rzeczpospolita, 10–11 November 1993). 80

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5 According to Polish privatization statistics, liquidation of insolvent SOEs (under the Law on State-owned Enterprises) has been considered as one of the privatization methods. 6 As a new development, in 1993 employment in this sector shrank by some 150,000 (Poland 1994). 7 Of this, joint ventures with foreign capital equity employed by end-1993 some 200,000 people. It should be pointed out, however, that the fast growth of employment in the private sector after 1989 was in part due to changes in statistical classification: the whole co-operative sector (employing around 1 million persons) was in 1990 included in the private sector. Hence, 1.8 million new jobs in the private corporate sector is net of the number of employees in co-operatives. It is also worth stressing that privatization of SOEs entailed in the short run the transfer of existing jobs from the public to the private sector, rather than the creation of new jobs. 8 It should be strongly stressed that—due to several systemic and statistical reasons —official data on real wages performance during 1990–3 cannot be directly compared to pre-1990 data nor can unambiguous conclusions be drawn, as would be the case in an established, mature market economy. A more comprehensive discussion on these issues can be found in Rapacki (1994). 9 It is worth stressing that this fall resulted predominantly from the dramatic depreciation of hard currency deposits in domestic currency terms (due to the fixed exchange rate regime or nominal anchor, applied within the stabilization policy package) in 1990 and early 1991; the real value of domestic currency deposits decreased only slightly. 10 It should be borne in mind, however, that during 1988 and 1989 real wages exhibited a fast growth (14.4 per cent and 9 per cent, respectively), and incomes of private farmers even more so (41.4 per cent combined in these two years) (GUS 1991). Thus, if compared to 1987, instead of 1989, the actual decline in real incomes of these two groups was much smaller.

REFERENCES CUP (Central Planning Office) (1993) Poland 1989–1993, Economic Reform— Structural Transformation (in Polish). Central Planning Office Report, in: Gospodarka Narodowa, no. 11. Czarny, B. and Czarny, E (1992) From Plan to Market (Polish Experience, 1990–91) (in Polish) Warsaw: The Friedrich Ebert Foundation. Gazeta Wyborcza (1994), 27 June. Gelb, A.H. and Gray, C.W. (1991) The Transformation of Economies in Central and Eastern Europe, Issues, Progress and Prospects, Policy and Research Series, no. 17, Washington, DC: The World Bank. GUS (Central Statistical Office) (1991) Statistical Yearbook, Warsaw. —— (1993) Concise Statistical Yearbook, Warsaw. Law on National Investment Funds and their Privatization (1994), Warsaw, 30 April. Lipton, D. and Sachs. J. (1990) Creating a Market Economy in Eastern Europe: The Case of Poland, Brookings Papers on Economic Activity, no. 1. Milanovic, B. (1989) Liberalization and Entrepreneurship: Dynamics of Reform in Socialism and Capitalism, Armonk, NY: M.E.Sharp, Inc. 81


Poland. International Economic Report 1991/92 (1992) Warsaw: World Economy Research Institute, Warsaw School of Economics. Poland. International Economic Report 1993/94 (1994) Warsaw: World Economy Research Institute, Warsaw School of Economics. Ramanadham, V.V. (1993) Constraints and Impact of Privatization, London: Routledge. Rapacki, R. (1993) ‘Political economy of transformation’, in Transforming the Polish Economy, Warsaw: World Economy Research Institute (Warsaw), International Center for Economic Growth (San Francisco). —— (1994) ‘Social and political determinants and consequences of systemic transformation in Poland’ (in Polish), Gospodarka Narodowa, no. 1. Rapacki, R. and Linz, S.J. (1992) Privatization in Transition Economies: Case Study of Poland, Econometrics and Economic Theory Paper no. 9011, East Lansing, MI: Michigan State University. Rzeczpospolita (1993), 13 October, 10–11 November. —— (1994), 17 June. Staniszkis, J. (1989) The Ontology of Socialism, Warsaw: Wydawnictwo In Plus. Statystyka Polski (1994), no. 1 (59). In: Rzeczpospolita, 7 February. Transforming the Polish Economy (1993), Warsaw: World Economy Research Institute (Warsaw), International Center for Economic Growth (San Francisco). UNDP (1993) Privatization and Distributional Equity, Report of the Expert Group Meeting held in New Delhi. UNDP Interregional Network on Privatization, 20–4 September. Warunkiz°ycia ludnosci w latach 1986–1990 (Living conditions of the population) (1991), Warsaw: GUS. World Bank (1994) Analysis and Evaluation of the Poverty Sphere in Poland, Washington, DC, June; excerpts published in: Rzeczpospolita, 14 June 1994. Zycie Gospodarcze (1992), nos. 49 and 51–2.

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5 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY IN THE PHILIPPINES Leonor Magtolis Briones INTRODUCTION: CONCEPTS OF PRIVATIZATION, DISTRIBUTIONAL EQUITY AND GOVERNMENTOWNED OR CONTROLLED CORPORATIONS (GOCC) For the purposes of this paper, the concepts of privatization and distributional equity developed by Ramanadham (1993) will be utilized. Privatization as a term denotes divestiture and non-divestiture options open to the government. ‘Its objective is to reduce state or public sector involvement in the nation’s economic activities through transfer of management control to private enterprises’ (Gouri 1991:7). The following elements promote distributional equity: (a) Helping the relatively poor sections of the community, the unemployed, and any identified groups of handicapped persons or of persons segmented by tradition or isolated into the backwaters of development. (b) Raising the share of incomes flowing in favour of the lowest income bracket. (c) Raising the share of wealth owned by the lowest wealth-owning categories. (d) Controlling excessive flows of income and capital outside the country (Ramanadham 1993:2). In the Philippine context, public enterprises are parts of public organizations which are classified as government-owned or controlled corporations (GOCCs). A government-owned or controlled corporation is a stock or nonstock corporation, whether performing governmental or proprietary functions, which is directly chartered by special law or, if organized under the general corporation law, which is owned or controlled by the government directly or indirectly through a parent corporation or subsidiary corporation, to the extent of at least a majority of its outstanding capital stock or of its outstanding voting capital stock (PD 2079, 1986). 83


BACKGROUND TO THE PRIVATIZATION POLICY OF THE PHILIPPINES Events leading to privatization Privatization as a declared policy of the Philippine government was instituted by the late Ferdinand E.Marcos in 1986, just before he was ousted from power. His successor, President Aquino, implemented the policy during her term as president. The present incumbent, Fidel V.Ramos, is continuing the policy. In 1983, two years before the collapse of the Marcos regime, the debt bomb exploded and the Philippine government declared its inability to pay its gargantuan $24 billion foreign debt and solve a balance of payments crisis. In the ensuing shambles the then Finance Minister, Cesar Virata, admitted that public enterprises were responsible for 80 per cent of the foreign debt. Negotiations for a restructuring of the public enterprise sector were initiated with the World Bank. Conditionalities specified a policy declaration defining government-owned or controlled corporations (the Philippine term for public enterprise) and explicitly limiting the participation of the public enterprise in the economy. A twin policy of privatization was likewise required. Two presidential decrees on public enterprises were among the last signed by the late President Marcos when the February 1986 revolution toppled his regime and ushered in Corazon C.Aquino. Those decrees were Presidential Decrees 2029 and 2030, which defined and restricted the definition of GOCCs and declared a policy of privatization. President Aquino later adopted these policies as major thrusts of her administration. She issued Proclamations 50 and 50-A in December 1986 to continue the privatization programme of her predecessor. On 8 December 1992 Executive Order No. 37 was issued by the present president, Fidel V.Ramos, restating his administration’s support for the privatization programme. The restructuring of the public enterprise sector was originally financed in 1986 by a World Bank Economic Recovery Loan for $300 million, thus giving it the formal and acknowledged lead role in every step of the process. Subsequent letters of intent to the International Monetary Fund gave primacy to privatization, which was also a major policy thrust of the development programme of Aquino, and later, of Ramos. Objectives of privatization Privatization, in the context of the current administration, is the major programme for the disposition of acquired assets, corporations and GOCCs. The programme objectives are four-fold: 84

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(a) To reduce the involvement of the state in the nation’s economic activities. (b) To reduce the financial burden on the government of loss-making and inefficient GOCCs and their assets. (c) To promote greater efficiency in government operations. (d) To raise funds from the sale of GOCCs and their assets. Scope and rationale While the concept of privatization is broad, the actual implementation to date is primarily focused on ‘re-privatization’ of non-performing assets (NPAs). These NPAs are assets foreclosed by the government financial institutions due to loan defaults of private enterprises. The last years of the Marcos administration saw the take-over by government of private corporations which could not repay their loans to government banks. Government financial institutions, such as the state-owned Philippine National Bank (PNB) and the Development Bank of the Philippines (DBP), acquired NPAs from the private sector and transferred these to the government for disposal. These assets constitute the bulk of the Philippine privatization programme in its first stage. Another element of the privatization programme is the privatization, restructuring, rationalization and divestment of government corporations and their subsidiaries, which proliferated during the Marcos regime. Some cases include abolition and privatization of certain operations of a GOCC. This phase of privatization is still limited at present. Finally, a more subtle strategy of privatization is market liberalization, that is, reducing government intervention and government competition against the private sector, and subjecting GOCCs to market forces by withdrawing from them tax exemptions, subsidies and concessional loans and assistance. Overall framework and objectives The basic framework underlying the privatization policy is both ideological and financial. Because of the poor financial performance of governmentowned or controlled corporations during the Marcos regime, the privatization policy appears desirable. Reduction of the financial burden to the government posed by GOCCs has been a pressing issue which spurs privatization. Another imperative is the need to raise revenue from the sale of non-performng assets (NPAs) and GOCCs to finance other governmental programmes, such as the agrarian reform programme. The privatization policy also hinges on the ideology of the private enterprise economy. Reduction in government intervention in the market and avoidance of competition with the private sector have been avowed policies in support of privatization. They are viewed as measures to achieve higher levels of efficiency and resource use, and to eliminate market distortions. 85


Legal basis for privatization PD 2030 issued by the late President Marcos declared the policy of privatization. Proclamations 50 and 50-A signed by President Aquino in December 1986 formally implemented and continued the privatization policy under her administration. The ideological framework of privatization is very clear in the opening statement of Proclamation No. 50. It declares that the twin cornerstones of the rationalization of the GOCC sector are: (a) judicious use of the corporate form of government organization, where the private sector is given primacy and government assumes a supplemental role under an environment of fair competition, and (b) reduction in numbers of GOCCs and circumscription of their areas of economic activity through the privatization and disposition of the NPAs or acquired assets. The Committee on Privatization, currently chaired by the Secretary of the Department of Finance, and the Asset Privatization Trust are the implementing agencies of the privatization programme. Distributional objectives in the Philippine Development Plan The current development plan of the Philippines is called the Medium Term Philippine Development Plan (MTPDP), covering the period 1993–8. The policy of privatization is reaffirmed in fiscal policy, which declares the need to ‘streamline the bureaucracy through privatization and sub-contracting arrangements, among others’ (MTPDP 1993:1–7). The same policy also declares the need to: Rationalize the government sector further through the following measures: a) pursue the privatization of government corporations and implement the government’s divestment strategy which includes other dispositive actions (e.g. merger, abolition, dissolution, etc.) with expediency; b) reaffirm the policy of limiting the creation of new government corporations particularly those involved in entrepreneurial and proprietary activities. (MTPDP 1993:1–8) On the other hand, poverty alleviation and employment generation is a major policy objective. An entire chapter of the plan is devoted to human resource development, with provision for promotion of equity. LIKELY IMPACTS OF PRIVATIZATION ACTIVITIES, ACTUAL AND CONTEMPLATED Privatization has been implemented as a major government policy since 1987, from the very start of the Aquino administration. Although this has long been proposed by academics, the impact of the policy has not been seriously 86

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examined. What are available from the government are reports on accomplishments in terms of assets and GOCCs disposed of and revenuecum-losses generated. Assessments have been made by independent researchers and institutions on the policy as a whole, as well as a few case studies. However, the need for a thorough examination of impacts cannot be over-emphasized. The transfer of profitable enterprises to the private sector During the past five years, much of the effort of the government at privatization has been directed towards the so-called NPAs, or non-performing assets. As mentioned earlier, these were once private corporations which were taken over by the government when they could not pay domestic and foreign debts. Since these constituted a tremendous drain on the resources of the government, the attitude was to dispose of them as quickly as possible. A few of them were turned around and made profitable before they were privatized. In addition to the NPAs, GOCCs privatized their own subsidiaries and assets. The immediate impact of the above activities has been on government revenues. At first sight, it would appear that substantial revenues were generated from the sales of GOCCs and assets. However, when the NPAs were taken over by government, the latter absorbed their liabilities. The government retained these liabilities and assumed responsibility for servicing them even when the assets were privatized. Thus, the expenditures for debt servicing have to be deducted from gross revenue in calculating net flows to the government from privatization. This is in addition to other expenses incurred in the sale, as well as the operational expenses of the Asset Privatization Trust. Table 5.1 clearly shows that, while sales appear to be impressive, these pale in relation to government exposure. From 1987 to 1990, P24.136 billion was realized from the sale of 230 corporations. However, government exposure (assumed liabilities) totalled P65.810 billion, resulting in a total loss of P41.673 billion. As of June 1993, a total of P34.1 billion was generated from the sale of assets and P25.4 billion from the sale of GOCCs, or a grand total of P59.5 billion (APT 1993:6). Again, these revenues have to be viewed in relation to liabilities which have been retained and serviced by the government. Thus far, the impact of privatization in terms of revenues for the government can only be minimal, due to the retained liabilities. Next in line to be privatized are the profitable GOCCs. These include Petron Corporation, the oil refining and marketing subsidiary of Philippine National Oil Company (PNOC). Petron ranks first among the top corporations of the Philippines in terms of gross revenue and is considered one of the ‘crown jewels’ of the government, along with other profitable GOCCs. If the profitable corporations are to be privatized, an impact on revenues 87


might finally be felt. This will be primarily in the short term. In the medium and long term, government will be depriving itself of revenues earned by its most profitable corporations. Techniques and processes of divestiture As mentioned earlier, privatization activity since 1987 has centred on the sale of acquired assets which were formerly private corporations. The method of divestiture was direct sales of corporations to single buyers or to consortia of buyers. This had a tendency to enhance the position of competitors who were also the avid participants in privatization. Buying corporations tended to be owned by big businessmen or by foreigners. Table 5.2 gives examples of assets which were bought by competitor-buyers. The negative implications on distributional equity are fairly obvious. In the words of Ibon Facts and Figures (1991:12), ‘This trend only strengthens the dominance of local big business and TNCs. Even the World Bank, the main proponent of privatization, criticized the programme for being ‘confined to and benefiting only business elites and their foreign partners’. Another negative implication for distributional equity is that workers and employees could not compete with big businesses in acquiring ownership of privatized assets. The open bidding process of the Asset Privatization Trust requires bidders to deposit at least 10 per cent of the appraised value of properties for sale. This is clear in the case of the National Sugar Refineries Corporation (Nasurefco). Sugar workers and farmers wanted to buy the corporations through a negotiated sale. They matched the offer of the highest bidder but requested to pay on an instalment basis. They were not allowed to do so. Another example is the case of the Pangasinan Transport Company (Pantranco), one of the biggest bus companies in Asia. Employees could not enter into an Employees Stock Ownership Programme because of APT rules on asset sales. Still another example is that of Philippine Air Lines, the flagship carrier of the Philippines. The employees’ association also wanted to participate in the privatization process of the airline, but could not compete with big business. According to Ibon Facts and Figures (1991:11), ‘the World Bank has noted that a number of the biggest companies which were sequestered or foreclosed by the Aquino administration were eventually sold to close friends and relatives of President Aquino’. The case of the Manila International Container Terminal (MICT) which eventually came to be controlled by ‘politically and economically powerful groups—such as the Lopez Family and business groups linked with middle-class anti-Marcos protest administrations’ is likewise cited. Another example is Philippine Nissan, Inc. which was acquired by the brother-in-law of the President ‘at a give-away price’ (IBON 1991:13). 88

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Changes in price structure While there are a number of studies on the implementation of privatization in general, detailed studies of impact have not been made. One case study which was made during the early stages of privatization stands out in its analysis of post-privatization impact in the sale of one corporation, the Island Cement Corporation, to Phinma, the dominant leader in the cement industry (Baulita and Zosa in Gouri 1991:433–66). Analysis of the post-privatization impact of the sale of the Island Cement Corporation to its leading competitor showed that it was not financially advantageous, since the government had to continue paying for its liabilities. In terms of industry structure, the writers warned about the possibility of the development of a cartel. According to the authors, after privatization and deregulation of the cement industry, ‘the immediate overall effect…is to raise cement prices’ (Ibid.: 451). The way in which privatized enterprises operate It is difficult to evaluate at this time the implications of the way in which privatized enterprises operate. Nevertheless, the case of the privatization of the Island Cement Corporation is very instructive. Shortly after its take-over by Phinma, the latter was in a position to control 46 per cent of the market. According to the authors, ‘the prevailing view in the industry is that this group constitutes a cartel, especially in the Metro-Manila and Luzon areas where they mainly operate’ (Ibid.: 451). In 1990, another cement corporation, Floro Cement Corp. (FCC), was sold to Alsons Development and Investment Corp. According to Business Update (1990:61), ‘With the conclusion of the sale, the Alcantara family now controls 41 per cent of the cement market in the Visayas and Mindanao. They also own Iligan Cement Corp., one of the largest cement factories in Mindanao.’ We have a picture of two dominant corporations which substantially increased their share of the market after participating in privatization. Phinma lords it over Metro-Manila and Luzon, while Alsons reigns over the Visayas and Mindanao. If two corporations dominate an industry, the implications for prices and distributional equity are only too obvious. Effect on employment One of the most contentious areas of debate on privatization is in terms of the impact on employment. While other countries have been careful about the possible reaction of labour to privatization, the Philippines has been brutally forthright. Section 27 of Proclamation No. 50, signed by former President Aquino, provides for automatic termination of employer-employee relations upon privatization of an asset or GOCC, thus: 89


Sec. 27. Automatic Termination of Employer-Employee Relations. Upon the sale or other disposition of the ownership and/or controlling interest of the government in a corporation held by the Trust, or all or substantially all of the assets of such corporations, the employer-employee relations between the government and the officers and other personnel of such corporations shall terminate by operation of law. None of such officers or employees shall retain any vested right to future employment in the privatized or disposed corporation, and the new owners or controlling interest holders thereof shall have full and absolute discretion to retain or dismiss said officers and employees and to hire the replacement or replacements of any one or all of them as the pleasure and confidence of such owners or controlling interest holders may dictate. The above provision directly contravenes the provisions of the Philippine Constitution on Labor, Section 3, Article XIII of which provides that: The state shall afford full protection to labor, local and overseas, organized and unorganized, and promote full employment and equality of employment opportunities for all. It shall guarantee the rights of all workers to self-organization, collective bargaining and negotiations, and peaceful concerted actitivies including the right to strike in accordance with law. They shall be entitled to security of tenure, humane conditions of work… More than any other provision of Proclamation No. 50, this has provoked vigorous debates between academics and labour groups, on the one hand, and government officials and the private sector on the other hand. The Assistant Secretary of Labour during the Aquino administration admitted that: the absence of clear-cut policies with respect to Sec. 27 of Proclamation No. 50 has somehow eroded the people’s view of privatization. Nevertheless efforts are being exerted at ensuring that our privatization does not lose ‘human dimensions’. Security of tenure must be protected at all times because at the very core of promoting productive employment is ensuring that people remain and stay employed. The Department of Labor and Employment and the Asset Privatization Trust has taken the initiative in this direction but, without a clear-cut policy on the matter only so much can be done. (Palafox and Barranco 1988:95) The leadership of the Asset Privatization Trust, and the Department of Labor and Employment, have reiterated that the workers will be protected in privatization negotiations. They have gone out of their way in negotiating for the protection 90

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of the workers. Nevertheless, the offensive section in Proclamation No. 50 has not been repealed, in spite of amendments which were instituted by former President Aquino. When President Ramos issued Executive Order No. 37 reiterating the privatization policy of the country, Section 27 was left untouched. This provision largely accounts for the strong resistance to privatization emanating from the labour sector, particularly those from the GOCCs and their subsidiaries. A set of case studies conducted by the School of Labour and Industrial Relations of the University of the Philippines on the implications of privatization on labour revealed the following: (a) The government, on the whole, did not prepare for the labour relations aspect of the privatization programme. Even the Department of Labour and Employment was unprepared and appears helpless in attending to the turmoils in labour relations that have arisen as a consequence of the foreclosure, sequestration, privatization and re-privatization of the above agencies. (b) The unions and the workers had no role whatsoever in the decision to privatize or re-privatize. (c) The response of the unions and workers to the privatization programme was mainly reactive, precisely because they were not consulted on the privatization decision. Moreover, many were not certain about their rights, particularly concerning job security and other related matters, during the privatization process (Ofreneo et al. 1989:6). Aside from the above case studies, other studies tend to show that workers have had difficulty holding on to their jobs precisely because of Section 27 of Proclamation No. 50. Those who were retained were placed on a contractual basis without guarantee of being made permanent. In the short run, the impact on employment cannot be said to have been positive. On the contrary, the policy on workers of privatized corporations has only kindled fear and resistance even before actual take-over of a GOCC or asset. Strengthening foreign ownership of privatized corporations One of the main issues that has been raised during the early stages of privatization in the Philippines is the matter of foreign control of the economy. The capital market in the Philippines is not well developed, and is perceived to be dominated by transnational corporations. Privatization which relies primarily on clean sales to single buyers might exacerbate not only monopolies but foreign control of the economy. While an actual count of foreign buyers may show there are not too many of them, the observation of an APT official is apt: officially, it is correct that only a small cross-section of GOCCs 91


(Government-Owned or Controlled Corporations) disposals may have been made to foreign firms…[However,] there is always the great possibility that local firms may have been used as vehicles for foreign ownership. (Milne 1992:33) The above issue is still a matter of concern for critics of privatization. The plan of the government to allow 100 per cent foreign ownership of profitable assets like Philippine Air Lines, Manila Hotel and others has raised strong public reaction (Ibon Facts and Figures 1991:12). The government has stated that this policy is only temporary. Nevertheless, it goes against the Constitution, which limits foreign ownership of enterprises to only 40 per cent. Again this is a distributional equity issue which will surely elicit debate when the profitable enterprises are offered for privatization. RESULTS OF PRIVATIZATION PROGRAMME SINCE 1987 Gross revenues As of June 1993, six years after the implementation of privatization, the Asset Privatization Trust and the Committee on Privatization reported accumulated gross revenues of P59.4 billion (APT 1993:6). At the prevailing exchange rate of P29:$1, this was approximately $2.048 billion in dollar terms. These revenues were generated from the sale of acquired asset corporations as well as from the sale of GOCCs and/or their subsidiaries. Of this total amount, P34.1 billion was generated by the Asset Privatization Trust, the entity tasked with disposing of private corporations taken over by the government when they became bankrupt. However, only P20.21 billion had been remitted to the Bureau of the Treasury. Part of the revenues have been held in escrow pending resolution of suits filed by former owners. The APT further reported that during the same period, it spent a total of P934.4 million for operations and custodianship. This constituted 3 per cent of the P34.1 billion sales and 5 per cent of the P20.2 remitted to the Treasury (APT 1993:8) On the other hand, the Committee on Privatization reported gross revenues of P25.4 billion generated from the sale of GOCCs and/or their subsidiaries (COP 1993:1). While the APT is required to turn over to the national government revenues generated from sales, GOCCs, with the exception of financial institutions and the National Development Corporation, can keep their revenues. This arrangement was changed when President Ramos issued Executive Order No. 37, mandating that with the exception of the subsidiaries of the Government Service Insurance System and the Social Security System, all GOCCs shall remit to the National Government at least 50 per cent of their net proceeds. 92

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All in all, the APT reported that 305 assets had been disposed of. Of these, 240 were fully disposed of through various modes and sixty-five were partially disposed of. The Committee on Privatization reported that twenty-eight GOCCs had been fully disposed of for a total of P9.2 billion, while P16.2 billion was generated from the partial sale of thirteen GOCCs. The report on the sale of GOCCs did not include expenses involved in operations and disposal of these corporations. As mentioned earlier, total gross revenues have to be considered in relation to the servicing of debts which were assumed by the national government. From 1986–91 alone, the Department of the Budget reported that a total of P116.4 was budgeted by the national government to service these assumed liabilities (Ibon Facts and Figures: 6). While revenues generated are impressive, these pale in relation to debts which continue to be serviced. Again, the implications for distributional equity are very important. These assumed liabilities were serviced by borrowings and taxes. Taxes in the Philippines are primarily regressive and rely largely on indirect taxes which impact on consumers, the majority of whom are poor. Problems in identification of impacts By law, the Committee on Privatization and the Assets Privatization Trust was to cease operating by 31 December 1993, unless their life was extended once more. It is therefore timely to examine the impact of privatization, particularly on distributional equity. So far, impact studies have not been conducted, although general assessments have been made for some time. Both COP and APT have likewise been reporting regularly on their activities and accomplishments. Nevertheless, these do not give sufficient information on impacts. Executive Order No. 37 claims that ‘the privatization program has proven successful and beneficial to the economy in terms of expanding private economic activity, improving investment climate, broadening ownership base and developing capital markets, and generating substantial revenues for priority government expenditures.’ These claims need to be validated through impact studies. One difficulty in evaluating the impact of privatization is the fact that, generally, three types of sale are involved. First is the sale of acquired asset corporations. These were not GOCCs to begin with. They were originally private corporations which borrowed heavily from government financial institutions, and were taken over. These assets constituted a massive drain on the resources of the economy because of the liabilities which had to be assumed by government. These assets accounted for a greater part of total gross revenues from privatization, some 56 per cent. An examination of the impact on distributional equity of this type of privatization would focus on concerns that such sales might exacerbate 93


monopolies, since buyers tend to be competitors. Another concern is the entry of foreign investors, considering the weakness of the domestic capital market. Still another would be on the concerns of labour with regards to employment. A final concern would be the matter of revenues from sales. It may not be correct to claim that revenue from such sales constituted a net addition to government funds since their debts still had to be serviced. The second type of sales would be those of loss-making GOCCs and their subsidiaries. Inquiries on distributional equity would look at pricing, since the private sector would be providing the services which the privatized GOCCs used to render. Related issues would be revenues and the exacerbation of monopolies. Until 1992, with the exception of financial institutions, GOCCs were allowed to retain revenues from the sale of their subsidiaries. Questions about transforming public monopolies into private monopolies have also been raised by concerned sectors. The third type of sale would be those of profitable GOCCs and subsidiaries. So far, privatization activities have been concentrated on assets and loss-making GOCCs. Few profitable GOCCs have been included. If the next round of sales should cover the profitable enterprises, then the issues raised earlier will assume sharper dimensions, particularly with regard to labour and employment, the danger of monopolies and the dominant role of foreign investments. Public debate is expected to be more vigorous. While there is little dispute over the necessity of disposing of debt-laden acquired asset corporations and loss-making GOCCs, there is considerably greater reluctance to let go of the profitable enterprises. These are the corporations which are considered big-ticket items. The above issues can only be resolved if impact studies are conducted. However, each of the three types of sale has to be evaluated separately, since the degree of impact would be different. BALANCING DIVERSE DISTRIBUTIONAL IMPACTS The question of trade-offs As pointed out in the preceding section, distributional impacts would depend on which of the three types of sale is involved. Thus, any effort at balancing or trading off distributional impacts would be influenced by the type of privatized entity—whether acquired asset, loss-making GOCC, or profitable GOCC. There is no doubt that the acquired-asset corporations have to be disposed of. These assets are largely responsible for the bleeding of financial resources in the national government. They are private corporations in the first place, and they must be returned to the private sector. The process of ‘re-privatization’ has been a protracted one. In spite of claims of huge revenues, consolidated calculations indicate even bigger losses. Nearly the same situation holds for 94

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the loss-making GOCCs, which also constitute a drain on national government finances. However, the process of disposing of these ventures has had ‘unintended’ consequences because of the mode of privatization, which was primarily through single buyers or consortia. The trade-off has been between shedding the burdens of acquired assets and loss-making GOCCs, and the consequences of revenue losses, dangers of monopolies, foreign control, and labour problems. It appears that in the process of trade-off, distributional equity has suffered. Theoretically, the sale of profitable enterprises should have a favourable distributional impact on equity. However, the method of sale, which is primarily through bidding, negates equity considerations, since the public has no chance to participate. Suggestions for maximizing favourable impact Based on the experience so far with privatization, the favourable impacts appear to have been outweighed by unfavourable impacts. This does not necessarily reflect on the agencies and professionals who are faced with the formidable task of re-privatization and privatization, but is largely due to the character of the entities which have had to be disposed of, the nature of the capital market, and the balance of power in the political and economic system. While suggestions are made here for maximizing favourable impact, a more urgent suggestion is for a comprehensive review of the entire exercise, particularly in terms of distributional impacts. First, the process of privatization has to be democratized, to minimize domination by monopolies and possibly cartels. Instead of relying on public bidding, the public has to be given an opportunity to participate. Perhaps the experience of Korea is instructive in this respect. Second, to minimize resistance from labour and avoid a negative impact on employment, the recommendations of the study team of the School of Labour and Industrial Relations are endorsed: (a) Labour should be represented in the Asset Privatization Trust and other agencies tasked with the disposal of firms/assets for privatization. (b) The Department of Labour and Employment likewise should be given a role in the privatization process, particularly in the mediation/arbitration of labour disputes. At present, labour dispute settlement in firms being privatized is anarchic because there is no clear agency responsible for this process. (c) There is a need to remove Section 27 of Proclamation No. 50 and to amend Section 31 and Paragraph 4 of Section 25 in a way that will give labour a say in the privatization process and a venue to seek legal remedies for perceived injustices committed against them. (d) The whole privatization programme should be made transparent to all parties concerned, particularly to the affected employees. 95


(e) There should be a programme of assistance to laid-off workers, such as retraining and livelihood projects. Finally, there should be no illusions that the privatization programme will produce huge revenues for the government. This is not realistic. Even without the acquired assets, sales of GOCCs are inevitably conducted at a loss. Reports of large revenues can only be misleading, since net revenues clearly show losses. CONCLUSIONS Unique features of the Philippine experience There are several features of the Philippine experience in privatization which influence the degree of distributional impact: (a) Privatization as a policy was adopted at a time when the economy had collapsed due to a crippling debt crisis. A large part of the public sector debt was accounted for by the GOCC sector. This was because the government took over three hundred private corporations which could not pay their foreign and domestic debts. (b) Privatization as a policy was part of a structural adjustment package directed primarily at the public enterprise sector, under the aegis of the World Bank. Subsequent agreements with multilaterals, as well as development plans by the Aquino and Ramos administrations inevitably included privatization as a major thrust. (c) Because of the circumstances outlined in (a), three general types of entity had to be disposed of: acquired-asset corporations which were saddled with massive debts, and associated with the Marcos administration; GOCCs and their subsidiaries which were losing heavily; and profitable GOCCs. These three types of entity had different distributional impacts. (d) The characteristics of the capital market, as well as the political system, led to consequences which were probably not intended but happened nevertheless. Because of the above features, there is a need not only to maximize ‘favourable’ impacts but to re-examine privatization as applied in the Philippines. In a paper I wrote two years ago, I raised some questions on the policy of privatization in the Philippines. At a time when the programme is nearing the end of its term (unless extended), the same questions need to be asked again: (a) Should privatization continue to be the centrepiece of corporate reform and rationalization? (b) How do we resolve the dilemma of reconciling demands from the international environment and issues of national interest? 96

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(c) Poverty is a pervasive problem which is supposed to be the focus of government programmes and projects. What is the role of government corporations in alleviating continuing poverty in the country? (d) What policy measures should be undertaken to integrate performance evaluation of the GOCC sector? (e) Present conditions call for consultation, transparency and democratization in policy formulation. Should mechanisms for consultation be included in policy formulation for GOCCs? APPENDIX 5.1 Table 5.1 Disposed assets, by industry, partial and full, 1987–90 (in P thousands)*

* $1=P25 as of June 1991 Source: IBON (1991:3, Table 2

APPENDIX 5.2 Table 5.2 List of competitor buyers

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Table 5.2 continued

Source: IBON (1991:8, Table 10) Note: PB—partial buyer SB—sole buyer

REFERENCES Asset Privatization Trust (1993) The 1993 Midyear Report. Business Update (1990) October. Committee on Privatization (1993) Communication from the Executive Officer. Department of Budget and Management (1991) Government Corporate Sector Rationalization Program: Policy Studies 1989–1990. Gouri, G. (1991) Privatization and Public Enterprise: The Asia-Pacific Experience, Hyderabad: Oxford and IBH Publishing Co. IBON (1991) Ibon Facts and Figures, 30 April. Milne, R.S. (1991) ‘The politics of privatization in the ASEAN states’, ASEAN Economic Bulletin, vol. 7, no. 3, March. —— (1992) ‘Privatization in the ASEAN states: who gets what, why, and with what effect?’ Pacific Affairs, vol. 65, no. 1, Spring. National Economic Development Authority (1993) Medium Term Philippine Development Plan. Ofreneo, R., Aganon, M., Logarta, J. and Palafox, J.A. (1989) Labor and privatization: The Philippine Case, University of the Phillipines. Palafox, J.A. and Barranco, N.O. (eds) (1988) Privatization and Its Impact on Labor Relations in the Philippines, Manila: School of Labor and Industrial Relations. Ramanadham, V.V. (1993) Basic working paper for the Interregional Expert Group Meeting on the impacts of privatization on distributional equity.

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6 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY IN THAILAND Kraiyudht Dhiratayakinant This paper attempts, first, to describe the privatization activities in Thailand since the early 1980s and to present the reasons for the relative success of each modality adopted. There is then an analysis of the distributional impacts. THE STATE-OWNED ENTERPRISE SECTOR IN THAILAND: A BRIEF OVERVIEW The public enterprise sector in Thailand has been noted for its efficiency in comparison with public sectors in other countries (Gouri et al. 1991). The sector has been relatively small in size since the reform in the late 1950s and early 1960s: formally there are only sixty-four state-owned enterprises (SOEs) in Thailand. Only a few of these SOEs are loss-making. Two of these lossmakers are providing services which serve the metropolitan masses at politically determined low prices, namely, the State Railway of Thailand and the Bangkok Metropolitan Bus Organization. Table 6.1 (see Appendix) shows the aggregate financial picture of the SOE sector with the latest available data.1 Although the SOE sector has fared relatively well, the impression among Thais is that the sector is not very efficient, and that it could do a much better job in its service delivery. There have been constant calls for improved performance, and privatization is one approach advocated to enhance the performance of the SOE sector. Even before the current vogue for privatization, Thailand had implemented a number of privatizations, as detailed in Table 6.2. The privatization activities since 1980 are discussed in the following sections. PRIVATIZATION ACTIVITIES IN THAILAND There were statements in Thailand’s Sixth and Seventh National Development Plans to the effect that the government would adopt a policy of privatization 99


as an instrument to improve the performance of the public sector, particularly the SOEs. Some privatization activity has taken place, but not of the magnitude one would have expected on the basis of the policy statement. Table 6.3 shows the relative importance of the different modalities of privatization employed in Thailand since 1980: franchising, leasing, contractingout, divestiture and joint ventures. MODALITIES OF PRIVATIZATION Franchising Franchising has been highly welcome in Thailand as the country has had to face severe bottlenecks in infrastructure, and the SOEs have been unable to provide adequate additional services due to inefficient management and resource constraints imposed by the state in the form of limits on internal and external public debt. Granting franchises to willing private enterprises does not provoke opposition from the public at large, the managements of SOEs or public agencies, labour unions or the politicians in charge of the relevant ministries. For the public, the assurance of service availability is the most important consideration. The management of the relevant SOEs are content because this deflects criticism of their inefficiency. For labour unions and their leaders, franchising is good as it does not involve any reduction of the existing labour force. For the politicians, franchising offers an opportunity to be seen to get things done, and more importantly, to give or receive favours from those who are interested in running such franchises. In short, franchising is very attractive in Thailand. However, it has yet to lead to many successful solutions. Most of the huge franchised projects are related to the capital city’s transport and mass transit system. Because the service is monopolized by an SOE or department, the franchise is of the ‘BTO’ variety (build, transfer and operate). That is, the franchisee invests in the structure and facilities, builds them, then transfers the ownership to the relevant SOE which in turn legally permits the private franchisee to operate the facilities to generate income. This income is then shared in accordance with the terms and conditions of the contract. Because of Bangkok’s heavy traffic congestion, the signing of the contract after lengthy negotiation was widely applauded. Things have not gone entirely smoothly since the signing of several mega projects, however. Up to now, no franchised transport system has offered a service. The most advanced franchise, in terms of construction progress, has run into problems because of a disagreement concerning the interpretation of the contract (i.e. is it a BTO or a joint venture?), resulting in conflict over the respective areas of responsibility between the Expressway and Rapid Transit Authority of Thailand (ETA) and the Bangkok Expressway Company Limited 100

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(BECL). The problem also concerns an unwillingness or inability to raise tolls as stipulated in the contract. The contract signed with the Hopewell Company to build and operate a rail mass-transit system contains many loopholes. The actual construction for the first phase began only in June 1993, after the signing in early 1990. Another project of a similar type, the ‘electric train’ project by the Thanayong Company, seems to be on schedule, yet an uproar about the use of a public park for construction of a repair depot and office site led to a change of plan; many fear that the inability to settle this issue will halt the project. The Lavalin Skytrain project, contracted in November 1991, never took off due to the franchisee’s inability to secure relevant partners. The Skytrain project is now being handled by a newly formed SOE, the Metropolitan Electric Train Company. The present government does not seem to be able to make up its mind whether to reprivatize the project again. The Don Muang Tollway project has run into the same type of indicisiveness. The dispute is about demolition of two overpasses, which was supposedly stipulated in the contract. However, traffic congestion this might cause, and the displeasure about the elimination of alternatives for motorists who are forced to use the tollway, are reasons behind the delay in the go-ahead decision. Things have been a bit better in franchising other public services. After the initial award of the right to build and operate an overlay network which can serve three million telephone lines in 1990, the franchise was renegotiated by the new government of the day because of alleged irregularities. The franchise was then split into two franchises, one for the metropolitan area, serving two million telephone lines, the other for the provincial area, serving one million telephone lines. The two franchises were awarded to the Telecommunications Asia Company (the original franchisee of the telephone network) and the Thai Telephone and Telecommunications Company, respectively. There are also other smaller franchises in the telecommunications area granted by the Telephone Organization of Thailand (TOT) and the Communications Authority of Thailand (CAT).2 Leasing When divestiture is politically unpopular and it is difficult to obtain approval of the concerned stakeholders, leasing is a good alternative. One SOE, the Preserved Food Organization, has adopted this route to privatization. It no longer manufactures its brand name products, though it has never been closed as an entity. Part of the new seaport at Laem Chabang on Thailand’s eastern seaboard has been leased to private enterprises. Other well-known cases are the operation of the Queen Sirikit National Convention Centre by NCC Management and Development Company, which is presently in the second five-year contract, the operation of a resort hotel at Hua Hin by the Central Group, and the private operation of an SOE-owned golf course in Chonburi. 101


Contracting-out Contracting-out of minor services has been increasingly popular in the public sector. In fact this was practised even before the advent of privatization. Construction of government buildings, roads and highways, maintenance and repair of elevators and other machines and equipments, and painting and upkeep of public buildings are all services which have been contracted out to private operators since the early days of public bureaucracy. One final public service that has been contracted out to the private sector is refuse collection by the BMA, an arm of local government. However, this privatization is limited to two districts and is still on an experimental basis. There is still a long way to go before the collection of refuse for the entire metropolis is in private hands. There has been increasing discussion about the possibility of contractingout other public services, for example, inspection and certification of quality standards relating to building construction, motor vehicle engines for annual registration, etc. This delegation of certain public duties to the private sector will lighten the workload and reduce the number of government employees. It will also lead to improvements in service quality, if proper liability can be imposed on the private operators. Though attractive in terms of potential efficiency gains, contracting-out of these final public services has yet to materialize. The slow progress in this form of privatization can be traced to the distributional impacts it generates, the details of which will be noted in a later section. The possibility of management contracting-out has also been mentioned. However, the SOE sector in Thailand precludes the adoption of this modality of privatization. Divestiture In Thailand the concept of divestiture is very unpopular among employees of SOEs. Except for the case of one small SOE, and the sale of two oil refinery plants to the lessee (which was itself partly owned by an SOE and other private concerns), divestiture of a whole enterprise has never been attempted. In the case of the flotation of Thai Airways International Limited, this was for additional equity shares to raise more capital, representing about 10 per cent of the total. Ownership was essentially unchanged after the sale. Though the size of stock floated represents only a small fraction of the total equity, it took more than five years of trying before this attempt at partial privatization could actually take place, in March 1992, and only under special political circumstances. The privatization of Thai International was a success story, in that its shares were oversubscribed. There were windfalls to be made during the initial period, although those who still hold the shares from the 102

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beginning, or who purchased them in the stock market during the first few weeks of the flotation, presently suffer capital losses, at least on paper. The initially favourable reaction led to much talk about other SOEs following suit. The performance of Thai International stock since then, however, has dampened the enthusiasm for this form of privatization among bureaucrats and the managements of SOEs. If the timing of flotation is bad, SOE shares may not be well received at all, defeating the fund-raising purpose of this form of privatization. There are other cases involving flotation of equity shares to raise additional capital. These include the Krung Thai Bank (1986) and the PTT Exploration and Production Company (1993), both of which have proved successful, in that their stocks have performed well following privatization. Of course, the flotation has not materially changed the composition of management. A few other cases of divestiture have involved the holdings of the Ministry of Finance in certain companies (via seizure of fallen politicians’ assets). The divestment has implied loss of SOE status for these companies, when the Ministry was no longer a majority shareholder. These cases in a way constitute an exception, insofar as this form of privatization is concerned. These SOEs were under the jurisdiction of the Ministry of Finance, which had final responsibility for their future. They were also small SOEs, the establishment of which had not been directly decreed by the government. Because of these circumstances it was relatively easy for the Ministry to divest its holdings. Another exception involving an SOE under the control of the Ministry of Industry is the divestiture of the Arum Organization, which was liquidated in the early 1980s. The minister in charge was a leading businessman who formerly had been the head of Thailand’s Board of Trade. Being a determined man and a close associate of the then prime minister, he arranged the liquidation of the Arum Organization and the rental of its plant after closure to a private company, which resumed operations. The business itself thrived soon after. Since then, not a single SOE has been divested. Many SOEs which suffer losses, especially those belonging to the Ministry of Defence, are in the manufacturing area, where the private sector is strongest. Some of these SOEs are attractive candidates for divestiture. However, it has been suggested that the privatization programme in Thailand should not be viewed as constituting either a serious or a sustained effort on the part of the government. The joint-venture approach This approach has not been greatly used, possibly due to the fact that SOEs are subject to close supervision and a conservative approach on the part of their boards of directors, who may be interested in making profit but are less interested in taking risk. If deregulation, a form of privatization, of existing 103


SOEs does come to pass, the joint-venture approach may be adopted more extensively. One instance of the joint-venture approach has been the construction and operation of a luxury hotel (the Grand Hyatt Hotel in Bangkok). The site is owned by an SOE which had also operated a well-known hotel built a few years earlier. In the face of necessary heavy capital investment to renovate the building as a modern luxury hotel, comparable to other leading de luxe hotels in town, and the need for expertise in modern hotel management, the government chose to adopt the joint-venture approach where the private partner has a higher equity share. The new hotel is managed exclusively by the private partner. Another case of joint venture is the National Fertilizer Company. The government is a minor partner in this case. The Lavalin Skytrain project is a joint venture of another sort, and a few joint ventures at the SOE level have also been transacted. They are mostly related to the decisions made by the management of the Petroleum Authority of Thailand. The joint venture approach has not yet been used extensively. Most SOEs in Thailand have been established under special laws which give them monopoly rights and usually preclude the right of private partners to participate in the business or any related business. With greater liberalization via change in the basic laws under which SOEs are established and with the adoption of ‘corporatization’ of SOEs, the public-private joint-venture approach as a means of improving performance and efficiency will find its way in the manner in which SOEs expand their business. DISTRIBUTIONAL EQUITY OF PRIVATIZATION The Thai experience of privatization as outlined above has indirectly shown that some forms of privatization have been more successfully pursued than other forms, and that privatization of some SOEs has been carried out without great success. The degree of success has much to do with the nature of distributional equity. Franchising Franchising of the right to offer additional public services that cannot be provided by the state (mainly by SOEs) is the form of privatization that has been received most enthusiastically, and the best-known privatization activities (in terms of relevance and size of investment) have been franchise arrangements. Social benefits in the form of service availability and economic growth made possible by the availability are quite obvious. Efficiency gains through private operation may not actually be realized, although there is the potential for such gains. Within a proper and effective regulatory framework, franchised services can be provided at a reasonable price commensurate with the quality of the service. 104

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Although most of these social benefits are confined mainly to people living in the Bangkok metropolis, the economic growth enhanced by franchised services could benefit people living in other parts of Thailand as well. They also benefit from this type of privatization in the form of employment expansion as the result of construction activities and operation of these services, to the extent that most additional employment is drawn from people who migrate to Bangkok. Moreover, the cost savings, either in the form of tax receipts from franchised private enterprises, which would not have been collected if the service had been provided by SOEs, or the subsidy saved which would have been given to the SOEs in charge of the service provision, will also benefit Thai people when these savings are used to finance other public expenditure or to allow tax reductions to be made. In spite of these positive distributional impacts, franchising thus far has not been as successful as expected. The problem lies in the distributional impact at the very beginning of the privatization process. Who is to receive the franchise? Obviously, whoever is granted a franchise must expect to earn a reasonable rate of return for the investment. Because of the size of the investments involved, the absolute value of the returns must be substantial. Because of the exclusion right provided by the franchise, this return is assured. Competition for franchises has always been very keen, and bidders have relied on political backing. The terms of reference and the basis for selection have not always been clear; selection of the bid winners has always taken a long time. Awarding the franchise in the case of the Skytrain project made headline news for a long period.3 Even when a winner has been chosen, changes in government will usually lead to a reopening of the case, as happened with the telephone network franchise. Delay in implementation is caused not only by competition among potential bidders, but by questions concerning interpretation of the contract after the winner has been chosen. Delays involving all mega projects, noted earlier, can be traced to this factor. Experience in this area may ultimately dampen the enthusiasm of the private sector to participate in big public utilities projects. The franchising approach to privatization, which at first seems to be the most attractive arrangement, may turn out to be less so, and no longer an efficient choice. Indeed, there are already indications of this. A new SOE has been established, ostensibly for the purpose of carrying out the Skytrain project when the Lavalin franchise was cancelled. The third-stage expressway in the Bangkok area is to be built and operated by the Expressway and Rapid Transport Authority. Leasing Leasing an area of land or an under-utilized asset is quite attractive to the property owner, who can earn additional income that would otherwise remain 105


uncaptured. Leasing is thus good for the economy in terms of business activities generated. It is good for the consumers if more facilities and services are created. It is also good for the people if additional employment is generated by leasing, and it is good for the government in respect of the additional taxes collected from increased economic activities. Leasing has been well received by the public and the government, as well as the management of the agency owning such property. However, leasing of property from which the owner can potentially generate revenue to the same extent as a private lessee would not be so welcome. The case of the Leam Chabang seaport illustrates this point. The transfer of income from PAT (the management and the workers) to the winning lessee prompted the protest. The income to be earned from the port operation is certain, though the size of the income depends on the operational efficiency of the proprietor as much as on the general health of the economy. PAT felt that the net income from the operation rightly belonged to it. Why let the private lessee capture the net income? PAT operation of the new port would also create greater opportunities for management to move up the ladder, as more openings would be available for higher positions. This was also applicable to PAT workers at the Bangkok port. Moreover, present PAT employees can secure additional job openings at the new Leam Chabang port for their relatives and friends. Employment expansion is at the discretion of PAT, not the would-be private lessee. Although the labour union was offered the opportunity to operate the new port as a private entity, hence benefiting from employment hiring and management positions, it did not accept the challenge because it was unsure of its management capability, and the risk of making losses, as opposed to certain gains to be captured through PAT. From the perspective of the government, it is the efficiency of the service, which benefits users of the port and the economy at large, that is more important. This increased efficiency can be translated into higher income for the private lessee who must pay PAT for the use of port facilities invested in by PAT and for incomes forgone by PAT. After much debate through several administrations, the government had finally decided that PAT and the private sector would share the port operation. Each was given the opportunity to operate two terminals. For the private sector, the right to operate each terminal was determined competitively. In 1992 PAT was ordered to transfer the operation of one of its two terminals to the private sector. Had the owner of the port not itself been in the business of port operation, leasing would not pose the types of problem noted above. This is clearly shown in the case of the Industrial Estate Authority of Thailand, which is leasing its deep sea port at Mab Ta Put to a private enterprise. 106

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Contracting-out Contracting-out as a form of privatizating is quite similar to leasing. As noted, contracting-out of input service to the private sector has been practised for quite some time, with little opposition. Contracting-out of road and highway construction has also been carried out, but contracting-out of final services which consumers receive directly has yet to be practised widely. The principal obstacle is associated with its employment and income effects on those who presently provide the service. By its very definition, contracting-out involves final services which previously have been provided by the public sector or are deemed to be the responsibility of the government. Their provision in the public sector suggests the employment of civil servants with implied job security and income or future employment in the public sector if these final services are to be provided. Contracting-out therefore eliminates these employment and income opportunities. The gain to the government via contracting out is the cost saving that would arise from improved efficiency as the result of private operation. The saving permits the transfer of budget for other important public services and/ or reduced taxes to be paid for the same amount of public services offered by the public sector. The general public would also gain by having higher-quality public services (in terms of speed, location, content and volume of service). This gain is more diffuse, however, as compared to the loss suffered by public employees who are laid off by contracting-out. Unless the government is in a tight budget situation, alongside rising demand, contracting-out of final public services to the private sector will not be prevalent. Divestiture In Thailand, divestiture has given privatization a bad name. Privatization originally involved the sale of SOEs, with the aim of improving the quality of the service, to benefit consumers. When a loss-suffering SOE is divested the government would be relieved of the burden in its continued support, resulting in a reduced tax burden for the public at large. When this former SOE is turned around and makes a profit, the government will gain via increased taxes paid by the former SOE. In spite of these benefits, however, divestiture has met strong resistance. No SOE of a meaningful size has been sold to private entrepreneurs in Thailand. The reason has to do with impacts on distributional equity. Rightly or wrongly, SOEs in Thailand have been viewed as places for employment security or life-time employment, just like government bureaux and departments. People who are employed in SOEs are not overly concerned with the quality of the service they offer to the public, nor with the loss sustained by their SOE. Sale of loss-suffering SOEs immediately suggests the 107


likelihood of the loss of employment for some, if not most, employees whose services are viewed as redundant. Those who are retained may have to suffer reduced income and/or fringe benefits. Their job seniority may be downgraded and job security can also be threatened. These consequences may also face employees of profit-making SOEs—the private operator would inevitably wish to minimize operating costs. Therefore even the sale of a profit-making SOE will be faced with protest from within. Aside from motives of self-interest on the part of protestors, arguments against the sale of SOEs focus on the strategic importance of the service in question, the contrived shortage of the service to push up price, the political reward to the winning buyer of the enterprise via undervaluation of enterprise assets, the kickback that would take place via divestiture (the corruption issue), and exploitation of workers under profit-driven private ownership. Some of these issues may be valid in certain contexts; but it would be mostly speculative to discuss them, since Thailand has yet to pursue this course of action. One thing is certain. The sale of SOEs to the private sector would certainly lead to reduced employment at the time of transfer. Only productive workers stand a chance of securing permanent employment after the changeover. The sale of two units of an oil refinery plant formerly owned by the state in 1992 by a caretaker government generated hot political debate. The point of contention was the underpricing of the assets, which generated windfalls to the buyer, which is partly owned by an SOE, a few private concerns and the current lessee of the refinery. The divestiture was not carried out in pursuit of privatization policy as such, but by the fact that the company, Thai Oil, had to own the assets for it to be listed in the stock market. The point raised may be valid in view of the market situation, but the asset valuation process adopted by government was consistent with the conventional method. Divestiture in the form of the sale of common stock has also taken place with one of the biggest SOEs in Thailand, Thai Airways International, noted earlier. Initially, the proposed privatization provoked much resistance from the Ministry of Communications and Transportation and from the military (the Air Force), from the national security perspective. The argument is that, with private involvement, private entrepreneurs would then make strategic decisions. The decision to privatize was put off year after year. With a tighter budget situation faced by the government, however, and the urgent need for investment in more aircraft the Air Force gave in to the idea of stock flotation to raise needed capital. As the floated stock amounted to only about 10 per cent of the total equity and carried no voting rights, the management was not materially turned over to the private sector. Moreover, with the boom in the stock market the leading figures in the Air Force who actually ran this SOE stood to make substantial capital gains from stock which was allotted to them. To recruit the support of the SOE employees, 5 per cent of the floated stocks were allotted to them at par (as opposed to market) value (10 baht instead of 60 baht). 108

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The flotation was extremely successful, and its timing was perfect. The stock market was bullish and the chairman of Thai Airways International was then the second most important military figure in Thailand. (There was later a coup d’état.) The stocks were over-subscribed at 60 baht. Since the flotation, however, the performance of Thai Airways International has deteriorated. With the coup d’état and a faltering economy, along with keener competition amidst a world-wide aviation recession, the net earnings and profit have fallen. Its stock value has been around 40–50 baht per share, mostly in the lower 40s. Whether the initial offering price of 60 baht per share was overvalued in the face of the subsequent market price is difficult to judge. In light of the heavy oversubscription, the opposite view could also be valid. Whichever is true, a redistribution of income did actually occur in the divestiture of Thai Airways International. Those private citizens who received shares initially and immediately sold them did make some capital gains. Those who have continued to hold them have suffered substantial losses. Aside from the redistributional impacts just described, this privatization venture did relieve the government of the pressure to guarantee loans to be secured by Thai Airways International which, if actually called upon, would have made impossible the financing of other investment projects. To this extent the social benefits were secured via the ability to carry out investment in other important public projects. The people who receive benefits from these investments have gained as a result. In the light of this experience, raising capital funds directly from the capital market, as a form of privatization, should be contemplated if the SOE in question is sufficiently attractive for private investment. Of course the timing of the flotation and the valuation of stock prices should be equitable to private investors. So far, this form of privatization has been infrequently attempted. Since Thai Airways International, only PTT Survey and Exploration Company has been attempted. This was successful but it did not generate the type of enthusiasm found earlier. With an improved economic situation in Thailand and a revival of the Thai stock market, more attempts could be expected. With efficient management, the flotation of SOE equity shares can be viewed as creating an opportunity for the business sector and the general public to own SOEs. And if the enlargement of the capital market and the development of capitalism among Thai people are the principal objectives, this form of privatization is certainly a very attractive measure. Public-private joint venture The public-private joint venture has its attractions, as in the case of franchising. In conditions of capital shortage and/or shortage of technology expertise, securing private partnership could be the best option. When an activity to be undertaken is in a new business area, and complementing the present business 109


pursued by the SOE in question or expanding the business would not be possible, the joint-venture approach is extremely attractive. Here no negative redistributional impact is involved. When the action is well planned, the joint venture would result in employment expansion and a net return to the present SOE. From the standpoint of the government, more taxes can be generated and there will be no pressure to raise needed capital for further expansion. For the public, availability of the service (new or existing) would be beneficial. Yet this particular form of privatization has not been used extensively. The main reason for this is the nature of special laws governing most SOEs. These laws limit the scope for SOEs to manipulate their business situation. Recognition of this has led to many attempts to change these basic laws. In the near future joint-venture measures will be used more frequently by leading SOEs in Thailand: among them are the Electricity Generating Authority of Thailand, the Telephone Organization of Thailand, and the Communications Authority of Thailand. However, the establishment of joint ventures to handle the existing business of SOEs may not receive the same type of enthusiasm. Employees of SOEs would view this action as a measure to divert their potential income to would-be private partners. If the provision of a service can be carried out by an SOE, why should there be a need for private partners for its provision? In addition to the income effect, an employment effect is also involved as the decision for hiring is lodged with the new venture. Unless it can be clearly demonstrated that there is no way for an SOE to increase the needed additional service, joint venture would definitely be opposed. It is also obvious that there is usually no strong case for using joint ventures to provide a service currently handled by an SOE. ISSUES IN DISTRIBUTIONAL EQUITY Distributional impacts are the most important factors in explaining why certain privatization measures are warmly received and successfully implemented, while other privatization measures meet strong resistance and hardly ever get off the ground. The preceding discussion of various cases experienced in Thailand is supportive of this proposition. Types of distributional impact and relevant focus Distributional impacts may be classified as either intended or unintended, and anticipated or unanticipated. Intended distributive impacts are expected, hence anticipated. Depending on the persons affected, most distributional impacts are either positive or negative. Few distributional impacts are totally unidirectional; that is, they are not good or positive for all involved or they are not negative for all involved. These anticipated intended impacts may not turn out as expected, both in 110

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terms of quantity and direction. Some of the distributional impacts may not be anticipated, either because their nature cannot be gauged from the beginning, or because they are the consequence of the first-round impacts of privatization, which may or may not be solely caused by the privatization measure. These unanticipated distributional impacts can be positive, in that some people benefit from them without corresponding loss, but they can also be negative. The point of the discussion is that it is important to be sure of the firstround anticipated distributional impacts. If they are positive impacts, their occurrence should be encouraged. Obviously, if they are also intended distributional impacts, the reason for encouraging them is reinforced. If they are negative impacts, measures should be taken to reduce their harmful effects. Since these are not the objective of privatization, negative distributional impacts serve as constraints against the achievements of privatization. The trade-off issue This leads to the issue of trade-off between the efficiency objective and the distributional constraint. The objective of privatization, in whatever form, is mainly efficiency-related. The principal objective of privatization is to increase the availability of a relevant public service, given the resource limitation faced by government. In the context of an SOE, the objective of privatization is to improve the quality and expand the quantity of the service by not expending resources as much as the amount to be expended by the SOE. This would occur with the existence of a competitive environment in the private sector. The achievement of this objective certainly has distributional implications in the form of social benefits to be captured by various groups of people, including the government. This achievement must be ascertained before a particular privatization measure is carried out. How these social benefits are distributed must become secondary, in that the distributional pattern should not overrule the launching of privatization if the achievement is to be attained. This position would probably be readily accepted. However, in launching any particular privatization measure, certain groups of people would be adversely affected. For example, they may lose their jobs. These people should then be compensated in a manner agreeable to the parties in negotiation. If privatization is efficient, social benefits to be gained would in the long run be more than enough to pay for this compensation. If negative distributional impacts are more apparent than real, they should be treated as such and no compensation is needed. To counter probable resistance, there must be mobilization of support from the people who actually benefit from a particular case of privatization. This can be done effectively when privatization is a transparent success. The possible benefits of privatization must be discussed openly: the pros and cons of a particular measure must be subject to public scrutiny. The 111


projected direct gains and expected losses, as well as associated gains and losses, must be identified to all concerned. Measures to take care of the losses when compensation is deemed equitable must be devised for acceptance. Transparency of the privatization process and open debates of relevant issues of a particular privatization measure would soften, if not eliminate, the resistance to privatization. Long-run gains from privatization would warrant the effort even though it prolongs the time for reaching final solution. The importance of transparency for the choice of the gainer One distributional impact that has not been identified in the privatization literature is the gains received by private entrepreneurs who are the direct party to a particular case of privatization. For one gainer in a specific context, there is at least one loser of an opportunity to gain. The method by which the winner is chosen is crucial for the smooth launching of a privatization measure. This method must be very efficient, one in which all terms and conditions are spelled out very clearly without giving way to differing interpretations. The same approach must be applied to the manner in which these terms and conditions are applied in arriving at the eventual winner. Again the choice of these terms and conditions, the execution of the bidding process and the choice of the winner must be transparent and open to the public. When the potential benefits are very high, the possibility of malpractice would be correspondingly high. The suggested approach above would reduce the scope for foul play inherent in the choice of the private winner and would facilitate the launching of a particular privatization with little time loss at this stage; it would also enhance the quality of implementation when the private party or the private partner begins his part of the operation. In view of the types of work involved and the experience gained from past privatization actions, especially those very large projects where the stakes are high for all involved, it may well be more efficient for the government to set up a privatization office, if the intention is to pursue the privatization programme seriously.4 This privatization office will not only develop the approach and procedure for various kinds of privatization measure, but will determine the type of privatization measure that is appropriate for various public services offered in the public enterprise sector and the government sector. For each privatization measure, in each instance the issues involved can be raised and solution sought from all relevant parties. The office would also help draw up the terms and conditions for privatization as well as the measures for compensating losers from that particular privatization measure. The final decision on privatization modality for each particular case should then be based on facts and well-reasoned arguments, including well-thought-out measures to guarantee success and minimize negative impacts. The action to implement this decision will then follow. All these steps should be transparent. 112

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The decision to privatize, or the case against privatization, of each specific instance should not be at the whim of politicians or the outcome of disagreement between two opposing politicians from the same or opposing parties. CONCLUDING REMARKS In Thailand, privatization activities have been undertaken with an eye to providing additional services which could not be supplied by the relevant SOE, on improving the delivery efficiency of the SOE sector (and the government sector) and on mobilizing needed capital funds. Distributional impacts have not been viewed, much less analysed, as important aspects in these actions. Consequently, distributional equity has not been relevant in privatization policy formulation and in actions taken. Of course, expected distributional impacts are in fact important factors in determining which contemplated privatization action is to succeed or to fail. The privatization experience in Thailand suggests that there are two stages in which a privatization measure faces problems. The first stage involves the conceptualization of a potential privatization measure to be adopted, potential impacts of the measure, the manner in which affected parties are handled, and the method by which the winning private operator is chosen for a particular privatization measure. The second stage involves the actual implementation of the privatization measure, once the winning private operator has been chosen. The first stage takes place behind closed doors and amid uncertainty as to the seriousness of purpose on the part of government. Few privatization proposals get through this stage, particularly the types of public service worthy of privatization. When they do, implementation can still run afoul, as in the case of the second-stage expressway and the Bangkok Tollway.

113

Source: The Public Enterprise Division, The Comptroller General’s Department.

Table 6.1 The performance of the state-owned enterprise sector (Million Baht)

APPENDIX 6.1

Source: Table 6 in Dhiratayakinant (1991).

Table 6.2 Privatization before 1986

APPENDIX 6.2


APPENDIX 6.3 Table 6.3 Privatization activities since 1980

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NOTES 1 An earlier picture of the financial situation may be found in Dhiratayakinant (1991), which also analyses other aspects in greater detail. 2 The franchises given by the CAT are described in Dhiratayakinant (1993). 3 The contention was between the Lavalin Consortium and the Asian-Europe Group. A more detailed study of these cases has been presented in Dhiratayakinant (1992). 4 The idea of such an office was first suggested in Dhiratayakinant (1989). Later an office of a similar nature with broadened scope, and restructuring of existing agencies overseeing public enterprise performance in separate departments, was proposed in Dhiratayakinant (1990). The latest suggestion of such an office has been made by a privatization team from the World Bank. (Bangkok Post, June 1993).

REFERENCES Dhiratayakinant, K. (1989) Privatization: An Analysis of the Concept and Its Implication in Thailand, Bangkok: Thailand Development Research Institute Foundation, Policy Study No. 2. —— ‘Public enterprise in the Thai economy: present status and approaches for the future’, paper presented at the annual seminar on Thai public enterprise policy now and the future, Graduate Institute of Business Administration of Chulalongkorn University, 3 September. —— (1991) ‘Privatisation of public enterprises: the case of Thailand’, in G.Gouri (ed.) Privatisation and Public Enterprise. The Asia-Pacific Experience, New Delhi and Oxford: Asian and Pacific Development Centre and Institute of Public Enterprise, IBH Publishing Co. —— (1992) ‘The political economy of decision-making: the Thai experience with privatization’, in D.G.Timberman (ed.) The Politics of Economic Reform in Southeast Asia, Manila: Asian Institute of Management. —— (1993) ‘Private sector participation in telecommunications and postal service’, in Future Directions of the Communications Authority of Thailand, Appendix D. A Final Report submitted to the Communications Authority of Thailand by Thailand Development Research Institute. Gouri, G. et al. (1991) ‘Imperatives and perspectives’, in G.Gouri (ed.) Privatisation and Public Enterprise. The Asia-Pacific Experience, New Delhi and Oxford: Asian and Pacific Development Centre and Institute of Public Enterprise.

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7 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY IN MALAYSIA Ismail Muhd Salleh BACKGROUND Privatization in Malaysia was officially initiated in 1983. It was made explicit that an excessive government presence in the economy would be reduced, while an increasing role of the private sector would be emphasized. Various factors influenced the Malaysian government’s intent to realign the balance between the public and the private sectors’ responsibilities. The concerted effort to privatize was thus a response to the need to: (a) redefine the public sector’s role in economic development; (b) increase the efficiency and quality of goods and services produced in the economy; (c) contribute towards meeting the distributional objectives of the New Economic Policy (NEP). The policy contained guarantees that privatization would be carried out without affecting the interests of consumers, employees of government bodies that were privatized, Bumiputeras, and the nation as a whole. This paper begins with an examination of the origin of privatization in Malaysia. There then follow sections examining the major privatization initiatives and the impacts of privatization in respect of efficiency, the budgetary position, equity and employment. The final section provides some concluding remarks. THE ORIGIN OF PRIVATIZATION The origin of privatization in Malaysia can be analysed by examining the growth of public enterprises and public sector. The expansion of public enterprises began in 1970 and the proliferation continued strongly between 1975 and 1989 (see Table 7.1). 118

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Some 901 enterprises, constituting nearly 80 per cent of all public enterprises today, were created during the mid-1970s to 1980s. At the time of Malaysian independence, in 1957, there had been only twenty-three public enterprises in the country. Most of the public enterprises at the time of independence were engaged in traditional activities associated with public utilities, transportation, communication, agricultural development and finance. The largest number of enterprises set up since then have been in the manufacturing and service sectors, although the general pattern of government intervention has appeared to be uniform and well spread throughout the economy. Public sector expansion was associated with an overall increase in public investment, which was at an annual average rate of 12.6 per cent in real terms throughout the 1970s. Statutory bodies’, government-owned companies’ and state governments’ share of the federal government outstanding debt rose from 21 per cent in 1970 to about 38 per cent in 1985 (Table 7.2). The federal government’s share of total interest service charges in operating expenditure also increased, from 11 per cent in 1970 to 25.1 per cent in 1985 (Table 7.3). By the 1980s, it was clear that the poor performance of the state-owned enterprises required that excessive government interference in the economy would have to be reduced. As set out in the government’s Guidelines On Privatisation (1985), some of the objectives of the programme are as follows: (a) To relieve the financial and administrative burden of the government in undertaking and maintaining a vast and constantly expanding network of services and investments in infrastructure. (b) To promote competition, improve efficiency, and increase the productivity of services. (c) To stimulate private entrepreneurship and investment in order to accelerate the rate of growth of the economy. (d) To assist in reducing the size and presence of the public sector, with its monopolistic tendencies and bureaucratic support in the economy. (e) To assist the national goal of redistributing wealth in the economy. The government has also issued its Privatisation Masterplan, spelling out its policy and implementation approach. (See Appendix for details.) The government has thus far privatized fifty-four projects (Table 7.4). Of the total, forty of these represent existing projects involving the taking over of government functions by the private sector, while the rest represent new projects involving the construction of infrastructure and utility projects such as roads and water supply. However, this does not include the privatization projects undertaken by the state and local governments, statutory bodies and companies that have been divested to Permodalan Nasional Berhad (PNB) and thereafter to the Amanah Saham Nasional (ASN) unit trust holders and those sold to individuals and companies under the scheme of transferring government equity in trust companies to Bumiputeras. 119


MAJOR INITIATIVES IN PRIVATIZATION AND THE APPROACHES ADOPTED Several methods of privatization have been adopted in Malaysia, ranging from divestment, corporatization, increased private sector competition, sale and lease of assets, build-operate-transfer (BOT) and build-operate (BO), to subcontracting. Partial or full divestment Malaysian Airlines System (MAS), Malaysian International Shipping Corporation Berhad (MISC), Tenaga Nasional Bhd (TNB), Cement Industry of Malaysia Bhd (CIMB) and Edaran Otombil Nasional (EON) are cases of partial divestment. Thirty per cent of MAS shares, worth RM350 million, was sold to the private sector in October, 1985 and a further 10 per cent was sold at a later date. The government has retained majority control of both companies to ensure that decisions affecting their operations were consistent with government policies and national needs. There has been no change in the terms of the management of MAS. Sports Toto Malaysia Berhad (Sports Toto), a separate case, was formerly a public-owned company with the government holding about 70 per cent of its shares. It became a public listed company in June 1986. In a few other cases, the state has undertaken to divest fully small public enterprises owned by the SEDCs. Although the overall magnitude has been very low in terms of the value of assets transferred from the public to the private sector, this approach is now being encouraged for a large number of enterprises being considered for sale by the government. Corporatization Syarikat Telekom Malaysia Berhad (STM) is the case of an intermediate step in the process towards eventual divestment. After the separation of the Malaysian telecommunications sector from the Ministry of Telecommunications, Energy and Post, the shares were transferred to an independent and fully state-owned company. When the commercialization process was completed, the STM shares were offered for sale to the public. In view of the company’s favourable corporate performance, STM went for public listing in October 1990, when about 474 million of its shares were offered to the public and to its employees. Under this approach, the private and public mix is not affected by any change in the company’s legal status. The company is assured of a twenty-fiveyear monopoly, by virtue of a licence granted which prohibits the establishment of any new telecommunications company. 120

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Increased private-sector competition TV3 represents the third privatization approach whereby the rules of entry in activities which are traditionally run by the government are liberalized. The licensing of an independent television channel, TV3, permitted greater competition with the two existing goverment-owned channels. Additional efforts are being considered to improve the efficiency of other state-owned enterprises, by subjecting them to competitive forces. Sale and lease of assets The lease method involved the transfer of rights to use assets for a specified period, for instance twenty-one to thirty years, in return for specified payments. Some projects have been privatized through a combination of lease and sales-of-assets methods, as in the case of Klang Container Terminal (KCT), Government Security Printing, and the Aircraft Inspection and Overhaul Depot (AIROD). The more profitable component of Port Klang’s activities, the container handling business, was leased to a newly established company. Port Klang Authority (KPA), however, retains a significant share. The Royal Malaysian Aircraft overhaul and maintenance facility was privatized through the incorporation of a joint-venture company, AIROD. Management contract Management contract involves the contracting of private-sector management expertise to manage a government entity for a fee. It entails the transfer of management responsibility and may or may not involve the transfer of personnel, but does not result in the transfer of assets. Examples of these were the privatization of RISDA Marketing Activities and the marketing of Radio Malaysia’s airtime. Build-operate-transfer (BOT) and build-operate (BO) Under these methods, the government allows the private sector to undertake major ventures and to recover its investment via user charges. A public listed consortium, United Engineers Malaysia Berhad (UEM), was awarded the concession to construct the RM3.5 billion North-South highway. UEM is permitted to collect tolls on parts of the existing highway for a twenty-five-year period, after which ownership and control of the highway will return to the government. 121


Subcontracting This usually involves low policy-content jobs, operated largely by municipality and local governments. Such activities include refuse collection, landscaping, security services, etc. This approach had been adopted long before privatization became an explicit policy. IMPACTS OF PRIVATIZATION It is still rather early to assess the impact of privatization efforts undertaken thus far. However, the initial impact does not seem to be very significant. The impacts can be classified in terms of efficiency, budgetary effect and equity. Impact on Efficiency One of the most crucial objectives of privatization in Malaysia is that of increasing efficiency. All projects that have been and are to be privatized should thus be assessed in terms of whether or not they have achieved this objective. But, first, what is meant by efficiency? Here, there are two aspects —productive efficiency and allocative efficiency. Productive efficiency is attained when the output of a firm is produced at minimum average cost, while allocative efficiency means producing up to where the consumers’ marginal valuation of the product equals the marginal cost of production (assuming no externalities). This implies that output should be produced up to where marginal cost equals price. To achieve both productive and allocative efficiency, a firm must not only be privatized but also be exposed to greater competition; for competition in the product market encourages firms to supply goods desired by consumers at a price which reflects the cost of production. Thus, a firm in a competitive product market has an incentive to achieve allocative efficiency, while private ownership would subject the firms to the additional discipline of the capital market, such as the need to avert the treat of take-overs. This promotes profit maximization as the object of managers, in line with the goal of shareholders. It is thus the interaction between private ownership and competition that enhances efficiency. Thus, a privatization exercise which involves merely selling a portion of the shares to the public but which is not accompanied by greater exposure to market forces may not bring about the desired improvement in efficiency. In assessing privatization in Malaysia based on the above criteria, it would appear that there are two problems. The first is the limited scope for increased competition in most of the industries involved (shipping, telecommunications, electricity, postal services and highway construction). These industries enjoy economies of scale, with characteristics of lumpiness of capital and capital indivisibilities, which were often the justification for bringing them under state 122

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ownership and control in the first place. With divestment—partial in most cases—the incentives to reduce costs are still limited, in view of the fact that they can achieve comfortable profits with no fear of competition. However, as argued earlier, even if there is no competition in the product market, market forces in the capital market will encourage managerial efficiency; for if costs are not reduced to achieve maximum available profits, the shareholders will recognize this and bring pressure to bear on management. But this is only possible if the shareholders are well informed. Another force is that of a possible take-over of the company by others confident of improving upon the current performance. But again this may be prevented by the controlling interest in the company held by the government. In any case, the Malaysian capital market may not be sufficiently well developed to impose the kind of discipline mentioned above. Unless privatization led to increased competition, the transfer of ownership from the public to the private sector would simply result in the substitution of private for public monopoly power. This would be a poor swap, and the danger of this immediately creates the need for public regulation to avoid abuse of monopoly power to the detriment of consumers. Privatization may, therefore, involve additional public administration, supervision and regulation, and there is a risk that civil servants may not have the capacity or the courage to monitor the private sector effectively, resulting in a lowering of standards of service or an increase in charges, or both. Although one of the stated intentions of privatization in Malaysia is to stimulate greater operating efficiency within the enterprises, eighteen out of the fifty-four privatized projects listed in Table 7.4 involved monopolies of one kind or another. For reasons that are unclear, most of the selected enterprises were natural monopolies, such as the municipal water supply, the toll road and the telecommunications company. These enterprises, regardless of whether ownership was private or semi-public, were in sectors that were not likely to be subjected to competitive pressures. In the case of divestiture of public assets, the potential benefit rests significantly on the argument of higher relative efficiency expected under private ownership. In the case of partial divestment of MAS and MISC, where portions of the shares were sold, it allows the government to retain effective control, but it is not clear what behavioural impact this will have on the corporation’s management in terms of increased efforts and efficiency. In a recent study of the MAS divestiture, undertaken by the World Bank, the following conclusions were reached: (a) Absolutely nothing discernible changed within the enterprises; responses to the external environment were unchanged. (b) Outside the enterprises, absolutely nothing changed in the government’s power to intervene in MAS decisions. What did change was the way in which it chose to exercise this discretion. 123


(c) In particular, investment and prices were both ‘righter’, in that economic factors played a larger role, and political factors a smaller role (though this was still far from being negligible) in deciding outcomes. (d) As a result of the new investment decisions, consumers gained at the expense of capitalists (the government and private shareholders), while the change in pricing had the opposite impact. The new impact was positive for both groups, however. Competitors also gained, so world welfare increased. (e) A considerable portion of the gains leaked to foreign shareholders, consumers and competitors, however, so that domestic welfare gains were only about a fifth of the total. (f) In particular, domestic consumers were net losers as they paid all the costs of the higher prices, but received only a fraction of the benefits of the expanded investment. However, there are some indications that efficiency has been gained through privatization. The commercial television station, Sistem Television Malaysia Berhad (TV3), has performed well to achieve a listing status after being in operation for only four years. It has also set new standards for the industry as a whole, to the benefit of the viewing public. Privatization of the third channel has also introduced some element of competition in an industry which was previously monopolized by the public sector. Taking another example, the performance of Sports Toto was immediately enhanced upon privatization, through the expansion of existing operations and the introduction of new products. The privatized Klang Container Terminal managed to increase efficiency at the port. Prior to privatization in 1985, the terminal handled 244, 120 TEUs, as compared to 773,335 TEUs in 1987, an increase of 216.8 per cent. The company made a profit of RM0.7 million and RM2.1 million respectively during the first two years of its operation, and is now ready to apply for a listing on the stock exchange. The World Bank study also found positive impacts resulting from the KCT privatization. The results are summarized as follows: (a) If the government had sold a gold-mine, then divestiture made it into a platinum-mine. Domestic welfare from the terminal increased in the order of 50 per cent per year as a result of the new form of ownership. (b) This alchemy was accomplished not primarily through external changes in pricing and investment constraints, as at MAS, but through internal management changes. (c) The most striking manifestation of the internal changes was in labour utilization. Succinctly put, this meant more pay for more work. Less succinctly, but more accurately, the new management provided incentives, training, and participative decision-making; workers responded by working a little longer, a lot harder and considerably smarter. Results were not 124

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(d)

(e)

(f)

(g)

(h)

manifest in acceleration in the rate of growth of output per worker, but in lower costs for administration and repair and maintenance: labour was substituted for other intermediated inputs and growth of total productivity soared. The other major manifestation of improved management was accelerated output growth as improved efficiency lowered costs (especially turn-around time), increasing quality of service and raising output. Although the resulting gains were impressive for KCT, the bulk came at the expense of competing transportation modes (especially conventional operations at Klang Port Authority (KPA)), so the welfare impact was considerably less. Nonetheless, real gains did accrue to both the port and its users from the acceleration in switching to lower-cost containerization. Only a small portion of the gains leaked to foreign shareholders, consumers and competitors, so that domestic welfare gains represented more than 90 per cent of the total. Foreign buyers netted only about 6 per cent of the gains, but their management know-how made a substantial (though unquantified) contribution to improved performance of KCT. It is a clear case of successful utilization of foreign buyers, in marked contrast to other divestitures where foreigners captured so much of the gain that domestic welfare actually declined. The government itself received the bulk of the gains, not through the sale price, but through three profit-sharing mechanisms. In addition to the usual corporate tax mechanism, the government retained a 49 per cent share in the company through KPA, and—most importantly— imposed a variable (per incremental TEU) lease-rental scheme which captured a substantial share of marginal efficiency gains. A unique feature of the KCT divestiture was its impact on the workers, who were induced to work considerably harder, but were more than compensated by increased wages. As a result, unions at both KCT and KPA have become advocates of divestiture, urging privatization of KPA and advising a Thai port union to support the sale of its own organization. Finally, the KCT divestiture was as close to Pareto improvement (no losers) as exists in this volume. Competitors did lose, but this was primarily KPA, whose losses as a competitor were more than compensated by its gains as a shareholder and rent collector. The only net loser was a foreign organization (Singapore Port Authority), and this by quite a small amount.

The corporatization of the Telecommunications Department, now operating as Syarikat Telekom Malaysia Berhad (STM), has opened up the telecommunications industry to competition. Although it is unlikely that full competition can be introduced in this natural monopoly, fragmentation of certain segments of the services or markets has been achieved, such as pay phones and paging services. Through the commercialization process, STM has begun to improve various aspects of the production processes. For example, 125


the detailed billing system has reduced errors, counter services have improved and there is quicker response to applications for connection to the service. Impact on the budgetary position The government’s financial burden has been relieved in two ways. Firstly, the one-off proceeds from the sale of government stakes in companies have to some extent helped to reduce government borrowing to finance its expenditure. What is more important to the government is that these revenues were earned at a time when its financial position was under some strain. To date, the sale of government-owned shares has generated more than RM6.7 billion. Apart from this one-off benefit, recurrent revenue from privatization comes in the form of lease payments and, more generally, corporation tax. In addition, the exposure of the government in privatized projects has also declined with loan prepayments undertaken by some of these entities. Privatization has also reduced the size of the public sector. In terms of personnel, there has been a reduction of the public-sector workforce by about 65,000. Privatization has also saved public-sector resources. These savings have enabled the government to rechannel its funds from these projects towards areas where poverty relief measures are needed urgently. As noted above, the government sold 30 per cent of its holdings in MAS, issuing a public offer on the Kuala Lumpur Stock Exchange in October 1985 for 105 million ordinary shares valued at RM189 million. The offering was oversubscribed by more than six times. After one year, the government returned to the market for a public offering of RM85 million ordinary shares in the state-owned MISC, valued at RM204 million. This offer was also oversubscribed by a large margin. The heavy demand appeared to indicate that the market would have no difficulty in absorbing the new shares of privatized concerns. As a measure of success, however, oversubscription can be misleading. Since the Kuala Lumpur Stock Exchange was established, every new issue sold on it has been oversubscribed, a strong indicator that offer prices did not accurately reflect prevailing market conditions. Table 7.5 computes the revenue forgone by the government due to the undervaluation of the share prices of MAS, MISC, Sports Toto and Tradewinds Berhad (Tradewinds). Using the opening trading prices as the indicator of prevailing market conditions, the difference between the value traded at this price and the value at the time of the share offer is a measure of revenue forgone. Based on this calculation, the revenue forgone by the government from the flotation of MAS, Tradewinds, Sports Toto and MISC was RM339.5 million—more than half of the revenue generated from privatization projects thus far. The major weakness in government flotation of shares came sharply into public view with Sports Toto, which was sold by the government to two investors in 1985, while the government retained 30 per cent of its share. 126

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According to the privatization agreement, once the lottery company was acquired by the investors, a portion of the outstanding government shares would be offered for sale to the public. In June 1987, about 5.2 million shares with a value of approximately RM10.4 million were offered for sale on the Kuala Lumpur Stock Exchange. The RM2.00 share price set by the Capital Issues Committee (CIC) was based on the price: earning ratio calculated from the financial data submitted by the company during the week preceding the public offering. However, at the same time, the new Sports Toto company was allowed to trade on the stock exchange. The company released earning results for the first half of 1987 of about RM13 million. This figure exceeded the earning projection for the whole of 1987, submitted earlier to CIC, by RM12 million. The stock opened for trading at RM10.00 and closed at RM9.55 per share, almost five times higher than the original offer price. The Sports Toto incident magnified the key difficulties that the government has encountered in its efforts to implement the privatization programme. In the case of the Telecommunications Department, the corporatization of the new company implies that it no longer receives operating and development expenditures from the government. According to the first annual report released by the company, it turned in a modest profit of RM4.91 million for the year ended 31 December 1987, but its balance sheet ended up in deficit because of substantial higher provisions. As a result of extraordinary items totalling RM101.53 million, the company ended up with losses amounting to RM96.92 million. According to one of the STM officers, this loss was essentially just a paper loss, since the new assets transferred to the company had been overstated by RM102 million. In the short run, the new telecommunications company also faces increased operating expenses resulting from privatization. These include an increase of 34 per cent in operating costs, amounting to RM91 million. There was a 13.6 per cent increase in salary and allowances, and other additional costs which include licence costs, medical expenses, postal, insurance, audit and legal fees. However, in the long run, the company expects to make a reasonable profit. It was anticipated that the company would issue 20 per cent of its shares to the public, employees and the National Equity Corporation in October 1990. The benefit of privatization in reducing the government’s financial burden can also be assessed in terms of the potential reduction of the government’s debt obligation. As shown in Table 7.6, a total of approximately RM7.451 billion, or about 18 per cent of the federal outstanding debt, was to be transferred to the private sector in the proposed privatization programme. In addition, the privatization of a large infrastructure projects, such as the North-South Highway and the Labuan Water Supply, allows the private sector to undertake major ventures and to recover their investments via user charges or tolls, to relieve the government of its budgetary constraints. There are of course instances where the government is required to provide a guarantee on 127


the demand forecast. This is required to support privatized project financing even when the government is required to provide concessionary loans directly to the enterprise, as in the case of the North-South Highway. This may go against the privatization objective but because of the nature of project, it has been deemed necessary owing to the massive costs involved. The potential savings that the government would gain from the BOT projects are shown in Table 7.7. It should be noted that these projects are financed against toll revenue or contract payments, which the government would itself have received in later years if the projects were undertaken by the public sector. Thus, the BOT projects have enabled several large infrastructure projects to proceed without direct financial commitment from the government. Though many privatization projects have not directly reduced public-sector investment, they have at least avoided an increase in the size of the public sector in terms of additional staff or investments in new projects which would otherwise have occurred. Examples of these would be the various BOT projects. Impact on equity As elaborated in the mid-term review of the Fourth Malaysia Plan (FMP), privatization will be implemented within the context of the New Economic Policy, and it must be stressed that it will not negate the NEP. Increasing opportunities for ownership participation, jobs and business opportunities to Bumiputeras and other Malaysians are expected to be generated by privatization. The substantial assets and other interests of the public sector which will be privatized will provide the basis for further corporate growth of the Bumiputera private sector, and will undoubtedly provide ample opportunities for Bumiputeras, at various levels and scales of operation, to share in the benefits arising from privatization. Thus the mid-term review of the FMP drew attention to the importance of dispersing ownership among Bumiputeras as privatization takes place. The government also emphasized the need to ensure that the ownership conditions imposed on privatized enterprises would be implemented flexibly, as it will be important to ensure that ownership imbalances between Bumiputera and other interests are further reduced. Efforts will also be taken to ensure that the benefits of privatization are widely shared. The interests and welfare of employees will be adequately taken into account before services are privatized. As a substantial proportion of the services involved will be basic services, the government will make necessary arrangements to ensure that the level of prices charged to the consuming public, especially the lower-income groups, will not be unduly high and unfair, following privatization. In terms of meeting the distributional equity objective of the New Economic Policy, a number of techniques and approaches were incorporated in the implementation of privatization. These include: 128

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(a) sales of government enterprises to individual Bumiputeras or companies owned by Bumiputeras; (b) pricing divested stock below the market price, preferential allotment of shares and sales methods; (c) allocation of shares to a National Equity Corporation (NEC), whose purpose is to provide a link between the objectives of NEP and privatization.

Sales of public enterprises Following the formulation of the New Economic Policy in 1970, the role of the public sector, particularly public enterprises, began to expand more rapidly and they became one of the principal vehicles for assisting the Bumiputera population to participate more fully in commercial and industrial activities. From the government’s point of view, it is not difficult to understand the need to re-evaluate the position of public enterprises in Malaysia. Without doubt, through them, the Bumiputeras’ share of the nation’s equity has increased, relatively. However, the selling off of a large number of government enterprises helps to hasten individual Bumiputera acquisition of equity—a cheaper and more effective strategy than the government itself setting up companies to enter into commerce and industry directly. The role of Bumiputeras can be advanced at a much faster pace through control and ownership of corporate capital in private markets. In respect of the restructuring target of the NEP, the privatization programme has helped to increase Bumiputera participation in the corporate sector. Most of the privatization projects have at least 30 per cent Bumiputera participation. However, in some cases Bumiputera participation has exceeded 51 per cent, while in a number of cases, such as Premba Bhd. and North Klang Straits Bypass, Bumiputera participation is 100 per cent. Bumiputera promoters have played an important role in the development of a number of new projects. Privatization has, therefore, become one of the instruments of increasing the role and participation of Bumiputeras in the commercial sector. Setting the price below the market price In order to encourage the lower income groups to purchase shares, the Malaysian government set the price of the shares of privatized entities at a price below the attainable market price. In the case of TV3, shares were apportioned among the major communities fairly in accordance with population ratios. Under these conditions, it can be safely assumed that there is no danger of the Bumiputeras losing ground in the equity stakes as a result of privatization. More importantly, there will be greater opportunities for small investors to participate in equity 129


acquisition. (See also the discussion of the implication of forgone revenues resulting from undervaluation of share prices.) Setting the price of shares at a level below the market value is not without its problems. The fact that the Malaysian Airline System’s issue of shares was oversubscribed seven times implies that the number of buyers exceeded the availability of shares. An oversubscribed issue often jumps in price as soon as the shares go on the market, since the buyers who could not get shares will want to buy once the stock starts trading. The subscriber usually does not object, since an oversubscribed issue sells at a premium, offering the opportunity of a quick profit if one sells immediately. Thus, the pricing of issues at levels below prevailing market prices could serve to intensify speculative activity, leading many investors to go in search of profits through stock market wheeling and dealing, serving to enrich certain already well-off groups. As such, the ownership and stake in the wealth of the country could lie in the hands of a few speculators. In other cases, there have been some modern ‘Ali Babas’ among the non-Bumiputeras who unscrupulously borrowed Bumiputeras’ names in a bid to get shares. Therefore, it is crucial that the market price of shares reflects the real performance index of a company’s progress. Even though the MAS issue limits any one shareholding to 10 per cent of the equity, it is important for the government to scrutinize the true distribution of shares. The obvious question, however, is who is likely to benefit from privatization? This is a relevant issue, because ownership through shareholding is not the only point at stake. The most spectacular short-term rewards will not go to buyers of shares, in general; the main beneficiaries are almost certain to be those who are able to take over control of the privatized firms. As such, the immediate beneficiaries will undoubtedly be Bumiputeras who already occupy high-income positions, with both the capital and management skills necessary to take over and run the privatized firms. It may be an inevitable consequence that this will have adverse effects on the distribution of income within ethnic groups, particularly the differential between the modern sector elite and the majority of Bumiputeras. And yet, the choice of partner is crucial to the success of privatization policy and the New Economic Policy. Given the small circle of capable Bumiputeras who are both entrepreneurs and financiers, it is undoubtedly the case that only a few will benefit directly from privatization. The privatization scheme is also likely to benefit a wider range of income groups within the non-Bumiputera community (mainly Chinese) than within the Bumiputera community. Malaysia’s private sector remains predominantly Chinese; as the work to be carried out may be subcontracted, it is expected that a large number of urban-based skilled non-Bumiputeras will be able to participate in this way. The government is thus in a dilemma. Assuming that the Chinese would be able to benefit more from privatization than the Bumiputeras, the likelihood that income distribution will be further narrowed is less. NonBumiputera acquisition of corporate capital has exceeded the 1990 target of 40 per cent, but to limit the level of participation of the Chinese in the privatization 130

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scheme would reduce the overall level of private investment in the country. Worth mentioning also is the fact that the political stability of the country could again be jeopardized if the non-Bumiputeras felt that they were being discriminated against, especially within the context of a free enterprise economy. Another problem arises if the privatization results simply in a change from a public to a private monopoly. A private monopoly might have a greater incentive to exploit its power. Furthermore, a privatized company will be less willing to provide uneconomic services. A major problem in the less-developed countries is getting private suppliers to provide services to remote rural areas, where many of the poor live. Resources released by privatization will be used more productively, but particular sets of consumers will lose as a result of the change. Although privatization is likely to improve the quality of the services, it is also likely to increase their price. The case of the Malayan Railway illustrates this problem. The government is considering leasing out this railway for a nominal sum of RM1 to any interested private concern. The Malayan Railway has accumulated losses—an estimated RM839 million, including interest on loans. It is anticipated that the only way the Malayan Railway could become a profitable enterprise would be by increasing its fares. Alternatively, service to uneconomic areas could be stopped altogether: about 85 per cent of Malayan Railway’s revenue comes from only thirty of the 130 stations in the country. One way or another, such moves would create problems, as the Malayan Railway is more of a social service to certain sections of the population who rely on trains as their main means of transportation and who might be unable to afford higher fares. This raises the question of how the losses to certain sets of consumers, often thought of as social obligations, should be handled. Differential pricing or subsidization may be necessary to enable the poor to consume certain goods or services. Regulation may also be required to protect consumers against loss of access to goods or services. If consumers have to depend on the government for certain goods or services, it is crucial that the government is able to exercise control over the efficiency and effectiveness of the institutional arrangements for provision of these goods or services. As far as the public is concerned, ownership of the enterprise is not as important as efficiency and equity, in terms of quality and quantity and the prices of the services provided. These people may represent the majority of consumers in some cases, and will almost certainly constitute a majority of poorer consumers. Because the majority of the poor are Bumiputeras, it is quite possible that they, in particular, may suffer as a result of privatization. The possible implications for equity as a result of privatization may not be clear-cut. We have established that privatization can be used to promote equity and to balance the economic power among races. However, there are bound to be some groups, mainly the well-off Bumiputeras and Chinese, who will be able to reap most of the benefits from privatization directly by buying out some of the firms to be privatized. To the extent that the numbers in these groups are still 131


small relative to those who are poor, greater intra-racial income disparities could result, quite apart from the uncertain impact on inter-racial income disparities. Impact on employment The position of organized labour in Malaysia is that privatization (especially that of essential services) is detrimental to both workers and consumers. As profit maximization is the main objective of private enterprises, they believe that there would be attempts to squeeze the workers and also to charge higher rates for services to the consumers. Trade unions are concerned that in the drive for profits, privatized enterprises may take cost-cutting measures, including trimming the workforce. In seeking to attain this objective, prices of the final output may be raised and this will affect adversely the interests of the low-income consumers, many of whom are workers. The possibility that the existing trade unions may no longer be allowed to represent employees in the newly privatized enterprises is another objection by trade unions against privatization. In an attempt to allay the fears of the unions, the government has stipulated that: (a) there should not be any retrenchment of employees for a period of five years after privatization; (b) those government employees involved in privatized services should not lose any benefit which they enjoyed in the government service. They can, however, opt for the private-sector scheme that would entitle them to share ownership, bonuses and other perks not normally given to government employees. Despite these assurances, the two largest labour organizations, the Malaysian Trade Union Congress (MTUC) and the Congress of Employees of Unions of the Public and Civil Service (CEUPACS), remain wary, citing the possibility that employers may still retrench workers under certain circumstances. Despite discontent on the part of the trade unions, labour problems have been successfuly managed in the privatization of the Klang Container Terminal. There, the 800-odd workers who opted to join KCT had sought various assurances, incentives and conditions from the new managers, most of which were met without affecting industrial harmony. The issue of labour was, however, one of the major issues being disputed in the case of the RM1.4 billion rural water supply deal won by Antah-Biwater, a joint venture between Malaysia’s Antah Holdings and the United Kingdom’s Biwater Group. The opposition to the privatized project 132

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argued that Antah-Biwater was giving expatriate engineers jobs that should be going to Malaysians. Underpinning this outrage was the high level of unemployment among Malaysian engineers. Furthermore, the Malaysian Association of Engineers claimed that the presence of some expatriates was infringing immigration regulations. The Board of Engineers criticized the issuing of work permits to Biwater’s foreign engineers, none of whom had registered with the board. Nine months after start-up, the joint venture already had thirty-seven expatriates on the project, eleven of whom were in engineering jobs. Antah-Biwater had received more than 1,250 applications from local engineers, yet had placed only forty-two. The Association of Engineers protested about the contract terms allowing Biwater to bring in up to fifty expatriates. It was expected that the venture would employ 257 local staff, 129 of them engineers, and fifty expatriates, including sixteen engineers. At the same time, if privatization results in people being laid off, the privatization scheme will need to be re-evaluated. After all, one of the purposes of privatization is to reduce the size of government. With the high unemployment rate, it can be expected that the public will respond negatively to the privatization scheme, if privatization is perceived as adding to unemployment. With the possible exception of new privatized projects, the scope for more employment opportunities has been restricted so far, under the privatization programme. The private sector has not expanded the privatized projects to increase job opportunities. This is perhaps because those who have taken over the entire pre-privatization staffs are in any case saddled with excessive numbers. However, since the privatization conditions prohibit retrenchment, there has been hardly any reduction in employment, despite the fact that many of the jobs in the privatized companies were created under non-commercial conditions. Only in the case of AIROD, one of the earlier privatization exercises, did the privatized company have the right to select only some of the existing employees required for operation. The remaining staff were absorbed by the government. Subsequently, the government declared an explicit policy of non-retrenchment of existing employees during the first five years of privatization. The largest group of affected government employees were the 30,555 staff of the Telecommunications Department, who were transferred to STM. While this exercise did not involve the private sector, the mechanism for the transfer was similar to that required, if transfer of ownership were to take place. In this exercise, government employees were given two options; either to join, or not to join the privatized entity. Those who do not wish to join will be retired and given their rightful retirement benefits immediately. Those who wish to join the private companies were allowed to select two remuneration packages, one reflecting the normal Public Services Department’s scheme and the other one on a strictly commercial basis. Under the latter scheme, the employees are entitled, among other things, to purchase the privatized company’s 133


shares and to enjoy bonuses that are declared as and when warranted, based on the performance of the company. In general the attractive packages offered by the government have prompted co-operation among employees, and reduced resistance to privatization efforts. The scheme, along the lines of that of the Telecommunications Department, will form the basis for future employee transfers. The Public Services Department is currently working on a standard scheme for this purpose. Table 7.8 illustrates the potential reduction of public-sector employment by grade categories from selected proposed privatization projects. A total of 91,864 (around 13 per cent) of employees in public-sector employment will be affected. (This figure does not include those employed in smaller enterprises that are being privatized.) CONCLUDING REMARKS The underlying rationale for privatization in Malaysia appears to have been driven more by economic pragmatism than by ideology. Serious questioning of the respective roles of the private and public sectors in the economy occurred in the early 1980s when there was a sharp reversal of the buoyant economic performance that had marked the previous decade. More than any other factor, privatization was a public policy response to the demonstrably poor running of state-owned enterprises, to rapidly increasing external and domestic debt levels, and to public-sector deficits that had become unsustainable. Thus far, the government has privatized fifty-four major entities and several other smaller enterprises. Since most of the major privatized projects are still within the control of the government, in terms of ownership, and many of the projects are still in various stages of implementation, it will be quite some time before a detailed analysis can be undertaken to study the potential benefits of privatization. Nevertheless this paper has attempted to provide some assessment on the impacts of privatization on efficiency and distributional equity. The possible implications for equity as a result of privatization may not be clear-cut. However, the lessons from Malaysia’s experience indicate that privatization can be used to promote equity and to balance the economic power among ethnic groups. APPENDIX 7.1 MASTERPLAN: A SYSTEMATIC APPROACH In order to overcome some of the constraints and problems discussed in this paper, in 1987 the government of Malaysia decided that a more systematic approach to privatization must be adopted to accelerate its 134

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process and to achieve better results. This decision found expression in a privatization ‘masterplan’. The aims of the plan are to: (a) clearly define privatization and policy; (b) develop an overall strategy, consistent approach and criteria; (c) prepare an action plan so that privatization efforts become easier and less time-consuming. The Masterplan study has identified six central requirements for an expanded, accelerated and effective privatization programme. The first two relate to the overall policy framework and the other four relate to actual implementation of the programmes. These requirements are: (a) (b) (c) (d) (e) (f)

incorporating privatization as part of a wider process of economic reform; aligning privatization strategies to national objectives; improving implementation machinery; ensuring that staff sensitivities are carefully managed; improving the legal framework; providing a supportive mechanism for the programme.

Apart from laying down the various outstanding issues relating to privatization, as discussed above, the Privatization Masterplan has also come up with a tentative Action Plan. The formulation of this Action Plan is based on an analysis of a large sample of public enterprises, both in terms of feasibility and desirability. In all, a total of 434 public enterprises were studied. Based on the results of the analysis, a privatization programme was proposed as set out in Table 7.9. The privatization programme envisaged in the Masterplan cuts across all levels of government—federal, state and local—as well as the nonfinancial public enterprises (NFPEs). Likewise, the programme also cuts across the various economic sectors, with the three major contributions concentrated in manufacturing, agriculture and transportation. In terms of time-frame for implementation, sixty-nine projects have been identified in category 1, which is defined as privatizable in the short term (within two years), 107 under category 2, which is considered as privatizable in the medium term (two to five years), and the remaining seventy projects under category 3, which represents projects privatizable in the long term (over five years). Obviously, the Masterplan is not meant to be a rigid document. The addition and deletion of some projects from the proposed privatization programme is only to be expected, as the situation may alter the desirability as well as the feasibility of a privatization candidate. The Masterplan is meant to provide an indicative Action Plan for the government and to provide a set of procedures for solving the problems raised by privatization. It presents a map for the privatization programme, rather than a single path. The Masterplan should be treated as a living and practical document, to be adapted and updated as experience is gained. 135

Source: Central Information and Collection Unit, Ministry of Finance

Table 7.1 Growth of public enterprises

APPENDIX 7.2

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APPENDIX 7.3 Table 7.2 Federal loans to statutory bodies, government-owned companies, and state governments as a percentage of total government outstanding debt

Source: Ministry of Finance, Economic Report, various issues. Notes: I Federal government total outstanding loan II Statutory bodies, government-owned companies and the state government loans III Federal loans to statutory bodies, government-owned companies and state governments as a percentage of total government outstanding loan

APPENDIX 7.4 Table 7.3 Consolidated public-sector finances 1970–90 (as percentage of GNP) and public-sector employment

Source: Ministry of Finance, Economic Report, various issues. Bank Negara Malaysia, Annual Report, 1987. Central Staff Records, Public Services Department.

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APPENDIX 7.5 Table 7.4 List of privatized projects as at 1 May 1992

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APPENDIX 7.6 Table 7.5 Estimate of revenue generated and forgone by the government from floating of MAS, MISC, Tradewinds and Sports Toto

Source: Kuala Lumpur Stock Exchange, Investors Digest, various issues.

APPENDIX 7.7 Table 7.6 Outstanding government debt

Source: Ministry of Finance. Treasury Report, various issues.

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APPENDIX 7.8 Table 7.7 Summary of savings in BOT projects

Source: Economic Planning Unit.

APPENDIX 7.9 Table 7.8 Potential reductions in employment in privatization projects (by grade category)

Source: Central Record Office, Public Services Department.

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Table 7.9 Summary indicators of Masterplan programme

APPENDIX 7.10


REFERENCES Economic Planning Unit, Prime Minister’s Department (1985) Guidelines on Privatisation, Kuala Lumpur. —— (1991) Privatisation Masterplan, Kuala Lumpur. Jones, L. and Abbas, F.A. (1992) ‘Malaysia, Kelang Container Terminal, Malaysian Airlines, Sports Toto’, World Bank Conference on Welfare Consequences of Selling Public Enterprises: Case Studies from Chile, Malaysia, Mexico and the UK’, Washington, DC, 11–12 June. Kay, J.A. and Thompson, D.J. (1986) ‘Privatisation: a policy in search of a rationale’, The Economic Journal, vol. 96, no. 381, March, p. 22. Mohd, S.M.K. (1989) ‘Privatisation: performance, problems and prospects’, paper presented at Tenth Economic Convention on the Malaysian Economy Beyond 1990: An International and Domestic Perspective, Kuala Lumpur, 7–9 August. Prince, C. (1988) ‘Privatisation: the British experience’, ISIS Focus, no. 39, June, pp. 21– 2, Kuala Lumpur. Salleh, I.M. (1990) ‘Privatisation of Port Klang: a case study’, in J.Pelkmans and N. Wagner (eds) Privatisation and Deregulation in ASEAN and the EC: Making Markets More Effective, Singapore: Institute of Southeast Asian Studies. Toh, K.W. (1986) ‘Privatisation in Malaysia, restructuring for efficiency?, ASEAN Economic Bulletin, vol. 5, 3 March, pp. 242–58. Wahab, H.Y.A. (1987) ‘Investment opportunities in government privatisation project’, Malaysian-Arab Trade and Investment Conference, Kuala Lumpur, November.

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8 THE IMPACT OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY The case of Sri Lanka Saman Kelegama INTRODUCTION The roots of Sri Lanka’s ongoing privatization programme can be traced to the policies of nationalization and the establishment of state enterprises under the left-of-centre political regimes of the pre-1977 period. These policies were supported by import substitution measures and direct government involvement in industry, trade and finance. Consequent to these policies, the size of the public sector amounted to nearly 24 per cent of GNP by 1977 (Karunatilake 1987, Kelegama 1993, and others). Economic liberalization was initiated in 1977. After liberalization, and especially during the 1980s, most of the state-owned enterprises (SOEs) found it extremely difficult to survive without substantial state subsidies and tariff protection. The former became a burden on the government budget, while the latter was contrary to further liberalization of the economy. By the mid-1980s, state transfers and subsidies for SOEs to meet their debt obligations amounted to nearly 10 per cent of GDP. The unsatisfactory financial position of the SOEs compelled the government to consider seriously reforming the public management and ownership of the SOEs. Thus, during the 1987–9 period, the government initiated a partial privatization exercise by (a) privatizing the management of selected SOEs, and (b) fully privatizing some subsidiaries of large SOEs. The process that was initiated could not be effectively implemented, however, due to the political crisis in the country during the late 1980s. However, after obtaining a second mandate from the Sri Lankan public to continue with the liberalization programme in late 1988, the government embarked on a full-scale privatization programme in mid-1989, which included privatizing industries and the service sector (principally bus transport).1 The criteria for privatization were based on: (a) present and future profitability and commercial viability of the SOE; 143


(b) the proportion of the SOE that could be divested in the domestic market, based on the capital market constraints; (c) the national importance of the SOE. These guidelines for divestiture are broadly comparable with those used in the United Kingdom and Malaysia for their privatization programmes (Fraser and Wilson 1980, and Adam et al. 1988). The strategy that has been formulated for the privatization of industries calls for a major shareholding in a public enterprise to be divested through the stock market or through open tender to a corporate investor. Although price was the main determinant on investor selection, some weight was given to the credibility of the investor, including the ability to transfer technology. The general norm for selling the majority of shares was that in a single tranche, 60 per cent to 90 per cent of shares are sold, thus giving the buyer a controlling interest over management and policies. To make privatization attractive to employees of SOEs, 10 per cent of shares are given free of charge to them. Any remaining shares are issued to the general public. In the bus transport sector, the privatization policy was to give away 50 per cent of shares of bus depots free of charge to the employees and retain the remaining shares in a consortium of banks for three to five years. The future strategy to dispose of these remaining shares remains unclear. By July 1993, thirty-two enterprises were fully privatized in the industrial sector (see Appendix 1). Around twenty-six SOEs remained under consideration for divestiture, and were expected to be privatized before the end of 1994. In the bus transport sector, all bus depots, except those in the Northern Province and some parts of the Eastern Province, had been fully privatized. In overall terms, by July 1993, the government had earned approximately Rs.8 billion from the privatization exercise (Appendix 1). The basic objectives of Sri Lanka’s privatization programme are, in short: (a) (b) (c) (d)

to increase efficiency in production and consumer service; to induce technological modernization and to increase productivity and growth; to reduce the fiscal burden on the government; to promote widespread share ownership.

The last objective mentioned above is the main item that is relevant to the distributional aspect of privatization. However, other objectives are also indirectly related to the distributional aspect and they cannot be overlooked in a study of this nature. This paper will analyse the Sri Lankan experience within the framework outlined by Ramanadham (1993). Since the data available on certain areas pertaining to distribution are inadequate, it is not possible to attempt a comprehensive study. Thus some areas of the study are of a descriptive nature and provide information for more analytical and comprehensive studies in the future. 144

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The plan of the paper is as follows. The next section discusses the techniques of privatization and their distributional implications, followed by an examination of the employment and taxation effects of divestiture. The social effects of privatization are then analysed, followed by some concluding remarks. DISTRIBUTIONAL IMPLICATIONS FROM THE TECHNIQUES ADOPTED FOR DIVESTITURE The techniques of divestiture have distributional implications, as they govern who gets what, and why. In this section the following aspects are examined in the framework of their distributional consequences: (a) (b) (c) (d) (e) (f)

divestiture pricing; free allocation of shares; regional and ethnic aspects; ownership concentration; foreign ownership; managerial emoluments. Divestiture pricing

Sri Lanka’s privatization process has been widely criticized for the reason that the prices at which the SOEs were sold to private individuals have been below the actual value of the enterprises concerned; as such, this has constituted a loss to the taxpayer, by virtue of the fact that the SOEs were public property. The performance of SOE shares on the Colombo Stock Exchange (CSE) after privatization strongly validates the allegations of underpricing of SOE sales. When United Motors was privatized in mid-1989, public investors were offered shares at the par value of Rs.10 per share. Trading of the shares on the CSE began at Rs.11 per share, and by the end of eighteen months had reached Rs.29 per share.2 Ceylon Oxygen was sold to the public at Rs.15 per share (Rs.10 share) and began trading on the CSE at Rs.87.50 per share. In several instances, the government was unwilling to add a premium to the par value of the share (see Appendix 8.2). When the government did so, the value was often very much less than the true value of a share as seen in subsequent market trading. The motives behind the government’s reluctance to add a suitable premium to the share prices were to ensure that: (a) the price of shares would be accessible to a large proportion of the public, allowing broad-based share ownership; (b) the capital constraints of the market were not exceeded; (c) investor confidence in the CSE would increase, by minimizing the financial risk faced by new investors. 145


The government succeeded in achieving these objectives during the initial stages of the privatization process. Nearly all of the share issues were oversubscribed several times, and the government had to restrict the number of shares each person could hold, in the interest of achieving the broadest holding of shares possible. Investor confidence in the market soared, as indicated by the All Share and Sensitive Price Indices increasing from 179.49 and 341.74 respectively, in 1989, to 605.31 and 826.57 respectively by the end of 1992.3 Although government policies for determining share prices were satisfactory at the beginning of the privatization programme, one is compelled to question the desirability of continued under-pricing of SOEs, at the expense of considerable revenue to the state. The divestiture of the National Development Bank in March 1993 at Rs.50 per share—a premium of Rs.40 per share—and the market price reaching over Rs.200 per share in the space of three months are an example of the government continuing to under-value its assets in the SOEs. The valuation of an SOE for the purpose of divestiture should take into account not only its assets and liabilities, but its future potential and earning power. This is not done at present, resulting in an under-valuation. It is at best a difficult process, involving market predictions and evaluations, assessment of economic trends, technology, etc., for which expertise is needed. The shortage of experts to assess the worth of tangible and intangible assets and liabilities is a problem common to developing countries embarking on privatization programmes (Cowan 1990). In Sri Lanka, the appraisal of SOEs remains inadequate and ineffective. For example, the Valuation Department, which advises the government on valuing the SOEs identified for divestiture, limited itself only to the evaluation of assets such as land and buildings, with little or no thought given to their future earning potential, as the necessary expertise for this is lacking. There are no plans in the Ministry of Finance or the Valuation Department, either, to provide more training to government valuers for the job, or to employ foreign experts. The sale prices of SOEs have also been affected by the speed of the privatization programme. The World Bank and International Monetary Fund have made the privatization of SOEs a precondition for aid (Kelegama 1993). The structural adjustments to the economy recommended by these two institutions in order to address Sri Lanka’s fiscal imbalance call, inter alia, for a rapid divestiture of SOEs and the disassociation of the state with commercial enterprises. In several instances, time constraints have limited the scope, method and completeness of the valuation process, resulting in ultra-conservative estimates (e.g., Ceylon Oxygen, Thulhiriya Textile Mills, Hunas Falls Hotel). In other instances, the time constraints have disallowed retendering procedures (e.g., Ceylon Oils & Fats), forcing the government to sell at a low price. The external pressure on the government to move ahead with the divestiture of SOEs has undoubtedly been great. However, in many cases, the immediate aid benefits available conditionally from the IMF and the World Bank have 146

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outweighed the long-term benefits to be derived from higher divestiture revenues. Due to capital constraints as well as time constraints, the government was disinclined to restructure some of the SOEs which were earmarked for divestiture, or to attempt any improvements to them, with a view to attracting potential buyers. For example, SOEs such as Ceylon Oils & Fats, the Nylon 6 plant and the textile mills in Thulhiriya, Pugoda and Veyangoda were in a state of neglect and several others were in urgent need of new machinery and refurbishing. Furthermore, the cumbersome and over-staffed management structures remained unchanged. The quest for foreign capital and technological expertise has also contributed to lower prices for the public enterprises, (PEs). The countries of the former East European bloc, the former Soviet Union, China, India, as well as several Latin American countries, are simultaneously undergoing major privatization programmes, creating immense competition in the world market for foreign capital and technology. While various incentives are offered to foreign investors, low sale prices for SOEs together with other fiscal concessions which are offered after privatization seem more attractive to foreign investors. The sale of 60 per cent of Ceylon Oxygen to Norsk Hydro of Norway for a low value of Rs.60 million, and the sale of Thulhiriya Textile Mills to Kabool of Korea for a very low value of Rs.200 million are examples of the price paid by the Sri Lankan government for foreign capital and technical know-how.4 These revenues are alleged to have been below the conservative estimates of the government’s chief valuer. The lack of clear-cut guidelines to follow, and the adoption of tender procedures for some sales, have had adverse effects on the divestiture process of SOEs. Most of the divestitures have taken place under tender procedures and not through competitive bidding. But it was from competitive bidding through the CSE that the highest revenue from a single divestiture was obtained. The Distilleries Corporation was offered for sale at Rs.4.00 per Rs.1.00 share, but fetched Rs.11.70 per share, and the government obtained a revenue of Rs.1,053 million on the sale of 60 per cent of the equity. Trans Asia Hotels and Asian Hotels are other SOEs that fetched high prices through public auction. In most instances, however, no efforts have been made to have an open competitive bidding procedure for the purchase of equity in the SOEs. The government has resorted to tender procedures where deals were reached between the interested parties and the government authority concerned. As a result of the absence of clearly defined and uniform procedures for divestiture, and hence a lack of transparency, allegations of political interference have been made. Certain basic steps are required to be taken when an SOE is put up for sale, but these are not always laid down and rigidly adhered to, for reasons based on flexibility (Kelegama, 1993), giving rise to doubts, in some instances, about the nature of the sale. For example, the subsequently annulled Milco sale, the sale of the Colombo International School, and the sale of the 147


Thulhiriya Textile Mills have drawn public criticism regarding divestiture procedures and the lack of fair play in the tender procedure. Some SOEs have been sold without any form of public advertisement, with particular individuals acting as agents between the purchaser and the government. In most instances, the government has failed to realize the full value of the enterprises it has sold. No action has yet been taken to make the necessary improvements in order to obtain better prices for the SOEs identified for divestiture. Private investors have thus been able to acquire public assets virtually at bargain prices, representing, in effect, a loss to the taxpayer. Gift of shares The state hopes to achieve three objectives by distributing free shares to employees of SOEs identified for divestiture: (a) by sharing profits, to give employees a greater incentive for dedicated work; (b) to let employees have a voice in decision-making, whereby their interests may be safeguarded; (c) to make trade unions more receptive to privatization, in view of their declared opposition to the policy. The state has been successful only in achieving the third objective, albeit in a limited manner, as trade unions have shown formidable resistance to the privatization process (e.g., Sri Lanka Telecom, State Banks, Kelani Tyres, etc.). The price of shares, once trading has begun, has almost always been several times the par value, and the profits made by employees through the sale of shares have been many times their annual salary. For instance, a storekeeper in the Asian Hotels Corporation whose annual salary was Rs.36,000 received shares to the value of Rs.639,120 on the first day of trading; a purchasing assistant whose annual salary was Rs.50,400 received shares to the value of Rs.601,520 (Jayasinghe 1993). However, due to the lack of a proper understanding of the long-term benefits of share ownership, employees have tended to sell their shares in the short run, to meet personal financial commitments, thus depleting substantially the shares originally allotted to them. For example, at Ceylon Oxygen, shareholding by employees dipped (from 10 per cent) to a low 3 per cent of the equity of the company within six months of its divestiture. Employees need to be instructed on share ownership, but no action in this regard has been taken either by the government or by the managements of the privatized enterprises. As a result, the benefits that are intended to accrue to them by the offer of free shares are nullified by the very ignorance of the employees of the long-term benefits to them of share-ownership, as opposed 148

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to the short-term gains obtained by selling off most of their shares. For example, most of these employees are unaware of their legitimate rights as shareholders, in the absence of any programme to enlighten them. Some even do not know that the annual general meeting of their company provides a forum where they can express their views and suggestions on the management of the company, and that they could send their representative to do so. When the government began the divestiture of SOEs in mid-1989, the total labour employed in pubic corporations and statutory boards amounted to 378,820 employees, or approximately 10 per cent of the total employed labour in the country (DCS 1993). By the end of June 1993, the total number of employees in privatized enterprises was 74,000, including those employed in the Central and Regional Transport Boards—19.5 per cent of the labour employed in government corporations and statutory boards, or 1 per cent of the total labour force in the country.5 The decision to distribute high-yielding shares free to this small portion of the labour force in employment, thus placing the recipients in a more favoured category vis-à-vis the greater number of non-recipients, would inevitably give rise to questions regarding the consequent inequality of opportunities and income disparities. SOEs were identified for divestiture on criteria such as their financial viability and ability to attract investors, long-term growth potential, etc., but factors such as level of employee benefits and wages, and future earning potential were not prime considerations. In this situation, employees of SOEs that were privatized benefited substantially, especially from the free shares offered to them, while those employed in SOEs that were not identified for divestiture had no such advantage. Furthermore, wide differences in share values and dividend payments exist among the privatized enterprises, as they have differing growth potential. For example, certain privatized ventures such as some ‘peoplized’ (another term for privatized) bus transport services are unlikely to make profits for several years, whereas ventures such as Sri Lanka Milk Foods, the National Development Bank and the Distilleries Company were very profitable even before divestiture. The market value of the shares of these companies at the end of July 1993 was Rs.23 per Rs.10 share, Rs.185 per Rs.10 share, and Rs.16 per Rs.1 share, respectively. Their combined profits for 1992 were nearly Rs.543 million (CSE 1992). On the other hand, the peoplized bus transport services in Kuliyapitiya, for instance, recorded losses of up to Rs.50,000 per day.6 Even within the privatized enterprises, benefits from the shares available to the various categories of employees have tended to differ substantially, in two respects. Firstly, employees at the upper levels of management have a better knowledge of share-market procedures and have greater access to information such as dividend rates and profit expectations than most employees in the lower categories. This advantage they have over the others allows them to maximize the profit on the sale of their shares. No measures are taken within the organization, or outside it, to educate the employees 149


who are ignorant of share-market procedure, etc., and how best they could sell their shares, if they so desire, to derive the maximum profit from them. Secondly, in addition to the gift of shares to all categories of employees, employees could also purchase shares if they so wish, but it is mostly the upper-management cadres who are able to do so, due to their better financial standing. Thus, certain employees of a privatized enterprise could also purchase a large number of shares and acquire a dominant interest in its affairs. Fear was expressed with regard to this happening in the pending divestitures in the banking sector. In sum, the benefits arising from the distribution of free shares to all categories of employees of privatized enterprises are greatly reduced by the inability of the authorities concerned to ensure that the recipients hold on to their shares for long enough after divestiture to obtain higher accumulated dividends and better share prices; present trends show both to be on the increase. Regional and ethnic aspects Location of the privatized enterprises (PVEs) predominantly in urban areas, or privatization of industries occurring predominantly in more developed provinces or districts of the country, could lead to worker discontent regarding the more favoured treatment of employees in those areas, especially in the context of the share ownership that they will enjoy, and the better prospects in privatized enterprises, with improvements in wages and long-term dividend payments. At the end of June 1993, except in the case of privatized transport services, nearly 80 per cent of employees in PVEs were from the Western Province (see Figure 8.1). The prime reason for this is the fact that the public and private industrial enterprises have historically been concentrated in the Western Province. The privatization of the bus transport services mitigates this

Figure 8.1 Provincial distribution of employment in PVEs Source: Plotted using data obtained from the Ministry of Finance, Commercialization Division

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disparity to some extent, with 36,000 employees in 104 depots across all but the Northern and Eastern Provinces being entitled to shares. However, many of these bus depots are plagued by losses and stagnant growth rates due to the lack of a corporate investor who could provide capital for modernization. Worker management of bus depots has so far proved to be ineffective in introducing more capital for future growth. At the end of the same period, approximately 37.5 per cent of the labour force in PVEs was from urban or semi-urban areas (see Figure 8.2). The remainder was in rural areas employed at the few labour-intensive textile industries and other labour-intensive small and medium industries located in these areas. The rural areas referred to are mainly in the Western Province, not in the poverty-stricken interior regions of the country. The unequal distribution of privatization benefits, region-wise, is compounded by the low level of interest in the share market process shown by the public at large. Despite government efforts, through its privatization policies, to draw the semi-urban and rural investor into share-market activity, the response has been poor. Two reasons could be adduced to this lack of interest. First, the Sri Lankan investor has historically invested in house and property, together with gold and jewellery, and has shown little inclination to deviate from these traditional forms of investment.7 Second, the government’s efforts at reaching and motivating the small rural investor to invest in privatized enterprises have been grossly inadequate and have been confined to the distribution of brochures in a few selected towns, inviting investors to participate in public share issues (e.g., in Kandy, prior to divestiture of the Veyangoda Textile Mills), and to some investment counselling entrusted to the provincial branch offices of the two state banks and a private bank. Here again, the financial incentives offered for this task were insufficient to motivate these banks to influence the small rural investor to any significant degree. The disparity in share-ownership evident among the various ethnic groups is primarily due to the regional concentration of privatized enterprises. Although accurate data are unavailable, due to administrative difficulties

Figure 8.2 Sectoral distribution of employment in PVEs Source: Plotted using data obtained from the Ministry of Finance, Commercialization Division. Note: The privatized bus service has not been taken into account.

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Figure 8.3 Ethnic/religious distribution of shareholders (percentage according to the number of shareholders) Source: The Colombo Stock Exchange, company secretaries of privatized companies and stockbrokers. Note: ‘Other’ includes foreign owners.

faced by company secretaries, provisional estimates from the company secretaries and the CSE indicate that the percentage of Tamil shareholders is far below the 19.97 per cent Tamil proportion of the national population. The Muslim groups were very dominant in the share market, displaying this community’s grip on the Sri Lankan business sector (see Figure 8.3). The Tamil separatist war in the Northern and Eastern Provinces, with the resultant displacement of persons, and the lack of viable SOEs for divestiture in these areas, have contributed to the present ethnic disparity in share ownership. Ownership concentration The privatization programme is called the ‘peoplization’ of SOEs in Sri Lanka, because of the government’s commitment to broaden the ownership of PVEs and disallow ownership concentration in the hands of a few local or foreign investors. The dilution of ownership concentration is the primary means by which the government expects the masses to share in the short-term and long-term profits of privatized enterprises. In order to minimize the concentration of share ownership, the number of shareholders should be large and the shares distributed equally among them. A ‘pyramid’ technique has been adopted by the state, under which all share applicants are given a minimum of 100 shares on a first-come, first-served basis, until the 152

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equity on offer is fully subscribed. If the issue is not fully subscribed in the first round of share allotments, a second allotment will take place in which those already assigned 100 shares will be allotted another 100 shares each. This procedure would continue until all the remaining shares were divided equally among all the shareholders. However, this method of divestiture could not be applied throughout the privatization process, as explained below. The PVEs required a core (or corporate) investor in order to meet the other goals of privatization, such as increased efficiency, better management and the introduction of new technology. Thus the government has allotted the controlling interest in ventures to a core investor as an inducement to manage the enterprise effectively, bring in new technology and make the PVEs more profitable. Obviously the core investor would have a great deal more at stake financially than a group of individual investors and thus would show greater commitment to profitability. The government’s divestiture formula has normally allowed for 60 per cent of equity in the PVEs to be allocated this way. However, some of the SOEs were so decrepit and plagued by mismanagement that they were not likely to attract much investment from the public. For these ventures, the corporate investors were given 90 per cent of equity, provided that they were willing to take the risk to resurrect them.8

Table 8.1 Public ownership of some privatized SOEs

In assessing share ownership concentration and distribution, the following factors should be considered: (a) whether ownership concentration in PVEs is greater than or equal to the levels seen in the private sector; (b) whether the allotments made favour the small shareholder who is entering the share market for the first time; (c) whether the government’s initiatives for strengthening the role of the small shareholder have been effective. 153


The peoplization of SOEs has ensured an unprecedented broadening of the pattern of shareholding. Several peoplized companies have shareholdings that number over 5,000 (see Table 8.1). The revamping of professional company secretarial offices, the addition of a company secretary’s department in PVEs and the removal of the traditional system of share transfer documents in favour of a central depositary system with the Colombo Stock Exchange are all changes that were brought about by the increase in the number of shareholders and the resultant increase in trading activity. The pyramid allotment procedure not only ensures the widest possible shareholder base, but allows for small amounts of investment to be made in PVEs. The ability to make an investment of only Rs.1,000 to become a shareholder has allowed the lower-income groups access to the share market and, for the first time, the investor is given the opportunity to risk only a small amount of money and get a feel for share investment practices, before embarking on major investments. Considering these achievements, the pyramid allotment has contributed significantly to distributional equity.9 The privatization programme has failed significantly in utilizing the mass media to stimulate public interest in SOE shares, although the government claims to have spent up to Rs.3 million on advertising prior to divestiture of an enterprise. For instance, much more could have been done to harness the investment potential of Sri Lankans working abroad, especially those in the Middle East, who are mainly from rural areas in Sri Lanka. The campaign in the Middle East to promote investment in privatized enterprises in Sri Lanka was limited to a few advertisements in one of their newspapers (the Khalid Times) at the beginning of the privatization programme. Some divestitures were not even advertised in the business pages of the popular daily newspapers, such as the Daily News and the Divaina. The international media have also been under-utilized, only some of the SOEs being advertised in the Asian Wall Street Journal and the Financial Times. Foreign ownership Foreign ownership of PVEs in developing countries is in many cases essential for sustainable growth. The lack of capital and technology can easily be overcome through foreign equity participation, thereby facilitating higher growth and profits for the investor, as well as lower costs and better services for the public consumer. However, there are disadvantages in foreign ownership—inter alia, the high levels of dividend repatriation that would occur, thus causing a drain on foreign exchange, the unfair competition fledgling local industries would face, and the discouragement of local entrepreneurship. The government was interested in foreign equity participation primarily to bring in technical expertise to SOEs and to provide capital for their further advancement. Ceylon Oxygen, Ceylon Oils & Fats, and the textile and ceramic industries required technical skills that were not available in the country. Furthermore, these were also capital-intensive industries that require expensive 154

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equipment that local industrialists can ill afford. The authorities also feared that the capital constraints of the local market would dampen sale proceeds from divestiture. The privatization-induced influx of foreign capital has brought with it several benefits for the economy. For example, there has been a reduction in the price of certain varieties of textiles, since Kabool of Korea purchased the Thulhiriya Textile Mills (CTMA 1993). The new company, Kabool Lanka, has also improved the ancillary sector of the garment industry by producing its own buttons and thread, thereby saving valuable foreign exchange and taking the first step towards increasing the value-added component of the garment industry from its present 30 per cent. Ceylon Oxygen has significantly improved the quality of industrial nitrogen produced in Sri Lanka, thereby making it possible to produce premium petrochemicals and improving the quality of plastics, paints, and textiles. These improvements in the former SOEs have provided the customer with better-quality products and supported the national balance of payments. The training programmes introduced by the foreign equity participants have brought technical expertise and international exposure in management techniques to Sri Lankan nationals. The profitability of PVEs such as United Motors Lanka Limited, Kabool Lanka, Ceylon Oxygen, etc. has improved tremendously since privatization, thereby benefiting the local shareholders.10 Nevertheless, the favourable effects have been offset by several unfavourable effects. The profit rates of enterprises sold to foreign companies have far exceeded the interest applicable to the invested capital, implying that the sale of these ventures has not realized their true values.11 The intense competition for growing capital and technical skills would no doubt have spurred these concessions, but the fact remains that the public coffers have been deprived of much-needed revenue. In some instances (Lanka Ceramics and Ceylon Oxygen) the foreign companies have unregulated monopolies in their market segments. The three increases in the price of industrial oxygen are an indication of such monopoly power. The regulatory body for monopolies, the Fair Trading Commission, has not been effective in checking these market powers, due to political factors (Kelegama and Cassie Chetty 1993). Foreign investors are generally attracted to profitable enterprises when divestiture of SOEs occurs in developing countries. In Sri Lanka, due to the low selling price through the preferred tender procedures, foreign investors have purchased several unprofitable SOEs and turned them around with infusions of capital and new technology (e.g. Thulhiriya Textile Mills). Although many of the privatizations are too recent for a detailed evaluation of the financial performance, companies with core foreign investors, such as Ceylon Oxygen, Kapool Lanka and Dankotuwa Porcelain have been performing very well in terms of profitability, employee benefits and identification of new markets for future growth. Kabool Lanka has increased its employee strength from 3,000 to 4,200, and provides its employees with a bus service to and 155


from work. Ceylon Oxygen’s projected profits for 1992 were Rs.54 million, 46 per cent above 1991, and Dankotuwa Porcelain has identified new markets for export and hopes to employ more workers in the future. Overall, the beneficial effects of foreign participation in PVE equity outweigh the adverse effects. Foreigners have come to the rescue in instances where the local investors have refused to buy equity due to reasons ranging from unprofitability to lack of technical skills, and have turned unprofitable companies around, giving local share investors and employees handsome returns. Managerial emoluments In developing countries, with the divestiture of SOEs, incentives by way of enhanced emoluments have, for the most part, been given to the managerial staff. Hitherto, before divestiture, their emoluments had been generally lower than those enjoyed by their counterparts in the private sector. Since most of the privatized enterprises in Sri Lanka have a pyramid-style employee structure with the management cadres at the top and the minor employee grades at the bottom, increasing only the salaries of the staff at the top can cause wide disparities in remuneration after privatization. There exist large disparities between SOEs and private enterprises in the remuneration packages offered to professional and upper-management staff, such as general managers and directors. For example, an accountant with an SOE is paid approximately Rs.100,000 per annum, whereas a counterpart in a private company of similar size (in terms of revenue) would have a take-home pay of approximately Rs.150,000 to Rs.200,000 per annum. The chief executives of SOEs are paid approximately Rs.180,000 to Rs.240,000 per annum, whereas the take-home pay of their colleagues in the private sector would be approximately Rs.500,000 to Rs.700,000 per annum. The privatized companies have increased the emoluments of their management cadres by approximately 30 per cent after allowing for taxation, from which the SOE employees were previously exempt. There was undoubtedly a need to increase managerial emoluments. Earlier, the top management posts of SOEs were held by political appointees who, in many cases, lacked the necessary qualifications and skills for these jobs. The privatized enterprises, being more profit-oriented, in order to attract skilled and highly qualified persons to their enterprises now vie with each other to offer them the best possible compensation package. Thus, the increase in upper-management remuneration is an integral part of the privatization process. Large disparities in wages do not exist among the lower categories of employees; both pubic and private enterprises pay similar wages, as skills at these levels are general and in greater supply. The local core investors in privatized enterprises have been mostly well-known 156

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privatecompanies(e.g.,Hayleys,Stassens,etc.)whicharereputedforpublicaccountability where remuneration of management personnel is concerned. Wider share ownership has, however, not ensured a sense of public accountability regarding emoluments in the privatized enterprise where the management is in the hands of foreigners. For example, at Ceylon Oxygen, the remuneration of directors for the four months ending December 1990 was Rs.48,800, and by the end of 1991 this figure had reached Rs.4,957,950, or 13.5 per cent of the post-tax profit.12 The magnitude of these emolumentsisprominentwhenthetotaldividendtoover10,000shareholdersamounted to only Rs.9 million, 15 per cent of the paid-up capital of the company. The lack of government policy in regard to managerial emoluments has had a bearing on these increases in emoluments after privatization. In the event of foreign management of PVEs, the government should consider the possibility of stipulating that the foreign company should bear the cost of the high salaries of their personnel for a few years after privatization, in order to reduce the burden on the privatized enterprises concerned. EMPLOYMENT AND TAXATION EFFECTS OF DIVESTITURE The employment effects of divestiture The privatization programme has affected nearly 78,000 employees of public corporations and statutory boards (in the manufacturing and transport sectors). Some of these employees have been made redundant and offered financial compensation according to various formulae, whereas others have retained their jobs and received shares in the PVEs. This section will examine the implications of the privatization of SOEs and its effects on the employees of these enterprises themselves, as well as on those employed in the privatized enterprises in comparison with employees of other private-sector enterprises. This will be done under three headings: employee redundancies and compensation, employee welfare, and technology, efficiency and wages. Employee redundancies and compensation At the end of June 1993, the privatization of SOEs had resulted in approximately 15,000 to 18,000 redundancies.13 Prior to May 1992, government policy on employee redundancies was that unabsorbed employees should be compensated on such terms as determined by the Cabinet of Ministers. Subsequently, under the direction of the President, the employee redundancy policy was altered to the effect that: (a) no worker should lose his/her employment as a direct result of peoplization; and 157


(b) any worker already retrenched consequent to peoplization of SOEs was to be compensated fully, on the basis of the financial benefits that would have been received had the worker remained in service up to his normal date of retirement. This change in policy was a direct result of the prevailing high level of unemployment and the fear that the privatization process would further aggravate it. More amendments were made to safeguard the rights of the employees in PVEs. These amendments were the Payment of Gratuity (Amendment) Act No. 41 of 1990 and the Employment Provident Fund (EPF) (Amendment) Act No. 14 of 1992. The amendment to the Gratuity Act called for the PVE to recognize the services rendered by an employee to the former SOE as services rendered to the PVE, in order to ensure that the employee did not lose gratuity rights as a result of interruption of service. The amendment to the EPF Act was made to enable any worker, irrespective of age, to withdraw EPF benefits on termination of employment consequent to privatization. The compensations offered to employees of PVEs have taken various forms, mostly depending on the generosity of the employers in question (see Figure 8.4). Nevertheless, three formulae have appeared through the privatization process as the guiding standard for compensation to employees made redundant: the Bulumulla formula, the Leather Products formula, and the Lanka Ceramics formula.

Figure 8.4 Distribution of compensation Source: SLBDC (1992). Note: All amounts are in rupees.

(a) The Bulumulla formula This formula for employee compensation has persistently been rejected by the trade unions. According to this formula, the amount of compensation, ‘C’, payable to an employee is given by: 158

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C = (Y + (half the number of years served)) × (the final monthly salary of the employee) where,

(b) The Leather Products formula The trade unions have responded more favourably to this formula for compensation, which has been sufficiently attractive for employees to leave voluntarily. Ceylon Leather Products, British Ceylon Corporation (BCC) and the three companies formed after the conversion of the Sri Lanka Sugar Corporation used this formula for compensating redundant employees. The compensation, ‘C’, = maximum of 50 months’ salary, subject to an upper limit of Rs.250,000 in the case of managerial grades, and Rs.200,000 in the case of other employees. (c) The Lanka Ceramics formula This formula is specific to the case of Lanka Ceramics Limited. The company had sufficient funds to meet the liability of its compensation package, which did not affect the entire workforce. The compensation, ‘C’, = maximum of 50 months’ salary, with an upper limit of Rs.300,000. The amounts paid as compensation to redundant employees, however, are sometimes far lower than the value of the shares given to those employees who were retained in the PVEs. In some instances, as mentioned earlier, the value of shares gifted has exceeded Rs.600,000, and the beneficiaries have also been guaranteed employment and subsequent wage increases, unlike those made redundant. The divestiture of the Sri Lanka Transport Board was unique, in the sense that employees were not only compensated for being made redundant from their employment with the SLTB, but were also given free shares to the value of Rs.11,000 per employee in the peoplized bus companies.14 Although the authorities have tried various methods of explaining this anomaly, extra compensation has been made to retained employees as a result of trade union agitation. The plight of the redundant workers was made even worse considering the fact that many of them used the compensation to pay debts rather than to invest in business, house and property or jewellery (see Figure 8.5, in which ‘income activity’ reflects debt payments). Whatever was invested took place mainly in bank deposits (Figure 8.6). As at June 1993, neither the government nor the PVEs had sought to advise the redundant employees on investment opportunities in order to ensure for them a stable and sufficient income. Furthermore, no arrangements were made by the government to assist them to find other employment. Although the privatization process has improved conditions for some, the distribution of benefits has been more in favour of those who have been retained in the employment of the PVEs. The significant number made redundant through privatization and, to a greater extent, those who are 159


Figure 8.5 Utilization of compensation Source: SLBDC (1992) Note: Some individuals have used the compensation for more than one activity.

Figure 8.6 Distribution of income-generating activity Source: SLBDC (1992)

employed in SOEs, have benefited little, and no appropriate measures have been taken, or are in the pipeline, to redress this disparity. Employee welfare The conversion of SOEs to PVEs provided former SOE employees still in employment with significantly advantageous legal rights that had not been available to them prior to privatization, when the employees of SOEs or GOBUs 160

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(government-owned business units) had not been covered by any labour legislation. A worker of a public corporation could be retrenched without the approval of the Labour Commissioner, whereas an employee of a PVE cannot be similarly retrenched. Furthermore, an employee whose services had been terminated from an SOE could not appear before a labour tribunal to get relief, whereas after privatization, with the labour law amendments referred to earlier, the employees of SOEs enjoy all the rights of their counterparts in the private sector. Undoubtedly, the state has taken prudent and welcome measures to safeguard the rights of workers subsequent to privatization. Although the employees of PVEs have benefited from the privatization process in terms of their legal rights, their counterparts in the SOEs have not been offered the same advantages by the state. The welfare of an employee of a PVE is linked undoubtedly to two factors: the relationship between the employees or their trade unions and the management, and the profitability of the enterprise. The PVEs, unlike their counterpart SOEs, are profit oriented and lack state subsidies to tide over the rough times. This may sometimes result in the management of the PVEs being obliged to curtail certain ‘excessive’ employee benefits, while providing at the same time incentives in the form of bonuses related to profits. Any weakening of the above two factors would lead to adverse effects on the employees. One of the greatest weaknesses of the privatization process has been its inability to overcome some of the fundamental flaws affecting employee welfare in private enterprise. The employees of the privatized enterprises, and the trade unions representing them, are distrustful of their employers and the workings of the privatized enterprises due to the lack of a proper understanding of the full potential of a business enterprise. Most of the labour administrators too in Sri Lanka tend to hold the view that private enterprises lack a sense of social responsibility and are concerned only with private profit. They fail to understand that private management, with its primary objective of making profit, must necessarily act in the interest of the core investor as well, in order to ensure an adequate return on the investment. This may sometimes require the retrenchment of redundant employees, but since profitability and employee benefits are closely linked, increased productivity would also mean greater benefits for those continuing in service. The employers, for their part too, often prefer to automate their industries rather than employ workers whose loyalties lie more with their trade unions. Poor exposure to industry management of those involved in labour administration is undoubtedly one of the reasons for the lack of a more productive relationship, for the most part, between labour and management. The recent trade union representations to the Cabinet of Ministers made on behalf of Sri Lanka Telecom, and the state banks identified for privatization, reflect present management-labour distrust. Another factor affecting industry in Sri Lanka is the practice of SOEs to fix wages and thereby compel private-sector companies to follow suit. As observed in most other countries, wage increases should be linked to levels of productivity 161


and profitability, rather than to the cost of living, as is the case with SOEs. Labour-market situations and international competitiveness have not been taken into account when determining national wages, resulting in wages in excess of productivity. The unions have a long history of opposing the linking of wages to productivity; however, there has been some progress in several PVEs, with the management and employees arriving at mutually beneficial collective agreements. The competitive nature of international trade requires flexibility in working arrangements and employee contracts. Commercial ventures can ill afford to incur large losses due to an excessive labour force in the face of a highly competitive world market. The Termination of Employment (Special Provisions) Act is therefore a hindrance, and an unwarranted constraint on the profitability of private industry.15 In order to give private industry more flexibility in this regard, the government should modify the Act to allow for termination of employment with the guarantee of a certain level of compensation. In the event of an employer pleading inability to meet compensation payments, he should be subject to an inquiry by an official sufficiently versed in the workings of the business. Some of the above structural constraints in the environment in which private enterprises try to ensure employee welfare have severely limited the exploitation of the full potential of PVEs. In almost all of the SOEs identified for divestiture, the corporate investor has had to come to an agreement with the government to refrain from eliminating employee benefits. Although such a policy safeguards the employee from exploitation and underpayment, the subsequent long-term effects on the employees themselves as a result of the lower profits that the agreement would lead to would undoubtedly be adverse. Technology, efficiency and wages Assessing the impact of changes in the level of technology and improvement of productivity and wages requires a longer period to elapse after privatization than has been the case so far in Sri Lanka. Nevertheless, whatever short-term trends are apparent at the time of this study can be made use of to assess the distributional aspects. The profit motivation of privatized enterprises would dictate that they will choose the most economical mode of production. In most instances, this has led to the substitution of labour with capital-intensive machinery. If the resulting increase in profitability is shared disproportionately amongst the shareholders, employees and the general public, the privatization process can create distributional disparities. In Sri Lanka, the evidence available suggests that such disparities have taken place. For instance, the average increase in wages since privatization at Ceylon Oxygen and United Motors Lanka Limited has been around 30 per cent and the increase in profits and shareholders’ dividends 162

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has been close to 50 per cent.16 There have been no significant reductions in the price of goods marketed by these organizations. After privatization, redundant labour, both skilled and unskilled, could swell the ranks of the unemployed. As a result, the hiring wage of skilled labour could go down, pushing the overall wage rate below the level of productivity per worker. A prolonged privatization programme and slow growth of low labour-intensive industry could mark the end of the pre-privatization situation of sheltered labour rewards and low productivity, as well as a weakening of trade union powers. The daily operations of privatized companies are solely dependent on market forces, requiring companies to have high levels of flexibility. A large labour force cannot provide a manufacturer with the equivalent degree of production flexibility provided by automation. This results in PVEs resorting to mechanization wherever the capital costs are low. The lack of a state subsidy compels PVEs to resort to profit maximization in the interest of long-term stability, unlike the SOEs which have a significant degree of market immunity due to state subsidies. Any attempts at giving socially desirable measures priority over profit maximization could only increase the danger of bankruptcy for PVEs. Therefore, the PVEs have necessarily to engage in increasing productivity and efficiency through mechanization, and are obliged to retrench employees and increase prices when necessary. The taxation effects of divestiture In the event that divestiture proceeds are used to bridge the fiscal deficits, there would be no immediate effects on the national tax structure. However, once the divestiture of SOEs is complete and the income from divestiture proceeds has stopped, there could be a change in the tax structure. Therefore the immediate effect of divestiture on taxation is an extension of the present tax structure over the period in which divestiture is taking place. If the divestiture is mainly of unprofitable SOEs, the state is then relieved of a significant national burden and the national tax rate could be reduced to stimulate investment; in the event that these enterprises are turned around, the revenues to government coffers would increase. The divestiture of profitable enterprises, on the other hand, would reduce government revenue and require an increase in taxation to overcome any resulting shortfall in national income. Unprofitable SOEs that could be turned around through private management are the best divestitures, because of the resultant increase in income and more equality in its distribution. This would reduce the national burden of supporting unprofitable SOEs, allow for an increase in tax revenues resulting from increased profitability, and fuel growth in private investor incomes. With the national interest in mind, the government has adopted various measures to increase long-term revenues, sometimes even in the form of 163


short-term tax holidays to private companies. The measures taken by the government in this regard are examined below as follows: investment incentives and tax revenues, competition in industry, and taxation of employees. Investment incentives and tax revenue Approximately ten changes with regard to national policy on taxation and investment incentives have taken place in the wake of the privatization programme. The investment incentives have been aimed primarily at removing the obstacles to the entry of the small Sri Lankan investor into the market. These incentives have taken the form of numerous tax breaks. The investment incentives are also aimed at attracting the foreign investor to the CSE and they were significant in attracting the large foreign investment. They allowed for finance houses such as Smith Newcourt and Crédit Lyonnaise to finance a part of the privatization mega deals such as those of Lanka Milk foods, Distilleries Company and Trans Asia Hotels. Without the financial backing of these institutions, the government would have found it difficult to attract the required revenues, that exceeded billions of rupees. The foreign investment in the Sri Lankan market has been the most significant factor for the bullish vibrancy of the Colombo Stock Exchange. These investors have made the market more attractive for the small investor in Sri Lanka through their trading habits of purchasing relatively large quantities of shares at high prices, paving the way for the small investor to earn a ‘quick buck’. The stock market incentives were primarily to encourage the small local investor who would otherwise have invested in either treasury bills (TBs) or fixed deposits (FDs), rather than in shares. In making the stock market more accessible to the small investor, there were two objectives in view. First, the reduction in taxes ensured that the small investor would get a larger return from the stock market than from comparable investment opportunities such as TBs and FDs, which are subject to higher rates of taxation. Second, the establishment of unit trusts, with their tax holidays and tax concessions, made them a viable alternative form of investment as they enabled the small investor to enter the share market. The privatization programme in Sri Lanka has brought with it a wave of unprecedented tax breaks. However, these concessions are intended to cause not a reduction but an increase in tax revenues. This view is held by economists who believe that the former Sri Lankan tax rate was to the right of the Laffer Curve peak. Although the privatization programme is as yet too new to assess changes in tax revenues with strict accuracy, the present trends show a significant increase in tax revenues from privatized enterprises and the Colombo Stock Exchange.17 The tax revenues from some PVEs have increased significantly (e.g. United Motors Lanka Limited, Ceylon Oxygen). According to present trends, public tax revenue has in fact increased as a result of privatization. 164

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Competition in industry The need to attract foreign investors to the Sri Lankan capital market has created several problems for the local industrialists. The foreign investors have been given tax breaks and investment incentives that most local entrepreneurs have not been granted, even though foreigners have a technical advantage over local industrialists that allows for their products to be cheaper on the local market. Discrepancies between the facilities afforded to foreign and local industries have created a ‘level playing field’ lobby among local industrialists. This lobby expects to address the current ‘unfair’ advantage enjoyed by the foreign investors who establish industries in which local entrepreneurs are also engaged. The lobby has called for similar tax rates for local and foreign industries engaged in similar areas of business, tariffs and export-only status to foreigners manufacturing in Sri Lanka, among other suggestions such as limiting foreign investment only to joint ventures with established local firms in similar industry. The hardship faced by local garment manufacturers as a result of foreign acquisition of Thulhiriya Textile Mills, and government concessions granted to them, is an example of the discrepancies faced by local industrialists (CTMA 1993). The granting of greater incentives to foreign companies which purchase SOEs adversely affects the local enterprises, which are placed at a disadvantage. For example, the local companies are compelled to cut margins in order to remain competitive, thereby reducing their profitability. In addition, tax revenue that could be available to the government is greatly reduced by a significant amount of sales being made by foreign companies which do not pay taxes.18 The need for technology and capital has compelled the government to grant huge concessions to foreign industrialists at the expense of local entrepreneurs. Today the problem of attracting capital is aggravated by the intense competition Sri Lanka has to face for foreign capital and technology. Sri Lanka lacks the infrastructure and the market available in countries such as India and China, and has to make other concessions such as tax reductions to attract elusive foreign capital and technical know-how. This is in fact an inevitable by-product of the privatization process in Sri Lanka. Taxation of employees The taxation structure prevailing in Sri Lanka for employees consists of two distinct categories: SOE employees, who do not pay any taxes on wages, and private-enterprise employees, who are taxed at a rate of up to 50 per cent of their assessable income, on a tiered basis. Only those who earn in excess of Rs.42,000 per annum are liable for taxes on income, however; therefore, taxation disparities lie only at the upper income levels. A further advantage is expected for employees in PVEs, as the maximum tax rate applicable is to be reduced to 40 per cent, down from 50 per cent. This would once again affect only the 165


upper sections of wage earners, as only a few managers and executives have earnings that fall into the highest taxation tier. After privatization, SOE employees’ wages were adjusted for taxation, increasing the per labour unit costs of wages by approximately 30 per cent.19 In addition, employers also increased the real wages of employees to levels that were the norm in the private sector. However, large wage disparities lie in the managerial and executive sectors. As stated earler, the privatization of SOEs saw a disproportionate increase in upper-rank employee wages, thereby increasing the disparity in favour of the richer segment of workers. The increase in wage rates faced by PVEs was to a large extent offset by employee retrenchments. Although several employee redundancy plans called for across-the-board voluntary retirement, many of the affected were employees in the lower ranks, such as minor staff and labourers. The compensation payments offered through packages such as the Bulumulla, Leather Products, and Ceramics formulae were more attractive to the lower ranks than to the upper levels of management. THE SOCIAL EFFECTS OF DIVESTITURE The driving force of SOEs was not profitability but the need to provide goods and services to the public where the private sector was reluctant to enter, for reasons ranging from unprofitability to lack of capital and technology. The state maintained these enterprises for the benefit of the public, even though some of them were unprofitable. The role of the state sector in this regard was to insulate the consumer from the vagaries of market forces and to ensure the uninterrupted supply of goods and services—at reasonable and, in some instances, subsidized prices, which even resulted in losses to the state, but continued to benefit the public. Privatization has changed the role of the former SOEs to one in which the interests of the private investor and profitability take precedence over public welfare. Thus the goal of public benefit has become secondary to profit maximization. In this context, the following areas are examined below: (a) (b) (c) (d)

utilization of divestiture proceeds; government subsidies and other benefits; urban and rural development; public welfare, laws and enforcement. Utilization of divestiture proceeds

Divestiture proceeds take two forms: the direct form, where the amount is realized from the sale of an SOE, and the indirect form, which is the elimination of a burden on the state from the sale of loss-making public enterprises less the cost of selling profit-making SOEs. In Sri Lanka the proceeds from the sale (see 166

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Appendix 8.1) were utilized primarily to adjust the fiscal deficit arising from high levels of debt servicing and defence expenditure. The utilization of privatization proceeds for new social welfare projects or for investment in infrastructure have been at best marginal. The state has not initiated any programmes to be funded directly from divestiture revenue such as export-oriented technical and management training programmes, or promotion of small industry. Perhaps the biggest drawback is the fact that no divestiture proceeds have been provided for future capital expenditures of the peoplized bus transport services. As stated, the bus transport system was privatized without resort to a corporate investor, and it is highly unlikely that the employees, who own 50 per cent of the equity, would be willing to inject capital for any future expenses such as re-fleeting. This would create a massive national burden in the near future, as over 40 per cent of the present peoplized fleet is older than the useful lifespan of a bus, which is eight years.20 Government subsidies and other benefits The privatization of SOEs led to the removal of state subsidies, with the resultant price increases imposed by some PVEs. Thus, in some cases the government’s privatization programme has favoured the private investor at the expense of the general public. Distributional inequality is best manifested in the bus transport sector after privatization. At the end of this programme in August 1991, eightyfive of the 104 former bus depots, other than in the Northern and Eastern Provinces, were converted to seventy-eight privatized bus companies.21 Since the nationalization of the bus services in 1957, the Central Transport Board (CTB) and the Regional Transport Boards (RTBs) together had cost the government Rs.12 billion. The CTB, which had been running the bus services at a loss, had had to be financially assisted by the government to the tune of Rs.400 million over several years. The purpose of privatization was to eliminate these state subsidies to the Sri Lanka Transport Board (which embodied both the CTB and RTBs). Privatization was expected to save the country several billion rupees in the long run, even though the government would have to bear the costs of the SLTB’s accrued liabilities. The situation improved somewhat with privatization; for example, prior to privatization, 2,849 buses were operated daily; this increased to 3,584 after privatization. The daily collection had averaged Rs.6.3 million before privatization; this increased to Rs.7.3 million after privatization. Four hundred new buses were added to the fleet, and several bus companies paid a 5 per cent dividend to their shareholders. On the other hand, the immediate loss to the government was considerable. On divestiture, employees of the SLTB were provided with Rs.800 million of public assets free of charge, while the liabilities of the SLTB, which were estimated at several billion rupees, were borne by the government; arrears to 167


the Employees’ Provident Fund alone amounted to Rs.1.2 billion. The peoplized bus fleet was increased after spare parts for the buses were bought at state expense. The most significant aspect of the divestiture, however, has been its long-term adverse effects on the bus travellers themselves. The National Transport Commission (NTC), which is the regulatory body of the transport sector, has failed for various reasons, some of which are beyond its control, to ensure a generally satisfactory bus transport service. For instance, low population density routes, especially in rural areas, have not been provided with adequate bus services, thus inconveniencing the commuters on such routes. The private bus services, being more profit-motivated, avoid these routes due to the poor returns, unlike the former state-owned SLTB, where the commuters’ interests could not be overlooked and took precedence over profitability. The subsidies provided by the state as an incentive for operators on unprofitable routes have been shown to be inadequate. Although the NTC tried to rectify this by staggering the costs of route permits for economic routes from Rs.500 to Rs.1,500, to compensate for the poor revenue, this has not been successful in improving the bus services on uneconomic routes. Also, buses do not ply certain routes after dark. The reluctance of the private buses to carry season-ticket holders can be attributed to the NTC’s firm commitment to ensure that the price to commuters be set by market forces. There is little price regulation now and the fundamental objectives of the NTC have become jeopardized.22 Where a route monopoly exists, the charges of the private and peoplized buses are exorbitant. To ensure the availability of night services, the NTC has permitted any bus to run on a given route after a certain time, but has failed to take into account the fact that these bus operators charge high fares to night travellers. The failure of the peoplized service to provide a reasonably priced, efficient bus service is highlighted by the recent call by all private bus operators to unilaterally increase bus fares in the Western Province by 75 per cent.23 The plight of the season-ticket holders, especially schoolchildren, is perhaps the worst after the privatization of the bus services. Schoolchildren, who are generally known to hold season tickets, are often bypassed by the bus operators; they prefer to carry commuters who pay their fares daily. Table 8.2 shows the concessions provided by the former state-owned SLTB. Table 8.2 SLTB commuter fare subsidy scheme

Source: National Transport Board

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The basic drawbacks of privatized transport for commuters are twofold: the increase in bus fares and the disruption of services on socially desirable but financially non-viable routes. Before privatization, the government made available a substantial subsidy to provide the commuter with low bus fares and a comprehensive route network. The single large body of resources that represented the SLTB had the ability and financial stability to provide experimental route services for short periods of time. These experimental route services were in most instances initially unprofitable, but when the public became aware that such services existed they utilized them, making the services profitable in the long run. The private and peoplized bus services, driven by the profit motive, lack the initiative and resources to carry out such experimental methods to improve their provision of services. This type of routeexperimenting not only provided for an increase in the route network, and thereby a better service for the public, but contributed to reducing the congestion on certain routes—a primary failure of the privatized transport system. Privatization of the national bus transport system has been unsuccessful in terms of providing the country with an acceptable balance between a socially desirable and financially viable bus service. Even though some peoplized bus services have reported dividend payments, the ability to continue to pay such dividends is questionable as the capital expenditure required for the purchase of new equipment for buses in the near future will be very high. The absence of a workable solution on how such capital requirements are going to be met only compounds the adverse effects of divestiture on the national economy. Furthermore, although the state has been relieved of a large fiscal burden through the divestiture of the SLTB depots, the short- and long-term costs to the general public have been very high. Bus travellers, who comprise 85 per cent of the population, now pay higher fares and are also inconvenienced by a reduced network of bus services. Furthermore, few of the shareholding employees of the privatized bus services have received a dividend. In sum, only a relatively few bus operators have been able to benefit from this divestiture. Urban and rural development As stated earlier, the majority of privatized SOEs are located in the urban areas of the Western Province. As a result, present economic activity and prospects for the future, job opportunities and income levels are greater here than elsewhere, especially the rural areas, which have not benefited to the same extent. During the pre-privatization period several SOEs, such as the National Paper Corporation, National Textile Corporation, Cement Corporation, Lanka Wall Tiles, factories of the Ceramics Corporation, chemical factories, etc., were opened in the rural areas of the Sabaragamuwa, Northern, Eastern, 169


Western and Central Provinces, with the aim of taking industrial development to the rural areas. Considerable sums of money had to be spent to improve the infrastructure in these areas, but they were still inadequate and contributed to the financial losses of some of these SOEs, notably the Paper Corporation, the Textile Corporation and the Cement Corporation, among others. Other factors contributing to the losses were a lack of consistent power supply, proper water supply, suitable road and rail transportation and port facilities, and skilled labour. Despite these drawbacks, successive governments of the pre-1977 period pursued industrialization in the remote provinces, thus helping many of the indigent people in these areas. The liberalization of the economy after 1977 saw the establishment of Export Promotion Zones (EPZs) in Katunayake and Biyagama of the Western Province, and Koggala of the Southern Province, to promote industrialization by the private sector in these areas. The large capital-intensive projects begun under the liberalization programme were restricted to the EPZs, especially those in the Western Province, due to the numerous benefits enjoyed by investors in the EPZs. As a consequence, there was little development of large private enterprises in the provinces. The chief beneficiaries of new employment opportunities, free shares and increased wages have been those living in the urban areas. The workshops and extra plant capacities installed in PVEs have been concentrated mostly in the urban and semi-urban areas (e.g. the repair shops of United Motors Lanka Limited, the ancillary button factory of Kabool Lanka, and new production lines planned by Kelani Tyres). There are two reasons for this bias. Firstly, the infrastructure available in the urban areas of the Western Province for further business expansion is far superior to that in other areas. Secondly, insufficient incentives, such as EPZ facilities, are available to PVEs to locate their industrial development projects in other provinces and rural areas. Unlike the SOEs, the privatized enterprises show little inclination to commence financially nonviable projects although they may be socially beneficial. In order to encourage PVEs to take their projects to rural and other areas, the shortcomings in the necessary infrastructure should be compensated by the offer of investment relief measures to prospective investors. The establishment of the Board of Investment (BOI) is seen as a step in this direction. The urban bias is also evident in the subcontracting ancillary industry sector. SOEs such as the Ceylon Plywood Corporation, Ceylon Oxygen and Ceylon Leather Products, patronized to a large extent the ancillary industries set up in the vicinity of the main industries, away from urban areas. Local entrepreneurs were given preference over large commercial suppliers and distributors on the basis of government policy during the pre-1977 period. But this preference has given way to profit-maximization measures, which include purchase of raw materials at the lowest cost and employing distributor networks. For example, Ceylon Oxygen is revamping its dealer network to include only professional dealers well versed in marketing techniques, with a view to 170

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increasing sales and profits. The subcontracting for Kabool Lanka and Ceylon Leather Products has given way to large professional commercial operations. The Distilleries Company Ltd has stopped subcontracting with the State Sugar Corporation and now depends on imported sugar from South Africa. Since the divestiture contracts between the government and the buyer have no stipulations with regard to banning or countering such profit-oriented shifts in operation by PVEs, most of the rural ancillary industries, such as dealer networks, etc., will be adversely affected. Public welfare laws and enforcement Before privatization, the industrial sector was dominated by SOEs or closely held family-owned enterprises, which were often jealously guarded from public ownership. The privatization of SOEs theoretically allowed for broader public participation in their operations. This section will examine the extent of public involvement in the management of investment and the implications of such broad management. The following questions are examined below: (a) Has broad-based share ownership changed the perceptions of corporate managers on how to conduct their businesses? (b) Has broad-based shareholding benefited the general public who are not shareholders? (c) Has a sense of public accountability appeared in corporate management? (d) What measures have the state taken to ensure the welfare of the individual investor? (e) How well are shareholder rights being observed? (f) Are shareholders aware of their rights and the legal action that can be taken against an errant management? (a) As a direct result of the privatization of SOEs, and with it the broadening of share ownership, the greater activity in the Colombo Stock Exchange after privatization is evidence of the increased emphasis on corporate performance indicators such as return on capital employed, earnings per share and annual dividend rates. The corporate managers can no longer depend only on bottom-line figures of profitability and net assets as investors need more information to gauge the strength and potential for earnings of an investment. As a result, there has been a significant increase in prudent resource management and exploitation, resulting in companies seeking innovative methods for making the maximum use of the resources available to them. For example, wastes from nitrogen production at Ceylon Oxygen are now being converted into industrial gases used in the production of plastics and paints, reducing the costs of these consumer goods and increasing the profitability of the company. Greater resource 171


(b)

(c)

(d)

(e)

utilization has led to several new innovations, ranging from new varieties and designs of cloth from the former National Textile Corporation Mills, to tyres of greater quality and variety from Kelani Tyres. Prices may have remained the same or increased, but now the consumer has a better variety of goods to purhcase. With the broadening of share ownership, the non-shareholding majority too has benefited, as the shareholders, who are widely representative of the general public, have often spoken for the public, and voiced public opinion on matters such as price increases, product variety, etc. To cite an example, when Ceylon Oxygen proposed to increase the price of domestic gas, the public displeasure this aroused was brought to the attention of the management by the shareholders themselves. With the increased number of shareholders, a greater sense of public accountability is now evident than formerly. The privatized SOEs have streamlined their accounting systems and are not lagging in dividend payments. United Motors Lanka Limited, for example, declared a 7.5 per cent dividend at the end of its first year of operation, which absorbed 60 per cent of the profits (UMLL 1992). This is indicative of the need to give quick returns to shareholders. Further, extraordinary general meetings of the shareholders are summoned to seek approval for new investments and annual reports are prepared in more detail and well presented. The state has created a Securities and Exchange Commission (SEC) to safeguard the interests of the investor. The primary function of the SEC is to formulate and enforce a set of corporate rules and regulations by which all quoted companies must abide, in order to safeguard the investments of individuals and corporate owners. Company accounts have to be approved by the SEC, and malpractices such as insider trading, dumping of company shares, and price manipulation to inflate the value of shares, etc., are investigated and penalties are imposed by the SEC. Currently, however, the SEC is under-staffed and under-budgeted. Its budgetary requirements are approximately Rs.8 million, but the state provides only Rs.3 million.24 However, even under such tight budgetary constraints, the SEC is doing a remarkable job of safeguarding the interests of the individual investor. Recent changes in accounting standards have also contributed much towards protecting the shareholder, by giving a more accurate picture of the financial position of a company. The rights of shareholders are safeguarded by the existing laws on corporate governance and responsibility. The PVEs have in most cases called for general meetings of their shareholders to ratify new investment or corporate strategy. Although the corporate investors have a controlling share of the equity, they have been largely receptive to the views of the other shareholders. No legal action has yet been found necessary by the shareholders to safeguard their rights in the privatized enterprises. 172

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(f) For the most part, the majority of PVE shareholders and new investors on the Colombo Stock Exchange are ignorant of their rights as shareholders. They rely chiefly on regulatory authorities such as the SEC, other knowledgeable corporate investors, and the benevolence of corporate managers in safeguarding their rights as shareholders. There are two basic reasons for the ignorance of the shareholders. Firstly, the average investor invests with the ‘quick buck’ in mind and is interested only in the price of a share. As soon as the right price is received, the investor dumps his shares and moves on to another company. The bullish trends of the CSE have contributed to this jumping from one stock to another, which occurs very frequently, and the shareholder has little time to get a clear picture of the inner workings of a company. Secondly, the training measures adopted by the CSE, the brokers and the companies themselves on how the investor should play the stock market have been inadequate. Neither the brokers nor the companies have been given any state funding to train shareholders. However, the introduction of unit trusts has somewhat mitigated the problem of risk to the inexperienced shareholder, but at the cost of long-term returns. More measures are needed in this area to ensure the success of broad-based shareholding. The shareholders who are more interested in short-term returns must take some of the blame for ignorance regarding their rights as shareholders. The privatization of SOEs has brought in its wake an increase in stockmarket activity caused by the shift in corporate power from a wealthy few, including family groups, to a greater number of shareholders among the general public. This has allowed a larger segment of the population some say in matters pertaining to the PVEs. CONCLUDING REMARKS It is clear from the forgoing analysis that the main problem related to the Sri Lankan privatization programme in the context of ensuring distributional equity is the lack of transparency in the programme and the adoption of ad hoc policies and techniques for divestiture. They appear to be the root cause for factors ranging from under-pricing to low-taxed income from foreigners to loss of socially desirable services. Lack of transparency has resulted mainly from the tender system adopted for the majority of the divestitures. Two reasons have been given by policymakers for adopting a tender system. Firstly, the tender allows the government to divest SOEs quickly, as the process does not require the rigorous financial information record of SOEs that is essential for divestiture through the stock market. Unprofitable SOEs tend to have accounting arrears and may not have produced annual reports for several years. It is claimed that an attempt to clear 173


the backlog and prepare a comprehensive annual report takes nearly nine months—time the government can ill afford—to enable such SOEs to enter the stock market. Secondly, tenders have normally allowed the government some degree of control over the buyer, because activities such as asset stripping after privatization are generally known to occur. Although there are advantages of a tender system in maintaining the speed of privatization, there is no justification for maintaining a non-transparent tender system. By increasing the transparency of the privatization programme, the government will not only be able to achieve far higher revenues than otherwise, but will mobilize greater public support for the privatization programme. The speed of the privatization programme may most often be determined by the conditionalities of international financial institutions. Of course, speed considerations require some degree of flexibility in the divestiture procedure. However, maintaining flexibility should not be viewed as a constraint to maintaining a consistent policy framework to govern the privatization exercise. In fact, a consistent and effective policy framework according to the objectives of the privatization programme can ensure greater distributional equity. Some aspects of a possible policy framework with reference to distribution are described below. The regional disparity arising from the privatization programme shows that the effective implementation of a ‘trickle down’ strategy is necessary to ensure a better distribution of divestiture benefits. In this context, the government could have considered a programme to allow Janasaviya (welfare programme) recipients to become shareholders of large PVEs or to become subcontractors to PVEs in a small way in order to spread the benefit of the programme and to avoid regional disparities. The government could also have used some of the divestiture proceeds to provide incentives to PVEs to establish labour-intensive ancillary industries in the outer provinces of Sri Lanka. It was seen that although broadening the spread of shareholding had a positive bearing on distributional equity, poor implementation had stifled the benefits that the ‘pyramid’ divestiture technique guarantees. In fact, substantial work needs to be done to achieve greater involvement of indigent people in the privatization programme. It was pointed out that in order to obtain a better balance between foreign and local ownership in the privatization process, wealthy Sri Lankan expatriates too should be motivated to invest. For this purpose, adequate information on the privatization programme and more frequent advertising abroad are necessary. The public awareness programme in this regard should also be more effectively carried out than in the past, to educate shareholders about their rights and the benefits they are entitled to under the privatization programme.25 At present, for instance, not all shareholders are aware of the benefits of holding on to their shares, nor do many of the employees who are shareholders know their legitimate rights as shareholders in their companies. 174

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The lack of alternative employment for redundant employees and the dearth of suitable investment guidance have been major drawbacks with regard to redundant employees of PVEs. An agreement between the state and the corporate investors prior to divestiture to ensure that redundant employees are found other employment is one way of overcoming this problem. The state, however, has shown little inclination to get involved in such a process because of fears of increased trade union action in the face of state intervention. The divestiture of the Sri Lanka Transport Board has proved to be the most ill-conceived exercise in the entire privatization programme. The programme is flawed, in the sense that 50 per cent of the shares have been gifted to the employees, who have strong trade union affiliations. Consequently, the government is hard pressed to find corporate investors who could finance operational expenses such as re-fleeting, new route experimenting and various subsidy schemes for the general public. The present employees cannot carry the financial burden of a rights issue that could support these needs. Poor planning and implementation of the bus transport privatization programme appear to have made the privatized depots government liabilities in the medium term, and once again, the bus services have become a burden on the national budget. Moreover, the 85 per cent of the population that depends on bus services for transport faces high fares and poor services. In short, the Sri Lankan experience has shown that privatization of the services in a developing economy is not easy and therefore not effective in ensuring distributional equity. All in all, the Sri Lankan privatization programme has shown both positive and negative features in regard to distributional equity. Generally, the benefits to the entrepreneurs and to the general public have been broadly similar, when one considers the long-term benefits of a reduced burden on the national economy, and enhanced industrial growth. However, the lack of an effective policy framework to ensure distributional equity in the privatization programme has offset some of the benefits that the programme could offer.

175

Table 8.3 Schedule of privatizations

APPENDIX 8.1

Source: Privatization Year Book (1993) and the documents of the Ministry of Finance. Notes: In the case of United Motors and Peoples Merchant Bank, the employees were gifted 5 per cent and 1 per cent respectively of the shares of the SOEs. In all other cases the employees were gifted 10 per cent of the shares. QPC = quoted public company

Table 8.3 continued


APPENDIX 8.2 Table 8.4 Privatized enterprises by July 1993: price per share and employment levels

Source: Ministry of Finance, Commercialization Division. Note: QPC = quoted public company.

178

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NOTES 1 The plantation estates were also privatized, but they remained state-managed. This sector is excluded from the analysis, as the paper is confined to full-scale privatization (i.e., both management and ownership). 2 All prices are from the Colombo Stock Exchange (CSE) statistical base. 3 CSE statistical base. 4 CTMA (1992) and Kelegama (1993). 5 Information of the authoritative sources of the Ministry of Finance. 6 Divaina newspaper, 8 January 1992. 7 This inflexibility in the investment pattern was evident when one of the more popular new sources of investment, the high-interest-paying finance houses, collapsed in the late 1980s and early 1990s. 8 A series of divestitures deviated from the standard 60–30–10 or 90–10 formulae, for unspecified reasons. 9 The introduction of unit trusts during the late 1991–2 period was another laudable effort by the government to involve the urban and semi-urban working population in the privatization process. The unit trusts not only offer tax benefits but provide a relatively safe way of enjoying the profits of the share market for those who have little or no skill in share trading. The unit trusts have, however, performed below expectations with regard to attracting investors. Analysts attribute this failure to the mistaken idea the public has that unit trusts should perform like regular shares in the market, showing rapid gains in a short period of time, rather than as a longterm investment. 10 CSE (1993). 11 United Motors (1991 and 1992) and Ceylon Oxygen (1991 and 1992). 12 Ceylon Oxygen (1990/91). 13 Labour Commissioner, Labour Department. 14 Ministry of Transport. 15 The Act requires that an employer with fifteen or more workers, who wishes to terminate the services of an employee with one or more years of service on nondisciplinary grounds, should obtain the written consent of the employee or the approval of the Commissioner of Labour. In short, ‘hire and fire’ is severely restricted. 16 UMLL (various issues) and Ceylon Oxygen (various issues). 17 UMLL (various issues), Ceylon Oxygen (various issues) and the Colombo Stock Exchange (various issues). 18 The loss to government revenue as a result of privatizing the Thulhiriya Mill alone, with numerous tax benefits, is in the region of Rs.106 million per year (CTMA 1992). 19 Ceylon Oxygen (various issues). 20 Ministry of Transport. 21 The usual formula mentioned earlier in the paper was followed for divestitures; however, the Werahera Central Workshop was divested under different terms, i.e., 40 per cent to employees and 60 per cent to the Trust. 22 These objectives are: (a) assess the availability of services of acceptable quality and determine the minimum number of buses required to meet the demand; (b) specify the conditions for the issue of route permits by authorized persons; (c) determine 179


rate chaNges in a manner that facilitates equitable distribution; (d) specify documents relating to driver and vehicle fitness; (e) lease with government for the carriage of mail and provision of services to students on concessionary rates; and (f) ensure the provision of services, even on unprofitable routes, by introducing a subsidy scheme. 23 The Island, 2 August 1993. 24 Sunday Observer, 1 August 1993. 25 Although Sri Lanka initiated a public awareness programme before the privatization programme during the period 1987–8, it has not proved very effective, due to the political violence that prevailed in the country during that period. Thus, it is essential to have a second round of the public awareness programme.

REFERENCES Adam, C., Cavendish, W. and Mistry, P. (1992) Adjusting to Privatization, London: James Currey. Bhaskar, V. (1992) Privatization and the Developing Countries: The Issues and the Evidence, UNCTAD/OSG/DP/47. Ceylon Oxygen Ltd. ( 1988, 1989–90, 1990–1 and 1992) Annual Reports. Colombo Stock Exchange ( 1989, 1990, 1991 and 1992) Annual Reports. Ceylon Textile Manufacturing Association ( 1992 and 1993) Textile Today, News-letter, June 1992 and March 1993. Cowan, L. (1990) Privatization in the Developing World, New York: Greenwood Publishing Group. Department of Census and Statistics (1993) Statistical Abstract 1993. Fraser, R. and Wilson, M. (1988) Privatization: The UK Experience and International Trends, Harlow: Longman. Jayasinghe, T. (1993) ‘Sri Lanka: combination of economic and social goals’, Privatization Year Book, Ministry of Finance. Karunatilake, H.N.S. (1987) The Economy of Sri Lanka, Colombo: CDSS. Kelegama S. (1993) Privatization in Sri Lanka: The Experience during the Early Years of Implementation, Sri Lanka Economics Association, March. Kelegama, S. and Y. Cassie Chetty (1993) Consumer Protection and Fair Trading in Sri Lanka, Law and Society Trust, Occasional Paper, No. 2. Ramanadham, V.V. (1993) ‘The impact of privatization on distributional equity’, basic working paper, Interregional Expert Group Meeting, UNDP, New Delhi, September. —— (1994) Constraints and Impacts of Privatization, London. Sri Lanka Business Development Center (1992) ‘Survey of Retrenched Persons of Public Sector Institutions’, No. 25. United Motors Lanka Ltd. ( 1989, 1990, 1991 and 1992) Annual Reports.

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9 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY IN BANGLADESH Muzaffer Ahmed AN OVERVIEW OF NATIONALIZATION AND PRIVATIZATION In Bangladesh, privatization represents a continuum of policy and policy changes. It may indeed be historically incorrect to say that privatization is of recent policy origin in Bangladesh. In 1947, Bangladesh had few industries– cotton textiles, jute bailing, sugar, tea, cement, a dockyard, a railway workshop, etc. After partition of India, the government of East Pakistan felt compelled to become directly involved in building industries in the jute and cotton textile sectors. A large integrated textile mill was set up to feed the weaving community with yarn and the domestic market with finished products. A large jute mill was also established to initiate the process of industrialization. These mills were then sold to a local migrant entrepreneur at a price that did not cover even a quarter of the cost. Similarly, the Pakistan Industrial Development Corporation (PIDC) built, along with other industrial units, a paper mill, which it then sold to a migrant entrepreneur at a negotiated price which was also less than a quarter of the actual cost. These two migrant entrepreneurs became part of the ‘twenty-two families’ of Pakistan who controlled over three-quarters of bank advances, besides owning a substantial portion of the physical and financial assets in the modern organized sectors of the economy. PIDC set up twelve jute mills as joint ventures with the private sector and then divested its share to the private parties. The second phase of privatization may be said to have taken place during the tenure of the East Pakistan Industrial Development Corporation (EPIDC) which had an unwritten mandate to promote local entrepreneurs. EPIDC worked hard to lcoate and motivate indigenous entrepreneurs; however, most of them had no business experience and had very limited financial capability. EPIDC prepared a standard blueprint for setting up jute mills as joint ventures, 181


and this included a financial and technical assistance package. The debt: equity ratio varied between 70:30 and 75:25. The loans came from public sector financial institutions, principally the Industrial Development Bank of Pakistan (IDBP). EPIDC picked up 50 per cent of equity (i.e. 15 per cent of investment cost). The Bengali entrepreneurs could not provide even half the remaining equity amounts, so EPIDC became the underwriter for loans provided by the commercial banks (normally another joint venture, the National Bank of Pakistan). Land was allowed to be over-valued for collateral, and over-valuation of machinery was allowed for a cash-flow injection by local entrepreneurs. Thus a local entrepreneur could become the owner of a jute mill with very little personal capital outlay. EPIDC also undertook training of workers and supervisors, and often managed the mills until the local owners were confident enough to operate them themselves. This was necessary when the mill-owners paid below the statutory minimum price to the jute growers, when the minimum wage was much lower than labour productivity, and when the sector benefited from an export bonus voucher scheme which allowed the owners free sale or use of a portion of the proceeds from jute goods exports. In this way, thirtytwo jute mills were set up by EPIDC in East Pakistan. Towards the end of 1960s, EPIDC divested a sugar mill, a cotton mill and a jute mill, for which EPIDC had to find financing from a consortium of banks, even when these mills were priced at below their investment cost; local entrepreneurs put up only 16–20 per cent of the negotiated price as down-payment. It may be mentioned here that the stock exchange and finance capital market were not effectively operating in East Pakistan. Had there not been the secession from West Pakistan, in 1971, EPIDC would have continued with its BOT (buildoperate-transfer) and joint-venture approach for privatization. A similar approach was taken to develop small industry as well. The East Pakistan Small Industries Corporation (EPSIC) financed around 1,008 units between 1958 and 1970 from its own sources or loans from a consortium of banks. Following a brutal war, Bangladesh became independent in December 1971. The policies which had been followed for promotion of the industrial and financial sectors had led to concentration of wealth during the previous regime. A study by Lawrence J.White identified forty-three families controlling 72.8 per cent of all the assets of stock exchange-listed Pakistani-controlled firms. Of the forty-three families, only one was from East Pakistan. Even including firms not listed on the stock exchange, the forty-three families still controlled nearly 60 per cent of the manufacturing assets and owned most of the banks and insurance companies. Fourteen insurance companies owned or controlled by thirty-two families controlled 75.6 per cent of all insurance assets, and in the banking sector seven of these families controlled 60 per cent of all bank deposits and about 50 per cent of all banks’ earning assets. A case against the concentration of wealth, assets, finance and economic power was made, and it was echoed in Pakistan’s draft fourth five-year plan. The Awami League, which led the liberation movement, was committed to nationalization of the 182

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jute and textile industries, and of banking and insurance companies as well as the jute trade. At the time of liberation, there were many industrial, commercial and real estate establishments in East Pakistan which were owned by nonlocals. The Bengali bourgeoisie was small and had grown through direct government patronage and assistance. This class expected to gain from the parity/autonomy movement, but had little entrepreneurial or managerial capacity to take over the assets left by the Pakistanis at the time of independence. As peaceful and negotiated transfer of power to the elected representatives of East Pakistan was denied, the public enterprise sector expanded to fill the vacuum. This trend was strengthened by the rise of the working class and radical student groups as influential political identities who advocated social ownership of the means of production. However as there was no planned build-up towards an independent Bangladesh, and as there were serious contradictions within the petty bourgeoisie-dominated Awami League, its decision-making lacked consistency or long-term vision. On the formation of Bangladesh, the government assumed responsibility for all abandoned enterprises. It was decided to nationalize all units in jute, textile and sugar and all other abandoned business with assets above TK1.5m. ($0.3m.). But the important decision with respect to divestiture was that all assets below TK1.5m. were to be divested to the public. Though an incomplete count, there were some 3,130 registered manufacturing units on the eve of liberation. Of these, fifty-three units were under public ownership, accounting for 34 per cent by value of fixed assets; 725 units, with 47 per cent of fixed assets, were owned by non-Bengalis; 2,253 units were owned by Bengalis, accounting for 18 per cent of fixed assets; and twenty foreign enterprises accounted for only 1 per cent of fixed assets. The public sector industrial units after liberation and nationalization consisted of fifty-three EPIDC units, 111 non-Bengali-owned units, and seventy-five Bengali-owned jute and textile units. Four hundred and sixty manufacturing units were to be divested by the Ministry of Industries, and thirty-five abandoned units were placed with two welfare foundations. Similarly, thousands of abandoned commercial units were placed under the Ministry of Commerce for eventual divestiture. A similar policy was adopted for construction units as well as houses abandoned by non-locals. However, banking and insurance firms (except those owned by non-Pakistani foreigners) were nationalized. Even public utilities which were already in the public sector were prepared for privatization. It should also be noted that during the Mejib era, 120 small industrial units were divested. The ceiling on private-sector investment was raised from TK2.5m. to TK30.0m. A moratorium on nationalization was announced. Foreign investment was given reasonable incentive and restrictions with respect to collaboration with public corporations were relaxed. The second phase of divestiture came after the assassination of Sheikh Mujiber Rahman by soldiers and assumption of power by General Zia Rahman. It is pointed out by Humphrey that by amending the basic principles of the 183


constitution (Article 47) through a martial law proclamation in 1977, Zia made denationalization of public sector units possible within the framework of ordinary law. The investment policy was revised in December 1975, a few months after the taking over of power by Zia. The ceiling of private sector investment was raised to TK100m. The reserved public sector list was drastically reduced. DFIs were permitted to provide equity and loan capital to the private sector; the stock exchange was activated; the Investment Corporation of Bangladesh (ICB) was established to provide bridge finance to the private sector, as well as to underwrite loans. The black money could be used to invest in new units, or to purchase abandoned units. All abandoned units placed under public control and management were eligible for divestiture, and partBengali-owned (majority or minority) units were to be returned to the local owners. In addition, tax holidays and other incentives for investment were increased. The policy statement, read literally, was that the divestiture would take place on cash payment only. By late 1977, twenty-one units under industrial corporations had been divested and handed over, fifteen were in the process of being divested and handed over, thirty-three were being processed for divestiture, and seventeen were being examined for possible divestiture. A total of 110 industrial units were divested under the regime. Of the 462 units with the Board of Management, 159 were released in favour of Bengali owners, 144 were sold and handed over, and fifty-six more were sold through tender and were in the process of being handed over. This meant that only 103 industrial units remained under the Board of Management. In addition, another 113 units were divested by the Directorate of Industries. Fewer than 200 industrial units were under the control of public sector corporations. It may be mentioned that some new public sector mills came on stream after completion. In the commercial sector, some 2,000 to 8,000 units taken over were almost without any assets, due to overdrafts taken by former owners from the formerly Pakistani-owned banks, and looting of properties after liberation. Most of these commercial units just disappeared, and officially only 745 such units were taken over, most of which were divested or were in the process of divestiture. But very little is known about the divestiture process. It is suspected that policy-makers and bureaucrats made use of these units for doling out patronage to party members, student leaders, trade union leaders, former soldiers, relatives and friends. The third phase of divestiture started after the assassination of Zia by the Army and the overthrow of the civilian government by General Ershad, whose martial law government announced a new industrial policy (NIP) in June 1982. The basic objective was to further limit the role of the public sector and to promote the private sector in export and import-substitution industries in order to reduce unemployment. The reserved list for public sector operation was reduced to those areas which are outside traditional manufacturing areas. The policy also allowed the selling of 49 per cent of equity shares of SOEs, and for releasing presumed Bangladeshi-owned jute and textile units to their 184

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former owners, irrespective of their level of shareholding. This meant that twenty-seven textile mills and thirty-three jute mills were released, in addition to the specialized (jute yarn and synthetic textile) mills returned or sold earlier. The industrial policy provided for generous incentives for investment by domestic and foreign investors. The list of sectors where no government permission would be necessary for investment was enlarged, the so-called ‘one-stop’ cell was set up for investors, along with rapid development of the export processing zone (EPZ). The push for privatization had come by 1982, although the private sector failed to take off. The new industrial policy did not result in much divestiture—the reason is said to be a statement by General Ershad in August 1984, when in search of legitimacy through election, that no further divestiture would take place. After the election, a revised industrial policy (RIP) was announced, which was basically a refinement of the 1982 policy. Additional incentives were provided to domestic and foreign investors. Discriminatory incentives were proposed for small, labour-intensive and agro-based industries. The scope for private sector investment in manufacturing was further widened, including an emphasis on public-private joint ventures, and provisions were made to convert public sector units into public limited holding companies. Under the NIP-RIP policy, 222 manufacturing units were divested. The Ershad regime opened the finance sector fully to private enterprise, privatizing two banks and allowing private banks and insurance companies to operate. Ershad was then ousted, however, and a caretaker government supervised a free and fair election which put the current government into power. The BNP government is firmly committed to private-sector development and is supported by the new business bourgeoisie. The industrial policy of 1991 has emphasized the role of the private sector. But, as Humphrey points out, there is no coherent or comprehensive policy for privatization. Despite the commitment of the government to privatization, divestiture has not gained momentum and the targets set for divestiture have not been realized. Only four SOEs have been divested by the current regime. PROCESS OF PRIVATIZATION IN BANGLADESH The privatization process involves many procedures. The first issue relates to whether to privatize, the second to how much to privatize, the third to how to privatize and the fourth to the conditions of privatization. Privatization has been accepted as a policy measure in Bangladesh and in theory there are no areas to which the policy might not apply, except defence and strategic areas. Thus, each enterprise or group of enterprises should be seen in the context of the benefits from privatization and the cost of retaining them in the public sector. In Bangladesh the approach was always ideological rather than ‘contextual’. 185


A proper privatization approach would involve the preparation of a feasibility study with respect to privatization, involving a range of social, economic, political, operational, financial, legal, human and other developmental criteria. Such an evaluation should be forthright, consistent and generally uniform. The analysis should be carried out by a group in whose integrity and expertise potential buyers and the general public have confidence. In Bangladesh, to the best of my knowledge, no such approach has ever been undertaken. Privatization came as a donor-conditionality for structural adjustment. If a broad feasibility analysis of privatization is undertaken, then priority ranking of the units identified for privatization is a necessity. Even when Eliot Berg referred to Bangladesh as a champion of privatization, he neglected to examine whether both micro and macro analyses, involving a multi-disciplinary approach with accepted methodologies, were employed to determine and demonstrate the justification for the almost wholesale and unplanned privatization that has been undertaken in Bangladesh. Unfortunately such analyses have been absent from the government’s policy-making and the donors’ prescriptive memorandum. There are various means of privatization. The most common is divestiture, where ownership and management is wholly transferred through a sale agreement, the terms and conditions of which are mutually agreed upon. The second is privatization of a part of the capital structure through the sale of shares, either through tender or through capital markets. The third is privatization of management, where ownership is retained but management is transferred to a private party under a contract, delineating the terms and conditions. The fourth is privatization of a part of the production process, e.g. introduction of a production contract while retaining the procurement and marketing functions. The fifth is adoption of a profit-sharing process or other modalities to effect an employee buy out. The sixth is outright liquidation; and the seventh is commercialization, where ownership is kept intact and public sector managers are freed from bureaucratic control in order to operate on comparable private sector lines so as to achieve certain defined targets of production and ROI. Bangladesh did not consider the alternatives. The option chosen was negotiated sales or sales through contract. Later, partial sale with eventual total sale was adopted in certain cases. Management contract was not a success in the few cases where it was tried at the behest of the donors (e.g., Machine Tools Factory). The privatization process in Bangladesh in recent years has involved fixing a floor price, determined on the basis of a report by a selected firm of chartered accountants (as in Bangladesh there are no chartered valuers of property). Property has been valued basically according to the book value and not the market value of land and of the ‘scrap’. Invariably the divested units have been undervalued. Once the floor price has been set, tenders have been invited from interested parties and the validity of bids examined mechanically by a so186

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called tender committee. A scrutiny committee verified the title and nationality of former Bangladeshi owners, who were given preference. This is a complicated process as tangled relationships exist and appropriate papers were either not available or were manufactured for convenience. A working group examined the offers in the context of the valuation of assets and shares. This group made a recommendation on the final decision. The entire process is mechanical and bureaucratic, and is subject to manipulation for patronage. The successful bidder makes a downpayment of 10–25 per cent of the negotiated price before transfer of the enterprise; this money has often been loaned from the nationalized commercial banks. This itself is subject to political manipulation, in a society where democratic accountability is absent. The balance of the money is to be paid in instalments from profits, but defaults have been quite common. Buyers have assumed the liabilities along with assets, and many of the buyers are currently negotiating to disown the liabilities, many of which existed even when the enterprises were taken over by the government in 1972. The sale of 49 per cent of shares through negotiation has followed a similar pattern. The government initially insisted on no retrenchments of employees for two years, and is currently following a ‘golden handshake’ policy before divestiture. This has not gone very far, due to budgetary constraints of the units, corporations and the government. It may be seen that neither the decision to privatize nor the methods of privatization have paid adequate attention to the impact of such a process on income and wealth distribution, employment, technical efficiency, technology development, improvement of financial health, consumer interest, productivity or the sustainability of such a policy when the capital market is in its infancy and when a proper management culture, entrepreneurship or good labourmanagement relations are generally absent. IMPACT OF PRIVATIZATION POLICY The basic premise of privatization policy has been that the public sector was being run inefficiently and was incurring loses. Rehman Sobhan and S.A. Ahson made a study of the economic performance of the privatized jute and cotton textile industries in 1986. The authors concluded that the performance of the denationalized units in the jute sector was no better than that of the public sector mills. The production of the denationalized mills actually fell by a larger percentage than that of the public sector mills. These conclusions hold even when the production figures are corrected for product mix, and even when enterprise-by-enterprise or product-by-product comparisons are made. There was no sustained improvement in productive efficiency in the privatized jute mills, measured in terms of amount of product per loom hour. The study also points out that wastage of raw material increased more in privatized jute mills, 187


both for narrow and broad looms, than in the public sector mills. In terms of financial performance, privatized jute mills performed no better when compared to public sector jute mills. Rehman and Mahmood also found that profit per ton, on the basis of mill-level data, was higher in the retained jute mills than in the privatized jute mills, while losses per ton were higher in the privatized jute mills than in the retained jute mills. In the case of the cotton textile mills, Rehman and Mahmood found that annual average production of yarn increased in the retained mills, while it had decreased in the privatized mills. With respect to cloth production again, there was a decline in production in the private sector mills following denationalization, while it increased in the retained public sector mills. The analysis holds even if enterprise-level data and product-mix differences are taken into account. If efficiency is measured in terms of ‘per spindle per shift’ production of yarn by weight, and ‘per loom per shift’ production of cloth by length, production efficiency declined in twenty out of twenty-two privatized units. No improvement in financial performance is seen for privatized textile mills if ‘before’ and ‘after’ comparison is made on unit basis. Rehman and Mahmood concluded that there is no evidence that privatized enterprises in general perform better than public sector units, which are subjected to a higher degree of bureaucratic control, political interference and adherence to rules and regulations. Humphrey came to the defence of privatization policy by proclaiming that the prosperity of the private sector is a function of the policy and regulatory environment and other external factors. The blame for non-performance of privatized mills has been put on the bloated and unmotivated staff inherited from the public sector, old equipments and substantial debts (albeit this is the case for public sector units as well). Humphrey rejects the accounting information as the basis of performance analysis because of its unreliability—he concedes that the private sector conceals its true financial records. He opted instead for a subjective approach of seeking opinions through a pre-structured questionnaire and case studies of ‘successes’. He took the view that in Bangladesh, business is basically a family affair and corporate management practices have yet to surface, despite the emergence of budding industrialists in the liberalized atmosphere. He further concedes that private entrepreneurs prefer to avoid long-term risk and to be assured of very high returns (200 per cent or more). He called them ‘aggressive slickers’, interested in making a fast buck at the expense of others. A recent review of the jute and textile sectors by the author of this paper did not show any significant evidence as to the efficiency of the privatized jute or cotton textile mills. An earlier study by Rehman and Ahsan on divested enterprises in sectors other than the jute and cotton textile industries found no conclusive evidence of superior performance by the privatized units. Thus it is not clear whether x-efficiency has occurred as a result of the large-scale privatization of SOEs. 188

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It has been pointed out that large losses have been incurred in the public sector. However, if one takes away the railways, jute, utilities and electricity, the total loss involved is a relatively small sum. The losses in railways emerged during the Ershad regime, due to over-priced purchases of rolling stock, and a breakdown of managerial discipline due to political interference. In the jute sector, even under the Pakistan regime, most of the mills made up their operating loss from bonus vouchers, depressed wages and non-payment of the minimum price for jute. In the power sector, losses emerged from leakage and increasing system losses. However, the losses in railways, utilities and the power sector are borne by the government. In addition the burden of private sector losses has been incurred by the government, due to defaults in payments by owners, the writing off of amounts due by reducing interest payments and losses from exchange rate adjustment, etc.; and the burden has been borne squarely by the taxpayer. Thus divestiture has relieved neither the government nor the taxpayer of the financial burden. I have indicated that divestiture pricing has been suspect and that many of the buyers have defaulted on payment. The study on divested jute and textile enterprises indicates a mix of improvement and non-improvement after divestiture. Rapid divestment has resulted in imprecise and low sale prices. I believe it has also reached a plateau as there seem to be few takers now even when the government is eager to shed the load. The disappearance of divested assets indicates that many of the divested units have been dismantled and the land has been put to other use, notably as real estate. This has provided the buyer with a windfall profit but has also reduced production capacity, helped in the laundering of black money and has not contributed to the dynamics of development. There has been a loss of revenue for the government. SOEs paid customs dues, excise and income taxes, whereas the privatized units continue to pay less; studies of before-and-after tax payment indicate that such tax evasion by privatized mills is quite normal. The ability of the government to retire public debt has not increased, as the government’s non-revenue expenditure increased very rapidly and conditionalities of donor assistance have put a lid on public borrowing by the government. The government’s income flow from the sale of assets has not been very impressive in percentage terms. Indeed, the allocation of resources for redundancy payments exceeds the generation of income from divestitures. The privatized mills include the more profitable ones, which were instrumental in paying the government’s budgetary levy on public corporations. Such divestiture has reduced the capacity of the public corporations to generate internal funds for running the retained enterprises and has thus increased their costs of operation. The SOEs now carry a relatively larger burden of loss-making units. 189


The owners of privatized mills are now making complaints about inconsistency of tax and tariff rates, bureaucratic absolutism, political interference, labour unrest, etc. and have sought relief from these. The SOEs suffered from all these phenomena and their petitions for redress most often produced little result. In many cases the losses made by SOEs were due to government policy. For instance, there was price control for sugar, kerosene, coarse cloth, fertilizer and insecticides. Paper and newsprint are sold at a subsidized price; so on and so forth. In fact a study by Rehman and Ahmad shows that 84 per cent of SOE products were subject to administered price control. The sale of loss-making units and the relaxation of price controls have meant that prices of products from privatized units have gone up. Bangladesh has started to build holding corporations, but divestiture has proceeded on a unit basis, mostly without involving any restructuring of equity capital. The procedure followed is basically determination of a minimum acceptable price. Such a process is conditioned by the fact that divestiture of the entire sector as a lot is difficult when the capital market is not developed and when buyers need to be accommodated by provision of loans from nationalized commercial banks and deferred payment arrangements. The government is also eager to show that the policy is not promoting concentration of wealth. However, unit-based divestiture provides greater scope for political patronage. The government has used divestiture incomes to offset the shortfall in revenue income. Divestiture incomes have not led to tax reductions, but income tax rates have been lowered in the belief that this would mean less evasion of taxes. Incremental public borrowings have declined, but not due to divestitures. Government borrowing has been restricted as a part of the macroeconomic policy management conditionalities imposed by the International Monetary Fund and the World Bank. Divestiture income has not been used for restructuring of enterprises, either, nor has it been used for fresh investment, though improvements in the socalled revenue budget have helped the government to finance greater development outlays. It is also difficult to say whether divestiture has provided more opportunity for social overhead expenditure. The development outlays do not pay much attention to education and health sectors as yet, despite the government’s commitment to education and health for all by 2000. Investment in physical infrastructure has not increased noticeably, either. The Ershad government, it may be said by inference, saw in divestiture income an added opportunity to implement wasteful projects related to urban beautification. No reversal of this policy by the present government is in prospect. The significance of divestiture for investors can be indicated by the level of concentration of privatized assets. The number of investors has increased, compared to the 1960s and 1970s, but small investors have little access to public and private financial institutions. The divestiture process benefits those who have access to power, that is, the bureaucracy, military and political 190

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authorities. The terms and conditions of divestiture are negotiated and the bureaucracy and decision-making political authorities have discretionary and discriminatory powers. The Bangladesh government is not known to have expressed a preference for the wide distribution of ownership of privatized assets. Even the limited allocation of shares to employees has been couched in a way that nips the enthusiasm of the working class in the announced processs. The result is that ownership of privatized enterprises is more concentrated than ownership of manufacturing assets in general. This is largely due to the built-in bias present in the bidding and negotiation processes. Such concentration has been augmented by the decision that 51 per cent of the shares of partly divested units will be given to the shareholder having majority ownership of the 49 per cent already divested. The lack of an effective stock exchange is also a contributing factor. The government has never encouraged employee buy-outs, nor has provision been made to help small investors, or to arrange for preferential allotment of shares to employees. Furthermore, there are no institutions representing the small investors who could step in for them. It should also be mentioned that foreign investors have played no role in privatization. Direct foreign private investment has been negligible—the MNCs have tended to withdraw from the scene. There have been large employee lay-offs by privatized mills, despite the prohibition of retrenchment within two years. There has been substantial overstaffing of SOEs, due to political interference. Part of this is due to the fact that the economy has failed to expand while entry into the labour force has continued to increase. The unemployment rate is estimated to be about 40 per cent of the civilian labour force. The phenomenon of overstaffing is not confined to SOEs but exists also in the government and public institutions. The privatized units have not operated efficiently enough to create sufficient employment opportunities for the underemployed labour force. Neither privatized units nor the government has made any meaningful arrangement for retraining of retrenched or surplus labour. The redundancy payments for retrenched labour are unlikely to be used as capital for small businesses; they are more likely to be used to buy land and real estate, or to retire debt. It is now being pointed out that the wage commission-determined minimum wage, based on subsistence need, is not related to productivity and that politically awarded fringe benefits to SOE employees have much less relevance to productivity and profitability. This is largely true. But the MNC executives or the owner/managers of private sector units also enjoy salaries and other benefits which have no relevance to their productivity. In a culture where one takes as one gets, it is difficult to relate wages to productivity. Further, this economy with surplus labour has generally been anti-labour and quite prone to exploitation. This is most glaring in the so-called dynamic sector of readymade garments, where the minimum monthly wage for a helper is TK350 ($9.00). Admitting that public-sector emoluments for labourers are generous, one 191


should also note that the private-sector emoluments are sub-human. In this context, privatization has created an insecurity among the labouring class that will lead to social instability in the future. The privatized units have refused to implement recent awards by the wages commission and have virtually withdrawn all fringe benefits and social expenditures that previously were common in SOEs. Thus privatization has resulted in distributional disadvantage for employees. Consumers are not better off, as the social pricing practices of SOEs have lost their currency. The prices of products, without exception, of all privatized units that sell in the domestic market have increased, despite liberalization of trade and competition. Consumers have choice if they have money. The SOEs, even when they were sole producers, did not exercise monopoly power, due to price control, competition from supplies through non-legal trade, and aidrelated imports. REFERENCES Ahmad, Muzaffar (1993) ‘Public Enterprise Reforms, Employment and Productivity’ in Social Dimensions of Economic Reforms in Bangladesh, R.Islam and W.K.Blank (eds), ILO-ARTEP. Berg, Elliot and Shirley, Mary (1987) ‘Divestiture in Developing Economies, World Bank Discussion Paper no. 11. Humphrey, Clarke E. (1988) Privatization in Bangladesh (mimeo), USAID. Rehman, S. and Ahsan, A. (1984) Divestiture and Denationalisation: Profile and Performance, BIDS. Rehman, S. and Ahmad, M. (1980) Public Enterprise in an Intermediate Regime, BIDS.

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10 THE DISTRIBUTIONAL IMPLICATIONS OF PRIVATIZATION The case of India’s divestment programme* Sunil Mani THE PRIVATIZATION PROCESS IN INDIA The process of privatization in India received an explicit character and form only with the statement of the new industrial policy, in July 1991. This policy statement contained four major decisions which affect the future role of publicsector enterprises (PSEs) in India. They are: (a) A reduction in the list of industries reserved for the public sector, from seventeen to eight, and the introduction of selective competition in the reserved area. (b) The divestment of shares of a select set of PSEs in order to raise resources and encourage wider participation of the general public and workers in the ownership of PSEs. (c) The policy towards sick public enterprises to be the same as that for the private sector. (d) An improvement of performance through performance contracts or through an MOU (memorandum of understanding) system, by which managements are to be granted greater autonomy but will be held accountable for specified results. The policy towards sick PSEs was made clearer, with a drastic reduction in the budgetary support to sick or potentially sick PSEs. In fact of all these policy decisions, from the point of view of their potential effect on income distribution, the two that are most important are the policies on divestment and sick PSEs. Before we proceed to analyse the detail of the Indian programme of privatization, it is necessary to clarify a number of issues. By ‘public sector * The author expresses his thanks to Professor K.N.Raj for his comments on the first draft of the paper. 193


enterprises’ we mean here only the non-departmental non-financial enterprises under the ownership of central government. We have adopted this rather narrow interpretation because the privatization programme has been confined exclusively to this subset of PSEs. The PSEs which are engaged in the provision of infrastructural facilities, such as road and rail transport, distribution of electricity and telecommunication services, and provision of water in urban and rural areas are still very much within the domain of the government. The only exception to this is air transport, where some limited privatization of the deregulation variety has occurred, with the authorization of private air taxi services. Even in social sectors like education and health there is no major change in the role of the public sector except that in some forms of higher education like engineering and management education there has been a drastic reduction in the subsidy component.1 However, we argue that this policy may not have any distributional impact, as the consumers of these forms of education have traditionally been in the middle and upper income groups. Banking and finance-related services continue to be very much within the ownership and management of the government, as before. However, the new economic policy is bound to have some effect on income distribution, with the dilution of the priority sector lending norms:2 the quantum of subsidized credit to the poorer sections is likely to be affected. Here again the impact is likely to be more in the long term than in the short term. Finally, in addition to the enterprises which are under the ownership of the central government, there are a large number of enterprises (approximately 900) under the ownership of the various state governments. But most of the state governments have not yet articulated any concrete proposals for privatization of the units under their ownership.3 Hence our main focus will be the manufacturing PSEs under the ownership of central government. Public sector reform and the divestment programme The government’s overall new economic policy lays special stress on an increased role for market forces, and consequently a reduction in the role of the state. In fact the PSEs are generally considered to be a drag on the government’s budget.4 The government’s newpolicytowardsthePSEsisusuallyreferredtoasthepublicsectorreformprogramme, of which the divestment programme is an integral component. In terms of operationalization of this programme, the following steps have been taken.5 (a) The budgetary support to loss-making PSEs in the form of ‘non-plan’ loans from the government is being phased out after 1994–5. (b) Public sector equity is being divested to the extent of up to 49 per cent in a select set of profit-making enterprises, partly to mobilize non-inflationary resources for the budget, but partly also to broaden the spread of ownership and to bring about a more commercial orientation in the management of PSEs. 194

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(c) The PSEs are being allowed not only to form joint ventures but to raise fresh equity from the market to finance their expansion plans. In this way the performance of an enterprise, measured in terms of its financial profitability, will be one of the main factors determining its ability to expand. (d) The Sick Industrial Companies Act (SICA) has been amended to bring public sector enterprises within the jurisdiction of the Board for Industrial and Financial Reconstruction (BIFR), which will now have to decide whether these units can be effectively restructured or whether they should be closed down. (e) In order to overcome the problem of losses on PSEs because of their inability to make timely price adjustments, many pricing decisions will have to be taken more flexibly in consultation with the enterprises concerned. Of all these programmes, the one that has most direct distributional consequences is that of divestment of government equity, and in fact it is this programme which has so far been operationalized. We now discuss the progress of this programme, the main rationale of which is to raise a non-inflationary form of finance for the budget; all other objectives are subsidiary to this main objective. The programme commenced in 1991–2, since when there have been four tranches of divestment of equity, affecting nearly thirty PSEs. The shares were initially offered to selected financial institutions and mutual funds, but in the sales during 1992–3 they were offered to the public and other financial institutions (see Table 10.1). Table 10.1 Divestments of PSE shares

Source: Government of India (1992–3:150).

The government is planning to offer PSE shares to workers and is also in the process of working out the details for floating new scrip offerings on the stock market. The other important component of PSE reform is the decision to close down the chronically sick enterprises. The workers thus retrenched are to be retrained and redeployed using the National Renewal Fund (NRF). This fund is to be supplemented with some of the divestment sale proceeds. The NRF 195


is thus viewed as a mechanism to minimize the social cost (i.e. in so far as displaced labour is concerned) of such plant closures. In the first instance, funds have been allocated from the NRF for implementation of voluntary retirement schemes of the central public-sector enterprises. THE DISTRIBUTIONAL IMPLICATIONS In our rather quick survey of the literature on privatization we noted that the distributional implication of privatization is one of the issues which has not attracted much attention. Ramanadham6 and Rama Seth7 are among the few who have analysed the distributional issues in the PSE reform process. According to Ramanadham8 the distributional implications of privatization may be analysed under three heads: divestiture per se; processes and techniques of divestiture; and use of divestiture proceeds. He then examines the distributional issues implied in each of the three heads, in some detail. For instance, he identifies a number of favourable and unfavourable effects of divestiture per se, as shown in Table 10.2. Table 10.2 The favourable and unfavourable effects of divestiture

Source: Ramana dham (1991:404–5).

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Needless to say, some of the negative effects may be delayed because of political pressure, and some of the positive effects could take time to show results, unless the agencies involved undertake the essential measures with the minimum loss of time, particularly by restructuring their equipment or by organizational reforms. Second, the process and techniques adopted in the course of privatization can also have distributional implications. Distributional goals have in fact often influenced to a considerable extent the choice of technique in privatization.9 When a specific investor profile was desired, a private sale has been preferred; most private sales have been to investors in the industry of the privatized firm, in both developed and developing countries. When wider share ownership has been a prominent goal, the fixed-price method has been preferred over a tender offer as the technique of privatization. Finally, the way in which the government utilizes the proceeds of the sale has some distinctive distributional implications. Very often the sale proceeds are used for reducing or financing the budget deficits. If they are used for filling the revenue deficits, divestiture could help in avoiding additional taxation and reductions in current expenditure. The distributional effects would be positive if (a) the taxes are regressive and (b) the expenditure benefited lowincome brackets. Otherwise, they would be unfavourable. Indeed, if the sale proceeds were used to finance additional expenditure, particularly in the social sector, and especially expenditure to finance social sectors of investments such as elementary school and public health, the poor are likely to be affected favourably. This aspect is further elaborated by Schwartz and Lopes.10 According to them, privatization without efficiency gains does not improve a country’s fiscal stance. This is because when a PSE is sold at a fair market price, the value of sale proceeds should more or less equal the net present value of future after-tax earnings. Hence, when a profitable PSE is privatized, the state obtains sale proceeds but forgoes future earnings; the opposite is true when a lossmaking PSE is privatized. In either case, all that takes place is a trade-off between current and future net proceeds. Depending on what the government actually does with these proceeds, the fiscal stance would at best be unaffected. We have thus seen the various possible distributional implications of privatization in general depending on a variety of factors. We now propose to analyse the distributional implications of the Indian programme of privatization. We discuss these under the three heads analysed above. Divestiture per se At the outset it should be made very clear that we are discussing only the potential distributional implications of the Indian divestment programme. A mere offloading of a small percentage share of equity of a select number of PSEs may not in fact have any perceptible distributional consequences at all. However, one policy may have an impact, namely the policy towards sick PSEs 197


and the decision to close down nearly fifty-four chronically sick PSEs. In fact we discuss the potential employment implications of the Indian privatization programme in some detail below. Impact of privatization on employment PSEs all over the world are considered to be overmanned, so the process of privatization of PSEs, which ultimately aims at improving efficiency, will necessarily have to resort to significant labour-shedding. This aspect is well-documented, at least in the context of UK privatization where, according to Bishop and Kay (1989), privatizations led to falls in employment between 1979 and 1988 of as much as 71 per cent in British Steel, 55 per cent in British Coal, 36 per cent in British Rail, 18 per cent in the gas and electricity supply industries, and 17 per cent in British Airways. This is because employment is lowered as profit-oriented newly privatized firms restrict output towards monopoly levels. In the context we examine the potential short-term implications with respect to employment in the Indian public sector reform process. There are two dimensions to the employment consequences of privatization, namely (a) attempting to arrive at an estimate of the approximate number of labour redundancies and (b) a critical analysis of the financial arrangements that are contemplated to reduce the social cost of such large-scale labour redundancies. We deal with each of these issues in turn. (a) Estimates of labour redundancies Though it is generally expressed that PSEs are overmanned, no precise estimate of the extent of overmanning, especially at a specific enterprise level, exists.11 However, the Department of Public Enterprises has identified nearly fifty-four central PSEs out of a possible 246 as being chronically sick.12 (A complete list of these enterprises appears in Appendix 1 to this paper.) If all these enterprises are closed down there will be a fall in employment of around 14 per cent (Table 10.3). Table 10.3 Employment consequences of closure of chronically sick PSEs (as at 31 March 1991).

In order to understand the relative size of this possible retrenchment, one should have some idea about the rate of growth of employment in the organized manufacturing sector during the 1980s. In fact after growing at a rate of 1.4 per cent per annum during the period 1973–4 to 1979–80, the rate of growth of employment declined significantly, to –0.6 per cent 198

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per annum during the 1980s.13 So the retrenchment in PSEs is taking place in the context of a fall in employment opportunities in the organized manufacturing sector in general. Most of those retrenchments which have been taking place have been through the Voluntary Retirement Scheme (VRS). This method of retrenching workers has an unintended effect, in that many of the senior and best-qualified workers and officers of the PSEs were making use of the scheme and then joining competitors in the private sector.14 In short, a haphazard retrenchment policy has led to the existing PSEs losing their most technically qualified personnel. So at the end of the day, a situation is going to emerge where the VRS is utilized by the technically qualified personnel to look for greener pastures elsewhere in the private sector, while the public sector will continue to be saddled with those very employees who should, arguably, be the actual target of this exercise. In view of the severe unemployment,15 those who are not that qualified and who might be affected are likely to swell the stock of unemployed persons. (b) Fiscal Implications of labour shedding In order to mitigate the sufferings of those workers who are likely to be adversely affected by privatization, the government has introduced a social safety net, popularly known as the National Renewal Fund (NRF). The fund, which was officially launched on 2 February 1992, is to be financed through plan grants from the union budget, sale proceeds from the divestment of PSE shares, and loans from the World Bank and from bilateral agencies. The size of this fund has been variously discussed; a sum of Rs.20,000 million is the usually cited figure. The union budget included a provision of Rs.8,297 million in 1992–3, and the budgeted estimate for 1993–4 was Rs.7,000 million.16 The NRF has three segments,17 namely, the employment generation fund, which will provide resources for employment generation schemes in both the organized and unorganized sectors; the national renewal grant fund, which will deal with payments under the VRS and compensation to workers affected by closure/rationalization resulting from approved rehabilitation schemes in both the public and private sector enterprises; and the insurance fund for employees, which will cater for their compensation needs in future. So the NRF is supposed to be used for compensating affected labourers in both the public and private sectors, though increasingly it is used only for implementing the VRSs of central PSEs. In fact we will try to show that even for this purpose it is grossly inadequate. This exercise is, admittedly, based on a number of assumptions. According to the government, approximately 300,000 employees of the central PSEs are considered to be redundant. At an average of Rs.250,00018 per employee in compensation, the central government will have to find at least Rs.75,000 million for this purpose in the next two or three years, whereas the size of the NRF is only about Rs.20,000 million, around a quarter of this requirement. It must be added that the 199


requirement for VRS alone is Rs.75,000 million, and that financial resources will also have to be found for the other payments contemplated in the NRF. This shows that the NRF is grossly inadequate as an effective social safety net. It is thus clear that, despite statements to the contrary, the privatization programme will have serious employment consequences. The second distributional impact of divestiture per se is that in the case of India, all the enterprises which are offered for divestment, and where the process has been completed, are profit-making ones (Table 10.4); the loss-making ones have remained within the public sector fold. Table 10.4 List of PSEs offered for divestment (as at 31 March 1992)

Source: Government of India (1991–2:37).

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The technique and process of privatization In India, the privatization that has been actually effected has mainly been by selling a portion of the equity to mutual funds. Hitherto, no sales in any significant manner have been made to the public at large. Hence, so far, privatization has not led to wider share ownership.19 Use of divestiture proceeds From the point of view of distributional implications, there are two issues with respect to divestiture proceeds that need to be discussed. The first concerns the actual size of the divestiture proceeds, and the second concerns the actual use of these proceeds. The former issue, namely the size of the proceeds, is important because it is generally noted that the size of the proceeds is less than should have been the case, due to the low prices at which the divestments have been effected. The latter issue, of course, has very direct distributional implications. As noted before, the process of divestment of public sector equity commenced in 1991–2, and so far there have been four tranches of divestment (Table 10.1), namely two each in 1991–2 and 1992–3. At the time of writing, no divestment had taken place in 1993–4. In the first two tranches the sales were exclusively to public financial institutions, while from the third tranche onwards, shares were sold to private individuals also. It has now become clear that the price at which the sales were effected in the first two tranches resulted in the government losing substantial amounts of potential revenue, while it was a gain for the public financial institutions which purchased the stock. The Comptroller and Auditor General (CAG) in one of its recent reports (Report No. 14 of 1993) has worked out the extent of loss to the government on this account. The extent of loss to the government in respect of the sale of equity in ten leading PSEs is presented in Table 10.5. The extent of loss to the government consequent to the underpricing of PSE shares has thus varied from 127 per cent to 616 per cent, and on an average the loss has been about 256 per cent. If we apply this percentage to divestiture proceeds of 1991–2 (given in Table 10.1), then potential proceeds would have been Rs.77,773 million, as against the Rs.30,380 million which have actually been obtained.20 The second issue concerning the use to which the proceeds of divestiture are put is that they can be used for various projects such as target-oriented anti-poverty programmes which have direct distributional consequences. It should of course be noted that in 1992–3 the actual divestiture proceeds (of Rs.18,660 million) had fallen short of the budget estimates (Rs.35,000 million) by as much as 47 per cent. Second, the divestiture proceeds, which are a capital receipt, are being used to finance shortfalls in revenue receipts.21 To that extent, this way of using the proceeds can have favourable distributional consequences, as some of the revenue receipts like indirect taxes (excise duty, 201


Table 10.5 The extent of loss to the government on account of PSE share divestment

Source: Government of India (1992a: Annexure III). Notes: 1. The loss has been worked by deducting the lowest of closing price on 30.10.92 or average of 52nd week from the average price at which shares have been actually sold. 2. Figures in brackets indicate the loss to the government in percentage terms.

for instance) need not be raised: indirect taxes are normally regressive. Finally, some of the items of revenue expenditure like subsidies and on social services (like education, health, etc.) can be maintained or may be marginally increased to the extent of divestiture proceeds. Needless to add, there is an important trade-off: by divesting government’s equity in profitable enterprises and using the proceeds for current consumption needs, the government has forgone future yields from these enterprises. Given the fact that the pricing has not been done ‘properly’, the proceeds have been much less than the discounted value of future after-tax yields. CONCLUDING REMARKS The privatization process in India has been predominantly of the divestment variety. We have examined the distributional implications of this process, namely its potential short-term effects, under three heads: divestiture per se, the technique and process of privatization, and finally the use of sale proceeds. As far as divestiture per se is concerned, we saw that the distributional impact is in terms of reductions in employment and wage incomes. However, the people affected are all in the middle-income category. Second, the government has used the sale proceeds essentially to bridge the fiscal deficit. The divestment programme is likely to have important long-run effects which we have not been able to examine in the present paper. The government has privatized only the profit-making enterprises, whose future earnings it has therefore forgone. 202

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APPENDIX 10.1 Table 10.6 Chronically sick PSEs under SICA, as at 31 March 1991

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Table 10.6 continued

Source: Column 2: Government of India (1991–2:35–6). Columns 3 to 5: Government of India (1990–1).

NOTES 1 Union budget for the year 1993–4 envisages drastic reduction in governmental grants to Indian Institutes of Technology (the IITs) and the Indian Institutes of Management (the IIMs), and to higher education generally. 2 See, for instance, Narayana, D. (1992) ‘Directed credit programmes: a critique of the Narsimhan Committee report’, Economic and Political Weekly, vol. XXVII, no. 6, pp. 257–8. 3 There are of course exceptions, like the government of Andhra Pradesh state, which has actually sold some of its enterprises to the private sector. For instance the Hyderabad-based light-engineering company Hyderabad Allwyn has been broken up into several units depending upon their product line, and each product line sold off to a private party. Some of the other states, like Kerala, have expressed their desire to sell off certain PSEs under their ownership. But hitherto no privatizations have actually taken place. 4 See, for instance, Jalan (1992). That PSEs are indeed a drag on the budget has been disproved empirically in a detailed exercise measuring the macroeconomic impact of the operations of PSEs. See Nagaraj (1993a:105–9). 5 See Government of India (1993:18–19). 6 See for instance Ramanadham (1991:404–20). 7 Seth (1989:29–43). 8 Ramanadham (1991:404). 9 Seth (1989). 10 Schwartz and Lopes (1993:14–16). 11 According to the Economic Adviser to DPE, only guestimates are available. 12 See for instance, Government of India ‘Monograph on the Performance Status of Central 204

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Public Sector Enterprises’, vols I and II, Department of Public Enterprises, Ministry of Industry, 1992. 13 Nagaraj (1993b). 14 See, for instance, Setalvad (1992:97–100). 15 The number of applicants on the live registers of employment exchanges, which is a good proxy for the number of unemployed persons, at the end of August 1992 was 37.12 million. See Government of India (1992–3:214). 16 See Government of India (1993–4) Expenditure Budget 1993–94, vol. 2, p. 120. 17 Assocham Parliamentary Digest, no. 19, 24–7–1992 to 31–7–1992, p. 985. 18 This is the average based on the official package for a retiring worker from a central PSE. However, depending on the financial health of the companies concerned, workmen are likely to receive significantly different amounts. For example, workmen from sick units have accepted Rs.150,000 and those in the textile industry, just Rs.75,000. At the other end of the spectrum, a general manager of Damodar Cements recently received a VRS package of Rs.700,000 when he opted to quit the company. See for instance Setalvad (1992:97). 19 In the UK privatization programme, an explicit objective was to widen the share ownership. Especially in the third phase of privatization, between 1987 and 1991, which included the sales of the water and electricity industries, the divestment was targeted at small investors. The privatization process successfully created many new shareholders. 20 In fact it should be mentioned here that the central government had appointed a committee under the chairmanship of the present RBI governor, Professor C. Rangarajan, known as the Committee on Disinvestment of Shares in Public Sector Enterprises to look into the various aspects of divestment policy. The committee submitted its report to government on 20 April 1993. The major recommendations of the committee relate to: (a) limits of equity to be divested, which according to it should be under 49 per cent in most cases and 74 per cent in exceptional cases; (b) the criteria for value of shares, which according to the committee should be the discounted cash flow method; (c) the preparatory steps that should be adopted prior to divestment, like restructuring; (d) the modus operandi of divestment, which in normal cases should be the fixed price method; and (e) the desirability of having a standing committee on divestment to recommend enterprise-specific action for reforms, restructuring and divestment, as well as monitoring and evaluating the process of implementation. It is not yet known whether all or some of these measures have been implemented. 21 This is because the capital budget usually has a surplus, while the revenue budget is usually in a deficit, in the Indian context.

REFERENCES Assocham Parliamentary Digest, various issues. Bishop, M. and Kay, J. (1989) Does Privatization Work? Lessons from the UK, London: London Business School. Government of India (1990–1) Public Enterprise Survey, vol. 2, New Delhi: Department of Public Enterprises, Ministry of Industry. —— (1991–2) Annual Report, New Delhi: Department of Public Enterprises, Ministry of Industry. 205


—— (1992a) Report No. 14 of 1992, New Delhi: Comptroller and Auditor General. —— (1992b) Monograph on the Performance States of Central Public Sector Enterprises, vols I & II, New Delhi: Department of Public Enterprises, Ministry of Industry. —— ( 1992–3 ) Economic Survey, New Delhi: Economic Division, Ministry of Finance. —— (1993) Economic Reforms, Two Years After and the Task Ahead, discussion paper, New Delhi: Department of Economic Affairs, Ministry of Finance. Jalan, B. (ed.) (1992) The Indian Economy, Problems and Prospects, New Delhi: Viking. Kay, J. and Thompson, D. (1986) ‘Privatization: a policy in search for a rationale’, Economic Journal, vol. 96. Nagaraj, R. (1993a) ‘The macroeconomic impacts of PSEs’, Economic and Political Weekly, 16–23 January, pp. 105–9. —— (1993b) Employment and Wages in Manufacturing Industries in India, Trends, Hypotheses and Evidence, Bombay: Indira Gandhi Institute of Development Research (mimeo). Ng, Y.C. and Toh, K.W. (1992) ‘Privatization in the Asian-Pacific region’, Asian Pacific Economic Literature, no. 2, pp. 42–68. Ramanadham, V.V. (1991) The Economics of Public Enterprise, London: Routledge. Schwartz, G. and Lopes, P.S. (1993) ‘Privatization: expectations, trade-offs, and results’, Finance and Development, June, pp. 14–17. Setalvad, T. (1992) ‘Public sector: the manpower mess’, Business India, 28 September— 11 October, pp. 97–100. Seth, R. (1989) ‘Distributional issues in privatization’, Federal Reserve Bank of New York Quarterly Review, Summer, pp. 29–43. Vickers, J. and Yarrow, G. (1988) Privatization: An Economic Analysis, Cambridge, MA: MIT Press.

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11 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY IN NIGERIA J.J.Bala This paper is divided into three main parts. The first provides a brief historical background to the privatization programme in Nigeria, and later explains the goals, objectives and scope of the programme. The second is concerned with the implementation of the privatization and commercialization programme in Nigeria, from 1988 to 1992. The third focuses on the impact of privatization on distributional equity. This is the main concern of the paper, which examines the allotment of shares of privatized enterprises to various categories of shareholders—individuals, institutional bodies, the staffs of enterprises, state institutions, etc., and the implications for distributional equity. The final section provides a summary of the main issues raised in the paper and conclusions. BACKGROUND TO PRIVATIZATION IN NIGERIA As in most developing countries, public enterprises were established in almost every sector of the Nigerian economy, especially during the 1960s and 1970s, as a necessary means for achieving rapid national economic development. This occurred against a background of inadequate entrepreneurial skills, a shortage of investible capital, imperfect capital markets and a concern to preempt foreign control of the national economy. The establishment of public enterprises took a major dimension in the 1970s, when the Nigerian government had at its disposal enormous revenues from its oil sector. By the end of the 1970s there were more than 1,800 public enterprises in Nigeria, involved in such activities as banking and insurance; oil prospecting, exploration, refining and marketing; cement and paper plants; hotels and tourism; fertilizer plants and sugar estates; iron and steel, and motor assembly plants; rail, sea and air transportation; and so on, including public utilities to provide infrastructural services such as water, electricity, post and telegraph, etc., and statutory bodies concerned with education, research, libraries, etc. 207


The drastic fall in revenue from the oil sector, due mainly to the 1980s crash in the world price of oil, revealed the problems of the public sector, as there was no longer the money to support gross mismanagement and general inefficiency in the public enterprises. Moreover, over the years the public enterprise sector had developed huge organizations that drained government financial resources without meaningful returns to the treasury. For example, by October 1985 the federal government of Nigeria had invested a total sum of N23bn. in the public enterprise sector. In addition to this, N11.5bn. was recorded as subventions to various parastatals and companies. The government revealed that the total dividends received from this investment, during the period 1980 to October 1985, was N933.7m., averaging approximately N159m. per year. Thus, in real terms, the returns on investment were not more than 2 per cent. From the 1960s, various regimes in Nigeria appointed study groups to find solutions to the problems of the public enterprise sector. Some of the problems identified by such study groups included unclear or conflicting missions, political interference in operating decisions, misuse of monopoly powers, defective capital structures, bureaucratic red-tape in their relationships with supervisory ministries, and mismanagement, nepotism and corruption. Very little effort was made to deal with the problems of the public enterprise sector in the period before 1980. It was against this background, in 1988, that Nigeria’s federal military government embarked on the programme for the reform of public enterprises. This was part of the structural adjustment programme which had been introduced in 1986 to deal with the imbalances in the Nigerian economy. THE NIGERIAN PRIVATIZATION AND COMMERCIALIZATION PROGRAMME In July 1988 the Nigerian government promulgated the Privatization and Commercialization Decree No. 25: (a) to improve the efficiency of parastatals through better role definition between the supervising ministry and the public enterprises; (b) to reduce the dependency of public enterprises on the treasury for the funding of their operations; and (c) to increase the participation of Nigerians in economic activity through share ownership of productive investments. The decree identified a total of 110 enterprises to be privatized fully or partially, and another thirty-five enterprises to be wholly or partially commercialized— see Tables 11.1 and 11.2. Furthermore, it provided for the establishment of the Technical Committee on Privatization and Commercialization (TCPC), vesting in it wide powers for implementing the programme for the reform of enterprises.1 The decree had major sections concerned with achieving a wide 208

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spread in the allocation of shares. The seventh section of the decree stipulates in subsection 2 that: Not less than 10 per cent, and not more than 20 per cent of total shares on offer shall be allotted to associations and interest group such as, but not limited to, State Investment agencies, workers, trade unions, market women organizations, universities, friendly societies, local and community associations; provided that in the case of an over-subscription, not more than 1 per cent of the shares on offer shall be allotted to each State through its investment agency. The remainder of shares not distributed in accordance with subsection 2 of this section shall be sold to the public in such manner and such amount as may be determined by the Allotment Committee of the Securities and Exchange Commission approved by the Federal Government. The allotment of shares under sub-section 2 of this section shall give priority to subscription by workers and management, as well as non-management of the particular enterprises to be privatized. Not more than 10 per cent of the shares on offer shall be reserved for the staff of the company. In the case of over-subscription, no individual shall be allowed to hold more than 1 per cent equity in any one enterprise. The above sections of the decree made the issue on distributional equity an important aspect of the Nigerian privatization programme. This is due partly to the highly political nature of the programme. Given the geopolitical conglomeration of forces in Nigeria, and the high level of importance that the various geopolitical groups attach to equal distribution of resources, the privatization programme has had to be a political programme, as much as an economic policy. PRIVATIZATION IN NIGERIA—IMPLEMENTATION The first task of the TCPC was the establishment of a Secretariat to ensure a proper and speedy implementation of the privatization programme. Members of the TCPC realized the necessity for establishing it outside the civil service structure, for a number of reasons: (a) it was deemed unreasonable to expect civil servants doggedly to implement a policy—privatization—which was to reduce their powers and prestige; (b) the type of manpower needed for implementing privatization did not exist in the civil service; and (c) it was necessary to provide conditions of service that could attract and retain people with a background in business, banking, finance, etc. 209


The chairman of the TCPC reports directly to the President of Nigeria, giving the TCPC the necessary political muscle with which to ensure speedy and effective implementation of the privatization programme. In order to accelerate the process of implementation, the TCPC adopted a multiple approach, as follows: (a) sub-committees, which are made up of knowledgeable and technically qualified persons, undertake diagnostic work on enterprises; (b) a technical advisory group, consisting of respected financial institutions, leads teams of experts who undertake detailed technical, financial, organizational and management appraisal of enterprises; (c) financial advisers, usually merchant banks or reputable accounting firms, prepare detailed briefs on capital restructuring for affected enterprises; (d) professional staff in the TCPC Secretariat are assigned simple cases of diagnostic work with which to prepare information memoranda. In all cases, the TCPC developed specific guidelines to ensure uniformity and comprehensiveness in the work of the sub-committees, as well as other bodies that were instituted for implementation of the privatization programme. The recommendations of the various sub-committees provided the basis for the five methods adopted by the TCPC in privatizing enterprises: (a) Public offer for sale of shares The Nigerian capital market has been the medium through which enterprises have been privatized through the method of public offer for sale. The authority for share price determination for public offers in Nigeria is vested in the Securities and Exchange Commission (SEC) by section 6 of the Securities and Exchange Decree No. 29 of 1988. The Allotment Committee of the SEC is to determine all allotments based on the guidelines in the Privatization Decree. In practice, the SEC, the TCPC and the issuing houses for each offer perform these functions, for approval by the federal government. Enterprises are privatized through the public offer method if they qualify for listing on the Nigerian Stock Exchange. Over 1.5 billion shares were sold to Nigerian citizens and corporate bodies through this method of privatization. (b) Private placement Private placement of shares of the affected enterprises occurs in cases where the government’s holding is small, and the TCPC is unable to persuade the majority shareholder(s) to accept the public offer of the government’s shares in the enterprise. This method of privatization has also been used in cases where the full potential of an enterprise is yet to be realized, and the enterprise needs to be nurtured for a few more years. In all, seven enterprises have been privatized through this method. (c) Sale of assets The sale-of-assets method occurs in cases where the affected enterprises cannot be privatized either by public offer of shares or by private placement of shares. That is, it is not possible to privatize an 210

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enterprise as a going concern, either because of a poor track record, or because its future outlook is considered hopeless. Such enterprises are normally liquidated and their assets sold piecemeal through public tender. A total of twenty-six enterprises have been privatized in this way. Eighteen of these enterprises were privatized before the establishment of the TCPC. (d) Management buy-out Under this method, the entire enterprise, or a substantial part of the equity, is sold to the workers of the enterprise. When an enterprise is so privatized, it is the sole responsibility of the workers in the enterprise to organize themselves and manage the enterprise. Only one enterprise has been privatized by a management buy-out. (e) Deferred public offer This method of privatization has been used for enterprises that are considered viable, but which would not yield revenue reflecting the real value of underlying assets if sold by flotation of shares. Thus a willing buyer/seller price (based on a revaluation of underlying assets) is negotiated, and the sales agreement stipulates that 40 per cent of the equity is to be sold to the Nigerian public within five years of the takeover. All the four hotels under the privatization programme were sold through deferred public offer. Public offer for sale of shares is the predominant method by which privatization has been undertaken in Nigeria. However, a number of enterprises were liquidated, and their assets sold to the public. The assets of eighteen enterprises were so privatized before the establishment of the TCPC, by the Federal Ministry of Agriculture (FMA) and the Federal Ministry of Transportation (FMT). The non-water assets of river basin development authorities (RBDAs), consisting of over 200 projects worth millions of naira, were privatized by the TCPC through assets sales. These assets included farmlands, rice mills, fish farms, combine harvesters, heavy machinery, office and residential buildings, etc. The asset sales undertaken before the establishment of the TCPC provoked a considerable public outcry and serious debate over privatization. Critics argued that privatization, as was then implemented, would make for the concentration of wealth in the hands of a few people. There was also the argument that, given the huge investment made by government in the public sector, it was unfair to sell public enterprises to a few individuals (Ezenwe 1988). It was against this background of controversy that the TCPC decided to adopt the public offer for sale of shares as the principal method of privatization, and to develop specific guidelines for the sale of assets. With TCPC, assets were offered for sale to various groups, in the following order of priority: (a) to the staff of the affected RBDA or project, either individually or as a group; 211


(b) to co-operative societies, development associations or any other interest group within the catchment area in which the project for sale was located; (c) to organizations (public or private), communities or individuals engaged in, or likely to engage in, business similar to the project or requiring the use of the assets of the project in question; (d) to local government councils of the catchment area where the project is located; (e) to state investment institutions in the catchment area of the project; (f) to other interested persons or corporate bodies in the country. In general, preference was given to tenderers around the area in which the projects were located, especially those who would operate the projects as going concerns. The assets of a total of 216 projects, worth N216,704,241, were recommended for sale by the TCPC sub-committees for sale of non-water assets of RBDAs. By December 1992, N61 million had been realized from sales of assets by the TCPC. All the funds realized from sales have been allocated to respective RBDAs for the refurbishment of plant, machinery and other capital projects for the irrigation services they provide. Apart from the RBDA projects, the TCPC sold the assets of seven companies for a total sum of N211,520,425. Part of the proceeds from the sale of these compenies has been used to settle staff termination benefits, trade creditors, bank loans, expenses for sales, etc. Details on the sale of assets of these companies are as provided in Table 11.3. The TCPC emphasized public offer for sale as the main method for privatization, so as to achieve the government’s objective of widespread distribution of shareholding in privatized enterprises. From the outset, the TCPC gave serious consideration to the merits and de-merits of privatization through the capital market. In Nigeria, the major disadvantages of using the capital markets are: (a) Given the low level of literacy, the cumbersome formalities of prospectuses, multiplicity of professionals and complicated forms that have to be returned through few banks and stockbrokers, a substantial percentage of the population could find the procedure of investment in shares unattractive. (b) The public offer for sale of shares could reinforce the existing geopolitical imbalance in the country arising from an unequal distribution of income, education, and banking and stock exchange facilities. For example, of 2,200 branches of banks and stockbroking companies in Nigeria (as at 31 December 1989) nearly 300 branches were based in Lagos. This could give people in Lagos an undue advantage in terms of access to information and finance with which to buy shares. On the other hand, the capital market has the following merits: (a) In contrast to other methods for privatization, the public offer enables a 212

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broader audience to participate in the privatization process. Furthermore, it provides a more objective mechanism for the distribution of shares, without suspicion of favouritism. (b) If the process was properly publicized, it could create a large crop of shareholders with a vested interest in ensuring that the privatized enterprises are managed profitably. This would ensure higher levels of accountability and checks on management. Moreover, the creation of a large crop of shareholders through the stock market could serve as a bulwark against future renationalization. (c) The potential existed for developing the stock market as a medium of investment by small shareholders, thereby creating democratic or popular capitalism. (d) The method ensures that enterprises are privatized as going concerns, thereby facilitating future developments in the enterprises, and ensuring expansion in employment and productivity. The necessity for creating public awareness so as to dispel certain misconceptions and fears about the privatization programme, as well as educating the populace on the benefits of investment in shares, was recognized at the inception of the TCPC. Public enlightenment was considered very important for promoting a widespread distribution of shareholding. Therefore, an intensive publicity and public-enlightenment programme was mounted to enable the TCPC to reach the populace. Apart from campaigns on radio, considered the most effective medium of communication, publicity was undertaken through newspapers, television, seminars, conferences, workshop, etc. A nationwide tour was conducted by members of the TCPC to meet opinion leaders, especially members of the business community, to explain the rationale for the privatization programme and to solicit their support. The tour also enabled members of the TCPC to inspect enterprises under the privatization programme, and to hold discussions with board members and management. In addition to public enlightenment, the TCPC advised that government request the Central Bank of Nigeria to extend credits to all persons interested in buying privatized shares. However, the banking system has not responded favourably to this request, for operational reasons. Employers of labour have also been advised to assist their employees with loans for the purchase of shares; the response here has been most encouraging. To promote the objective of widespread ownership of shares, between 200,000 and 600,000 copies of application forms for shares are printed and circulated across the country. This is despite the fact that no public issue of shares in Nigeria, before the privatization programme, had attracted even up to 100,000 applications. Application forms are distributed throughout the 489 local government offices in the country, post offices and state investment companies. The normal channels of banks and stockbroking firms have been 213


used for the collection of the completed application forms and relevant sums of money, for onward submission to the main issuing house for an offer. IMPACT OF THE NIGERIAN PRIVATIZATION PROGRAMME The Nigerian privatization programme may perhaps be the only component of the structural adjustment programme which has achieved a high level of success in achieving its stated objectives. In the four years since the TCPC began programme implementation, work has been successfully completed on the following: Enterprises privatized through public offer of shares Enterprises privatized through deferred public offer method Enterprises privatized through sale of assets method Enterprises privatized through private placement method Enterprises privatized through management buy-out method Enterprises privatized by FMA and FMT before the establishment of the TCPC in 1988 Enterprises in which no further privatization action is necessary Total number of enterprises privatized to date Enterprises yet to be privatized Total number of affected enterprises

35 4 8 7 1 18 11 89 22 110

So far, the privatization exercise has generated over N3.3bn. in privatization revenue. According to the records of the Federal Ministry of Finance, the original value of the investment by government in the enterprises that have been privatized was N652m. This means the government has realized a capital gain of over N2.6bn (without taking account of inflaction. Four years after implementation, there is no doubt that the TCPC has achieved a modest level of success. The thoroughness of the exercise and the transparency of implementation have been hallmarks of its success. However, the concern with implementation has left little time for a vigorous evaluation of the exercise. Such an evaluation would provide a clear understanding of the various ramifications of the privatization programme, such as the impact of privatization on efficiency, 214

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government’s budgetary allocations, level of employment/unemployment, tax structure, price structure, etc. It is for this reason that a Department for Research and Publications was established in the TCPC at the beginning of 1993. A better understanding of the whole programme will emerge when the results of research programmes in the Department become available. However, there remain a number of issues that can be raised on the impact of privatization, at this point. The programme of privatization and commercialization has contributed to reducing budgetary deficits, by relieving the government of what was a huge and growing burden of financing the investment needs and operating deficits of the public enterprise sector. Although there are no concrete figures (at present) to support this position, we reckon that the government has made savings of billions of naira annually, by the reduction or (in some cases) virtual elimination of budgetary allocation to public enterprises. From the 1986 fiscal year, subventions to public enterprises were either eliminated or fixed at 50 per cent of their 1985 levels. Enterprises were expected to approach the financial market for credits, or to increase prices, charges and other tariffs, as part of their commercialization plan. It has been estimated that by the time the public enterprise reform is fully in place, the total annual savings in subventions will be in excess of N5bn. Moreover, by reducing the reliance of public enterprises on government for finances, the privatization programme has introduced a spirit of competition and entrepreneurship in public enterprise managers. It is now common for public enterprise managers to approach the capital market for money to finance capital projects. For example, Ashaka and Benue Cement Companies have been able to raise N290m. to finace plant optimization programmes. NITEL (Nigeria’s sole telecommunications company) is to finance capital projects worth over N3bn. from an internally generated fund. This was unheard of in the pre-privatization period. A number of public utilities like NITEL and NEPA have become financially solvent and have begun to record substantial operating surpluses. Therefore, it is not premature to say that the financial autonomy and freedom from interference in day-to-day management of enterprises has contributed in improving internal efficiency—specifically, allocative efficiency in privatized enterprises. The flotation of the shares of privatized enterprises has also stimulated the rapid growth of the Nigerian capital market. At the inception of the privatization programme, a number of international finance institutions expressed serious doubts on the absorptive capacity of the Nigerian capital market. So far, most of the enterprises privatized through the capital market have been oversubscribed. For example, the return rate on applications for the flotation of African Petroleum Plc was 23.4 per cent as against the usual rate of return of 4.6 per cent on similar flotations. A total number of 110,970,930 shares were applied for, as against the 17,280,000 shares on offer—N210,844,771 was received from applicants, 6.42 times the value of the shares under offer. Market capitalization in the Nigerian Stock Exchange had grown from N8bn. in 1988 (when the privatization programme began) to over N32bn. by November 1992. There is no doubt that 215


the privatization programme has made a substantial impact on the development of a capital market. IMPACT OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY Privatization has massively expanded personal share ownership in Nigeria. The TCPC has introduced over 800,000 new shareholders in the Nigerian Stock Exchange. The importance of this will be fully appreciated when one realizes that the new shareholders represent twice as many shareholders as there were in 1988, when the privatization programme started. The programme has also demystified the operations of the capital market, creating a new awareness of the virtue of holding shares as a form of saving. Despite the important role of privatization in expanding shareholding, it is pertinent to ask whether implementation of the programme has made for a fair geopolitical distribution of shareholding, as stipulated in the Privatization Decree. Distribution of shares in privatized firms We have noted that the Privatization Decree provided clear guidelines on the distribution of shareholding. The question to ask at this juncture is, to what extent has implementation of the guidelines ensured an even distribution of shares to the various social and geopolitical groups in the country? The allocation of the shares of twenty-seven privatized enterprises to individuals, institutional investors, friendly societies, staff and state institutions will be used to illuminate the issues raised by this question. Table 11.4 provides the percentage distribution of shares of privatized enterprises to this category of shareholders. A total average of 49.87 per cent of shares (almost half of the shares on offer) were allotted to individual investors. The total average allotment of shares to institutional investors, friendly societies and staff was 17.40 per cent, 8.78 per cent, and 8.75 per cent respectively. When the allotment to individual investors in each enterprise is examined, it is clear that a very high percentage of the shares on each offer were allotted to individuals. This ranges from 74.23 per cent, in Flour Mills of Nigeria Plc, to 25.01 per cent, in Guinea Insurance Company. The percentages of allotments to individuals in insurance companies were generally high. There was a joint flotation of the shares of all insurance companies in December 1989. Given the unfavourable climate for investment in shares during the month of December,2 the shares of the insurance companies were undersubscribed. As such, the unsubscribed shares were warehoused with stockbrokers who sold them on the stock market, outside the guidelines for allotment of shares by the TCPC. This explains the high percentage of allotment to institutional investors in insurance companies. Apart from the case of the insurance companies, however, the percentage 216

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allotment to institutional investors has ranged from 18.63 per cent in Benue Cement to 0.40 per cent in National Salt Co. of Nigeria Ltd. There has been a similar range of allotments to friendly societies in non-insurance companies. Table 11.4 shows that there have been disproportionately high percentages of allotments to institutional shareholders, especially state institutions, in banks that have been privatized. It is necessary to give an explanation for this. In November 1993, the Nigerian government directed the TCPC to sell its shares in thirteen banks, and gave guidelines for the allocation of the shares. The guidelines stipulated that: (a) Ten per cent of the shares on offer were to be allotted to the staff of affected banks, provided that where the staff already owned shares, the maximum they would own post-privatization will be not more than 10 per cent of the paid-up capital of the bank. (b) Ten per cent of the shares on offer would be allotted to interest groups in accordance with section 7 (2) of the Privatization Decree. (c) The remaining 80 per cent would be allotted to individuals in states (regional subdivisions of the country) on the basis of equality as reflected by senatorial (electoral) districts. In practical terms, this would mean dividing the 80 per cent into ninety-one portions, with each of the thirty states in the country allotted three portions and Abuja (the Federal Capital Territory) allotted one portion. The implication of the above guidelines is that the shares of the banks to be privatized are allotted to states, a priori, even where investors in those states are not immediately available. Thus, allotment results show oversubscription in some states, while in other states there are undersubscriptions—see Table 11.5. The government investment companies in states where there is undersubscription must pay for the unsubscribed shares, and sell them to individuals (in the same states) at a later date. It is this mopping-up of unsubscribed shares by state investment companies that made for high percentages of allotment to state institutions with the privatization of Savannah Bank Plc (79.12 per cent), Union Bank Plc (97.12 per cent), Afribank Plc (89.01 per cent), and International Merchant Bank Plc (79.12 per cent). Although allotment of shares through the privatization of banks has the potential for achieving a geopolitical spread in the distribution of shareholdings, in the mean time it has resulted in state ownership at the regional level. If state governments fail to sell the shares they have acquired, the procedure for privatization of federal government investments may merely lead to state ownership at the regional level of government. Another issue of interest is the pattern of allotments to individual investors, to determine whether allotments are skewed to small shareholders, or large shareholders. The allotment of shares in Flour Mills of Nigeria Plc (FMN) will be used for this purpose. The FMN offer was the first under the privatization programme, and it has the highest percentage of allotment to individual investors. 217


The government divested its shareholding of 6.9 million shares in FMN, and 86.06 per cent of the shares were allotted to the public—74.23 per cent to individual investors and 11.83 per cent to institutional investors. Table 11.6 shows that 74.95 per cent of the shares in the offer were allotted to individual investors within the lowest range of shareholding (200–1,500), while the other individual investors, within the range 1,600 to 200,000 and above, had a total allotment of 11.70 per cent of the FMN shares. This bias in allotment to small shareholders is facilitated by the guideline, in the Privatization Decree, that no individual or institution should be allotted more than 1 per cent of the shares in any offer. In accordance with this guideline on allotments, the bias towards small shareholders is a general character of the distribution of shareholding under the Nigerian privatization programme. Clearly, a major implication of this is that most of the shares sold under the programme went to individual small shareholders. Taking note of the fact that an average 49.87 per cent of the total shares that were offered so far (under the privatization programme) went to individual investors, it is tenable to argue that, in general, there is an even distribution of shareholding under the Nigerian privatization programme. Foreign ownership in privatized enterprises and the Zonal Shareholders Association Although the Privatization Decree acknowledges that foreigners have a role to play in the privatization process in Nigeria, no provision was made for foreigners in the guidelines for allotment of shares, nor have any shares been allocated to foreigners under the privatization programme. However, foreigners held a substantial percentage of the equity of some privatized enterprises, in the preprivatization period. The allotment of a substantial percentage of shares to individual categories of investors, as discussed in the preceding section of the paper, has created a situation in which Nigerian shareholdings in privatized enterprises are fragmented, while foreigners continue to have substantial consolidated shareholdings. Table 11.7, which sets out the post-privatization structure of United Nigerian Insurance Company Plc, shows that no single Nigerian shareholder, including state institutions, holds even 4 per cent of the equity, although the total Nigerian shareholding is 60 per cent. Such an ownership structure facilitates the domination of board and management decisions by the minority foreign shareholders. After the first set of allotments under the privatization programme, the TCPC was confronted with the problem of how individual Nigerian shareholders can exercise their rights, especially concerning appointments to boards of privatized enterprises and ensuring equitable distribution of board membership, with the necessity for achieving an equitable geopolitical spread in shareholding. To solve these problems, the TCPC decided to promote the formation of an association to organize the fragmented individual shareholders, 218

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so as to put them in a position of greater effective control over their newly acquired companies. The Zonal Shareholders Association was established in 1991 with the following objectives: (a) to undertake the education and enlightenment of Nigerian shareholders and to stimulate their interest in the affairs of their companies; (b) to facilitate shareholders’ participation in corporate decision-making, through regular attendance at annual meetings; (c) to nominate their representatives to serve on the boards of directors of privatized companies; and (d) to facilitate easy access by individuals to information for the purpose of claiming their dividends and scrip share certificates. In order to ensure a geopolitical spread in board membership and nationwide participation in the affairs of the Shareholders Association, the country was divided into seven geographical zones, each of which is to have equal representation on boards of privatized enterprises. So far, more than 100 seats on the boards of privatized companies have been allotted to shareholders in the seven zonal associations. By the time the allotment of shares of privatized enterprises is completed, more than 300 board seats will have been taken over by the zonal associations. Representatives of the associations are already playing active roles on boards of privatized enterprises. On the whole, the formation of the Zonal Shareholders Association has served as an effective means for responding to the problems of fragmentation of Nigerian shareholding under the privatization programme. In the four years since the establishment of the TCPC, the Committee has completed work on most of the enterprises for privatization. We noted that the guidelines for privatization through sale of assets gave priority to the staff of enterprises and institutional buyers. The transparency with which the TCPC has implemented the guidelines on the sale of assets has ensured that there has been no public outcry, or protest against concentration of wealth in a few hands, as with asset sales before the establishment of the TCPC. Furthermore, the clearly defined guidelines on the distribution of shareholding and its effective implementation have made for the achievement of the major objective of the Nigerian privatization programme on equitable geopolitical spread of shareholding. As we have noted, an average of 49.87 per cent of shares allotted under the programme went to individual investors. Furthermore, most of the shares allotted to individual investors were purchased by small shareholders. The explicit policy of ensuring that no shareholder has more than 1 per cent of the shares under an offer has facilitated this spread of shareholding. To promote the further expansion of shareholding, 10 per cent of the shares on each offer have been allotted to the workers in privatized enterprises. On average, workers have bought 8.75 per cent of the shares offered so far, under the privatization programme. In sum, it could be argued that the allotment of shares under Nigeria’s privatization programme has facilitated the accommodation of the interest of 219


various socio-economic and geopolitical groups in the country. Yet, it is pertinent to ask whether privatization has made for an equitable distribution of income/wealth in Nigeria. Here, we must reckon with the fact that broad income and wealth inequalities, which have a regional dimension, existed in Nigeria before the privatization programme (see Rweyemamu 1980, and especially Ewusi 1980). Given the background of income and wealth inequalities, even the most equal distribution of shares is bound to have an adverse effect on the existing distribution of income and wealth. In developing countries like Nigeria, it is the category of people that already have a sizeable share of the nation’s income and wealth that can most easily afford to buy shares. Thus, for developing companies that seek to address the problem of income and wealth inequality, privatization must be built into policies that emphasize free education, industrialization, employment, better wages, rural development, public housing policy, etc. APPENDIX 11.1 Table 11.1 Privatization

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APPENDIX 11.2 Table 11.2 Commercialization

Notea The African Re-Insurance Corporation was inadvertently included in the decree, but as a multilateral institution, Nigeria cannot take unilateral action to reform the organization. This reduced to thirty-four the number of enterprises to be commercialized.

APPENDIX 11.3 Table 11.3 Sale of assets

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Table 11.4 Share distribution of some privatized firms in Nigeria

APPENDIX 11.4

Notes: a Average percentage figures for all firms other than the banks. b Shares warehouse to TCPC and later sold in the floor of NSE. c Allotment to the Flying Eagles. d Shares sold to Core Group Investors. e Allotment to individuals and corporate bodies combined. f Allotment to the Federal Capital Territory.


APPENDIX 11.5 Table 11.5 Summary of valid applications on Union Bank Plc offer, with shortfall or excess beyond 4,326,924 shares allotted to each state

APPENDIX 11.6 Table 11.6 FMNL Plc ordinary shares allotted to the general public

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APPENDIX 11.7 Table 11.7 Post-privatization shareholding structure of United Nigerian Insurance Company Limited

NOTES 1 Privatization involves the transfer of government ownership of shares/assets to private individuals, while commercialization makes for reorganization of public enterprises to enable them to operate as profit-making commercial ventures without government subventions. 2 December is usually a holiday season and most Nigerians engage in expenditure on consumption items.

REFERENCES Ewusi, Kwesi (1980) ‘Income distribution in English-speaking West Africa’, in J. Rweyemana, Industrialization and Income Distribution in Africa, Codestria Dakar. Ezenwe, Uka (1987) ‘Nigeria: The Limits of Privatization in a Developing Economy’. Paper presented at a Seminar of the Nigerian Economic Society, Lagos.

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12 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY The Chilean case, 1985–9 Cristián Larroulet INTRODUCTION Following several decades of a closed economic strategy with a high degree of state intervention, in the mid-1970s Chile undertook a new economic development strategy, based on free markets and an open economy. One of the key aspects of this policy was the privatization of state-owned companies, which ushered in a wave of private-sector participation in the economy. Within a period of five years—from 1974 to 1978—approximately 600 companies were privatized. Simultaneously, an open economy was established and conditions were created which were conducive to the active participation of the market and private enterprise in the allocation of resources. These policies resulted in a substantial level of growth, and the world spoke of the ‘Chilean miracle’. Nevertheless, in the early 1980s, Chile’s economy suffered a reversal in the face of a strong recession, and the state once again intervened in a significant portion of the nation’s productive and financial activities. This paper analyses a set of policies implemented to overcome the recession: the privatizations realized between 1985 and 1989 and their effects on employment and the distribution of income. Given that Chile engaged in its privatizations well ahead of other Latin American countries, the nation offers a case study which may shed useful light upon this important process, currently under way in a variety of developing nations in the Americas and around the world. This paper begins with an analysis of the general economic policies implemented during the 1985–9 period. Subsequently, specific privatization programmes and the strategies followed in their implementation are explored. The final section of the paper examines the impact of such privatization processes—including different aspects of the country’s development—and suggests some lessons that can be learned from the Chilean case. 226

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THE ECONOMIC PROGRAMME In early 1985, Chile’s economic situation remained difficult, despite the tireless efforts by government officials to implement policies aimed at accelerating growth. Unemployment affected 16 per cent of the workforce (or around 24 per cent, if those participating in special government programmes were counted among the unemployed.)1 Chile’s foreign debt was $19.48bn., representing 121.4 per cent of GDP.2 In order to confront these problems a so-called ‘structural adjustment’ programme was conceived, which consisted of three main elements. First, an effort was made to restore macroeconomic equilibrium, which would allow steady growth. This meant taking steps to eliminate the public deficit, stabilizing the balance of payments and devising a monetary policy compatible with the goals of reducing inflation and allowing for healthy growth. The results of the programme are shown in Table 12.1. By 1988 the public deficit had been practically eliminated, monetary expansion reacted to the growing demand for money, there was a significant accumulation of reserves, and the export:foreign debt ratio had returned to reasonable levels. Table 12.1 Data on the Chilean economy, 1984–9

Source: Central Bank of Chile.

Second, macroeconomic policies were adopted which were intended to allay fears among economic actors and to increase the efficiency of economic operations. In particular, free-market policies designed to foster Chile’s integration into the international market-place were introduced. Moreover, in 1985 a privatization programme was launched. Legislation was approved to set prices at efficient levels. The trend of improved export figures, shown in Table 12.2, is an indication of the good results of the policies. The third set of measures were long-term policies aimed at sustaining growth and a significant reduction in poverty. In particular, domestic savings had a boost, and there was a tax reform to correct the ‘anti-savings’ bias inherent in Chile’s income tax schedule.3 Table 12.3 shows the favourable results. 227


Table 12.2 Exports during 1983–9

Source: Central Bank of Chile.

Table 12.3 Savings, investment and employment, 1984–9

Source: Central Bank of Chile and National Institute of Statistics. Note: a Percentage variation in employment for October-December of each year.

Clearly, these policies were a success. The economy achieved sustained growth,4 inflation was brought under control, unemployment was reduced,5 and the social conditions of the poor improved.6 THE PRIVATIZATION PROGRAMME Table 12.4 illustrates the degree of involvement of the state in Chile’s economy, in 1985. Nearly 9 per cent of Chile’s GDP was accounted for by companies that lacked clear property rights, and 17 per cent of GDP was in sectors in which development was severely limited as a result of fiscal indebtedness.7 If we examine in greater detail the industries in which the state was directly or indirectly involved, it is clear that all of them required large capital contributions. Therefore privatization was an approach which was not only consistent with a free and open market economy, but was a central instrument for accelerated growth. Efforts were focused on moving towards developing a nation of property owners, in an effort to achieve greater social stability. 228

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Table 12.4 Involvement of the state in the economy (% of GDP)

Source: Based on J.C.Mendez (1981); C.Larroulet (1983); A.Foxley (1985); R.Lüders and D.Hachette (1991). Notes a Including state-owned companies created by law and subsidiaries of state holding organization, CORFO: 1981 figures. b Includes companies under state control after the 1982 crisis, known as the ‘odd sector’ as they were indirectly managed by the state, while being privately owned in strict legal terms. c The total aggregate value for state companies does not originate from the same Source as the remainder of the sector.

The goals were prioritized in different fashions within the three key areas of the programme which were introduced: privatization of banks and pension fund administrators in which the state had intervened; privatization of the ‘odd sector’ —companies indirectly controlled by the government; and privatization of traditional state-run firms. The financial sector As of December 1984, the banking system as a whole showed losses in its nonreserve supported assets in the order of 200 per cent of the capital plus reserves, or 18 per cent of GDP. Twenty-two institutions came under administration, or were shut down; this represented a reversal of the privatization process, in a sense. Nearly 68 per cent of pension funds were also subjected to state control. In the case of banks, privatization was part of a global policy which included the rehabilitation of the financial system.8 This was achieved by increasing capital through old and new shareholders, liquidating non-viable projects, and modifying legislation affecting the industry to avoid a recurrence of similar difficulties in the future.8 In the case of the two largest banks, new shares were issued at book value, which in essence were underwritten by individuals.9 In order to reconcile the real economic value of the newly issued shares with the placement price, and to diversify property ownership, very attractive purchase conditions were offered to the public. These stimuli consisted of long-term credits, a cash down payment requirement of just 5 per cent together with a 30 229


per cent discount on timely payments, as well as tax incentives. The system was open to people in compliance with their tax obligations. Acquisitions made in this fashion could never exceed 2 per cent of the shares tendered for sale, however.10 Implementation of this programme involved legislation and a substantial campaign aimed at placing shares among the public.11 Three years later, the banks were reprivatized. Their ownership had been divested and their creditworthiness had been recovered, as can be seen in Table 12.5. Table 12.5 Bank statistics, 1984–7

Source: Valenzuela, M. (1989) ‘Reprivatizacíon y Capitalismo Popular en Chile’, Revista de Esudios Püblicos, no. 33, summer.

In the case of the reprivatization of the pension fund administrators, an effort was made to spread ownership among a broad range of shareholders, while allowing for the participation of a single controlling stockholder. The goal was to ensure that contributors would participate in the ownership of the companies controlling the system, as well as to transfer management—as quickly as possible—to qualified groups, given the economic significance of these activities and the limited experience in Chile with a social security system base on individual capitalization. To distribute ownership, favourable credit conditions for small shareholders (provided that they were active or retired contributors to pension funds) were offered. Similarly, a number of shares allowing for corporate control were offered, which were acquired by foreign investors.12 In addition, nearly 14,000 ‘popular capitalism’ stockholders participated in these privatizations. The ‘odd sector’ companies The ‘odd sector’ came about as a result of the economic crisis and the government’s control of the country’s primary conglomerates. The companies included in this category accounted for a high proportion of GDP, as already mentioned, but additionally comprised an important portfolio of investment projects which were essentially oriented toward the export sector. Decisionmaking was restricted as a result of uncertainty over property rights to these companies: some were owned by investment societies which had failed to service 230

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the credits granted to them by requisitioned banks, while others were firms which had been unable to repay loans made to them directly. The executives assigned to these companies, for the most part, were experienced business and administrative managers selected by the government as temporary trustees, who were charged with overseeing daily corporate operations. Consequently, these executives were hesitant to make long-term decisions, an impairment which substantially hampered the operations of the affected companies, threatening their efficiency and impeding the recovery of the economy as a whole. As noted earlier, high priority was attached to the rapid recovery of the economy. Thus, in the case of these reprivatizations, resolving the problems of ownership and initiating divestment was considered decisive. To this end, a series of share packages were sold off through the stock market. As legal issues were resolved, packets were tendered for sale under normal—rather than special—conditions. Some thirty companies from different sectors were sold, being acquired, primarily, by local businessmen.13 Several of these companies have subsequently entered into investment agreements with foreign businessmen. Around $640m. was the market value involved in this privatization over a four-year period.14 State companies In this case, the general goals mentioned earlier were complemented with specific goals aimed at creating a wide variety of pension fund investment opportunities, obtaining resources for fiscal requirements, and enhancing the efficiency of state-run companies.15 Although each privatized company followed its own procedures, some general criteria were applied to the privatization process. During the first two years (1985 to 1986), CORFO and participating companies made an important effort to disseminate their economic results and capabilities.16 This was chiefly done through the specialized communications media and the offering of small packets of shares from the companies to be privatized on the stock market.17 Moreover, a majority of companies was initially authorized to divest 30 per cent of their stock. This amount was tendered primarily among company employees through the direct sale of shares (at the market price in effect as of the close of negotiations). Such sales were bolstered through a variety of creative mechanisms, such as allowing employees to make use of a significant portion of employer-guaranteed indemnities (retirement funds, etc.) to acquire shares. Workers received assurances that if, at the time of retirement, their shares were worth less than the purchase price, the company would make up the difference. In other cases, privatization took place through shares granted as bonuses or as part of a collective bargaining process. In 1985, pension funds were authorized to acquire shares of companies which, by virtue of their liquidity and profitability, had been selected by a Commission on Classification and Approval of Investments established in accordance with the new Chilean social security system. State companies were 231


included in the system if they had undergone privatization and diversification, and so long as they made at least 30 per cent of their shares available to AFPs for investment. The sale of shares to employees has been called ‘labour capitalism’, while the process of selling to pension funds has come to be known as ‘institutional capitalism’. Once the sale of the initial 30 per cent had been completed, the sale of packets of nearly 19 per cent of corporate capital commenced (sales were made in different combinations to employees, pension funds and small stockholders). At this stage, some groups of employees obtained direct loans from financial institutions in order to buy shares, the shares themselves serving as collateral. Subsequently, the full privatization of the companies was announced and the sale of larger share packets on the stock market ensued. At this point, acquisition by foreign investors gained increased relevance. Nonetheless, it is important to note that the level of participation by foreigners was only moderate, given the total volume of resources involved in the privatization process. Table 12.6 shows the participation of foreign investors in some of the more prominent sales. Table 12.6 Participation of foreign investors, up to 1988

Source: Larroulet, C. (1990) Seminar on Privatization, Warsaw: UNDP—Polish government, October.

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In 1989, the privatization programme was completed, marking the transfer to the private sector of approximately 14 per cent of GDP. This figure is particularly important when compared to similar processes undertaken in the West. For example, the British Conservative government, led by Margaret Thatcher, reduced the size of the state sector from 11.5 per cent to approximately 6.5 per cent of GDP.18 The most relevant aspect of the privatization process may well be in qualitative (rather than quantitative) terms, given the role played by key companies in the export and public utility industries in fostering the overall expansion of the economy. Nonetheless, it is useful to bear in mind that— notwithstanding the privatizations effected as of the mid-1970s and those conducted between 1985 to 1989 (as analysed in this paper), which encompassed a large number of state companies—the Chilean state sector remains quite large. State-run industries currently account for some 12 per cent of GDP in Chile, vastly more than the 6 per cent norm common in the developed nations of the Western world.19 IMPACT AND RESULTS OF PRIVATIZATION The impact of the privatization process in Chile was profound and generated a vast array of results. This section provides an overall review of some of the most important impacts on employment and on distribution of income. The impact on employment One of the most acute problems facing Chile in the wake of the foreign debt crisis was the nation’s exorbitantly high unemployment rate. Some observers ventured to suggest that privatization might well make the situation even worse. Unfortunately, memories were still fresh of the high unemployment rates which had coincided with the privatization efforts undertaken a decade earlier. In fact, quite the opposite occurred; companies increased their employment by 10 per cent after privatization, as illustrated in Table 12.7. The unemployment rate dropped from 15 per cent in 1985 to 6.5 per cent in 1990, the increase in employment in privatized companies being the result of both the overall headway achieved throughout the economy in those years and an escalation in investment by these firms. For example, in the case of the telecommunications industry, the increase in investment can be measured in a variety of ways, including the increase in urban services, as shown in Table 12.8. The results of the privatization process in the electrical industry also show a surge in investment. The data on Enersis, the Chilmetro holding company, indicate that during the three-year period preceding privatization, average annual investments totalled $13m., while for the period 1987–9 the average was some $33m. Data for Chilgener serve to confirm the trend, with an increase in 233


investment of 270 per cent over a similar time period, while investment by CAP, the steel company, for the period 1987–9 (following privatization) was 564 per cent higher than for 1984 to 1985. Furthermore, Soquimich, the privatized nitrate company, increased its annual level of investment by some 196 per cent. The global increase in investment is shown in Table 12.9. Table 12.7 Employment in privatized companiesa

Source: Based on Lüders, R. and Hachette, D. (1992) La Privatizatión en Chile, Panama: CINDE. Note: The annual average employment level for the two years preceding privatization was compared with that generated in a similar term once private capital in the companies accounted for 51 per cent.

Table 12.8 Growth in telecommunications servicea

Source: CTC Note: a The period between 1985 and 1987 precedes the privatization of the Compañía de Teléfonos. As of 1988, private participation was over 51 per cent.

Table 12.9 Gross domestic investment (% of GDP)

Source: Central Bank, Cuentas Nacionales y Dirección de Presupuestos.

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Impact on distribution of income Given the lack of concrete data on the impact of the privatization process on redistribution, it is simply not possible to analyse this topic in depth. Nonetheless, some initial conclusions as to the probable effects of this process can be drawn. In the case of banking privatization, the sale prices used were based on book value. However, this value was considerably higher than the corresponding market value, due to the unusual situation of the banking system mentioned earlier. Consequently, it was necessary to offer favourable credit and tax conditions in order to reduce the gap between these appraisals. Critics argued that, given the companies’ book value, this adjustment constituted a huge subsidy. To them, the profits obtained by the shareholders of the newly privatized banks served to confirm their thesis. Nevertheless, these evaluations took place after the fact and were based on an extraordinarily short time-span. The most relevant aspect of this situation, and one that is well worth looking at more closely, is why the combination of sale prices, credit and tax conditions and discount rates applied to the private banking market in 1984 failed to serve as a strong incentive for attracting new shareholders. In any case, the incentives were limited to credible taxpayers, who were authorized to acquire only a small number of shares. Moreover, through the privatization of both the banking system and the pension fund administrators, the state sought to redistribute ownership. This goal was successfully fulfilled and helped to stimulate the participation of non-traditional investors in the stock market. Second, in the cases of privatization of companies in the ‘odd sector’, no incentives were provided and divestment took place through transparent and broadly advertised market mechanisms. Third, in the controversial privatization of state-owned companies, the majority of transfer capital was not offered under special sale conditions, and the stock market was used to conduct such operations. Incentives were granted solely to employees. Of these, the most relevant was the authorization for employees to use advance severance pay to purchase shares. Furthermore, in the case of larger companies, public sector employees were also allowed to make use of their severance pay to acquire shares. For privatization processes requiring a large volume of capital, employees and small stockholders were granted the option of making payment by instalments.20 Sales to employees were conducted directly on the basis of benchmark prices quoted on the stock market at the time of the transaction. Sales to pension funds were carried out exclusively through the stock market and included strict procedures to guarantee transparency. A similar approach was taken with the small packets of shares placed on the market gradually. Table 12.10 shows the participation of the main shareholders in a select group of privatized companies. It confirms the high level of workforce participation. Some studies on the privatizations conducted in 1985 and 1986 have alleged that resources were transferred from the state to the buyers, in implicit 235


Table 12.10 Distribution of shareholdings following privatization (1985–8) (percent)

Source: CORFO, Standardization Department.

subsidies.21 Were this true, the transfer would have primarily served the interests of labour—that is, the employees of the privatized firms and participants in the social security system in general—rather than large capital holders, because the majority of the shares sold in that period were bought by workers and pension funds. Another aspect that should be analysed is the role that foreign capital played in the privatization process. Although foreign capital was important in allowing Chile, the pioneer of foreign debt conversion in Latin America, to return to the international financial markets, it had no real significance in privatization. Around $500m. in acquisitions were made in this fashion, of which just over half were used to acquire public firms sold by CORFO. The remainder was used in the purchase of ‘odd sector’ companies, in which there were also no significant transfers in favour of foreigners. It is interesting to observe what occurred in this period with the distribution of income in the country. As shown in Table 12.11, the poorest 30 per cent of the population increased their participation in the national income. Thus we may initially conclude that the privatization process did not have Table 12.11 Chile: income distribution, 1985–90 (percentage of monetary income received by each decile)

Source: CASEN Survey, 1985 and 1990

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negative repercussions for the redistribution of income, but rather that it enhanced access to capital among sectors of society which did not traditionally engage in such investments. In other words, the privatization process resulted in a redistribution of assets. For example, in the case of the privatization of the two largest banks, shares were sold to some 37,356 individuals. The situation of the Banco de Chile is a case in point: prior to privatization, through ‘popular capitalism’, ten shareholders accounted for 34.2 per cent of the bank’s stock. Following privatization, those shareholders held just 3 per cent of the bank’s paper. The case of the Banco de Santiago is even more impressive. Here, the percentage of ownership of the top ten shareholders plummeted from 98.1 per cent to a mere 8 per cent. In the pension funds industry, nearly 14,000 shareholders were incorporated into the two most important privatized administrators of pension funds, while two foreign investors with experience in the field acquired majority shares. The priority given to the workers of the privatized SOEs, and to small shareholders, produced a significant change in the distribution of shares. Specifically, the number of shareholders in privatized companies increased by 40 per cent, from some 26,604 individuals in 1985 to nearly 200,000 in 1989 (see Table 12.12). In addition, it is important to consider the increase in the number of shareholders resulting from the incorporation of administrators of pension funds into the market-place. Thanks to this mechanism, some three million employees have become indirect shareholders. For similar reasons, the level of dispersion among owners also rose, as can be seen in Table 12.13. Table 12.12 Number of shareholders in privatized public companies

Source: Based on Cecilia Cifuentes. “Impacto…”. Notes: a Workers holding shares in privatized employer companies. b Number of shareholders in these companies as compared to the stock market as a whole.

Table 12.13 Percentage control by ten major shareholders

Source: Based on data from the Bolsa de Comercio and Superintendencia de Bancos. Notes: a Refers to the Banco de Chile and the Banco de Santiago. b Includes companies privatized by CORFO.

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The data clearly indicate that the labour force, whether employees of the privatized firms, the public sector or indirect beneficiaries (the three million people participating through the pension fund system), was granted one of the greatest opportunities in Chilean history to acquire shares and capitalize their savings. The magnitude of the process can be appreciated if we note that, in terms of aggregate value, the labour force increased its participation by approximately 2.2 per cent of GDP over a period of just five years. CONCLUSIONS As we have seen, the privatizations conducted during the second half of the 1980s were decisive among the policies implemented to avert Chile’s crippling economic crisis. Recovery was successfully achieved, by the end of the decade. GDP was 35.2 per cent higher than in 1984. Privatization contributed directly to economic recovery by increasing efficiency within companies and expanding the markets within which they operate. Furthermore, privatization brought new opportunities for investment. Indirectly, the process generated favourable expectations for growth, strengthened Chile’s weakened capital markets, and enhanced the nation’s image abroad. This impact on growth produced positive effects on employment and incomes. The distribution of income improved over the period of the privatization process. The main explanation for this is the adoption of social policies that produced a concentration of public resources and programmes on the poorest groups in the country. The growth in GDP with its effect on employment and wages was another key element. Chile’s case is interesting because it provides an example of a concrete experience in which a radical privatization programme promoted a redistribution of shares, which produced a positive distributional impact. Perhaps the most important effect has been that resulting from the transfer of property ownership from the state to thousands of direct proprietors, including the employees of the privatized firms themselves. Attention must also be paid to the importance of the thousands of beneficiaries who have accessed the market indirectly through the pension funds system. The magnitude of the assets privatized, both in terms of state-owned and ‘odd sector’ companies, was significant. As a result, a large number of people who were traditionally barred from property ownership (due to financial limitations, rather than outright discrimination) have been able to acquire shares in large, important companies. NOTES 1 During the 1981–2 economic crisis, special employment programmes were created to confront the sharp rise in unemployment. The PEM (Programa de Empleo Mínimo) 238

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commenced in March 1975 and concluded in December 1988. This employment scheme was established by the Ministries of the Interior and Finance and was implemented by the municipalities as a subsidiary and temporary programme with social welfare purposes. The programme focused on poorly qualified workers. The POJH (Programa Ocupacional para Jefes de Hogar) began in October 1982, by virtue of administrative policies adopted in accordance with instructions from the Ministry of the Interior, and ended in December 1988. Funding for the later programme was allocated in the annual budget. This programme focused on more qualified workers. 2 The government intervened in a significant portion of the private sector during the period 1981–3; import duties were increased from 10 per cent to 35 per cent between 1982 and 1984; the fiscal deficit totalled 4.4 per cent of GNP in 1984. All of this was diametrically opposed to the official core policies of promoting the role of the private sector, opening the economy, and maintaining fiscal discipline, adopted as of the 1970s. 3 The new policy called for only funds withdrawn by the company’s shareholders to be subject to income taxes. Initially, this was not applied to corporate taxes. The latter were incorporated in 1989. However, in 1990, the inclusion of corporate taxes was reversed. 4 Decree Law 600 regulating foreign investment was modified to establish more convenient conditions for project financing; at the same time, tax rates were readjusted to bring them into alignment with the reductions adopted in earlier years. 5 Based on national employment levels for the quarter October-December of each year. 6 At the beginning of the 1980s, major reforms in education were launched which decentralized public education and generated competition between private and public educational facilities. This reform was curtailed during the economic crisis. 7 The foreign debt of the public sector increased from $6.6bn. in 1982 to $13.7bn. in 1985, as a consequence of the state guarantee on private debt and an increased use of public indebtedness to meet balance of payments needs. For more information, see: Fontaine, J.A. (1989) ‘The Chilean economy in the eighties: adjustment and recovery’, in Edwards and Larrain (eds) Debt, Adjustment and Recovery, Oxford: Basil Blackwell. 8 Prior to privatization, debtor and banking system support programmes were implemented through the sale of portfolios to the Central Bank. 9 These were Banco de Chile and Banco de Santiago. The remaining banks undergoing privatization were Banco de Concepción, Banco Osorno and Banco Internacional, which were sold to corporate institutions without the added incentive of so-called ‘popular capitalism’. In addition, Banco Colocadora Nacional de Valores was merged with Banco de Santiago, while other banks were liquidated. 10 See Valenzuela, M. (1989) ‘Reprivatización y capitalismo popular en Chile’, Revista de Estudios Públicos, no. 33, summer. 11 Law 18.401. 12 Bankers Trust acquired 40 per cent of AFP Provida, while Aetna Chile bought 51 per cent of AFP Santa Maria. Other smaller administrators were privatized through the stock market. 239


13 The most important were: in the energy sector, COPEC; in the forest sector, in addition to COPEC and its subsidiary Celulosa Arauco y Constitución, the company Inforsa; in the industrial sector, Compañía Cervecerías Unidas, Compañía Tecno Industria, Textil Viña, Industria de Radio y Televisión and Compañía Industrial; in the transport sector, the airline LADECO and part of Compañía Sudamericana de Vapores. 14 Labbé, F. and Llevenes, M. (1988) ‘Evolución del proceso de privatización chileno 1973–1987’, paper by the Centro de Estudios Públicos. 15 Thanks to policies implemented in 1974 which imposed a goal of maximizing profits, performing under competitive conditions by eliminating all privileges, with strict control on credit and investments, state companies were able to eliminate their losses and substantially improve their financial position within a six-year term. Nevertheless, from a long-term standpoint this behaviour was not likely to continue, given the structural problem inherent in public companies whereby the political goals set by government officials tend to increase inefficiency. 16 CORFO is a state holding organization and a development bank which owns the great majority of Chile’s privatized public companies. Through its upper management, this institution served as sales agent. Final decisions were adopted by the board, composed of four ministers and a representative of the President. An informal advisory team was formed which included representatives of the ministers of the economic sector who collaborated on strategic design. In addition, the services of a stockbroker were utilized to carry out sales in this market and to advise and support CORFO in these operations. Specialized financial institutions were utilized solely for the sale of large-scale assets and to conduct promotional activities in foreign countries. 17 It is important to note that, in the case of the power companies, use was made of a mechanism known as ‘reimbursable financing’, whereby an electrical distribution company was given the right to request that a client—to whom the company was committed to providing a timely supply of power—provide new monies in exchange for shares, bonds or other paper. Initially, these contributions were reimbursed through shares which, in the case of Chilectra, meant that some 10 per cent of the company was privatized between 1983 and 1985. 18 Vickers, J. and Yarrow, G. (1988) Privatization: An Economic Analysis, Cambridge, MA: MIT Press. 19 Lüders, R. (1991) ‘Massive divestiture and privatization in Chile’, Contemporary Policy Issues, October. 20 Such mechanisms were primarily used in the cases of CAP, Iansa and Chilmetro. Credit facilities were granted to privatize Endesa. 21 Marcel, M. (1989) La Privatización de las Empresas Publicas en Chile 1985–88, Santiago: Notas Tecnicas, CIEPLAN.

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13 THE IMPACTS OF PRIVATIZATION ON DISTRIBUTIONAL EQUITY IN GUYANA Carl B.Greenidge INTRODUCTION Distribution is such a sensitive issue in the context of privatization that it has often given rise to disputes among those who would otherwise have no difference of views in relation to privatization. Some idea of just how contentious it can sometimes be may be had from the recent controversy in Italy as a result of which the Italian Minister of Industry resigned over the sale of Banca Commerciale Italiana.1 Serious doubts have been raised about the distributional implications of programme sin other respects regarded as successful, including those of Mexico and the UK.2 Mexico, which has organized the divestment of 940 of its 1,155 enterprises to date for $21bn., is estimated to have experienced the consequential loss of 400,000 jobs since 1983 and an increase in rivalry among the thirteen rich families which benefited from the exercise.3 Given the relatively recent genesis of privatization, a full assessment of its impact on medium- and long-term income distribution would be somewhat speculative at this stage. There are still too many imponderables. In view of the extent of privatization in Guyana and the very difficult economic situation there, a preliminary examination of its distributional consequences and related socio-economic changes would be useful. The available information does permit some trends to be discerned and conclusions to be drawn, if only tentatively. Those findings are discussed in this paper. Income distribution is a particularly contentious issue in Guyana’s politics because of the low level of incomes and the apparent maldistribution of wealth, including assets such as land. Distribution has tended to be closely associated with occupational categories, and the latter is in turn ethnically stratified. Changes in economic opportunities are usually followed closely, because of this nexus. Public interest in the issue was heightened in the 241


1960s when there were communal disturbances which were fuelled by ethnic insecurity and competition. Subsequently, pursuit of socialist policies until the late 1980s gave rise to debates about incomes policies and the role of the state. Among the policies contributing to the controversies were those on public-sector wages. These included the pursuit of egalitarian wage policies and a belief, inter alia, that policies which initially lead to the stagnation of total income may be politically justifiable and economically effective in the longer term, if the redistribution favours groups which, even if they might have relatively low propensities to save, spent their incomes on locally produced commodities that enhance employment and local value added in GDP. In ‘post-socialist’ Guyana there has been a re-emergence of public debate over widening income disparities. This debate has not, as might have been expected, turned on implications for economic efficiency, but rather on the protection from the law which higher income affords certain groups, and the social cleavages associated with this phenomenon and its implications for social stability.4 Guyana’s distribution of income is not an issue which has been at all extensively studied. Very little domestic data exist on which to conduct analysis, and even less use has been made of the available data. Until the economic crisis of the mid- and late 1980s, distribution was relatively even, by Caribbean standards. In 1977, the Gini coefficient for the country was 0.57 for all households, with urban and rural households being 0.77 and 0.47 respectively. ‘For the country as a whole the poorest two thirds of the households account for barely one quarter of all household income. In the rural areas, however, this group accounts for about one third of total household incomes’ (Greenidge 1982:182). Additionally, PEs seemed to have had higher average incomes than the private sector, while the private sector showed greater income disparities than did the PEs. During the 1980s there was a severe compression of public sector incomes and conflation of the salary structures. In 1982 the earnings of the bulk of employees fell within 20 per cent of the minimum wage. After a few fitful attempts to undo these structures, in 1989 and in 1990, much to the dismay of the labour movement, a decision was taken to widen the pay scales systematically. The World Bank has estimated that to be other than dysfunctional, the compression ratio (that of the highest to the lowest salary) should range between 9:1 and 12:1. In 1987 that ratio was, for the public service, 9:1. By 1992 it had worsened to 6:1 (IBRD 1993).5 As may be seen from Table 13.1, in 1992 27 per cent of all employees earned less than G$6,000 per month. In the public sector the comparable figure was over 33 per cent. Between G$6,000 and G$12,000 the public sector boasted less than 34 per cent, compared with the private sector’s 37 per cent, and in the uppermost range the reported difference, although smaller, was still some 2 per cent. 242

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Table 13.1 Income distribution of wage earners by sector, 1992

Source: National Insurance Scheme (NIS), January 1993. Note: These figures derived from NIS data do not cover employees with incomes in excess of G$14,000/month. Neither do they take into account allowances (for the public service this latter factor accounted for 28 per cent of employment costs: IBRD 1993:58). Coverage of the self-employed is also very limited. In January 1992 the national minimum wage was G$106/day (G$2,750/month). In the sugar industry the minimum wage was G$350/day (G$9,100/month).

THE LIKELY IMPACT OF PRIVATIZATION In making an assessment of privatization it is necessary to draw a distinction between theintentionsof thestateandtheactualoutcomeof privatizationpolicy.Notwithstanding intentions to the contrary, privatization may result in alterations in the distribution of incomes.Frequently,objectiveshaveof necessitytobeimplicitbecauseof thecontroversy concerning their acceptability and the appropriateness of the tool. The impact of privatization and the duration of any changes consequent on that policy will depend on a variety of factors. The most important of these factors are: (a) The nature of the enterprises involved. (b) The mode of transfer of the enterprises: — the type of ownership. (c) The markets in which the enterprises are to operate: — the pricing policy pursued in the market; — the arrangements for regulation of the markets if they are not free. (d) The tax system. The privatized enterprises Between 1984 and 1992 some twenty-seven of Guyana’s SOEs were privatized. It is instructive to examine the main characteristics of these enterprises, 243


Table 13.2 Significance of enterprises privatized, 1984–92

Note: a Includes the former Republic Bank, which was merged with the GBTI prior to the latter’s divestiture.

which spanned a wide spectrum. The sectoral distribution is shown in Table 13.2. Most of the entities are natural resource-based and manufacturing businesses. Across the economy as a whole, manufacturing was the sector most adversely affected by the economic crisis. The telecommunications utility was transferred to the private sector as a monopoly. In both agriculture and this utility there is some provision for public regulation. We shall return to this in due course. This group of enterprises included the least profitable (except for the electricity utility) as well as the most profitable of the SOEs, such as the Guyana Telecommunications Corporation (GTC) and the Guyana Bank of Trade and Industry (GBTI).6 Some sixteen of these privatized entities had been regular loss-makers, for tax purposes. The profits of most of the others, such the Sijan Plaza and Palace, were marginal.7 The Guyana Sugar Corporation (Guysuco) had been a major loss-maker until the steep devaluation of the Guyanese dollar in 1988 and subsequent years, whereas the bauxite mining entity BIDCO/Guymine had been in profit during the 1970s. Fifteen of the loss-making enterprises were closed prior to privatization; of these, nine remain defunct. The assets of eight of the latter were sold off in parts. Six of the enterprises were subsequently reopened and made operational in their entirety or in part.8 Four of the largest employers of labour in the public sector (Guysuco, Guymine, DDL and Telecoms) are to be found among this group. Of just under 50,000 employees that were in the public sector in 1990, some 40,000 were to be touched by privatization in one form or another.9 The mode of transfer of the enterprises The impact of privatization will depend in part on the choice of mechanisms. The mode of privatization may determine the nature of the income to be 244

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derived from the enterprise, and its periodicity. This is very evident if one looks at the extremes. At one pole would be closure of the enterprise and the sale of its assets. At the other is the sale of the SOE’s shares. In the former case, the labour force is displaced and the income generation to which the assets or stocks contribute will depend on the uses, if any, to which the assets are put. In the latter case, nothing except the ownership need change. In both cases, decisions on pricing are once and for all. In the case of leasing, however, the government has an opportunity to revise the price, as well as the terms of the transfer. Leases and rentals have no unique distribution implications. They do provide an opportunity in time to review the terms of the temporary divestment. Usually employment is not an issue, because facilities are not necessarily acquired to undertake the same activities as took place previously. The asset is a means of generating income; so it can affect the distribution of income. Of course if the lease rental is not properly set, an economic rent may accrue to the renters. No special tax regime is required in such circumstances, since the legal standing of the SOE does not change. Management contracts do not really change the circumstances of the enterprise with regard to the distribution (foreign vs. local) of surpluses and costs, etc., unless of course the terms on which the contract is agreed affect the profits substantially or unless the costs are so high as to reduce the net profits. The capacity of the state to monitor this exercise will determine whether exceptional transfers will accrue to the managers. Usually, the new managers are granted conditions which were not available to their predecessors. If that freedom applies to pricing, procurement and employment, it will affect income distribution. Where the enterprises are sold, a range of factors may impinge on income distribution. By and large, in Guyana the focus has been on the sale price and on the nationality of the purchaser. In the latter case this can involve local vs. foreign buyers, as well as workers vs. others. Some methods of sale, such as public auction, may reduce the scope for debate and others may strengthen the seller’s hand. In the latter case the use of outside consultants would be one such method. It is perhaps worth saying that in the two enterprises where there has been the most debate, the government had the benefit of written advice from a reputable international merchant bank. Some of these issues are also relevant to the flotation of shares, especially in relation to pricing and other policies. Where enterprises are liquidated, the creditors are the beneficiaries and they may well recoup only a fraction of the debts they are owed. Properly conducted, this is about all that can be said on this mode. However, in many developing countries the skills required for a satisfactory completion of this exercise are usually absent. There is also a loss of employment. As with closure, however, it may involve some relief for the Treasury and for those who are the major bearers of taxes. In Guyana, the latter are mainly enterprises in the enumerated (and urban) sector, urban households and public-sector employees. 245


Closure, in addition to sharing the above features with liquidation, may involve the state having to continue servicing the debts accumulated by the enterprise. Some debt repayments may continue for many years after the closure of the enterprise. Future taxpayers will be obliged to carry that burden on behalf of past consumers, employees, possibly contractors and others who may have benefited. Public flotation of shares will affect income distribution at a variety of levels. First of all, there is the question of the extent of shareholding—who acquires shares and at what cost. Second, it will depend on the profitability of the enterprise and the effectiveness of the tax regime. In Guyana’s case the latter is low with regard to the main imposts—consumption tax, income and corporate taxes, trade taxes. Additionally, it will also depend on the pricing policy, efficiency and the nature of the market in which the enterprise operates. Labour and technology policies are also relevant. Debt swap arrangements, for example, involve an obvious transfer, most often to rentiers or suppliers. In Guyana, most creditors would be foreign. The net effect of this mechanism would depend on how the forgone payment is utilized—in addition to the opportunity cost of the surpluses or losses which the enterprise may have been making; that is, the government’s portfolio management and the effect of its related monetary policies on wealth holding and consumption by members of the public. In this regard there are sometimes arguments over the use to which the proceeds should be put. We would argue that the efficiency of the use of funds is not a function of the source of the funds—i.e. it is not a function of privatization per se (Greenidge 1993). We have noted that not all ownership forms have the same implications for distribution. Additionally, not all owners have the same implications. The operations of large national enterprises outside of the countries of their owners have in the past triggered extensive debate in the literature on development and taxation. That debate had focused on the implications of global profit maximization for decisions about location, local value added, employment and the impact on economic growth and development. The debate was in a sense resolved by an understanding that ownership did not necessarily involve control, and that capital was to some extent blind and that the role of the state was to provide an appropriate area in which the new-age transnational corporations would operate as good corporate citizens. It is interesting to note that in the climate of economic recession this very issue has surfaced among the OECD countries. This is therefore no longer only a preoccupation of developing countries. The theory behind it is now being revisited, and it is now being recognized that the HQ of a company may determine where the R. & D. is undertaken and where the value added and employment are channelled. The recent undoing of the proposed merger between Volvo AB of Sweden and Renault of France is testimony to this evolution of attitudes. The Swedes’ unhappiness resulted in a boardroom insurrection over this merger, which would have 246

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created the world’s sixth largest carmaker and nineteenth largest industrial group, with sales of $40bn. 10 One aspect worthy of mention here is the extra legal protection afforded by home governments to transnational corporations. In this context we have in mind the web of diplomatic support as well as financial obligations which a privatized entity may bring. The ‘diplomatic’ aspect of this factor has been discussed in the context of the regulation of the telecommunications monopoly. But there are other pertinent dimensions. In the USA, shareholder suits are being brought against owners of publicly quoted companies whose share prices fall.11 These writs charge managers/ owners with perpetrating frauds on the market—Rule 10b-5 of the Securities Exchange Act of 1934. With the marked upsurge in suits against companies, the profits of which are highly volatile anyway, many managers and owners have sought to protect themselves by various forms of insurance. This can mean trouble for host governments such as Guyana. Where local shareholders are involved, they may find their receipts of dividends severely limited by agreements entered into by the enterprise, such as those which may be concluded with creditors. The markets in which the privatized enterprises operate A great many privatizations take place against a background of marketization. Where the marketization framework is less than adequate, privatized enterprises through pricing, investment and employment policies in particular may contribute to unintended and possibly undesirable changes in the pattern of income distribution. Where structural adjustment programmes are already creating a group of ‘new poor’ and adding to the escalation of political tensions, these changes will not be viewed with equanimity. In other words, liberalization, deregulation and marketization have provided opportunities for some persons and institutions to make windfall profits, whether by fraud, the manipulation of markets, or whatever. Others have also been displaced as a result of the closure of enterprises (Greenidge 1993). It has also to be admitted that in the process of privatization, some individuals may well have made windfall profits at various stages such as prior to closure while enterprises are in limbo. Some may have been able to collude with other interested parties and to secure assets at bargain prices. The most popular examples of such windfall profits are usually anecdotal and are the result of basic factors influencing the working of the system itself, rather than of privatization per se, e.g. fraud, and wealth imbalances. Those possibilities cannot be ruled out, but to a large extent they can be properly regarded as once-and-for-all transfers. We are not in a position to tabulate all such events. They are to a large extent the product of administrative weaknesses. 247


Pricing policies Specifically in relation to the forgoing enterprises, the author noted that the telecommunications company had operated for thirteen years with unchanged tariffs. Similar stability characterized the tariff policies of the transport enterprises. Formal price controls governed the pricing policies of the utilities, the Guyana National Trading Corporation and other distributors (not privatized such as Guyana Stores Ltd and the Guyana Pharmaceutical Corporation). The controls were intended to keep down the cost of living for the poorer sections of the community. They applied to basic commodities such as milk, rice, wheat, flour and petroleum. Rice and sugar prices further reflected the crosssubsidization of domestic prices from higher prices received in preferential markets such as the EC and the Caribbean. Sugar prices were held at the same absolute level for twenty-seven years! The consequences of this combination of policies were extensive. In addition to the transfers from the company and therefore the taxpayer to lower income groups, there were periodic shortages which became endemic and gave rise to a parallel market. The policies spawned and sustained the smuggling of major commodities, which started with toothpaste and ended up embracing everything for which foreign exchange was needed to facilitate the process of production, including rice, sugar, whisky and rum. Only bauxite escaped this blight. In response to this and the increasingly inflammatory conditions of sale imposed by private distributors, private sector distribution was progressively curtailed. It is arguable that de facto price controls alongside shortages of inputs occasioned by the foreign exchange crisis contributed in large measure to the massive flight of Guyanese in the late 1970s and 1980s. In some cases where the commodities involved were not considered to constitute a significant proportion of household incomes and where elasticity of demand appeared to be low, the distributors were used as tax agents. The government’s preoccupation with prices and the cost of living was in part attributable to its adoption and prosecution of a stated policy to feed, clothe and house the nation. That policy preceded the widely acclaimed ‘basic needs’ strategy. Thus, in pursuit of this policy the agricultural, forestry and fisheries entities were charged with keeping prices down via their control of the bulk of productive capacity in the sector. The forestry enterprises, Guyana Timbers Ltd and Demerara Woods Ltd, for example, were specifically mandated in conjunction with other public sector agencies such as the Guyana Mortgage Finance Corporation with establishing a housing programme based on affordable houses. This policy of what might be termed price leadership was only effective in the housing and fisheries sectors (initially) as well as the rice milling and the copra milling industries. However, in the latter industries it forced many private operators out of business and in all cases prompted or contributed to liquidity crises in the SOEs themselves. As in the distributive sector, the state was not always able to ensure that all the products reached consumers or users without the appropriation of their scarcity value by middlemen. 248

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Some enterprises, such as the commercial banks and non-banking financial intermediaries, were permitted to charge what the traffic would bear. They were, however, also expected to provide credit to groups normally discriminated against by the sector, namely small borrowers including especially farmers without collateral, businessmen of African origin, and non-trading enterprises and co-operatives. In fact, co-operatives and small householders were net contributors to the system. As was mentioned elsewhere, the pricing policies of the commercial banks at times contributed to serious difficulties for the Treasury when they were licensed to trade in foreign currency. The industrial customer of the glass factory could only obtain import licences to import bottles if the management of Guyana Glassworks Ltd. indicated that they could not meet users’ needs. The prices of those bottles turned out to be much more expensive than the imported products. Notwithstanding this and a substantial Treasury subsidy towards its operating costs, the enterprise failed to make a profit, and often even to deliver the product. Regulation problems The less competitive the industry, the greater the need for regulation and the more unlikely it is that the public interest can be adequately protected without extensive bureaucracy. A regulatory structure is intended to help to safeguard the public interest in its widest sense. The need will depend on the extent of competitiveness in the market and the cost characteristics of the industry. In many cases enterprises may have been nationalized or established in the public sector precisely because of failure of the markets. Inability to put in place appropriate and effective regulatory mechanisms may be costly in the case of some industries. The absence of an appropriate regulatory framework in a monopolistic market may have very serious implications for income distribution. Administrative weaknesses compounded the public intolerance or fatigue over the prospect of another large state bureaucracy which regulation of privatized entities seems to have spawned in the UK. Furthermore, the racial aspect is relevant here. Given the structure of employment, regulation will once again tend to pit Afro-Guyanese bureaucrats against largely East Indian and Portuguese businessmen, an old point of tension. Tax regime The tax structure can influence the pattern of income distribution and wealth by moderating both the flow of income and the transfer of wealth across generations. In the late 1980s and under the aegis of the Economic Reform Plan (ERP), in particular, the government of Guyana, in keeping with the conventional wisdom prevailing in the multilateral financial institutions at the 249


time, extensively moderated the progressiveness of its tax system on grounds of enhancing efficiency.12 Although Guyana’s government resisted the imposition of a value added tax, the consumption tax was increasingly relied on. Its base was a wide range of items both imported and manufactured locally, but it was collected from a relatively narrow range of enterprises.13 In time the tiering of rates which gave it an element of progressiveness was also reduced and the differing rates for commercial and other companies were abolished. In other words, the tax system became more regressive in all aspects.14 All this meant that the enumerated businesses were called upon to bear the burden of taxes because the tax authorities were at the same time labouring under severe human and equipment constraints. In this context, SOEs which were liable for taxes were far more reliable taxpayers than the private sector, for obvious reasons, although it would be foolhardy to believe that they were angels in this regard. Divestment per se in such circumstances can be expected to make life more difficult for the fiscal agents (see for example Crittle 1991; IMF 1985). To the extent that enterprises were closed, or only management control was divested, no change in the tax regime would have been necessary or relevant. The same applies to leasing and rental of facilities. In such cases the tax system would exercise no different influence on income distribution. As a general rule, there was no special tax regime for SOEs, although for some time the consumption tax regime carried exemptions for the mining entities and agricultural entities.15 These concessions were withdrawn in 1990 (Customs Amendment No. 2 Order 1990), but since they continued to be the subject of some dispute, the Consumption Tax (amendment) Order No. 2, 1992 was passed to ensure that Guysuco and other corporations could be in no doubt that they were obliged to pay consumption taxes on their imports. Since the entities did not contribute much to the Treasury by way of dividends, the change of ownership is not likely to have much of an impact on it. Indeed, notwithstanding guidelines from the Treasury, prepared in conjunction with the Public Corporations Secretariat and the State Planning Secretariat (SPS), the SOEs resisted the payments, with the aid of various ruses. The establishment of National Industrial and Commercial Investments Ltd (NICIL) under the supervision of the Ministry of Finance was intended to ensure that the state would be able to attend systematically to dividend policies and to the related matters of corporate law and practice arising from the state’s holdings of shares in a large number of companies. With regard to the tax regime to be applicable to the privatized enterprises, mention should be made of the case of Guysuco. Because of the preferential market for sugar, the government imposed a special levy on the revenues of the industry in 1974. In essence, the formula captured for the Treasury 70 per cent of the premium. The import of this formula should not be over-estimated, because the Treasury’s ability to garner a tax contribution from the industry has been 250

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substantially eroded by a binding arbitration ruling which grants to workers a generous profit share before tax, i.e. it constitutes a component of the company’s costs. This rather unique decision has substantially undermined the capacity of the state to tax the company. At some point after 1989 Guysuco and Guymine were granted permission by their minister to pay incomes earned as a result of overtime without the deduction of income taxes. This represented a variation of an otherwise generalized and acceptable system. Its maintenance after the company is privatized would have grave implications for the tax yield. SHORT-TERM AND LONG-TERM IMPACT OF PRIVATIZATION Distribution as an objective of privatization In 1974 in Guyana there was some discussion of a proposal similar to the efforts of Poland and Czechoslovakia whereby vouchers would be issued to adults as part of a programme of people’s capitalism. Nothing came of this proposal, which was in part designed to overcome the uneven distribution of wealth which characterized the community. In the subsequent era of privatization, the democratization of the ownership of the productive sector, or what may be termed popular capitalism, was no longer a major plank of policy, although it did remain an objective. Wherever share issues were deemed to be an appropriate device, the opportunity was taken to facilitate access to as many members of the public as possible. This was the case with the commercial banks, where public interest was very high. The response was very positive. In the case of Lidco and Sapil, where there were no such provisions, the main reason was an assessment that as either borderline or not well-known companies, they would not attract the same interest; therefore arrangements to give priority to small shareholders would be unnecessary. On the other hand Guyana Stores (GSL), which was a very profitable enterprise because it enjoyed a monopoly in certain lines, would have been a popular case.16 The government’s concern to provide the rice farmers with some continuing protection against the monopsonistic practices of rice millers influenced the arrangements concerning the sale of the formerly government-owned rice mills. In those cases the agreement of sale made allowance for farmers to acquire up to 25 per cent of shares, in some cases, in the divested company. Since the fiscal objective was the over-arching priority in the privatization programme, no financial assistance was provided to the public in the purchases. In the rice industry the agreements allowed for a reasonably long period of time within which the company was to make the shares available and within which the buyers could take up the offers. The reason for the lack of financial subsidies and support was also attributable to the experience with the provision 251


of subsidized goods, which were frequently resold even before receipt by the targeted beneficiary.17 In keeping with its standing philosophy, the government toyed with the idea of providing special assistance to co-operative societies to acquire a rice mill, in an area where a significant number of their members were rice farmers. This may have been especially useful because milling, like machinery rental, was a device by which some groups in the rural community coerced minorities out of their (ownership of) farms. The floating of shares in the commercial banks was deliberately aimed at striking a balance between the needs for the absorption of liquidity held by the financial institutions and meeting the wishes of the populace for claims on real assets. This was also the factor behind the earmarking of shares for the public and/or employees from the Sapil and other issues. Rice-industry shares were reserved more out of concern to give the farmers a say in the policies of the privately owned mills, which exert an important influence on their viability, than out of distributive concerns per se. In none of these cases were shares provided at preferential prices. Part of the reason for the allegation that special preference was being awarded to foreigners lay in fears about the impact of privatization on the economic participation of different groups, which were quite deep-seated. A significant number of privatized entities has been sold to foreigners. These sales have included telecommunications, rice, container manufacturing, and livestock enterprises. However, the extent of the transfer to foreigners has been exaggerated18 (Greenidge 1993). Nonetheless, in the discussions on privatization in Guyana the question of whether this was a deliberate intention of government policy is frequently raised, albeit discreetly. Indeed, early in the course of the exercise an internal document on this matter prepared by a member of Guyana’s Support Group came to the notice of the government. It was thought that the majority of buyers were likely to be East Indians, which would give rise to political problems because of their current domination of private business. The document suggested that the government had been proceeding slowly with privatization because it was not prepared to countenance the distributional consequences. The government’s concerns and preoccupations at the time were actually quite different. The main factor contributing to the greater leverage of the foreigners was macroeconomic— the devaluation of the Guyanese dollar. Furthermore, a major constraint was the paucity of serious offers from all quarters, either local or foreign. Impact of closures A large number of the privatized19 enterprises was closed. Given this, it might be said that there was a shift from wage earning in favour of other types of income earning. However, this is more apparent than real. Of the fifteen entities which 252

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were closed, six were sold and reopened entirely or in part by their new owners. Eight others were sold off in parts and one other is still awaiting a buyer, because of the very specific nature of the equipment. The total number of employees affected by way of loss of jobs would have been no more than 2,250. In almost all these cases alternative employment could have been offered to displaced workers because there existed a chronic shortage of skills in all sectors of the economy, including other SOEs and the civil service. Thirteen of the privatized enterprises (not including GRMMA) continue to operate in some form or another. For those which ceased operations prior to sale and reopened later, we are not able to say how many, if any, of the former employees were able to regain their jobs. For the remainder, provision was made in the agreements of sale for the retention of the labour force subject to good behaviour. A full picture of the impact of the closures on distribution can be gleaned if these changes in employment and wage incomes, on the one hand, are contrasted with the relief to taxpayers which the curtailment of subsidies involved, on the other hand. The subsidies saved were substantial, especially in the cases of Guyana Glassworks Ltd and the Guyana Rice Milling and Marketing Co. Procurement policies Privatization, as has been pointed out, involves a variety of forms. In the case of management contracts the change vested management with powers over all line decisions. This autonomy is not quite as complete as the contract suggests. Guysuco, the sugar company, has always guarded zealously its powers to conclude arrangements for the importation of inputs—fertilizers. In 1993 the company was directed to award the contract to Hanson Import/ Export Co. and to rescind the contract with International Raw Materials Ltd, a US company, on grounds that the former company was in a better position to supply. Actually, Hanson Import/Export Co. failed even to secure the necessary financing, and the sugar crop in question was seriously jeopardized. A very disturbing point about this experience was the fact that the owner of the company was a parliamentarian better known for his skills as a medical doctor and political fund-raiser. The willingness of contractors to accede to commands of this nature, outside of their contracts, will determine whether the public sees privatization as a device for enriching some groups at the expense of others. Pricing A major debating point in the Guyana privatizations has been the pricing of the entities. Some work on this area has been published and it is only necessary to make the following points here: 253


(a) For most of the transactions the arrangements were quite transparent and defensible. (b) Determination of price requires a market—in a market economy it is not meaningful to argue about the appropriateness of a price if there is only one taker and the state cannot afford to keep the enterprise operational. (c) A good deal of the criticism has been fed by inflated expectations about prices, and there has been a consistent tendency for the consultants’ estimates to exceed the bids. (d) The financial state of the companies seems hardly to be taken into account in these estimates. (e) Many of the corruption allegations are unproven. (f) The most contentious debates have surrounded prices in relation to which the state had secured and acted on external advice—in the case of the Guyana Telecommunications Corporation, for example, such advice was provided by the merchant bankers, S.G.Warburg and Co.20 (g) The most spectacular case of a windfall gain by the purchaser has turned out to be quite erroneous, but still a convenient story for some parties (Greenidge 1994a; 1994b). Prices received by domestic rice producers increased substantially in the initial period after the privatizations. The increases were the result of a combination of factors, including more enterprising marketing and competition among millers. Subsequently, market prices fell.21 These changes, together with different procurement practices, have, however, transferred to the farmer the cost of carrying paddy stocks. Whether there is a net loss will depend on pricing policies, the lucrativeness of the markets secured and the efficiency of the mills. In reality the financial problem of the main privatized company has overshadowed the impact of pricing policy per se (Greenidge 1994b). In monopolies such as GT&TC, there have been radical changes in pricing policies driven by different ownership and a host of sharp, as well as irregular, business practices—in this case the movement from stable, long-term prices to what may be termed opportunistic pricing. The increases in the tariff and in deposits for plant and penalties for late payment have been substantial. Most certainly the improvement in the quality of the service has not matched those increases. The main beneficiaries of these changes, which have clearly involved imposts in excess of the cost of delivering the service, are the majority owners of the enterprises. In examining beneficiaries, a distinction needs to be drawn here between owners, because the majority owners have been appropriating benefits not so much via dividends as by unrequited payments. Other beneficiaries are the foreign employees contracted under arrangements which at one stage involved no deduction of taxes on income. The losers would be the consumers and the taxpayers. The latter, without having received any dividends, will ultimately have to bear the burden of the higher level of debt being contracted by the company (Greenidge 1994a). 254

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Many other prices are market-determined. The forestry, sawmilling and liquor enterprises operate in competitive external and domestic markets. Guymine and Sapil sell their products into external and competitive world markets and the distributional issue turns on whether the local value added is significant or has changed relative to the pre-privatization era, and on the effectiveness of the tax regime and the leverage of the labour movement. Domestic sugar prices have not been radically altered as a reult of the management change, but price movements have been subject to ministerial approval because it is such a sensitive item. Under the IMF programme, the government has undertaken to free prices, but it is not clear as to how long this process will take. In the interim, the taxpayer and public-sector employees in particular will have to meet the bill for the shortfall in the companies’ operating surplus. In many of the other privatized enterprises and those operating in the domestic market only, the change of ownership has had no apparent impact on pricing policies. This has been the case in some of the commercial banks and with DDL, the distiller. Employment As mentioned earlier, among some communities in Guyana there was a great deal of unease about the employment implications of privatization. The matter did not surface as a major issue, partly because Guysuco and Guymine operated under management contracts22 which did not threaten the status of their employees. As mentioned elsewhere, there is good reason to believe that the privatization of this company is unlikely to proceed to any great extent, given the political interest of the government in the company (Greenidge 1993). In the case of bauxite a programme of labour retrenchment was already being implemented by the local managers before the divestment of management control. The firm taking on the management contract was required to make its own assessment of the labour requirements. The sugar industry, on the other hand, took on a programme which was already benefiting from the devaluation of the Guyanese dollar and they were able to expand production substantially, an exercise which required additional labour and in pursuit of which they started off with a 70 per cent wage increase. In addition, the government was able to include in the contracts of the firms which were acquired as going concerns a clause requiring the new owners to maintain the employment of those they took over for a specified, but limited, period on condition that they did not give cause for dismissal. In the light of the factors which have transpired, privatization may well have saved the jobs of some of these employees. The government, in keeping with intentions stated prior to the 1992 elections, has taken steps which are directed at modifying the participation of different ethnic groups in the civil service and the SOEs. In the process, some institutions, including Guymida 255


and Gahef, have been closed, and within the civil service senior civil servants have been fired.23 The privatized enterprises have been spared this experience, which a former president has described as ‘political malfeasance’, directed against the Afro-Guyanese segment of the society under various ‘antinational’ and ‘enemies of the state’ guises.24 Whatever the rights and wrongs of the case, a similar debate (which was expected) over the privatized entities would have engulfed and diverted the privatization process.25 The redefinition of employment opportunities which has taken place in the privatized enterprises pales into insignificance in comparison with that which may be in prospect for the SOEs. Employment equity has not been a major problem in privatization to date. That at least is encouraging because privatization is a difficult enough exercise without being encumbered by such problems. Actually, the overall effect of privatization on employment has been quite positive, in the sense that the level of employment has been enhanced in all the operational entities except Guymine, which is a special case as mentioned earlier. Additionally, average income levels of employees have increased (Greenidge 1994b).26 As could be anticipated, there has been a decompression of salary structures. It is not possible to say whether this has resulted in an increase in the share of national product going to some wage earners vis-à-vis other income earners, because it would appear that most companies have at the same time improved earnings. Sugar is an exception in this regard. The adjustment of sugar wages has contributed to a decline in the operating surplus of the company, equivalent to 6 per cent of GDP (Greenidge 1994b). Some of the foreign privatized entities enjoy special tax concessions. These concessions may allow them to appropriate a larger share of value added than their domestic counterparts. These are mainly the forestry entities. The concessions were granted under circumstances which changed significantly, but the wording of the concession did not make allowances for such changes.27 These constitute losses of revenue to the Treasury and in that way affect the distribution of income between locals and foreigners. The Public Utilities Commission (PUC) investigations have provided a brief glimpse into the various devices employed by some entities to evade tax payments and to divert resources to foreign investors, in so far as the state is not in a position to assess expenses and profits as accurately as was the case with SOEs. Additionally, company and corporation taxes will not alone approximate the volume of transfers that taxes and administrative arrangements raised in the past. But in absolute terms, the really significant tax issue turns on the sugar levy. The importance of this impost was discussed above. Both the management contractors and the prospective investors have lobbied to have it removed. The success of this effort would have serious implications for both local and foreign distribution after privatization but also public/ private and taxpayer/wage-earner distribution. Generally, no direct subsidies, outside those agreed as part of the sales 256

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transactions, are enjoyed by privatized entities. The exception is probably the case of the Alesie Group of rice companies, which has encountered liquidity problems. As a result of the company’s outstanding indebtedness to farmers, the government-owned commercial bank, GNCB, was ordered to grant it an overdraft. In the past such loans were never repaid by the state-owned rice mill, and pressure from farmers always ensured that another loan was forthcoming at the next crop. That problem lay behind the decision to privatize. Such pressures are likely to be less resistible to a government which regards rice farmers as the most important of its constituents. In any case, given the legal dispute between the owners of the company, now before the courts, it is not obvious that the company will ever be in a position to repay the loan (Greenidge 1994b). The state has already had to bail the bank out of financial hot water. If the arrangement is put to the test, the taxpayer will have to foot the bill. Debt-equity swaps In an economy as indebted as that of Guyana, there is no real prospect of repayment of much of the foreign debt. To conclude debt-for-equity swaps would in effect involve the transfer of resources from taxpayers to foreign creditors. Cognizant of this danger, approval of swaps was restricted and subject to very stringent conditions which were met by only two privatized entities—Lidco and Sapil (Greenidge 1994b). They remain a very serious risk. The problems associated with Guyana’s negotiations with the bauxite trade creditors also point to some of the dangers of this device and the relative beneficiaries and losers (Greenidge 1994a, 1994b).28 Regulation The inadequacies of the regulatory mechanisms have been fully spelt out elsewhere (Greenidge 1994a). The result has been the siphoning off of profits of the telecommunications enterprise and the intervention of a foreign government and its agents with the purpose of undermining the authority of the PUC in Guyana (Greenidge 1994a). Such action has facilitated an increased flow of income in favour of the foreign corporation. Since that study was undertaken, former President Carter of the USA intervened, following which a minister of the government announced that the legislation was to be changed in accordance with the demands of the monopoly and its advocates (Greenidge 1994b). Prior to that the government’s two representatives on the board of directors, one of whom had on several occasions dissociated himself from decisions that were purported to have been taken by the board, were replaced. It hardly came as a surprise to learn that the Chairman of the Commission had also been removed. It is difficult to see how utility regulation could ever again be taken seriously in Guyana by any foreign company or the local consumers. 257


Public flotations In terms of the distribution of ownership, the public flotation of shares is widely regarded as the most effective device available. This is particularly true if its administration is supported by some straightforward mechanism of allocation and a level of pricing which does not significantly exclude a substantial element of the population. Share flotation to the public as part of a process of privatization was first undertaken in 1985. The Demerara Distilleries Ltd (DDL) exercise was handled by the managers of the holding company, with practically no government supervision; dissatisfaction with, and complaints about, the consequential distribution of shares were so widespread that the cabinet came close to ordering an inquiry into the criteria governing the allocation.29 The subsequent wiles of the holding company’s management were to be its undoing (Greenidge 1993). The intention of the state in floating shares, as mentioned earlier, was primarily to widen the range of ownership. This objective may be derailed on at least two points. First of all, if one or some set of individuals is really committed to securing a major chunk of shares, it is not too difficult for them to achieve their goal.30 It is only possible to deal with this challenge effectively by committing a substantial quantity of resources to investigating applicants and monitoring the exercise. In a small society where almost everyone is related by blood or debt, or somehow obligated to another, this is especially problematic. After the allocation has been completed, a variety of factors of either a general or specific nature may militate against the maintenance of that initial pattern of share distribution. The outcome of the exercise in the long term may therefore be far from what is expected. The decision to float the shares of the GBTI and NBIC commercial banks reflected recognition that the public, although very suspicious of share issues in general, were very keen to acquire shares in the banks. This was partly because of the NBIC’s demonstrated capacity to maintain earnings when devaluation and inflation were wiping out the value of other investments. No work has been undertaken so far on the pattern of distribution of the shareholding which resulted from this exercise. However, as mentioned earlier, one of the main complaints about privatization has been that it has been a boon to foreigners. On the domestic front, it was also widely felt that the selling of SOEs even through share issues would compound the existing skewed distribution of income and wealth in the country. It has also been alleged that the government did not favour management or workers. It would be useful to have a look at the effectiveness of one of these issues relative to its objectives. To this end we examine briefly the flotation of the commercial banks in 1992. Enough general information is available to permit some global statement about the government’s use of the device. 258

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Few companies make public share issues in Guyana, and those shares which are issued are hardly traded (Greenidge 1994a, 1994b). They are held by very few people. Banks DIH, a local manufacturer of beverages and fast foods, made the largest and most well known, if not the first, public issue. It was very popular and up to the time of writing the company’s shares constitute the largest stock in Guyana. As may be seen from Table 13.3 there are 8,346 DIH shareholders. GRL, the second-largest private entity with public shareholders, has approximately 2,300 shareholders. Table 13.3 Relative impact of government share flotations on shareholding by the public

DDL has some 3,600 shareholders and together with those of the two commercial banks expanded public shareholding considerably. By this measure, therefore, the privatization of SOEs via share issues may be said to have contributed significantly to the democratization of capital or shareholding in Guyana. Many of the holders had never held shares before, and indeed many had had no opportunity to do so in the past. In order to limit the possibility of a few persons monopolizing the issues, ceilings were placed on the total amount of shares which could be acquired by individuals or households. The specific arrangements have been outlined in a general study of privatization in Guyana; suffice it to say for purposes of explanation in this paper that the prospectus ranked potential applicants from employees to foreign companies, in that order of priority (cf. Table 13.4 and Greenidge 1993). An examination of the share issues does not bear out allegations about foreign domination. Two per cent of the NBIC issue went to foreign companies in Guyana and 1 per cent to foreign individuals resident in Guyana (categories 7 and 6, respectively). In the case of GBTI there was no allocation to foreign companies, and foreigners as individuals were allocated 1 per cent of the total issue. The actual allocations represented 20 per cent of the shares bid for in each case. The figures have not been ascertained in the case of the DDL issue. On the other hand, over 57 per cent of Lidco’s shares were taken up by two Trinidad and Tobago firms.31 259


Table 13.4 Allocation of shares: selected privatizations

We can test the perception about the allocation among individuals by examining the allocations to categories 2 and 5. These categories account for some 79 per cent of the allocation in the case of GBTI and 40 per cent in the case of NBIC. The allocation to private individuals was greater in the case of GBTI than for NBIC. The number of shareholders as well as the bundles bought were greater in the case of GBTI.32 The information on the take-up of shares allocated to staff may be instructive. As mentioned earlier, the Guyanese government, like many others, has provided for the preferential allocation of shares to workers in SOEs which have been privatized. In the three privatized banks, 7 per cent was allocated but at no substantial discount, although there was an implicit price because the issues were heavily oversubscribed. In the case of the privatized rice mills, the share allocation reserved was as much as 25 per cent. Share issues were undertaken by Guyana Stores (10 per cent) and the banks. The 10 per cent was apparently taken up in the case of the GSL, but the story was rather different for the banks, where the response was not very enthusiastic. In the case of NBIC, only a fraction of the allocation was taken up. Indeed, only forty of over 280 staff members took advantage of the opportunity and they were allocated all (4 per cent) they applied for. This was the case even though they were afforded the opportunity to buy with advances from the pension fund. The experience was very much the same at GBTI, where thirty-four of the bank’s almost 200-strong staff purchased shares via the allocation. The average offer to purchase was 3,941 shares, worth G$19,705.00, compared with 8,254 by individuals (who were not bank staff) in the remainder of the country as a whole. The reason for this low level of takeup is far from clear. The decline relative to 1984 is no doubt attributable in part to the severe decline in real incomes and the consequential dissaving that had been experienced since NBIC was divested. That is not a persuasive explanation in this case, however, because average incomes in the GBTI are above those of NBIC and are denominated or tagged to the US dollar. 260

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Further analysis suggests that the degree of concentration was very high indeed. If the shares sold to individuals purchasing over 100,000 shares (worth roughly $8,000 in total) are examined, the results are rather startling. Out of the total of 1,903 persons who received shares, some forty-seven or less, representing 2.67 per cent, acquired 72 per cent of the total allocation. In spite of the efforts of the team to weed out multiple applications by households, as many as seventeen of the forty-seven applications may have constituted multiple applications from the same family or household, and therefore really amounted to four applications. This goes to show that even the device of share issues is imperfect, and rather than correcting skewness or major imbalances may actually compound them. It should be stressed that this outcome, while not well received by the administration, was not the result of corruption or malfeasance on the part of those responsible for making the allocations. As with registration for elections, the use of aliases as well as the switching of names is common in Guyana. The team abandoned the attempt to draw the line between immediate nuclear and extended families and various proxies with different names. If a closer look is taken at the allocation of shares between ethnic groups, an even more extreme picture can be discerned: between twelve and twentyfive East Indian (EI) families accounted for some 50 per cent of the total allocation! On the other hand, there appears to be some difference between the behaviour of the members of the public and the bank staff. Acquisition of shares by GBTI staff was twenty-four to ten in favour of non-EIs. The reason for this apparent anomaly, if such it is, is not clear. All together, the companies bidding for shares show a wider ethnic participation in that the individuals with mixed and Portuguese companies, larger non-ethnic companies and traditional institutions like co-operatives, burial societies, credit unions and lodges also feature prominently. However, as one would expect, the latter group did not have great resources. This was evident in the quantities bid and reflected in the allocations. A look at the allocations to companies reinforces the picture of skewness. Roughly fifty-one ‘other local companies’ were allocated shares. Again, only three companies accounted for 25 per cent of the shares (one company alone obtained 14 per cent). Again, the ethnic differences are very evident. All together, somewhere in the region of 40 per cent of the companies were EI-owned. All three of the aforementioned local companies which acquired the 25 per cent of the shares in this category were EI-owned. Additionally, the company which acquired 14 per cent of the shares has the same owners, Edward B.Beharry (& Co Ltd), as the finance house which accounted for 37 per cent of the allocations to trusts and pension funds. As a consequence, this family now holds some 38 per cent of the shares in GBTI and has, through the finance house Secure International Trust Company, been offering to buy at a premium shares in all the banks. From an initial price of G$12 per (G$10) share in 261


1992 immediately after the divestment, they raised the offer to G$15; most recently their offer stood at G$32. OVERALL DISTRIBUTIONAL CONSEQUENCES It is not possible to discern a clear and unambiguous distributional change resulting from privatization in Guyana. The debate on the issue has been somewhat narrow in focus, and what evidence there is suggests that some criticisms are erroneous. First of all, the Guyanese economy, which had been characterized by a relatively even pattern of income distribution was, when the privatization process commenced, undergoing an adjustment programme which gave rise to increasingly inequitable distribution of income. The impact of privatization on this situation turns on a variety of factors. Ownership changes as such reflected a wider distribution of incomegenerating assets. Under the privatization exercise, a minority of entities was leased and placed under management contracts. The sale of many enterprises other than as going entities contributed to the sale of some assets, such as those of the GNTC, in lots which were small enough to be affordable by local businesses. Thus a considerable number of purchases were undertaken by locals, notwithstanding the popular views to the contrary. The floating of stocks in other enterprises provided opportunities for small savers and wage earners to hold shares. At the same time we see the consequences of the economic crisis on incomes and on the capacity of employees to take advantage of some of the opportunities. There were clearly cases of concentration of ownership even where efforts had been made to restrict such occurrences. These concentrations have implications for the distribution of current and future income. There can be little doubt that foreigners have been among the main beneficiaries of privatization, but the same may be said of investment which is uninfluenced by the privatization exercise as such. In fact investment appears to be sectorally narrower than privatization. For that reason, privatization may not be the most serious of the problems faced by the country. The employment practices in the privatized entities were expected to be informed by the nature of the ownership changes. Domestically, there was some apprehension over the possibility that most employees would find themselves displaced because of the recruitment practices of the family business in particular. Under the circumstances, the politics of the public sector have rather diverted attention from the problem, if it emerged to any significant extent. The labour movement expected the foreign owners to pursue policies inimical to strong worker representation and collective bargaining. The industrial relations problem surely did materialize, but there is no reason to believe that it exerted any significant influence over the power of the labour 262

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force to pursue their interest in improving the rewards to labour. Both of these problems will unfold in the context of the wider political and economic changes in the country. Pricing policies and efficiency changes would probably not have worsened income distribution when all factors are taken into account. The main factor contributing to this situation is the competition in many of the markets and the fact that many of the enterprises were closed, thereby releasing many workers to more productive areas. Some of the largest of the enterprises were operating in competitive external markets and were able to undertake the retooling and recapitalization that many of their plants required for re-entry to those international markets. Labour has benefited from improved emoluments in virtually every enterprise. In some cases the state is still in a position to direct that special wage and price policies which are beneficial to its favoured constituents be implemented. In the process, the viability of the enterprise and the direction of the flow of benefits are affected. There is not much evidence to suggest that the tax system is yet in a position to significantly modify the consequences of any undesirable inequalities generated by the privatization process. The takings of the state in this entire exercise remain doubtful. Given special fiscal concessions and the time required by some enterprises to restructure and reorganize themselves, it will probably not be safe to hazard a guess as to the impact of divestment on this particular area before much more time has elapsed. The preliminary results suggest that within the first two years of divestment, there has been a reduction in the number of companies paying income and corporate taxes. The operations of the main regulative agency in attenuating the behaviour of the foreign-owned monopoly leave us with cause for considerable alarm. The débâcle suffered by the PUC as a result of foreign interference has no parallel in any other country in which the Atlantic Tele-Network (ATN) monopoly has an operation and that must say something for Guyana’s ability to run its business. Vitelco, ATN’s other subsidiary, has encountered the same problems as GT&T but that country’s PUC has been protected by the state. Although it has handled the matter no differently from Guyana’s PUC, it continues to operate independently and efficiently. Guyana’s has in effect been captured by a foreign monopolist with its government in its wake. In the long run, privatization per se cannot by itself determine the course of income distribution. It may have beneficial or adverse impacts on income distribution, depending on the time perspective and one’s objectives, but the final pattern will be settled by overall economic policy and the capacity of the private sector in alliance with its partners, local and foreign, government and private sector, in relation to its foreign competitors. It should be easy to recognize that this is really a restatement of the issue of economic growth, and its study remains one of the most intriguing and unsolved puzzles of political economy. 263

Table 13.5: Privatization of public enterprises, 1984–8 and 1989–92

APPENDIX 13.1

Source: Ministry of Finance files. Notes: a Includes a payment of G$495m. to the Commissioner of Inland Revenue. b This enterprise was not operated for long enough to make an assessment. In any case, their accounts were not kept separately for tax purposes.

Table 13.5: continued


NOTES 1 Apparently the debate concerned whether or not institutional means should be employed to avoid it falling into the hands of a rich elite. This enterprise was known to be a potential prize for Mediobanca, a merchant bank, and a consortium of industrialists. The minister favoured more widespread ownership. 2 In the UK, this has centred on underpricing in general and there have also been share price scandals associated with Guinness and Blue Arrow. 3 International Herald Tribune, 28 October 1993. 4 See for example the numerous letters to the newspapers on these issues. A former prime minister in a press conference following the shooting of a member of the public by a vigilante group in rather unusual circumstances referred to lawlessness by the ‘rich and reckless’ directed against ‘young urban dwellers’ and putting the poor ‘at risk’. (‘Green against the “rich and reckless”’, Guyana Chronicle, 4 February 1994, p. 12.) 5 It was estimated that at the end of 1992 the real earnings of the lowest grade of public servants stood at 62 per cent of the 1987 levels, whereas for the specialists and heads of department it was 41 per cent and 44 per cent (IBRD 1993:46–7). In the light of these problems the outgoing (1992) government negotiated a loan agreement with the IBRD for purposes of supplementing the salaries of public servants with critical ERP skills. 6 This entity still remains a fully owned state enterprise. During a short period in the 1970s it had been run via a distinctly unsatisfactory management contract; under the IDB-financed rehabilitation programme, various aspects of its management had been due to be contracted out. 7 A restaurant and a foreign-currency-only duty-free distribution outlet, respectively. 8 The facilities of Guyana Fisheries Limited (GFL) have been leased; Guyana Rice Milling and Marketing Authority (GRMMA) still has a single operational mill; Guyana Timber Limited (GTL) (now Guyana Resources Ltd.), Demerara Woods Ltd. (DWL) (now Demerara Timbers Ltd.,), Guyana Nichimo Ltd., GNL, and the Guyana National Trading Corporation, GNTC (bookstore) reopened under new owners and with different employees and management. The government has still to find a buyer for the Guyana Glassorks Ltd. 9 Strictly speaking, four had already been privatized or closed by 1990. But the point remains valid for 1985, when the proportion was even higher. 10 In Guyana’s experience, nationality may not be a guide to propensity to capital flight. There has nonetheless been continuing concern about the nationality of the beneficiaries of privatization. Some aspects of the debate have been discussed elsewhere (Greenidge 1993). 11 Securities class action suits pending and filed rose from around 400 in 1983 to 1,000 by 1993. 12 It was widely believed that progressive taxes constituted a disincentive to work input and saving and encouraged avoidance and evasion. The irony of this is that even in these institutions, that view was being revisited by researchers. Of course the imposition of these policies tends to lag the fruits of research, even when it is undertaken in the same institution. In this regard see Shome (1994). 13 This was exactly why the value added tax could be expected to fail. It would have had to be collected from a large number of businesses, when the Customs and 266

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Excise Department was already having difficulty collecting a tax from a comparatively small number of clearly identifiable businesses. 14 Personal income taxes also become less progressive and more proportional. 15 Between 1976 and 1991 these were all publicly owned. 16 Ten per cent of the company’s shares were divested to the staff. 17 The most spectacular case of this kind was the importation of bicycles for workers, an exercise undertaken at the request of the TUC. 18 There has been in the private sector of Guyana something of an ‘anti-foreigner’ tendency. This started with opposition to the fiscal concessions granted to remigrants. The latter, which had been quite generous, were aimed at facilitating the return of Guyanese from abroad. It had to be substantially reduced in the face of substantial criticism, partly because of abuse and also because the massive devaluation of the currency made it so attractive. 19 In the context of this paper we reserve the use of this term for entities where there has been no less than a 50 per cent of ownership from the state, leases, management contracts and closures. 20 Some members of the administration had regarded that advice as ill informed, but that is a different matter. 21 After the 1992 elections the government raised the price offered by its sole rice mill above that of the market. 22 These two entities accounted for some 68 per cent of total PE employment. 23 The Guyana Manufacturing and Development Agency and the Guyana Agency of Health, Environment and Food, respectively. 24 Since the 1992 general elections there has been a rising chorus of allegations concerning racial discrimination in Guyana. See, for example, Caribbean Contact, May 1993, ‘The phoenix rises’; Stabroek News, 2 February 1994, p. 7, ‘PNC says there is consistent racial discrimination’, Stabroek News, 17 October 1993, p. 5, ‘The reckless disbanding of institutions’; New Nation, 28 June, ‘Jagan regime takes witchhunt to IDB’ and in the same issue, ‘The deterioration of race relations’ and ‘Future bleak for black professionals’. 25 The above allegation was made in Mr Hoyte’s submission to the World Bank-led Caribbean Group for Co-operation in Economic Development (CGCED) which was organized to raise financial assistance for Guyana. Obviously, such a controversy would not help the case. Indeed, as a consequence, former President Carter of the USA and now of the Carter Center, has offered to mediate in this and related disputes and has called on the government to establish a meaningful race relations mechanism. 26 On the other hand, in the sugar industry, expanded employment opportunities pulled some Afro-Guyanese into the industry. Of course it needs to be noted that the skill mix of the displaced Guymine employees and new Guysuco entrants are not the same. 27 The first entity was granted the facility when there were special regimes governing the price of fuel imported primarily from Venezuela and paid for by the Bank of Guyana. Since the company was in a position to import fuel from the Republic of Trinidad and Tobago at prices prevailing in that country, they were exempted from the regime which would have required them to pay the local price. The exemption included the consumption tax which all other users were required to bear. This anomaly was further compounded when the government agency granted the same 267


concession to other foreign companies which subsequently applied. Naturally, this discriminatory treatment has been a bone of contention between the state and the domestic forestry producers ever since. It has also contributed to the latter’s antiforeigner stance. 28 In those negotiations the government was hamstrung by the absence of chapter 11type bankruptcy laws as exist in the USA. One entity recognizing the interest of the government in an amicable conclusion to the negotiations organized opposition to the government’s proposals and has been seeking instead to have the government agree on a fifty-year lien on all the bauxite reserves of the country, licences to mine, and the attachment of revenue from all bauxite mining, inter alia. In the end, the government took on all the debt, much of which was unguaranteed, and fixed compensation to the creditors on terms consistent with those agreed between the government and its bilateral creditors at the Paris Club. 29 The holders of the company’s stock seemed to come almost exclusively from one ethnic group. This added to a concern that this, the third largest SOE employer, had a labour force almost completely drawn from the same group. Its nineteenstrong board of directors in 1992 appears to include one Afro-Guyanese. 30 Even in developed countries with infrastructure for this purpose, this often proves impossible to avoid, since interested parties find alternative ways around rules. Witness the furore in France over La Redoute. On 4 March 1994 the Commission des Bourse, France’s stock market watchdog, launched an investigation into the sharp pre-merger fall in the prices of the company’s shares. A controlling interest in the company had been effected though the Trojan horse of shares carrying double voting rights. 31 The remainder were distributed as follows: the government, 30 per cent; others, 13 per cent—GNCB, Gaibank, GBTI, NBIC, GTM (fire and life) Insurance Co; Bank of Nova Scotia, Rupununi Development Co., William Stoll Ltd.; North Am Life Insurance Co., Dr H.A.Fraser’s estate. 32 In the interim there had been a significant devaluation of the Guyanese dollar.

REFERENCES Bunting, P. (1991) ‘Privatisation: a path to economic transformation’, paper delivered at the Ninth Annual Conference of the T&T Economics Association: ‘Privatisation: Panacea or perdition’, Valley Vue Hotel, Port of Spain, 15–16 November. Crittle, J. (1991) A Study of Consumption Taxes in Guyana, Georgetown, Guyana: UNDP/IBRD. Farrell, T. (1991) ‘Socio-economic effects of privatisation’, paper delivered at the Ninth Conference of the T&T Economics Association. Gonsalves, T. (1991) ‘Privatization as conditionality: the role of the international lending agencies’, paper delivered at the Ninth Annual Conference of the T & T Economics Association. Greenidge, C. (1982) ‘The state and public enterprise in Guyana’, Social and Economic Studies, special Issue on Public Enterprises. —— (1993) ‘Privatization under structural adjustment’, in V.V.Ramanadham (ed.) Privatization: a Global Perspective, London: Routledge. —— (1994a) ‘Privatization: constraints and impacts’, in V.V.Ramanadham (ed.) Privatization: Constraints and Impacts, London: Routledge. 268

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—— (1994b) ‘The monitoring and regulatory aspects of privatisation in Guyana’, in V.V.Ramanadham (ed.) Privatization and After, London: Routledge. —— (1994c) ‘A curate’s egg: the case of privatisation in the Caribbean’, mimeo. Guyana Chronicle, Guyana National Newspapers Ltd., Lama Avenue, Bel Air Park, Georgetown, Guyana. IBRD (1992) ‘Guyana: from economic recovery to sustained growth’, report no. 10307GUY. Washington, DC: World Bank, Latin America and the Caribbean Region. —— (1993) ‘Guyana: public service review’, main report and annexes, vol. 2, report no. 11753-GUA. Washington, DC: World Bank. IMF (1985) ‘Guyana: a review of the fiscal system’, Fiscal Affairs Dept. Prepared by Messrs Gisli Blondal et al. —— (1993) ‘Economic adjustment in low-income countries: experience under the enhanced structural adjustment facility’, IMF occasional paper no. 106, Schadler et al. Washington, DC. Jones, C. (1991) ‘The Jamaica experience’, paper delivered at the Conference on Privatisation in Developing Countries, Commonwealth Secretariat, Islamabad, Pakistan, 2–6 March. New Nation, Guyana Media Company, U6 Tucville, North East La Penitance, Demerara, Guyana. Shome, P. (1994) ‘The taxation of high-income earners’, IMF Papers on Policy Analysis and Assessment Series, no. 93/19. Washington, DC: IMF. Stabroek News, Guyana Publications Ltd, 46/7 Robb Street, Lacytown, Georgetown, Guyana.

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14 CONCLUDING REVIEW V.V.Ramanadham The contributions included in this volume indicate, as may be expected, substantial variety in the distributional impacts of privatization in different countries. Their coverage is not entirely uniform. For example, Paul Cook and Colin Kirkpatrick focus on ownership options; so do Saman Kelegama and Carl Greenidge; and Cristián Larroulet’s analysis of the Chilean situation is chiefly in terms of divestitures. Ryszard Rapacki refers to ‘grass-roots’ privatization as well, a term he employs to denote the stupendous development of new private enterprises in Poland. Leonar Briones deals with reprivatizations in the main, which have been the major focus of privatization activity in the Philippines. Kraiyudht Dhiratayakinant refers to several non-divestiture options (especially franchising, leasing and contracting-out) besides the divestiture option, which is not yet popular in Thailand. Muzaffar Ahmed concentrates on divestitures. J.J.Bala refers to both divestitures and ‘commercialization’, a term used in Nigeria for a variety of marketizing measures of restructuring the public enterprises not disposed of. Ismail Muhd Salleh includes in his study not only divestitures, partial or full, but corporatization, leasing, sale of assets, management contracts, subcontracting, and build-operate-transfer/ build-operate arrangements. Sunil Mani has comments on both the limited divestments in India and the memorandum of understanding (MOU) technique adopted in the case of the many continuing public enterprises. Ryszard Rapacki focuses on the unemployment issue and on the wealth and poverty effects of privatization and systemic transformation in Poland. Carl Greenidge provides a comprehensive picture of all distributional impacts in Guyana. The papers, on the whole, provide us with insights on the equity impacts not only of divestitures but several non-divestiture options. The latter are quite prominent in many countries as the papers indicate. There is an obvious commonality in the contributions as regards the marginal attention that distributional impacts have attracted from privatizing governments and others concerned with the subject of privatization. Cook and Kirkpatrick opine that it is common practice to examine the efficiency impact, leaving it to the political process to resolve the distributional effects. Briones contends that distributional impacts have not been seriously examined yet and goes on to suggest that they should be separately assessed in respect of asset reprivatizations, divestiture of profitable enterprises and divestiture 270

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of loss-making enterprises. Dhiratayakinant holds the view that distributional impacts have not been viewed, much less analysed, as important aspects of privatization activities. At the end of an elaborate survey of privatization activities in Bangladesh, Ahmed concludes that adequate attention was not paid to the impacts issue. Bala expects that in Nigeria relevant research into this issue might be undertaken in future by the newly established Department of Research of the Technical Committee on Privatization and Commercialization (TCPC). Some of the contributors, such as Kelegama and Dhiratayakinant, have also emphasized the usefulness of transparency concerning the benefits or losses caused (or likely to be caused) by privatization and have suggested that adequate information ought to be made available to the public in this regard. This can help reduce the scope for malpractice in the choice of the new owner and in the fixing of an artificially low divestiture price. Transparency helps different groups to appreciate the nature of the results (including the tradeoffs) and prevents them from entertaining unrealistic expectations. Further, it prepares them to respond to the remedial policy measures that the government might adopt, in a spirit of understanding. It would be unrealistic to assume that privatization decisions have totally ignored distributional considerations. ‘Wide ownership’ has been mentioned generally among the objectives of privatization in most countries. However, the need for speed has had an unfavourable influence on divestiture pricing and on the choice of the buyer, by and large. The quest of technological expertise and managerial commitment and the compulsions of the capital markets, which in many countries have placed a premium on private, negotiated sales, have made for ownership concentrations and the emergence of monopoly, e.g., in the cement sector in the Philippines. Many attempts have been made to encourage the small investor, but these have been rewarded with limited success. Basically the prevailing wealth disparities in the community have a bearing on the way in which shares of privatized enterprises are acquired; for the wealthier sections, possibly with access to information, credit and entrepreneurial capacity, would be able somehow to mop up the plums of privatization. J.J.Bala notes this in his paper. Specific attempts have been made to facilitate ownership by employees through a variety of concessions, as described in some of the papers—by Ryszard Rapacki, for example, with reference to Poland. There is extensive evidence, however—e.g., from Malaysia and Sri Lanka—that they tend to dispose of their shares quickly. In any case, they do not ordinarily account for a major part of the share capital of the enterprises concerned. The establishment of effective shareholders’ associations which bring small shareholders together might have a healthy effect not only in educating them in their rights, but in enlightening them on the benefits of holding on to their shares. The Zonal Shareholders Association promoted by the TCPC in Nigeria provides an interesting example, and a number of seats on the boards of 271


privatized companies there have been allotted to the Association, on a zonal basis. This can be a desirable development in protecting the ownership interests of small investors, even if to a limited extent. Management buy-outs (MBOs) have not taken root in many of the countries covered by this volume. The MBOs promoted in eastern Germany as an antidote to West German investors swamping the privatization scene are described as poor risks in Dieter Bös’s paper. These are possibly the enterprises that informed (West German) investors rejected. He expresses the fear that their managerial efficiency might not turn out to be high. The eventual distributional merit of such MBOs is, therefore, in doubt. There have also been instances of employees’ bids being rejected in favour of big business interests. Briones cites several cases of inability on the part of employees to acquire enterprises—National Sugar Refineries Corporation, Pangasinan Transport Company and Philippines Airlines. The most common reason for an MBO ending up as an unsuccessful bid is its inability to organize the finance necessary for the purpose. The contributors’ views have been divergent on whether governments positively wish to pass on public enterprises to particular groups. Cook and Kirkpatrick use the example of Malaysia and state that the privatization process has strengthened the ruling party UMNO’s corporate interests. More blatant has been the policy favouring Bumiputeras. It is even argued by some that divestiture pricing has been maintained at a relatively low level in order to enable them to buy the shares. Further, the ownership conditions are expected to be enforced discriminatingly so as to ensure corrections in the ownership imbalances between Bumiputeras and other ethnic groups. Briones quotes the World Bank while making the point that a number of privatizations have been effected in the Philippines in favour of close friends and relatives of President Aquino. While the Malaysian programme has been attuned to the benefit of Bumiputeras as a group, it has not yet tackled the problem of disparities in ownership among the Bumiputeras themselves. The extreme skewness in distribution of share ownership of Permodalan Nasional Berhad—the unit trust meant for Bumiputeras—illustrates the point. At this point brief reference may be made to programmes of privatization attempted in some countries through the issue of free vouchers. Among the country studies contained in this volume, Poland is an example. There it is entitled ‘mass privatization’. Ryszard Rapacki mentions it but does not pursue the distributional implications at length, perhaps because the programme is yet to take off in earnest. (Such a programme has already done so in the Czech Republic, and various versions of it are being tried in some other formerly socialist countries.) Several aspects of this device are worth keeping in mind from the equity point of view, in the context of Poland: e.g., the restriction of benefits to those that register, as against all the (adult) citizens; the precise pattern of allocation of the shares initially held by the government; the 272

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consequences of resale of shares by the initial holders of the certificates or vouchers; the influence of future decisions by different holders of certificates in converting them into shares of companies; the interests of the fund managers, as distinct from those of the companies concerned; and so on. Though the future will unfold the nature and severity of the equity problems that the mass privatization programme could raise, it would be desirable for analysts to give thought to the possibilities under these heads. One of the interesting issues raised in the papers concerns distributional pricing. Many of the privatizations so far effected have related to infrastructural industries, as mentioned by Cook and Kirkpatrick. These include public utilities in the communications, transport and energy sectors. It is in these sectors that the externalities of enterprise operations are particularly substantial in developing countries. Many public enterprises in these sectors have been operating with prices not necessarily derived from related costs; they have often been so designed as to favour certain (low-income) groups of consumers. In some cases the overall price level itself may have been low, relative to the costs of supplying the outputs. Does privatization eliminate all traces of the pricing structures employed earlier as media of conferring distributional benefits to select groups, or lead to radical changes in service schedules (or the product mix), as in the case of the privatized bus transport in Sri Lanka? If it does, the redistributions could cause public protests; and governments would be compelled to react with remedial measures, especially where the affected groups are clearly the poorer sections of the community. Perhaps in several developing countries the forces of competition in these sectors would not be so powerful as to bring about radical changes in the pricing structure which postprivatization competition is normally expected to encourage. Competition and market entry should, no doubt, be encouraged, as argued by Dieter Bös; but the results may not be spectacular. (We may note Ismail Muhd Salleh’s observation that there is limited scope for increased competition in most of the privatized and to-be-privatized industries in Malaysia.) The question, therefore, boils down to finding the best way to meet the identified inequities caused by the price changes. That might consist of open budget assistance which reaches, without leakage, the target groups, and of not permitting private monopolies to operate cross-subsidies at their discretion. This remedy may prove difficult in practice, as illustrated by Guyana. Carl Greenidge suggests that the budget has not yet been able to modify the inequities arising out of privatization. Basically the reason is twofold: the fiscal position might be too delicate; and the technical expertise called for in the accurate application of budget policies might be too scarce. Even the necessary degree of progressivity in the tax system might not be easy to achieve. The observations of the contributors on foreign capital involvement in privatizations do not add up to a single conclusion, naturally. Cook and Kirkpatrick cite figures that clearly indicate progressive increases in foreign participation. In some cases, such as Chile and Nigeria, foreign participation 273


has not been very significant. While little doubt is expressed by the contributors as to the utility of such participation not merely for the success of privatization but for technological upgrading and overall economic growth, some reservations are apparent. Saman Kelegama complains of the unfair advantages derived by foreign investors. These, he argues, have placed local enterprises at a disadvantage. Ismail Muhd Salleh cites the privatization of the Malaysian Airlines System, in which a considerable part of the gains leaked to foreigners, and domestic consumers tended to be net losers, receiving only a fraction of the benefits of expanded investments. It is alleged that the Philippines privatization programme benefited business elites and their foreign partners. Carl Greenidge states that in Guyana privatization has been a ‘boon to foreigners’. Apart from favourable divestiture pricing, over-generous tax concessions have been gained by the foreign buyers; and the public exchequer or the taxpayer has been at a corresponding disadvantage. Countries heavily dependent on foreign capital for the success of their privatization programmes have to reckon with this consequence, against which there might be no ready protection, given the priority attached to speed in privatization and the prospect of several advantages from the standpoint of growth. The papers clearly reflect wide concern with the employee impacts of privatization. Muzaffar Ahmed refers to large lay-offs by privatized mills in Bangladesh, despite the two-year condition of non-retrenchment. Sunil Mani’s figures suggest that there would be a serious fall in employment if all the sick units in the public sector in India are closed. The employment losses will be particularly catastrophic, since they occur in the context of a fall in employment opportunities in general. It is useful to recall here the lesson that the Poland study offers. In several countries the very paramountcy attached to structural transformation causes, in many ways, labour lay-offs. Ameliorative measures have been initiated at the government level, with the establishment of the National Renewal Fund in India, for example. That fund is grossly inadequate, prompting Sunil Mani to observe that despite statements to the contrary, privatization will have serious employment consequences. An interesting line of analysis which Ryszard Rapacki prompts concerns the redistributions which may be traced to the unfavourable relationships evolving between real wages and consumption—a point somewhat connected with the poverty-line consideration. With high rates of inflation—a fairly ubiquitous circumstance—the inequity of the situation is aggravated. Here again examples are not restricted to Poland. The anatomy of the population below the poverty line, statistically delineated in the Poland paper, has instructive significance with regard to remedial policy measures. Efforts have to be made to solve the employee problem thrown up by privatization, with a few exceptions like Guyana. Conditions in the divestiture agreement against retrenchment, even if for a short, specified period, could only be a temporary expedient. They go against the very objective of efficiency underlying privatization. As long as the enterprises carry surplus staff, either 274

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their viability is affected (if they work in competitive markets) and they become bankrupt, or they maintain themselves through some kind of market control. Under the latter course their consumers lose through prices which are high because surplus workers’ wages are built into the costs. This involves a redistribution in favour of the employee, as against the consumer. If a welldeveloped regulatory structure is instituted, this cannot go on for a long time. The enterprises will be obliged to effect all possible cost economies, including labour lay-offs on strict criteria of productivity. Once again the economy has to face it as a national problem, as argued in the opening chapter. Saman Kelegama’s criticism that the biggest drawback of bus transport privatization in Sri Lanka is the failure to provide necessary funds for future capital expenditures by the privatized enterprises seems to be useful in a wider context. There would be many cases, in developing countries, of privatized enterprises not finding the necessary funds for expansion or even modernization. The smaller ones and those owned by employees or other relatively low-income groups might be in particular difficulty. (Several privatized units in Bangladesh have disappeared, for example.) Whether the mere availability of financial resources for investment will remedy the situation of the enterprises, one cannot say. But the lack of such resources might accelerate their liquidation, with corresponding employment consequences. Funds for the start-up of new businesses (on a small scale) by the displaced employees can also be a palliative in providing employment opportunities. Some small attempts have been made in many countries in this direction and also in retraining. There is a major problem, however. It concerns the availability of the necessary funds at the government level or under some version of ultimate government direction or guarantee. Saman Kelegama looks at the divestiture incomes as a source. More frequently, however, these have been used to meet revenue expenses, as Muzaffar Ahmed says with reference to Bangladesh. In any case, their utilization for the provision of capital funds for privatized and other enterprises has two serious implications. The first is that the government would have correspondingly less funds for repaying the public debt and thereby reducing interest charges, and also for undertaking welfare expenditures aimed at moderating the distributional equities plaguing the community. Second, the government gets down into financing enterprises under uncertain conditions of prompt recovery of principal and interest. It is just possible that some of these will be written off in the course of time. (India provides an example of how the nationalized banks are saddled with a high proportion of bad debts among their advances.) Moreover, such soft funding of enterprise operations goes against the very objective of privatization, aimed at marketizing decisions on investment and operations. It would be realistic, on the whole, to explore the ways and means of dealing with unemployment, including that caused by privatization, as a national problem, through budget measures, independently of the divestiture incomes. 275


The latter might come in handy temporarily and to some extent. It may be remembered that divestiture incomes are in the nature of a one-off capital receipt, while unemployment-relief measures tend to be of a recurring nature in many developing countries for a long time. Several contributors referred to the impacts of privatization on the public exchequer, which might trigger tax effects in the course of time. A major source of the impacts has been low divestiture pricing, as documented in the papers on Malaysia, Sri Lanka, the Philippines, Bangladesh and India. The taxpayer eventually loses to the extent of the under-realizations and through excessive tax concessions offered to (foreign) investors. These could trigger tax measures to his disadvantage. Dieter Bös shows how the huge deficit of the Treuhandanstalt will be a burden on the taxpayer, mainly the West German taxpayer. Such measures might, in most cases, aggravate the regressivity of the tax system, since indirect taxes are of substantial importance in developing countries in general. Dieter Bös suggests that increases in value added tax would be the least progressive of all tax measures aimed at meeting the deficit; but they are not regressive, he contends. Tax consequences have not yet materialized in many countries, for the divestiture incomes have been used to fill the fiscal deficits, as may be seen from the contributions of Saman Kelegama, Muzaffar Ahmed and Sunil Mani. However, this facility will not be available over the long run. Besides, the public debt, which divestiture incomes are not used to reduce, will involve the budget in continuing obligations of interest payments. If the loss-making enterprises continue to stay in the public sector, the disadvantage to the budget is even clearer. Of course, one can assume that privatization will so improve the economy that the government’s tax receipts will expand sufficiently to compensate for the negative effects indicated above. Whether the assumption will prove correct, only time will tell. Some of the contributors made the point that privatization has relieved the government of the need to find resources for investment and to offer guarantees of loans taken by enterprises. The government will, therefore, have lesser needs of borrowing and greater resources at its command for undertaking expenditures that confer social welfare. This could be particularly beneficial to economies struggling to implement adequate programmes of poverty alleviation. It is interesting to note, in this connection, that governments have been achieving this convenience to some extent by permitting the entry of private capital into areas so far reserved for the public sector, or into public enterprises themselves. Malaysia, Thailand and India (which is wooing private capital in the energy sector) are examples. There is an important point to ponder in this connection. In several cases the foreign investor is almost offered, in effect, guarantees of a high return on capital— say, 16 per cent or 18 per cent in the case of India in the power sector, a sector of activity in which the demand is in fact far in excess of the supply. These can bring in their train all the demerits of the rate-of-return kind of regulation. It is also useful to note 276

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that performance contracts—a major non-divestiture option—can offer benefit to the exchequer by scaling down subsidy payments to public enterprises and by curtailing even capital contributions from the budget. The ‘partial’ and ‘full’ commercialization programmes in Nigeria illustrate the point. There is an unmistakable moral that comes out of the contributions. Privatization options and techniques of divestiture ought to be more meticulously determined than has been the case so far, with adequate consideration being given to the impacts on distributional equity. Kraiyudht Dhiratayakinant makes an interesting suggestion, namely that a privatization office should be set up in Thailand, which, besides the usual privatization functions, should draw up measures to compensate actual losers from each particular privatization measure. It is doubtful, however, if such an office, while most desirable in the implementation of privatization programmes, is the right agency for drawing up measures of dealing with the equity impacts. This is best placed in the government, with the Finance Ministry playing a crucial role, and Parliament being involved in the process. The involvement of the privatization office in this respect may be limited to the provision of facts of privatization relevant to the identification of the impacts. We may conclude this review by highlighting some of the fundamental issues pertinent to discussions on the equity impacts of privatization. First, there are serious problems of identification and measurement. Partly these emanate from the lack of reliable data, particularly in developing countries. The more important difficulty lies in the need to isolate the impacts traceable to privatization from those attributable to developments external to a given measure of privatization. The total systemic transformation attempted in the former socialist countries illustrates the point. Besides, in certain cases a general slump (or expansion) in the demand for outputs in a given sector might be the more relevant cause of the poor (or prosperous) condition of the privatized enterprises and of the consequential equity impacts (e.g., on employment). Second, the immediate impacts associated with a given measure or series of measures of privatization may not persist in the long run. Examples can be found in the context of employment and the public exchequer. The future operations of the privatized enterprises and their market structures shape the long-term effects. In many countries, privatization is just taking off; and it can be argued that we will have to wait for some years before we can generalize on the ultimate impacts. While this is true in a sense, it seems reasonable to argue in favour of analyses of likely results, so that, while precise quantifications would be difficult, the nature of the impacts can be visualized and remedial measures contemplated in good time. Third, the redistributions that occur as a result of privatization are not all in one direction. In several cases, while one group gains, another loses. The best example is that of an enterprise which maintains an unproductive labour force with corresponding disadvantage in cost structures and pricing. The employees gain, while the consumers lose. To take another case, deliberate 277


under-pricing or gifting of shares in favour of the employees has favourable impacts on that group, but the taxpayer in general loses correspondingly. Even MBOs, as a rule, have a similar effect; for they tend to be accompanied by a variety of concessions as regards the divestiture price and the schedule of payments of the price. Further it is possible that several kinds of inequity arise even among the employee groups, for they do not all receive the same kind of benefit in the course of privatizations. Thus there are significant trade-offs, which one has to consider while evaluating the distributional impacts. This is one of the most complex aspects of the problem; and it often calls for value judgements. To take another example: dominant foreign ownership is double-edged. On one side, it can bring benefits of technology and offer the conditions for expansion of output, thereby leading to favourable effects on industrial growth and employment. The benefits might in fact extend to the balance of payments area by enabling the country to reduce imports and/or increase exports because of the competitive efficiency of local production. On the other hand, the profits of the enterprises reach foreigners and flow out of the country. Where the rate of profits is very high, and where foreign capital occupies a large proportion of the most profitable enterprises in the country, this can be treated as a particular disadvantage. Fourth, analysis of equity impacts would gain in relevance, given the backdrop of a national policy expressed in governmental declarations or any other guidelines on national well-being. The less vague these are, the better for the analyses. At the time of writing, we do not have such definitive policy enunciations; and it is not clear, in the case of every privatizing government, what precise weight it attaches to the distributional impacts in the course of its privatization programmes. Nor is it certain that governments in general have evinced serious interest in the analyses of such impacts. Fifth, some inequities, e.g., loss of jobs and reductions in non-commercial outputs, may have to be accepted as a price for the efficiency aimed at by privatization. Attempts to deal with them should best emanate from the government budget, as argued in the opening chapter. To the extent possible, these should be visualized in the context of national problems such as unemployment, poverty or regional backwardness, and the most appropriate measures should be closely targeted through discussion at the highest levels of government. As far as possible, the consumers of individual enterprises should be relieved of direct burdens of equity effects traceable to efficiency efforts as a sequel to privatization. Sixth, if governments are willing to give due place to distributional impacts in their decisional matrix concerning privatization, there would be enough room for exploring optimal options in given cases. Full divestiture might or might not be the only good option in every case. (It may be noted that divestiture in tranches effectively weakened the evil of divestiture underpricing in Chile.) Certain non-divestiture options might involve moderated versions of inequities. 278

CONCLUDING REVIEW

Under most of them, the taxpayer does not suffer; and the government can envisage remedial measures in a graduated and deliberate manner. This is not a plea against divestitures; it is a plea for a careful exploration of non-divestiture options also, case by case and, equally importantly, of several possible techniques in the sequencing of the divestiture option itself. Seventh, the weight of public concern with the issue of distributional equity under privatization depends on how important privatized enterprises are in the economy. Their importance is to be assessed not in terms of mere numbers but in terms of their externalities. Where they are large in number, account for a large share of investment and employment in the organized sector, and abound in infrastructural and key sectors, privatization does produce sizeable equity impacts, not only through mere changes in ownership but from the private sector model of operations that will be the guiding principle of privatized enterprises. The equity impacts would be considered to be the more painful, the more articulated the public policy objectives of a distributional nature happen to be. A number of developing countries come within this description, as do all the socialist countries in transition. Analysis of the equity impacts is, therefore, highly relevant in all such cases. The developments in Chile, post-privatization, which Larroulet considers as very positive, are worth a serious study.

279

INDEX

accountability, public 172 acquired asset corporations 85, 93–4, 94–5 advertising 154 Afribank Plc 217 African Petroleum Plc 215 Ahson, S.A. 187–8 Aircraft Inspection and Overhaul Depot (AIROD) 121, 133 Alesie Group 257 allocative efficiency 122; see also efficiency Alsons Development and Investment Corporation 89 Amanah Saham Nasional 119 Antah-Biwater 133 application forms 213–14 Aquino, C.C. 84 Argentina 2 Arum Organization 103 Ashaka Cement Company 215 Asian Hotels Corporation 147, 148 Asset Privatization Trust (APT) (Philippines) 86, 88, 92, 93 asset sales 121; Nigeria 210–11, 221; see also liquidation Atlantic Tele-Network (ATN) 263 Austria 50 Awami League 182–3 ‘backward classes’ 5 bailing-out expenditure 29 Banca Commerciale Italiana 241, 266 Banco de Chile 237 Banco de Santiago 237 Bangkok Expressway Co. Ltd (BECL) 101

Bangladesh 181–92; impact of privatization 187–92; nationalization and privatization 181–5; new industrial policy (NIP) 184–5; privatization process 185–7; revised industrial policy (RIP) 185 Bank Slaski 80 bankruptcy see liquidation banks: Chile 229–30, 235; Guyana 249, 251, 258–62; Nigeria 217 Banks DIH 259 Benue Cement Company 215 BIDCO see Guymine bidding process 112–13 BNP government 185 Board of Investment (BOI) (Sri Lanka) 170 Bös, D. 7 Brazil 5 British Aerospace Plc 33 British Airports Authority (BAA) 15 British Airways 14, 26, 198 British Coal 198 British Rail 198 British Steel 26, 198 British Telecom 14–15 budget deficits 197, 276; India 201–2, 202; Nigeria 215 budget policies 25–30, 31, 276–7, 278–9; Malaysia 126–8; see also government expenditure, safety nets, subsidies, taxation build-operate (BO) 121 build-operate-transfer (BOT) 121, 127–8, 140 Bulumulla compensation formula 158–9

280

INDEX

Bumiputeras 17, 46, 119, 128–32 passim, 272 CAP 234 capital expenditure: government 29–30; privatized enterprises 275 capital incomes, surcharge on 62–4 capital market development 212–13, 215–16 capitalism, popular 50–1, 64 Carter, J. 257, 267 Cement Corporation 169–70 Ceylon Leather Products 159, 171 Ceylon Oils and Fats 154–5 Ceylon Oxygen 145, 148, 157, 162–3, 170–1, 171, 172; foreign ownership 147, 154–5, 155–6 Chigener 233–4 Chile 226–40; domestic investment 233–4, 234; economic recovery 227–8, 238; employment 233–4; exports 227, 228; income distribution 235–8, 238; ‘odd sector’ 230–1, 235; privatization programme 228–33; state involvement in economy 228–9, 233 Chinese ethnic group 130–1, 132 closures 245, 246, 252–3 Colombo International School 148 Colombo Stock Exchange 164 command economy 79 commercialization 208–9, 221, 225 compensation, redundancy 157–60, 162, 166 competition: with foreign investors 165; for franchises 105; increased in Malaysia 121, 122–3; postprivatization pricing 53, 273 competitor-buyers 88, 97–8 concentration of ownership 13, 31, 271; Bangladesh 182–3, 190–1; Guyana 261, 262; regional 17; Sri Lanka 13, 152–4 Congress of Employees of Unions of the Public and Civil Service (CEUPACS) 132 consumers 3, 31; Bangladesh 192; divestiture 19–21; non-divestiture options 22; subsidies 27 consumption 274; Poland 74–5, 76 consumption tax 250; see also value added tax contracting-out 102, 107, 116 control, government 41, 47 core investors 153 CORFO 231, 240

corporatization 120 corruption 31–2 current expenditure, government 30 Czech Republic 50 Dankotuwa Porcelain 155–6 debt-equity swaps 43, 246, 257 deferred public offer 211 Demerara Distilleries Ltd (DDL) 255, 258, 259, 268 developing countries 5–7, 35–48; domestic dimension 44–6; international dimension 41–4; political economy approach 37–41; see also under individual names development outlays 190 developmental state 39 ‘discouraged worker’ effect 72 Distilleries Company Ltd 147, 149, 171 distributional equity 2–5; elements promoting 83; importance of transparency 112–13; trade-offs 36–7, 111–12 distributional impacts 7–32, 270–9; anticipated and unanticipated 110–11; divestiture 7–21; nondivestiture options 21–2; policy measures 22–30 divestiture 7–21; Bangladesh see Bangladesh; consumers 19–21; employees 17–19; favourable and unfavourable effects 196– 7; Guyana 245; India see India; investors 13–17; Malaysia 120, 129; Philippines 88; Poland 73, 79–80; policy measures 24; pricing see pricing, divestiture; Sri Lanka see Sri Lanka; taxpayers 7–13; Thailand 102–3, 107–9, 115, 116 Don Muang Tollway project 101 E-credits 28 East Pakistan Industrial Development Corporation (EPIDC) 181–2 East Pakistan Small Industries Corporation (EPSIC) 182 Eastern Europe 5; see also under individual countries economies in transition 51 education 71 efficiency: Bangladesh 187–9; Malaysia 122– 6; Nigeria 215; Sri Lanka 162–3; trade-

281

INDEX

off with distributional equity 36–7, 111–12; see also productivity, profitability employee buy-outs see management buy-outs employee shares/ownership 14–15, 271; Chile 231–2, 235–6, 237–8, 238; Germany 52, 64; Guyana 260; Malaysia 134; Nigeria 219; Poland 79–80; Sri Lanka 15, 144, 148–50 employment/employees 3, 274–5; Bangladesh 191–2; Chile 233–4; employees’ welfare 160–2; Germany 54–5; Guyana 255–7; impact of divestiture 17–19; impact of nondivestiture options 22; India 198–200; Malaysia 132–4, 140; Philippines 89–91; Poland 68, 73–4, 80, 81; redundancies see redundancies; Sri Lanka 149, 150–1, 157–63, 178; Thailand 107–8 Enersis 233 equivalence incomes 54, 55–6 Ershad, General 184–5 Ethiopia 18 ethnicity/race 17; Guyana 256, 261–2, 267; Malaysia 17, 46, 119, 128–32 passim, 134, 272; Sri Lanka 151–2 Export Promotion Zones (EPZs) 170 Expressway and Rapid Transit Authority of Thailand (ETA) 100–1, 105 Fair Trading Commission (Sri Lanka) 155 financial aids to small investors 16, 28, 164, 213, 230 financial sector 229–30; see also banks fiscal deficits see budget deficits Fleet Group 45 Floro Cement Corporation (FCC) 89 flotations, public 13; deferred 211; Guyana 245, 246, 258–62; Nigeria 210, 211–12; Sri Lanka 176–7; Thailand 102–3, 116 Flour Mills of Nigeria Plc (FMN) 217–18, 224 foreign debt: Chile 228, 239; Philippines 84, 93, 96 foreign investment/ownership 33, 274, 277, 278; Chile 232, 236; divestiture 16–17, 18; Guyana 252, 256, 262, 263, 267; impact on developing countries 40–1, 42–4; Nigeria 218; Philippines 91–2;

Poland 73; Sri Lanka 16, 147, 154–6, 164, 165 France 11, 15, 50, 268 franchising 100–1, 104–5, 116 fraud 31–2 Gahef 256 Germany 8, 42, 49–67; background to privatization 50–4; distribution of incomes and satisfaction 54–6; distribution of property 60–1; MBOs 15, 60, 65, 272; privatization 56–7; unemployment 58–9; see also Treuhandanstalt GNCB 257 government budget see budget deficits, budget policies government-conducted privatization 69, 73–4 government connections 45, 88 government control 41, 47 government debt see foreign debt, public debt government expenditure: Malaysia 119, 137; policies 29–30 government-owned or controlled corporations (GOCCs) 83, 85, 92–3, 94 government revenues see proceeds of privatization, taxation Grand Hyatt Hotel, Bangkok 104 ‘grass-root’ privatization 68 ‘grey’ economy 70, 71, 80 Grout, P.A. 52 GT&T 263 Guyana 241–69; debt-equity swaps 257; distribution as objective of privatization 251–2; distributional impact 262–3; Economic Reform Plan (ERP) 249–50; employment 255–7; impact of closures 252–3; markets 247–9; mode of transfer 244–7; pricing 253–5; privatized enterprises 243–4, 264–5; procurement 253; public flotations 245, 246, 258–62; regulation 249, 257, 263; taxation 245–6, 249–51, 256, 263 Guyana Bank of Trade and Industry (GBTI) 244, 258, 259–62, 266 Guyana Glassworks Ltd 249, 253

282

INDEX

Guyana Refrigerators Ltd (GRL) 259 Guyana Rice Milling and Marketing Company 253 Guyana Stores (GSL) 251, 260 Guyana Sugar Corporation (Guysuco) 244, 250–1, 253, 255 Guyana Telecommunications Corporation (GTC) 244, 254 Guymida 255–6 Guymine 244, 251, 255, 256 Hanson Import/Export Company 253 Hopewell Company 101 Humphrey, C.E. 188 Hungary 10, 11, 16, 28, 52 Hyderabad Allwyn 204 income distribution: Chile 235–8, 238; developing countries 5–6; Germany 54–6, 58–9; Guyana 241–3, 256, 266; Nigeria 220; Poland 75–80; see also wages income tax: Germany and surcharge on the rich 62–4; Sri Lanka 165–6 incomes from privatization see proceeds India 5, 28, 193–206, 277; Board for Industrial and Financial Reconstruction (BIFR) 195; Committee on Divestment of Shares in Public Sector Enterprises 205; distributional implications 196–202; National Renewal Fund 196, 199–200, 274; privatization process 193–6; PSEs offered for divestment 200; public sector reform 194–6; sick PSEs 193, 195–6, 198, 203–4; Voluntary Retirement Scheme (VRS) 199, 200 Industrial Estate Authority of Thailand 106 industrial relations 79, 161, 262–3 infrastructure projects 100–1, 127–8 institutional investors 14; Chile 231–2; Nigeria 216–17, 222–3 internal subsidization 53 insurance companies 216 International Finance Corporation (IFC) 44 International Merchant Bank Plc 217 International Monetary Fund (IMF) 146–7, 190, 255 Investment Corporation of Bangladesh (ICB) 184

investment incentives: Chile 229–30, 235; Nigeria 213; small investors 16, 28; Sri Lanka 153, 164 investors 271–2; Bangladesh 188, 190–1; Chile 231–2, 235–8; divestiture 13–17; Guyana 258–62; Malaysia 129–31; Nigeria 216–18, 218–19, 222–3; nondivestiture options 21; shareholders’ rights 172–3, 218–19; Sri Lanka 14, 151, 172–3, 174; subsidies for 28 (see also investment incentives) Island Cement Corporation 89 Italy 241, 266 joint ventures 2; Poland 68; Thailand 103–4, 109–10, 116 Kabool Lanka 147, 155, 155–6, 171 Kelani Tyres 172 Kenya 17 Klang Container Terminal (KCT) 121, 124–5, 132 Klang Port Authority (KPA) 121, 125 Korea 95 Krung Thai Bank 103 labour-management relations 79, 161, 262–3 Labuan Water Supply 127 Laem Chabang seaport 101, 106 Lanka Ceramics 155, 159 Lavalin Skytrain project 101, 104, 105, 117 lay-offs see redundancies leasing 21, 22, 245; Malaysia 121; Thailand 101–2, 105–6, 115, 116 Leather Products compensation formula 159 Lidco 251, 257, 259 liquidation: Guyana 245–6; Nigeria 115 116; Poland 69, 72, 73, 79; Thailand 115, 116 local government 28 loss-making enterprises: Bangladesh 189, 189–90; Guyana 244; impact of divestiture on taxpayer 9–11; India 193, 195–6, 198, 203–4; Philippines 85, 87, 94, 95; Sri Lanka 153; see also profitability Mab Ta Put seaport 106 macroeconomic crisis 40 majority share, sale of 176–7

283

INDEX

Malayan Railway 131 Malaysia 2, 14, 118–42, 272; budgetary position 126–8; distributional equity 2, 128–9; divestiture prices 8, 129–32; efficiency 122–6; employment 132–4, 140; ethnicity/race 17, 46, 119, 128–32 passim, 134, 272; government expenditure 119, 137; growth of public enterprises 118–19, 136; impacts of privatization 44–6, 122–34; Masterplan 119, 135, 141; New Economic Policy (NEP) 46, 118, 128–9; North-South highway 121, 127–8; privatized projects 119, 138–9; privatization initiatives/approaches 120–2; public debt 119, 127, 137, 139; taxation 6 Malaysian Airlines System (MAS) 120, 123–4, 126, 139, 274; pricing 8, 130, 139 Malaysian Association of Engineers 133 Malaysian International Shipping Corporation Berhad (MISC) 8, 120, 123, 126, 139 Malaysian Trade Union Congress (MTUC) 132 management buy-outs (MBOs) 15–16, 211, 272; Germany 15, 60, 65, 272 management contracts 21, 22, 121, 186, 245, 253 management-labour relations 79, 161, 262–3 management limited partnerships 60–1, 65 managers: emoluments 17, 156–7; entrepreneurship 215; managerial deficits 61 Manila International Container Terminal (MICT) 88 Marcos, F.E. 84 marketization 247–9 mechanization 162–3 memorandum of understanding (MOU) 21, 193 merging 115 Mexico 241 MIGA 44 migration, internal 55 Milco 148 monopolies 123, 131, 271 National Development Bank (Sri Lanka)

146, 149 National Equity Corporation (NEC) (Malaysia) 129 National Fertilizer Company (Thailand) 104 National Industrial and Commercial Investments Ltd (NICIL) (Guyana) 250 National Paper Corporation (Sri Lanka) 169–70 National Renewal Fund (NRF) (India) 196, 199–200, 274 National Sugar Refineries Corporation (Nasurefco) (Philippines) 88, 272 National Textile Corporation (Sri Lanka) 169–70, 172 National Transport Commission (NTC) (Sri Lanka) 168 NBIC 258, 259–60 Nepal 10 new political economy (NPE) approach 37–41, 46–7 Nigeria 11, 17, 207–25, 272; distributional impact 216–20; impact of privatization 214–16; implementation of privatization 209–14; Privatization and Commercialization Decree 208–9, 220–1, 225; public enterprise sector 207–8; share distribution 216–18, 222–3; see also Technical Committee on Privatization and Commercialization NITEL 215 non-divestiture options 21–2, 279; see also under individual forms non-performing assets (NPAs) see lossmaking enterprises Norsk Hydro 147 North Klang Straits Bypass 129 North-South highway (Malaysia) 121, 127–8 ‘odd sector’, Chile’s 230–1, 235 Pakistan Industrial Development Corporation (PIDC) 181 Pangasinan Transport Company (Pantranco) 88, 272 partial divestitures: Bangladesh 186, 187; Sri Lanka 176–7 PAT 106 pension funds 231–2, 235–6, 238

284

INDEX

pension funds administrators 229, 230, 237 ‘people’s property’ 51 performance contracts 21, 22, 193, 277 Permodalan Nasional Berhad (PNB) 5–6, 17, 119, 272 Petron Corporation 87 Philippine Air Lines 88, 272 Philippine Nissan, Inc. 88 Philippines 13, 83–98, 272; Asset Privatization Trust (APT) 86, 88, 92, 93; balancing distributional impacts 94–6; likely impacts of privatization 86–92; Medium Term Philippine Development Plan (MTPDP) 86; privatization policy 84–6; results of privatization programme since 1987 92–4 Phinma 89 Poland 15, 28, 50, 68–82, 274; governmentconducted privatization 69, 73–4; grassroot privatization 68; income distribution 75–80; mass privatization programme 69, 80, 272–3; unemployment 70–5, 80 policy/policy measures 22–30, 31, 278; budget policies 25–30; divestiture techniques 24; impact of privatization in developing countries 36–7, 39–40; public sector in developing countries 6; regulation 25 policy-makers 38 political economy approach 37–41, 46–7 political interference/manipulation 147–8, 187 popular capitalism 50–1, 64 portfolio investment 43 poverty 5, 274; Poland 72, 74, 77 Premba Bhd 129 Preserved Food Organization 101 pricing, divestiture: Bangladesh 186–7, 189; Guyana 253–5; impacts on taxpayers 7–9; Malaysia 8, 129–32; SriLanka 145–8, 178 pricing structures/tariffs 20; Bangladesh 192; with distributional objectives 53–4, 273; Guyana 248–9; Philippines 89; regulation 25; Sri Lanka 168–9 private placement of shares 210 privatization 1–2

privatization office 112, 117, 277 privatization paradox 39–40 privatized enterprises, importance of 279 proceeds of privatization 41–2, 246, 275; Bangladesh 190; India 201–2; Malaysia 126–8, 139; Nigeria 214; Philippines 87–8, 92–3, 97; SriLanka 144, 166–7, 176–7; uses and distribution 11–12, 197 procurement 253 producer subsidies 27 productive efficiency 122; see also efficiency productivity 22, 162 profitability: divestiture’s impact on taxpayer 9–11; Philippines 87–8, 94; regulation 25; Sri Lanka 155–6, 161, 162–3, 171–2; see also loss-making enterprises PTT Exploration and Production Company 103, 109 public accountability 172 public awareness programmes 174, 180, 213 public debt: Bangladesh 189; Chile 227; Malaysia 119, 127, 137, 139 public flotations see flotations, public public utilities 53 Public Utilities Commission (PUC) (Guyana) 256, 257, 263 public welfare 37–8, 171–3 Pugoda Textiles Lanka Ltd 14 pyramid allotment technique 152–4 Queen Sirikit National Convention Centre 101–2 race see ethnicity/race Ramanadham, V.V. 196 Ramos, F.V. 84 Redoute, La 268 redundancies 274, 275; Bangladesh 191; divestiture’s impact 17–19; India 198–9; non-divestiture options’ impact 22; Poland 73; safety nets 26; Sri Lanka 157–60, 162, 166, 179; see also unemployment regional concentration 17 regional disparities: income in developing countries 6; privatization benefits in Sri Lanka 150–1, 174; unemployment in Poland 71

285

INDEX

regulation 25, 123; Guyana 249, 257, 263; pricing with distributional objectives 53–4, 65 Rehman Sobhan 187–8 reimbursable financing 240 Renault 246–7 restructuring 9–10, 21, 22, 147 retail sales 76 revenues, government see proceeds of privatization, taxation rice industry 251–2 rich, surcharge on the 62–4 Richter, H. 62–4 Rose, M. 62–4 Royal Malaysian Aircraft 121 RPI-X regulation 53–4, 65 rural development 169–71 Sader, F. 42, 43 safety nets 26–7; India 199–200 Sapil 251, 255, 257 Sapura Holdings 45 satisfaction 54–6, 57, 59 Savannah Bank Plc 217 savings: Chile 227, 228; Poland 75 Securities and Exchange Commission (SEC) (Nigeria) 210 Securities and Exchange Commission (SEC) (Sri Lanka) 172 shareholder suits 247, 266 shareholders’ associations 219, 271–2 shareholders’ rights 172–3, 218–19 Shipping Corporation of India Ltd 2 Sistem Television Malaysia Berhad (TV3) 121, 124, 129 Slovenia 16 small investors 14, 271; financial aid 16, 28, 164, 213, 230; Nigeria 217–18 social effects of privatization 34; divestiture 19; government expenditure 30; Poland 79; Sri Lanka 166–73; Thailand 104–5 solidarity charge 62–4 Soquimich 234 speed of privatization 146–7, 174 Sports Toto Malaysia Berhad 8, 120, 124, 126–7, 139

Sri Lanka 143–80; Board of Investment (BOI) 170; concentration 13, 152–4; divestiture pricing 145–8, 178; employee shares 15, 144, 148–50; employment 149, 150–1, 157–63, 178; foreign ownership 16, 147, 154–6, 164, 165; investors 14, 151, 172–3, 174; managerial emoluments 154–5; privatization programme 143–4; schedule of privatizations 176–7; social effects 166–73; regional and ethnic aspects 150–2; taxation 6, 163–6 Sri Lanka Mild Foods 149 Sri Lanka Transport Board (SLTB) 144, 150–1, 159, 167, 175, 179; subsidies 167–9 subcontracting 122, 170–1 subsidies 27–8; Guyana 256–7; internal subsidization 53; Sri Lanka 167–9 suppliers 3, 170–1 Syarikat Telekom Malaysia Berhad (STM) 120, 125–6, 127, 133–4 Tanzania 17 taxation/taxpayers 3, 31, 276; Bangladesh 189; budget policies 28–9; developing countries 6; divestiture’s impacts 7–13; Guyana 245–6, 249–51, 256, 263; nondivestiture options’ impacts 21; Poland 74–5; Sri Lanka 6, 163–6; THA deficit in Germany 62–4; see also consumption tax, income tax, value added tax Technical Committee on Privatization and Commercialization (TCPC) (Nigeria) 208, 209–10, 211, 216; Department for Research and Publications 215, 271; evaluation 214–15, 219 technology 162–3 Telecommunications Asia Company 101 Telekom Malaysia 45 tender system: Bangladesh 186–7; SriLanka 147, 173–4 Thai Airways International Ltd 102–3, 108– 9 Thai Oil 108 Thai Telephone and Telecommunications Company 101

286

INDEX

Thailand 99–117; distributional equity 104–10; issues in distributional equity 110–13; modalities of privatization 100–4; privatization activities 99–100, 115–16; privatization office 112, 117, 277; state-owned sector 99, 114 Thanayong Company ‘electric train’ project 101 Thulhiriya Textile Mills 147, 148, 155, 165, 179 trade-offs 36–7, 278; Thailand 111–12 trade unions 132, 148, 161 Tradewinds 8, 126, 139 Trans Asia Hotels 147 transitional economies 51 transnational corporations 246–7 transparency 271; importance for the choice of the gainer 112–13; lack in Sri Lanka 147, 173–4 Treuhandanstalt (THA) 11, 55, 58; financing the deficit 62–4, 276; MBOs 15, 60; privatization mechanism 56–7; property distribution 60–1 TV3 121, 124, 129 Uganda 17 UMNO 45 unemployment 31, 276; Bangladesh 191; Chile 227, 233, 238–9; developing countries 5; Germany 58–9; India 199, 205; Poland 70–5, 80; safety nets 26; see also redundancies Union Bank Plc 217, 224 unit trusts 164, 173, 179 United Engineers Malaysia Berhad (UEM) 121

United Kingdom (UK) 35, 50, 241; divestiture pricing 8, 266; electricity supply 53; employment 198; management pay levels 17, 33; price regulation 53–4; size of state sector 233; use of divestiture proceeds 11 United Motors Lanka Ltd 145, 155, 162–3, 172 United Nigerian Insurance Company Plc 218, 225 United States of America (USA) 247, 266 urban development 169–71 valuation 146 value added tax (VAT) 62–4, 65 Vitelco 263 Volkswagen 50 Voluntary Retirement Scheme (VRS) (India) 199, 200 Volvo AB 246–7 voucher system 12–13, 251; Poland 69, 80, 272–3 wages 274; Bangladesh 191–2; Sri Lanka 161–2, 162–3; see also income distribution Warsaw Stock Exchange 80 welfare: employees 160–2; public 37–8, 171–3 windfall gains 25, 31, 247 workers’ councils 79 World Bank 44, 84, 190; privatization as precondition for aid 146–7 youth unemployment 71 Zia Rahman, General 184 Zonal Shareholders Association 218–19, 272

287

Privatization and Equity

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Liabilities and Equity

Ipos And Equity Offerings

Intergenerational equity and sustainability

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Handbook of Corporate Equity Derivatives and Equity Capital Markets

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Markets And Equity in Education

Equity Derivatives: Theory and Applications

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