 Public Sector Reform – Privatisation  (Dr. Christopher Gan)

Why Involve the Private Sector?  The Problem Chronic poor performance is the rule rather than the exception in many publicly run municipal services  many households lack good access to services (especially the poor)  service is often of poor quality  service delivery is inefficient  (Source, Penelope Brook, the World Bank)

What is Privatisation?  According to the World Bank, privatisation “is the transfer of ownership of State Owned Enterprises (SOEs) to the private sector by sale (full or partial) of going concerns or by sale of assets following their liquidation”

What is Privatisation?  Privatisation helps establish a free market, as well as fostering capitalist competition, which its supporters argue will give the public greater choice at a competitive price  Privatisation embraces denationalisation or selling-off state-owned assets, deregulation (liberalisation), competitive tendering, as well as the introduction of private ownership and market arrangements in the ex- socialist states  Privatisation is a political process and, therefore, requires political will, commitment and clarity

What is Privatisation?  Consider University education: Nationalization implies public good  Assumes a constituent policy:  Equity before efficiency Everyone pays the cost, because everyone is better off  Privatization implies private good Assumes a distributive policy: Everyone pays the cost, benefits flow to only a few Admin students moving to Alberta?  Therefore, efficiency-based, user-pays model Includes higher-tuition Academic-based/merit funding only

If the Objective is Achieving Maximum Asset Value  Grant an exclusivity period before the introduction of competition  Don’t limit foreign investment  Minimise the obligations on the incumbent (e.g., for network roll-out, price cap tariff control)  Sell the company in several stages including and IPO (timing is important)  (Source: Kelly, 1999)

If the Objective is Maximising Consumer Welfare  Introduce competition at the earliest opportunity in all parts of the Sector  Sell the company as quickly as possible, including employee share options  Put Universal Service Obligations into license of incumbent and its competitors  Pro-competition regulation during early years  (Source: Kelly, 1999)

Privatization Benefits  The global trend toward state-sector privatization is driven by the recognition that market-based economies are better suited to maximizing societal wealth than nationalized industries and planned economies Industry privatization and deregulation are necessary steps toward free market competition Eliminates conflicts of interests resulting from state ownership: political versus economic objectives Promotes efficiency gains through the introduction of competition  (Source: AEAC, 2002)

Privatization Benefits  Economics Benefits Raising revenue for the pursuit of other public policies through divestiture of government owned enterprises Raising external investment capital for the energy sector Establishing the basis for growth in taxable income Efficient allocation of resources (labor, natural resources, and capital) The promotion of efficiency and productivity gains  (Source: AEAC, 2002)

Privatization Benefits  Social Benefits: Commercial control over enterprise (more disclosure) ‘Private – dividend’ more public money for programs and services  (Source: AEAC, 2002)

Privatization Benefits (Source: Bleas, Estache Kaufmann) Fiscal Benefits Improved Efficiency Improved Access

Privatization Benefits Form and extent of private involvement Market structure and competition Regulatory approach Extent of benefits depends on policy choices on three main issues (Source: Bleas, Estache Kaufmann)

Arguments Against Privatisation  Democratic Government Incentive pressure of future elections  Public Interests Vs Profit Max satisfy needs of the majority as instrument to implement government policy  Essential Services Availability socially necessary but unprofitable services

Arguments Against Privatisation  Profit Contribution To The State Revenue motivation for the government to improve the performance profits directly into common wealth of the whole country - better equity  Consumer Interest Protection low competition, infrequent choices and lack of expertise

Arguments Against Privatisation  Costs of Privatization:  Economic Costs: Loss of annual government revenue  Social Costs: Loss of ‘guaranteed’ jobs Loss of government influence in market outcomes (Public Interest) Loss of government control over provision of public goods and services

Why Privatisation Fails?  Lack of strong high-level political commitment to the privatisation program  Inappropriate design of privatisation strategy (in terms of scope, technique, sectors and institutional capability of the government)  Unclear and weak institutional framework: decentralized (ministerial/ provincial level) or centralized (such as an independent privatisation committee under the head of state)  Poor preparation of enterprises for privatisation or divestiture (such as inadequate accounting and auditing, treatment of losses, or social and environmental safety nets)

Why Privatisation Fails?  Insufficient transparency and flexibility in terms of the method of privatisation, balancing ownership and control (corporate governance)  Vested interests of managers, employees and customers  Lack of appropriate legal frameworks (e.g., property rights, foreign ownership, bankruptcy laws)  Underdeveloped capital markets

Preconditions for Privatisation  Irreversible political commitment to economic stabilization and liberalization  The accomplishment of necessary legal and regulatory reforms, such as the establishment of property rights, streamlined investment laws, and enforceable bankruptcy laws  Structural reforms across all economic sectors

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

Service Contracts  Definition: specific tasks are contracted to the private sector, but overall utility management remains with the public sector  Typical duration: 6 months - 2 years  Pros: can inject good technical expertise  Cons: unlikely to improve performance greatly where overall management is weak  (Source: Penelope Brooks, World Bank)

Management Contract  Definition: a private company is paid a fee to operate a set of municipal services  Typical duration: 3 to 5 years  Pros: gains in managerial efficiency  Cons: gains can be difficult to enforce; city remains responsible for investment  (Source: Penelope Brooks, World Bank)

Example: Solid Waste Collection  Management contracts for waste collection are common  Caracas, Seoul, Bangkok, Jakarta, Lagos  Contractors are often medium-size enterprises  100 contractors in Lagos, 85 in Seoul  Cost savings can be significant  US data - private sector is 10-30% cheaper  UK & Canada data - private sector is 20-40% cheaper  (Source: Brooks, World Bank)

Lease  Definition: a private company leases the assets of a utility, and maintains and operates them, in return for the right to revenues  Typical duration: 10 to 15 years  Pros: commercial risk borne by the private sector, giving strong performance incentives  Cons: administratively demanding; government remains responsible for investments  (Source: Penelope Brooks, World Bank)

Build-Operate-Transfer  Definition: private sector develops, finances and operates bulk facilities  Typical duration: 15 to 30 years  Pros: good way of getting efficient delivery of bulk services, with private investment  Cons: not a good solution if supporting distribution systems are in bad shape, or traffic levels are uncertain  (Source, Penelope Brook, the World Bank)

Example: Solid Waste in Hong Kong  DBO (Design-build-operate) for refuse transfer stations and a chemical waste plant for waste plant, capital cost paid over 5 years in monthly installments  DBO for landfills (including restoration and aftercare) capital costs paid in lumpsums at milestones  (Source: Brooks, World Bank)

Concession  Definition: city owns the assets, but contracts with the private sector for operations, maintenance and investment  Typical duration: 25 to 30 years  Pros: potential for high efficiency in operations and investment  Cons: requires considerable commitment and regulatory capacity  (Source: Brooks, World Bank)

21 Example: Water & Sanitation in Manila  A 25-year water and sewerage concession began in Manila in 1997 – requires increase in water connections from 65% to 100% of households within 10 years – requires increase in sewerage connections from 8% to 83% of households within 25 years – requires decrease of technical and commercial loss from over 60% to 25% within 25 years – projected to involve total investments in excess of $7 billion  (Source: Brooks, World Bank)

22 Divestiture  Definition: the assets of a municipal utility are sold to the private sector  Typical duration: indefinite, but may be limited by a license  Pros: potential for high efficiency gains  Cons: requires credible regulatory framework  (Source: Brooks, World Bank)

22 Voucher Programs  In much of Eastern Europe, the only politically feasible alternative to auctioning off SOEs was to effectively give the SOEs directly to the nation's citizens by giving them the exclusive right (and the means) to purchase shares  These voucher programs had the virtues of speed and perceived fairness: literally thousands of firms were privatized in five years or less, and the non- discriminatory nature of these voucher distribution programs ensured their popularity

22 Voucher Programs  The principal drawbacks are threefold: Voucher programs do not raise cash for the SOE or the government  Voucher privatizations do not result in an infusion of new technology or managerial expertise. Vouchers do nothing to establish an effective monitoring mechanism for newly privatized firms, and the ownership structure that results from their exercise is usually highly flawed

22 Direct Selling of Assets  In a direct sale, all or part of an SOE is auctioned, either to an existing company (foreign or domestic) or to a group of investors  They bring in significant revenue for the government; they frequently inject new technology and expertise into the SOE's operations; and they solve the monitoring problems that an atomistic ownership structure creates  Asset sales also compare favorably with SIPs in terms of the speed with which direct sales can be arranged, the ability of governments to sell SOEs piecemeal, and the fact that the direct sale format means that buyers are obliged to commit to certain operating standards of their acquired firms

Other Privatization Methods  Contracting Out/Outsourcing The state enters into agreements with private vendors to provide services. The state pays contractors to provide the services  Public-Private Partnerships The state conducts projects in cooperation with private vendors, relying on private resources instead of tax revenue Examples - Management contract, Leases, Concession, Divestiture, Build-Operate-Transfer (BOT)

Privatization - Conclusions  Do privatised enterprises improve performance in terms of profitability, efficiency and investment?  Does privatisation improve government finances?  What is the social impact for consumers and employees?  What are the overall effects on the economy?  How do different approaches to privatisation affect end results, and what lessons can be learned?

References  AEGIS Energy Advisors Corp. (AEAC), “State Oil Company Privatization, “ November 8, 2002  Isabelle Bleas, Antonio Estache, and Daniel Kaufmann, “Public-Private Partnership in Infrastructure and Poverty,” World Bank Institute  Penelope Brook, “Private Sector Roles in Delivering Public Services: Policy Options for Developing Cities, “ the World Bank  Tim Kelly, “Process and impact of commercialisation/privatisation: Worldwide trends,” CTO Senior management seminar: Telecoms restructuring and business change, Malta, May, 1999