Privatization—Why and How?

Adil Najam wrote a great thought-provoking article on privatization in The News in Pakistan on Saturday. Adil asks absolutely the right question, why are you privatizing? In theory ownership does not matter if the enterprise can be run efficiently.

Even though I am from the University of Chicago and have been perhaps the strongest proponent of free market policy in Pakistan, our approach to privatization has always made me uncomfortable. Yet I found it very hard to discuss with my lazy economist friends who think that somehow privatizing everything will balance the budget and bring in efficiency.

They do not see the SRO culture and how our private sector is more rent-seeking than competitive, more ready to make a buck from government handouts than market competition, and always ready to live off anti-consumer and anti-market practices.  The assets we want to privatize include decreasing cost industries such as discos, area monopolies such as the Sui companies, and large oil and gas franchises. Without adequate quality regulation such privatized assets could lead to a lot of market manipulation.

Privatization is important and necessary. But like all public policy issues, it should be well thought out and capably conducted. Unfortunately, in Pakistan public policy it is the blind (bureaucracy) leading the blind (politicians) to make a mess.

There is a rush to sell and I am afraid no one will do the homework. There are several considerations that must be borne in mind.

First, there is a need to be very clear determination of the asset that is being sold. More often than not privatization should be the privatization of a business and not land. Both the steel mill and PTCL privatization were confounded by land being inadvertently thrown into the privatization.

Second, privatization should also look at the state of markets post privatization. Selling a monopoly to the private sector will not do much accept placing a burden on the consumer. Moreover, without adequate regulation, monopolies can continue to profit through maintain high prices and poor services. The state of post-privatization competition can also be affected if a large enterprise that dominates the market is now put in private hands.

Essential services like electricity where there is not only a monopoly component but also that it is an essential service require very competent regulation if they are to be in the private sector. With privatization in this case, there is a strong possibility of extracting rents from the government. Pricing in this area is not market determined and will depend strongly on regulation.

Third it is important to clarify if there are any additional agreements with the government accompany the unit that is being privatized and what advantage to profitability and market share will those agreements give to the enterprise. In an SRO ridden world, it should also be seen if what is being privatized is a long term SRO and how it would affect market development over the long run.  Moreover, input supplies such as gas and oil, are also dependent on government pricing and supply conditions. Here we have experience of long contracts that have been arbitrarily written to confer favors on certain companies such as KESC and the fertilizers.

Fourth, is wrongfully thought that the bleeding will stop if we privatize. It should be remembered that the buyer will not sustain losses. When our banks were privatized, the losses were covered by the government. Even today in the KESC agreement the line loss figure is larger than that of public sector DISCOS. The private sector will fire people and generate some efficiency gains but will not be too quick to reinvest unless they can see some gains. If they can get the government to pay for the reinvestment or put that investment in price they will.
  

Fifth, this notion that there has to be a strategic investor is hard to understand. In the search for this investor, the process involves several rounds of non-transparent negotiations and complex agreement that confers a large gain on the buyer. Why not simply off load shares on the market and allow management to be professional. Let the market work instead of a bureaucratic process that can easily lead to side deals.

Sixth, how is the process going to be transparent and open to all! Will all assets be properly audited and placed on the web? Will there be open meetings explaining the assets? Will the rules and surety bonds be written in such a way that only members of the rent-seeking elite be allowed in? Can other groupings such as unions, collectives and NGOs be allowed in? Will the process be open to all foreigners? Will businessman who own banks have a clear advantage over others? These are some of the auction design mechanisms that can seriously be thought through to determine the outcome we want?

I agree with Adil, the reason for privatization is better utilization of resources an eventually growth. But this will only happen if the government has a market development focus and privatizes in the context of that focus. In Banks we did not and created an oligopoly which we are seeking to deepen by allowing big banks to eat the small ones. In airlines merely privatizing PIA may not be enough. With airports run as sleepy bureaucratic enterprises, privatization alone may not work.

Ultimately as argued in the Planning Commission Framework of Economic Growth (FEG), government and our thinker should focus on markets and privatization would be only one tool in that direction.  Thinking in that manner will also make for better privatization.

And following Adil and the FEG, it cannot be emphasized enough that it is critical to develop excellent regulation and a competition commission before we privatize.  Even today, a large amount of our problems stem from the lack of adequate regulation and antitrust action. Privatizing without regulation and vigilant antitrust is merely exacerbating rent-seeking. But for that we will need a civil service reform.

So thank you Adil for a great piece and making us think. Like him I am also not confident that we will be able to manage this process well despite Dastgir who to me probably the best man for the job (and also the most thoughtful minister).