Theory of Privatization Analysis
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The aim of this report is to provide a general idea about the term of "privatization", and spot the light on the reasons that create the privatization. Also to describe the types and applications today, advantages and disadvantages. Followed by second part which describe the privatization in Bahrain with real applications, and to see whether it is an effective tool should be implemented in Bahrain or not.
Review of the literature:
There is no single word to describe the term of "privatization" as this term has different meaning from one place to another.But if we want to define this phenomenon which becomes a main subject used in most of countries, it is new economic philosophy with a strategy to convert many economic and social services sectors which are not directly linked to the supreme policies of the countries from public to private sector as the country in the new economic concept should take care of the big things like political, administration, security and social which are linked to the supreme policies as the other sectors can be secured by the privet sectors within the laws and regulation set by the country.
The American economist Steve Hanke defines privatization as "the transfer of assets and service functions from public to private hands. It includes, therefore, activities that range from selling state-owned enterprises to contracting out public services with private contractors".
Privatization is defined as "a method of allocating assets and functions from public sector to the private sector" (Fillipovic, 2005). As such privatization constitutes a fundamental structural change of ownership which is transferred from public to private sector, leading to a drastic shift in the underlying incentivesof the respective owners and in the objectives of the firm (from political oriented to profit oriented)
For several decades, privatization has become one of the most important elements of structural reform programs in both developed and developing countries (Sheshinski&Lbpez-Calva, 1999). According to Megginson and Netter (2001), the political and economic policy of privatization is broadly defined as the deliberate sale by a government of assets or state-owned-enterprises (SOEs) to private economic agents. Since its introduction by Britain's Thatcher government in the early 1980s, privatization has been widely in use in more than 100 countries (Megginson & Netter, 2001), and has had a remarkable impact on the society as a whole (Prizzia, 2005; Xu& Lee, 2012).
Theoretically and economically, privatization helps establish a free market and foster competitions which, in turn, give the public greater choices at a competitive price. Based on efficiency considerations, D'Souza and Megginson (1999) argued that, not only the customers of privatized enterprises enjoy benefits from privatization, but also, as the enterprises become more efficient, the whole economy will benefit. The economic prosperity gives government a means to maximize social welfare which furthers its legitimacy. For example, Boles de Boer and Evans (1996) examined the impact of the 1987 deregulation and 1990 privatization of Telecom New Zealand on the price and quality of telephone services. They found significant declines in price of phone services, significant improvement in service quality, and significant benefit to its shareholders. Similarly, in the airline industry facing competitions globally, Eckel, Eckel, and Singal (1997) analyzed the effect of privatization on the performance of British Airways, and documented increased competiveness of the privatized organization in comparison to its closer rivals (i.e., its U.S. competitors). Ideally, as Megginson and Netter (2001) stressed, privatization propels a country to establish an integrated political, social, and economic system that boosts income and welfare for all citizens.
History of privatization
It started from ancient Greece, when the government made contracts with private sector for almost everything rather than do it by itself. Individuals and privet sector was doing the majority of services in the Romanian republic such as tax collection, army supplies.
In pre-20th century, Europe during renaissance was following the feudal economic system while in china's golden age of Han Dynasty, the movement toward privatization perhaps came at that period as the first ideological movement. Taoism came into prominence and it advocated the laissez-faire principle of Wu Wei, which means "do nothing".The Ming dynasty in China began once more to practice privatization, especially with regards to their manufacturing industries. This was a reversal of the earlier Song dynasty policies, which had themselves overturned earlier policies in favor of more rigorous state control.
In 20th century, privatization received strong political support by the prime minister of England Margaret Thatcher (1979-1990) and the U.S president Ronald Reagan (1980-1988), and Chilean president Augusto Pinochet (1974-1990), who were all strong proponents of market fundamentalism.
Privatization has been implemented fordifferent countries such as after the collapse of the soviet bloc to get rid of the social system and in in the developing countries of Africa, Asia, and Latin America.
Reasons of privatization
As the private sector has important advantages, such as the strong management capability with potentially greater experience in developing facilities and providing services attuned to the competitive world of global trade.
The government might try to promote the private sector with long term objectives to achieve good mix of public and private sector.
The primary reason is to improve efficiency and productivity of operations. As we know, the government aim is not to earn profit as the private investor is. And that's why the government activities faced by lack of efficiency, and to improve the efficiency the ownership will be transferred to the private sector.
The second reason is to reduce the financial and administrative burden on the public sector, when the government transfer the ownership to a private investor.That will rescues it from any additional financial burden and may end with possibility of profit sharing which will increase the public revenue.
One of the motives for the government to privatize is to promote private sector involvement in the economy and increase the opportunity for private investor.
Supporters of privatization Argument
Proponents of privatization argue that whereas government producers have no incentive to hold down production costs, private producers who contract with the government to provide the service have more at stake, thus encouraging them to perform at a higher level for lower cost. The lower the cost incurred by the firm in satisfying the contract, the greater profit it makes. On the other hand, the absence of competition and profit incentives in the public sector is not likely to result in cost minimization.
Although private firms may pay lower wages and fringe benefits than governments, the major cause of the cost differences between the private and governmental sectors is employee productivity. Lower labor costs may arise either from lower wages (which means that the government was paying wages higher than necessary for a given skill) or from less labor input (which means that the government retaining more employees than necessary to fulfill need). Private firms have more flexibility than governmental units to use part-timers to meet peak periods of activity, to fire unsatisfactory workers, and to allocate workers across a variety of tasks.
Supporters of privatization argue that the trend has spurred improvements in performance by public service providers. "Evidence shows that public agencies should be allowed to bid on contracts along with private operators, since this exposure to competition has led many public agencies to improve their service delivery and significantly reduce costs.
Supporters of privatization often cite the competitive environment that is nourished by the practice as a key to its success. Private owners have a strong incentive to operate efficiently, they argue, while this incentive is lacking under public ownership. If private firms spend more money and employ more people to do the same amount of work, competition will lead to lower margins, lost customers, and decreased profits. The disciplining effect of competition does not occur in the public sector.
Still, even advocates of privatization agree that private ownership produces the public benefits of lower costs and high quality only in the presence of a competitive environment. Privatization cannot be expected to produce these same benefits if competition is absent. Given this reality, analysts strongly encourage municipal governments to make sure that the bidding process is an ethical one.
Privatization is understandably viewed as an alarming trend by public employee groups. In some cases, privatization results in layoffs of public sector employees, although governments often reassign them to other government jobs, place them with private contractors, or offer them early retirement programs.
Privatization in Bahrain
- Privatization in Bahrain in glance and a modern application
To reduce the financial burden on the government budget and to advancing economic development, Bahrain government moved toward privatization in the way to reduce government consumption and improve the efficiency. Bahrain privatization program is cautiously moving, as the privatization law was issued at the beginning of 20s, exactly at 2002 which is considered as a framework that regulates and manage this sector.
This law focuses on a gradual process that assures covering the both services and production sectors especially tourism, telecommunication, transportation, electricity and water, harbors, airports and postal services.
Under the ministry of finance, government established a department that relates to privatization. It is called Privatization & Outsourcing. Its duties and responsibilities summarized in:
- Conduct specialized studies of supporting government performance through adoption of privatization strategy outsourcing services and restructure services for the concerned Ministry through changes when need arises.
- Carry out projects of privatization, outsourcing and restructure services, taking into account economic domestic and global conditions, as well as market circumstances which prevail the sector in which the concerned project is included.
- Review the documentation, study, commentary and analytical services as well as proposing amendments and improvements on projects of privatization, outsourcing and restructure services which were previously carried out in the Kingdom of Bahrain.
- Coordinate and provide required support for Government Bodies and Economic Development Board in order to identify, study and apply projects and privatization, outsourcing and restructuring services which have become required to foster the performance of private sector.
- Select, appoint and supervise over external consultants (who are appointed on basis of their experience and reputation in the global market according to the concerned project) to ensure the sound application of projects of privatization, outsourcing and restructure services in compliance with international standards and criteria, to encourage global investors and divert their attention to the Kingdom and its ambitious projects to eventually ensure the success of these projects.
- Commence and apply projects of privatization, outsourcing and restructure services on the fast track when need arises and on basis of internal and external factors prevailing in the concerned sector.
- Maintain records, correspondence and all activities of the department with other external bodies and agencies. Commence and establish necessary cooperation with other authorities and establishments to foster close internal links with other government bodies and establishments during the period of applying the projects of privatization, outsourcing and restructure services, to avoid any deficiencies or violations or dual works which are unnecessary.
At the first years of issuing and implementing this law, Bahrain governments moves to privatizing meats imports and cleaning services and exclusively granted the right to import live cattle to Bahrain cattle company which includes shareholders from private and public sectors. The government also has also been able to sell all of its shares in five companies which are basically works in the field of hotels and tourism it sells its whole shares in Bahrain Hotel Company, national hotels and Gulf hotel and Bahrain Tourism Company. Also, it applies the same issue in different fields and companies like Bahrain Cinema Company, Bahrain Dates Factory, Asri and other companies which became fully owned by private sector.
Lately, the government directed its ministries to prepare plans to privatize some department's tasksuch as survey & Land registration bureau, ministry of water and electricity, some departments of the ministry of works, Salman harbor and Khalifa harbor, central markets, some divisions in traffic department and some departments in Ministry of Works, Municipalities Affairs and Urban Planning.
After lawmakers discussed reducing government stakes to not more than 30%, Bahrain is going to privatizing the biggest public companies by opening Gulf Air, Alba, Bahrain Airport Company, Batelco and the National Bank of Bahrain (NBB) to the private sector. However, the current capital of all the companies under Mumtalakat, Bahrain's sovereign wealth fund, was around BD7 billion. Oil enterprises and Bahrain International Circuit would not be included in the privatization drive.
The oil sector in Bahrain is currently working according to a clear strategy that requires the involvement of the private sector in the implementation and management of oil projects, excluded making decisions on the privatization of oil activities in Bahrain during the current period because they need have studies take into account the achievement of competitiveness, efficiency and return on the national economy.
It privatized over the past years some of the supported services for the oil sector such as privatizing the gas stations, inspections and liquefied natural gas port, which is being developed in partnership with the private sector, and will be implemented based on Build Own Operate and Transfer of Ownership System (BOOT), according to the Convention Renting a fixed term of 20 years with Bahrain LNG, transfer its assets to the Government of the Kingdom of Bahrain after that.
Potential benefits of privatization
1. Improved efficiency
The main argument for privatization is that private companies have a profit incentive to cut costs and be more efficient. If you work for a government run industry, managers do not usually share in any profits. However, a private firm is interested in making profit and so it is more likely to cut costs and be efficient. Since privatization, companies such as Alba, and Batelco have shown degrees of improved efficiency and higher profitability.
2. Lack of political interference
It is argued governments make poor economic managers. They are motivated by political pressures rather than sound economic and business sense. For example a government enterprise may employ surplus workers which is inefficient. The government may be reluctant to get rid of the workers because of the negative publicity involved in job losses. Therefore, government owned enterprises often employ too many workers increasing inefficiency.
It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is inefficient then the firm could be subject to a takeover. A government owned firm doesn't have this pressure and so it is easier for them to be inefficient.
4. Increased competition
Often privatization of government owned monopolies occurs alongside deregulation - i.e. policies to allow more firms to enter the industry and increase the competitiveness of the market. It is this increase in competition that can be the greatest spur to improvements in efficiency. For example, there is now more competition in telecommunication industry between 3 companies, rather than only Batelco in the past.
However, privatization doesn't necessarily increase competition; it depends on the nature of the market. E.g. there is no competition in electricity and water because it is a natural monopoly. There is also very little competition within the transportation industry.
5. Government will raise revenue from the sale
Selling government owned assets to the private sector will raise significant sums for the Bahrain government in the coming years.
Potential Disadvantages of privatization
1. Natural monopoly
A natural monopoly occurs when the most efficient number of firms in an industry is one. For example electricity and water has very significant fixed costs, therefore there is no scope for having competition amongst several firms. Therefore, in this case, privatization would just create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly which can exploit the consumer.
2. Public interest
There are many industries which perform an important public service, e.g health care, education and public transport. In these industries, the profit motive shouldn't be the primary objective of firms and the industry. For example, in the case of health care, it is feared privatizing health care would mean a greater priority is given to profit rather than patient care. Also, in an industry like health care, arguably we don't need a profit motive to improve standards. When doctors treat patients they are unlikely to try harder if they get a bonus.
3. Government loses out on potential profit.
Many of the privatized companies in the Bahrain are quite profitable. This means the government misses out on that profit, instead going to wealthy shareholders.
4. Problem of regulating private monopolies.
Privatization creates private monopolies, such as the electricity and water. These need regulating to prevent abuse of monopoly power. Therefore, there is still need for government regulation, similar to under government ownership.
5. Short-termism of firms.
As well as the government being motivated by short term pressures, this is something private firms may do as well. To please shareholders they may seek to increase short term profits and avoid investing in long term projects. For example, the electricityand water in Bahrain cut the service on the citizen didn't pay the fees, regardless whether they are able to pay or not.
The privatization concept is very wide, there are many factors that must take into consideration before apply the privatization; it depends on the industry at the first place.
An industry like telecoms is a typical industry where the incentive of profit can help increase efficiency. However, if you apply it to industries like health care or public transport the profit motive is less important.
The other factor is the quality of regulation. Do regulators make the privatized firms meet certain standards of service and keep prices low? If not, there is no need to privatize.
Is the market contestable and competitive? Creating a private monopoly may harm consumer interests, because some goods and services and necessary for the daily people need and increasing in the cost will harm them. But if the market is highly competitive, there is greater scope for efficiency savings.
Overall, we think that the privatization in Bahrain should not be applied, except the case of the market that could be a competitive market. Such as the telecoms. And the successful experience of Bahrain Telecommunication Company prove that.
- BOER, D.B.D. and EVANS, L. (1996) 'The economic efficiency of telecommunications in a deregulated market: The case of New Zealand', Economic Record, 72(216), pp. 24-35.
- Ifionu, E. and Ogbuagu, A. (2013) 'Privatization and economic performance: Evidence from Nigeria (1990-2010)', African Research Review, 7(2).
- Layne, J. (2001) 'An overview of the privatization debate', The Journal of Public Management, 30(2), pp. 20-25.
- Megginson, W. (2000) 'Privatization', Foreign Policy, (118), p. 14.
- Megginson, W.L. and Netter, J.M. (2001) 'From state to market: A survey of empirical studies on privatization', Journal of Economic Literature, 39(2), pp. 321-389.
- Ministry of finance - kingdom of Bahrain (2016) Available at: http://www.mof.gov.bh/topiclist.asp?ctype=organ&id=331&from=organ (Accessed: December 2016).
- Mulvany, P. (2012) Bahrain: Privatization in the air. Available at: http://me-confidential.com/11738-bahrain-privatization-in-the-air.html (Accessed: December 2016).
- Okten, C. and Arin, K.P. (2006) 'The effects of privatization on efficiency: How does privatization work?',World Development, 34(9), pp. 1537-1556.
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