Pakistan Privatization Of State Owned Enterprises Economics Essay
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Published: Mon, 5 Dec 2016
The most recent two decades have witnessed an extensive shift in global State owned enterprises (SoEs) management paradigm, giving way to a progressively liberalist and free market reform doctrine. The structural restructuring process involves a variety of measures, including privatization and deregulation of SoEs, which are supposed to bring about more growth and development. The extraordinary growth of privatization has changed, probably irreversibly, the underlying traditional economic relationships to study the global economy. Nevertheless, the new arrangement has not effectively tackled the consumer benefits; rather they have become more vulnerable to monopolistic forces of cartels established in the stir of privatization. And these problems more aggravate in the non-existence of an successful regulatory mechanism for the privatized sectors of economy. Privatization policies are currently in steps forward the world over, in Europe, North America, Japan, and many developing and newly industrialized countries.
However, its basis in theory was somewhat uncertain to start with. Moreover, a sizeable adequate body of empirical evidence, which has been tested, are available. A large amount of the early momentum to privatization entailed a dive in faith, and, as happens all too often in the development of knowledge, attempts to explain its impact have followed on the heels of extensive existing practices. Even though ideological thoughts exemplified by such statements as, “governments have no businesses to be in business” – have often been dominant to augment the dynamics privatization in various parts of the world, it is also true that governments have sought to justify privatization in relation to certain objectives. In general, government include one or more of the following reasons:
To promote increased efficiency.
To lift revenues for the state (and thereby bridging fiscal deficits).
To decrease government interfering in the economy and promote greater private initiative.
To encourage the wider share ownership which leads towards the growth of capital markets?
Of these, the most dominant, debatable and leading objective is the first one. For the reason that there is a dire need to promote efficiency in running commercial organizations There is a prevailing sense that public ownership by some means leads to lower levels of efficiency than are possible under private ownership. The inefficient SoEs, in turn, are seen as creating other problems such as the use of government revenues through subsidies and non-competitive industries in the economy.
It is important that neoclassical theory does not have much to say about firm ownership, dwelling instead on the importance of market structure in generating efficient outcomes. Successive literature, portrayal on agency theory has, however, come up with a number of reasons why private ownership might be superior. Firstly, the managers in the public sector not have incentives to achieve targets because they are poorly monitored (Vickers & Yarrow, 1991). Poor monitoring, in turn, stems from the fact that ownership is diffused, and, in addition, the firms are not publicly traded and hence not open to the threat of takeover. Secondly, managers in the public sector not have incentives to perform is that they do not frightened from bankruptcy. Managers in the public sector can look forward to be compensated through public funds (Kornai, 1980). Agency theory also suggests that, unlike their counterparts in the private sector, managers in the public sector might lack focus because they are expected to pursue a variety of objectives, not all of which are calculated to maximize profit, (Shleifer & Vishny, 1997). Multiplicity of objectives arise from the fact that public sector managers are answerable to different constituents, such as legislators, civil servants and government also to militate against profit maximization.
Privatization: Views & Reviews
Privatization is conventionally defined as the deliberate sale by a government of state-owned enterprises (SOEs) or assets to private economic agents, (Megginson & Netter, 2001). Privatization shifts ownership and control of public assets to private investors, (Qian Sun et al., 2002). In this fast-changing economic landscape, virtually every country has sought privatization to facilitate economic progress. This is evident as; privatization is withdrawal from the state, not of individual involvement, but of assets, functions, indeed, entire institutions, (Starr, 1988). Privatization is defined on two levels, on the broader level, as “reduction in the regulatory and spending activity of the state” and at the more specific level as “excludes deregulation and spending cuts except when they result in a shift from public to private in the production of goods and services” (Starr, 1988). Privatization can also be called denationalization or disinvestment. All three terms describe a situation where a government decides to transfer control of a government, and thus public owned, resource to the private business sector, either partially or totally. Furthermore, privatization represents an ideological and symbolic break with a history of state control over a country’s productive assets (Megginson, 2000).
Privatization efforts in both developed and emerging economies result in the transfer of ownership from the state to new owners and, therefore, can create the agency problems of managerial perquisite consumption, (Gedajlovic & Shapiro, 1998) and entrenchment (Walsh & Seward, 1990). Perquisite consumption refers to short-run cost-augmenting activities by managers designed to enhance non-salary income or provide other on-the-job consumption, (Gedajlovic & Shapiro, 1998). Entrenchment refers to actions of management that reduce the effectiveness of control mechanisms designed to regulate management behaviours (Walsh & Seward, 1990). Agency theorists would argue that new owners must be concerned with managerial perquisite consumption and entrenchment problems (Eisenhardt, K. M., 1989; Fama, E. F.,1980; Jensen, M. C., & Meckling, W. H., 1976).
Different studies have attempted to analyze the important dimensions of privatization including patterns and trends in policies and implications like, (Ramamurti R., 2000), saying privatization is any measure that increases the role of the private sector in the economy-for example, through deregulation, which permits private entry into markets previously reserved for SOEs; economic liberalization, which exposes them to greater competition (e.g., through lower tariffs or fewer restrictions on foreign investment); or institution buildings, which improve the functioning of private firms and markets.
1.2 Privatization: The Conceptual Framework
In the last decade many countries have introduced privatization programmes. In 1995, the value of state sell-offs is reported to have reached a record figure of 37 billion US dollars with at least 45 countries in the process of privatising some industries (Economist, 13 January 1996, p.5). This figure may exaggerate the degree of true privatization since some governments choose to describe the sale to the private sector of only a small part of the total share holding as a privatization. Nevertheless, there can be no profound effect of world-wide privatization on industrial organization both in the developed and the developing world.
The political pressure for privatization came from a combination of disillusionment with the result of state ownership and from a belief that private ownership will bring substantial economic benefits. State-owned industries were viewed as highly inefficient, slow at developing and introducing new technologies subject to frequent political intervention and dominated by powerful trade unions. Privatisation seemed to offer a means of ridding the state of the financial burden of loss-making activities, while at the same time spreading share ownership and curtailing union power, (Arbomeit, H., 1986). This source of state funding is considered vital when economic policies were geared to reduce the public sector deficits. Empirical study of the effect of competition on productivity in manufacturing has borne out that it affects both the level and growth rate positively (Nickell, 1996). Competition sharpens the incentives for management to manage the firm’s assets efficiently. Also, where there is a competition, the firm’s profits reflect and identify the differences in managerial ability creating a dynamic link between the product and the capital market.
The modern idea of privatization as an economic policy was pursued for the first time by the Federal Republic of Germany in 1957, when the government eventually sold majority stake of Volkswagen to private investors. The next big move in privatization came in the 1980s with Margaret Thatcher’s privatization of Britain Telecom and Chirac’s privatization of large banks in France. Privatization spread to other continents as Japan and Mexico privatized government owned communication companies (Megginson, Nash & Randenborgh, 1994). Another major contribution to the world-wide process of privatization has been the fall of the communist regime in Eastern Europe and the former Soviet Union. In recent times, countries like China and Cuba, as well as many other developing countries have begun to implement privatization in the hope of stimulating economic growth. Over the period of 10 years between 1984 and 1994, there has been a world-wide shift of $468 billion in assets from the public sector to the private sector (Poole, Robert W., 1996).
The theoretical framework behind the idea of privatization is largely dependent on understanding the concept of property rights. In order to develop an expanded, specialized market system, a society must have an efficient way of dealing with numerous transactions that take place in a specialized economy. Specialization and allocation of resources depends on low transactions costs, which are dictated by prices in market economies. Competitive markets, in which transactions are effectively handled by market prices, rely heavily on formal, well-defined property rights (Mankiw, N. Gregory, 2001). De Soto (1996) explains, “To be exchanged in expanded markets, property rights must be ‘formalized’, in other words, embodied in universally obtainable, standardized instruments of exchange that are registered in a central system governed by legal rules”. In fact, that the lack of formal property rights is “the missing ingredient” that is keeping underdeveloped countries from sustaining long-term growth. Furthermore, the lack of property rights limits the amount of goods and services that can be exchanged in the market. An important implication of well-defined property rights is that it creates strong individual incentives, which, according to Easterly, is a significant factor in the quest for long term growth. By creating strong incentives, property rights lead to an increase in investment since people are certain and secure about the ownership of their property. Furthermore, individuals gain an access to credit since they can use their formal titles as collateral for loans, ultimately leading to an increase in investment. Finally, property rights give people an incentive to pursue long-term rather than short term economic goals. In the case of land ownership, individuals who have secure and well-defined ownership will invest in their land instead of continuously draining new land.
There are many theoretical economic benefits that are connected to the process of privatization. One of the main reasons why countries pursue privatization is in order to reduce the size of the existing government, based on the idea that many governments have become too large and overextended, consisting of unnecessary layers of bureaucracy. Therefore, many countries require restructuring in order to improve efficiency, which can be achieved through privatization. The private sector responds to incentives in the market, while the public sector often has non-economic goals. In other words, the public sector is not highly motivated to maximize production and allocate resources effectively, causing the government to run high-cost, low-income enterprises. Privatization directly shifts the focus from political goals to economic goals, which leads to development of the market economy (Poole, Robert W., 1996). The downsizing aspect of privatization is an important one since bad government policies and government corruption can play a large, negative role in economic growth (Easterly, W., 2001).
By privatization, the role of the government in the economy is reduced, thus there is less chance for the government to negatively impact the economy Privatization can have a positive secondary effect on a country’s fiscal situation. As Easterly discusses, privatization should not be used to finance new government expenditures and pay off future debts. Instead, privatization enables countries to pay a portion of their existing debt, thus reducing interest rates and raising the level of investment. By reducing the size of the public sector, the government reduces total expenditure and begins collecting taxes on all the businesses that are now privatized. This process can help bring an end to a vicious cycle of over-borrowing and continuous increase of the national debt (Poole, Robert W., 1996).
Megginson and Netter (2001) argue that the theoretical arguments for the advantages of private ownership of the means of production are based on a fundamental principal of welfare economics; a competitive equilibrium is optimal under certain assumptions. These assumptions are that there are no externalities in production or consumption, that the product is not a public good, the market is not monopolistic in structure and the information costs are low. Thus a theoretical argument for government intervention based on efficiency grounds rests on an argument that the markets have failed in some way, in that one or more of these assumptions do not hold, and the government can resolve the market failure. There are non-efficiency arguments for government ownership, generally based on redistribution resources. That is, government ownership will change the distribution of wealth and income. Privatization is a response to the failings of state ownership.
They also outline some of the theoretical arguments on the advantages of private versus state ownership. First, the contracting ability affects the efficiency of state ownership. Secondly, the use of revenues from privatization to improve government finances. Thirdly, privatization is used to factor markets, product markets and security markets. Welfare economies argue that efficiency is achieved through competitive markets. If privatization promotes competition, privatization can have important efficiency effects. Many of the theoretical arguments for privatization are based on the premise that the harmful effects of state intervention have a greater impact under state ownership than under state regulations. (Megginson & Netter, 2001)
1.3 Privatization Techniques
Governments usually choose one of these three techniques to privatize:
Share issue privatization (SIPs)
With an asset sale, the government sells ownership of the state-owned enterprise to an existing private firm or to a small group of investors. This is similar to the traditional use of the private capital market in non-SOE transactions. The government may sell a fraction or all of the SOE through an asset sale. In share issue privatizations, the privatizing government sells equity shares through the public capital market to both retail and institutional investors.
SIPs are the largest and most economically significant of all privatizations, and account for the preponderance of assets privatized in terms of values.
Voucher privatization is similar to SIPs but in this privatization mode, the government distributes vouchers (paper claims) to each citizen. Thus voucher privatizations result in assets being virtually given away to citizens.
The government universally distributes vouchers to its eligible citizens, which can be sold to other investors or exchanged for shares in other institutions being privatized. Although this method does not create revenues for the state, it does privatize state-owned firms in a short period of time (Stirbock, C. 2001).
Countries around the world have pursued different methods of privatizing state assets depending on the initial conditions of the country’s economy and the economic ideologies of the political party in charge. The process of privatization is often easy for small institutions, while the process becomes vigorous when it comes to finding the appropriate buyers for larger enterprises. One of the main methods of privatization is the sale of state-owned enterprises to private investors. The state would simply decide which institutions should be privatized and through the use of market mechanism, private investors are able to buy shares of each firm. The benefits from this method of privatization are that it creates badly needed revenues for the state while putting privatized firms in the hands of investors who have the incentives and the means of investing and restructuring.
Privatization efforts in both developed and emerging economies result in the transfer of ownership from the state to new owners and, therefore, can create the agency problems of managerial prerequisite consumption (Gedajlovic & Shapiro, 1998). and entrenchment (Walsh & Seward, 1990). Perquisite consumption refers to short-run cost-augmenting activities by managers designed to enhance non salary income or provide other on-the-job consumption (Gedajlovic & Shapiro, 1998). Entrenchment refers to actions of management that reduce the effectiveness of control mechanisms designed to regulate management behaviours (Walsh & Seward, 1990).
Sometimes, insider dealings and various facets of corruption frequently occur in developing countries that have privatized through vouchers and on asset-sales. Asset-sales are often conducted in a non-transparent manner, such as a poorly publicized sale, giving insiders the chance to manipulate the transaction in their favour. By contrast, privatization programs executed through public share-offerings tend to be models of transparency (Megginson, 2000).
A comprehensive review is presented after the sub-regional workshop on privatization in South Asia in Katmandu, they are of the view that The process of privatization has been difficult and lessons have been learned along the way – in relation to the structuring of transactions and sale process, and in relation to balancing the interests of investors and consumers, as well as those of government, workers and regulators. He also cautioned that no country can claim to have delivered privatization without some failures and some highly criticized deals. So, each country needs to evolve its own approach to privatization, keeping in view the lessons learnt from others.
Historical Perspectives of privatization
Privatization is not merely an economic concept; rather it is more comprehensive in terms of socio-economic and political philosophy. During the 1970s, privatization became an organic phenomenon with the rise of conservative governments in Great Britain. In addition, USA and France were also seeking:
(1) Shifting of activities or functions from the public sector to the private sector
(2) Shifting of the production of goods and services from public to private hands.
1.4.1 Phase 1 (1961-1980)
The rise of the Keynesian economy and World War II are the two crucial factors for the active role of government including ownership of production and provision of all types of goods and services, in most part of the world. The regulation of the national economy in terms of state ownership and private-ownership became the vital agenda of discussion throughout the world. The first breakthrough came in 1979 when Thatcher’s conservative government decided that the government should possess telecommunications and postal services, public utilities and most forms of transportation (especially airlines and railroads). Thatcher adopted the label “privatization,” which was originally coined by Peter. F. Drucker, replacing the term “denationalization” (Yergin, D., & Stanislaw, J. 1998). Many politicians also believed the state should control certain “strategic” manufacturing industries, such as steel and defence production, (Megginson, W.L.; and J. Netter, 2001). In many countries, state-owned banks were also given both monopolistic or protected positions, as discussed in (La Porta, Rafael, and Florencio Lopez-de-Silanes, 1999), and (Shleifer, A. 1998).
Privatization reduced the role of the government in the provision of marketed goods and services. The general government sector (health, education, community services and social welfare) continued to grow in absolute terms and, in many countries, as a proportion of GDP, throughout the 1980s and 1990s (Quiggin, J. 2002).
Albeit the movement was provoked in United Kingdom but it was also adopted by many other countries of Western Europe (Burton J., 1987). Countries adopting privatization measures (variously, in telecommunications, banking, railways, car manufacture, electricity generation, etc) also now include Bangladesh, Mexico, Thailand, South Korea, Malaysia, Sri Lanka, Japan, Spain, Turkey, Chile, Sweden, Singapore, West Germany, India, Portugal, Australia, the Philippines, Jamaica, Uganda, Pakistan and Brazil. Even Cuba and China are selling off public housing stock moves towards privatization in (service industry) have recently occurred in the Soviet Union, (Young P., 1987).
The gigantic growth in privatization is in fact associated with the government of Conrad Adenauer, elected to power in the Federal Republic of Germany (FRG) in 1957, that launched the first large-scale, ideologically-motivated privatization program. The first major sale occurred in 1961, when the FRG sold a majority stake in Volkswagen in a public share issue heavily tilted towards small investors, and four years later it orchestrated a similar, but even larger, secondary share issue for VEBA Company. These two issues increased the number of shareholders in Germany from approximately 500,000 to almost 3 million, (Megginson, W.L.; Nash, R.C. & M.V. Randenborgh 1994).
Privatization became the main economic policy measure in UK after the success story of British Telecom initial public offering in November 1984. During the 1980s share issue privatization method gained importance to reduce the role of SOEs in United Kingdom (Megginson, W.L.; and J. Netter, 2001).
1.4.2 Privatization Expansion Program (1985-1993)
After the initial success of privatization program in United Kingdom, it was followed by Denmark, Italy, Chile, Malaysia, and Singapore. A robust growth was experienced in the form of limited sales of individual companies. However, after the United Kingdom, France has adopted privatization program in multiple spheres. In addition to France, Austria, Belgium, Holland, Jamaica, Japan, Spain, Sweden, and the United States all executed significant privatizations through share issues during late 1986 and 1987. The case of Nippon Telephone and Telegraph (NTT) is significant in Japan. Finally, the mid-1990s also witnessed an acceleration of privatization programs in the European Community. After 1987, the accelerated growth in privatization was witnessed in many countries of South America, Africa, and South Asia. Selling SOEs and share issues options were widely used in Bangladesh, Brazil, Chile, Gambia, Malaysia, Mexico, Nigeria, Sierra Leone, Singapore, and Venezuela (Megginson, W.L.; and J. Netter, 2001).
This is widely noticed that many countries in the world are following the British lead in privatizing its state-owned industries. This is due to the success story of the United Kingdom case. Investors and consumers have rarely done as well with offerings in other countries as they have done on U.K. issues. In France, the share price of every company is privatized since 1993 but two are trading below their issue price. Italy has an even worse record. Only a handful of other western European countries besides Britain have actually begun to privatize utilities. The crucial distinction lies in the fact that in Britain-as in many former Communist countries in Eastern Europe eager to build a solid foundation for newly regained freedoms-privatization has been pursued as a matter of conviction by governments committed to the program. Among other western industrialized countries only Canada has set precedents for public offerings, by recently privatizing its air traffic control system and rail services, and in these cases has closely followed the precedents for privatizations set in the United Kingdom (Gibbon, H. 1997),
1.4.3 Shift towards Transition Economies
The first major “denationalization” program (as privatization was originally known) took place in Germany in the early 1960s, when Chancellor Conrad Adenauer’s government sold part of its stakes in Volkswagen and the industrial company VEBA to private investors. Latin America alone accounted for about one fourth of the value of worldwide privatizations from 1988 to 1993, during the heyday of the region’s market liberalization and economic reform efforts. Japan also pursued privatization: The first three Nippon Telegraph and Telephone (NTT) offerings raised nearly 80 billion US Dollar for the Japanese government, with the second NTT offering alone hauling in $40 billion (Megginson, 2000).
China has undergone massive yet quiet privatization since the mid-1990s, (Cao, Y., Qian, Y. and Weingast, B., 1999 ; Lin, Y. and Zhu, T. (2001); Garnaut, R., Song, L. Tenev, S. & Yao, Y. 2003).
The number of state-owned enterprises (SOEs) fell by 40 percent in the period 1996-2001 and most of the remaining SOEs were scheduled for privatization within a short period (Garnaut, R., Song, L. Tenev, S. & Yao, Y., 2003)
SOEs handled most of Egypt’s economic activity under the direction of various ministries. Poor management and weak capitalization of SOEs inevitably had a negative effect on their efficiency and financial viability. In an effort to improve its economy, Egypt launched a privatization program in 1991 as a part of its economic-reform programs. In 1991 Egypt’s 314 SOEs were grouped under 27 holding companies (reduced to 14 by 2001) responsible for all the affiliates in various sectors.
In the Czech Republic, 26,000 such establishments (or leases for their use) were auctioned off between 1990 and 1992, raising an amount equal to 3.4 percent of GDP and 4.7 percent of government expenditures in 1991. In Poland, 30,000 to 80,000 units were sold in 1992, (Frydman, R. et al 1994), and in Hungary, where the private ownership of such establishments had been allowed previously, 8,700 had been sold by mid-1993 (Mihalyi, P. 1994b, p. 367). Where this sort of privatization program has been pursued with vigour, it has created numerous small private businesses, albeit concentrated in retailing and catering. In general, these programs have been among the most popular and least difficult aspects of privatization. In effect, only Germany has been able to privatize the bulk of the state-owned enterprise sector through the sale of the state-owned enterprises.
Final analysis states that Privatization has certainly been an overriding force in financial market development, contributing substantially to the total capitalization of world’s stock markets. The massive wave of privatization by international offerings has fostered the development of global capital markets and the scope of cross-border investment (Asher, B. 1996).
1.5 Objectives of Privatization
Many people ask this question that why government want to own industries and why want to privatize them afterwards. The government own organization to get better control and achieve their objectives. The positive aspect or the rationales behind that entire are, they have different objectives as compared to the other business at least in part because their major objectives are maximizing employment, developing backward areas and other social aspect.
In order to achieve those objectives government has to provide some non market Benefits like, variety of (usually) indirect subsidies, reduced prices on inputs and implicit guarantees to cover operating losses.
Literature proves that normally the State-owned enterprises are persistently unprofitable Improvement in state finances, widening and deepening capital ownership, protecting the interests of employees and the very important factor performance of SOEs is the source of inspiration for privatization.
According to Megginson, W.L.; and J. Netter, (2001) the state is unlikely to allow a large SOE to face bankruptcy. Thus the discipline enforced on private firms by capital markets and the threat of financial distress is less important for state-owned firms.
(Kornai, J., 1988, 1993, 2000; Berglof, Eric and Gerard R. 1998 & Frydman, R.; Marek H., and Rapaczynski A. 2000) all suggest that soft budget constraints were a major source of inefficiency in firms.
They also discuss the objectives of privatization. Infect the major and fundamental goal of privatization is to raise revenue, but generally the more important objective is to improve the operating and financial performance of the former SOE by exposing it to market forces. But most governments actually expect employment to fall, discussed by (D’Souza, J.; Megginson, W.L. & Nash R., 2001; Megginson, W.L.; and J. Netter, 2001)
Another important aspect of these objectives is that these were same set for the British privatization program by the Conservatives as those listed by the Adenauer government twenty years before-and almost every government since.
Changes in Goals, Incentives, and Controls after privatization
Privatization redefines the firm’s objective function. While state-owned firms typically pursue multiple and often conflicting objectives which includes social objectives, betterment of different remote areas and employments etc., but privatized firms focus on profit maximization. However, the degree to which the privatized firms can pursue profit maximization differs considerably across our sample companies. (D’Souza, J.; Megginson, W.L. & Nash R., 2001) Most privatization programs around the world pursue two basic objectives:
(1) Revenue generation, either to get out of fiscal crises or to serve redistributive purposes; and (Starr P. 1988)
2) Efficiency enhancement, through depoliticizing SOEs and improving corporate governance, (LaPorta, R., & Lopez-de-Silanes F., 1997). Simultaneously, Cuervo, A. & Villalonga, B., (2000), widely recognized that the goals in private firms are clear and are related to profit maximization and value creation for shareholders. In state-owned firms, however, the goals are usually blurred, multiple, conflicting, and unstable and include both financial and political objectives (Cuervo A., 1997).
1.6 OBJECTIVES OF THE STUDY
Pakistan adopted nationalization policy in 1974 and the entrepreneurs strongly reacted and with-held their investments. Such a policy adopted by the Government was fatal for the industrialization process of the county. However, the Government in 1989 initiated the process of divestiture of Government holding in SOEs by first public offering partial Government holding in PIA. This public offering was a small step towards privatization, initiated a long list of SOE facing privatization. Successive Government in support of their consistent commitment to this process along with sustained pressure
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