Privatization of Public Utilities Essay

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A National Government’s Decision to privatize It’s Public Utilities

Introduction

There has been a prevalent political agreement on improving-benefit effect of private governance in the last decades. More than $1 trillion revenues have been generated for the government on the sale of government-owned firms to private owners. Public executives nowadays evaluate privatization as a suitable tool to implement a rapid growth of promising product innovations, facilitate financial economy development and promote more efficient production technologies. However, substantial figures of firms across the world are still owned by government. (Aghion and Tirole, 1994; Ahmed and Ashutosh, 2008). Having mentioned the privatization benefits, why are there general impediments in the decision process from the government, prioritizing to privatize some firms over the others to private sectors?

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In answering this research question, certain firm’s political and financial-economy factors were investigated in the selection of companies for privatization. As supported by literature on private firm decision to go public, financial characteristics of firms that can probably influence the decision to privatize were recognized (Ansolabehere and James, 2007). Arguably, the sale of government owned firms can not only confide in financial-economy factors but also on political settlement and costs.

However, Dixit and Londregan (1996) argued that privatization may be seen as a negative development by the public on the opinion of undemocratic shift of property owned by the government to private investors. This can result in the governing party losing its votes in such region. The position of political patronage in the decision to privatize was considered, such as; hiring decisions of government-owned firms can be influenced by politicians to favour supporters.

Further to the evaluation of political and financial-economy effect on privatization, research was conducted on India Government. This country was used as a case study because it has a huge political competition among its political parties with multiparty democracy (Dinc and Gupta, 2011).

This research contributes to the political and finance-economy literature by investigating privatization effects suggest that selection of companies for privatization are done randomly, but the result presented from Dinc and Gupta (2011) point out that privatization decision is probably endogenous to characteristics of the firm.

The literature is structured as follows; Section one describes the political system in Indian along with its privatization. Section two, discusses the political and financial-economy factors that are possible to affect government decision to privatize its public utilities. While section three, presents the conclusion of this research.

1. Privatization and Indian Political System

1.1. Firms Owned by Government

In Indian post-independence era, firms owned by government were justified by anxiety that projects that involve large investment and time-consuming gestation periods will not be awarded to private sectors. There was rapid nationalization of firms across all sectors between 1960 and 1991, which boost the formation of gross capital in firms owned by the Federal Government to 40% of the entire gross capital establishment in the market economy (Ministry of Finance, 1996).

According to Ministry of Finance (2004), the wages of government companies’ workers are higher compare to private companies’ staff and overstaffed usually occur in government companies. For instance, federal government firms employed over 10% workers from various structured sector in 2003, and their wages were averagely double that of private sector (Panagariya, 2008). This huge difference in their wage recommends why government workers vigorously disagree with government decision to privatization.

1.2. Political System

India has a legislative system where representatives are directly elected from 543 single member constituencies dispersed across 35 states, while the national government was formed by alliance of parties or political party that wins most of the constituencies. About 450 political parties participated in five elections to the federal government, held since the commencement of privatization program in 1991. These elections are 1991, 1996, 1998, 1999 and 2004. It is important to recognize the establishment of alliance among national political parties, before the commencement of election so as to inflate their probability of acquiring the majority (Dinc and Gupta, 2011).

The Congress Party initiated the economic reforms that won the 1991 elections with the support of its allies and remain in as the ruling party until the 1996 election. After 1996 election, there were successive short-lived governments that later collapsed as a result of support deficiency from affiliated members (Dinc and Gupta, 2011).

1.3. Privatization Process

In 1991, Indian created sweeping economic reforms which comprises of privatization and deregulations, as a reaction to balance payment crisis. 50 companies out of 280 nonfinancial companies that are owned by the Federal Government were privatized between 1991 and 2006. The decision to privatized list of companies was takes at the Cabinet level where every government produce its own list. The Congress government commenced the privatization in 1991, and later continued in 1999 by the BJP administration after a brief interruption by the successive government (Dinc and Gupta, 2011).

Comparatively, privatization is not famously practiced in India unlike United Kingdom (UK) where almost all government-owned firms are been privatized such as British Gas, Transport for London (TFL), British Airport Authority. Since Congress and BJP parties have engaged in privatization, neither any of them as an intellectual obligation to privatization, as both parties have campaigned against each other using anti-privatization rhetoric (Dinc and Gupta, 2011). For instance, the Congress government were attacked by the BJP conservatives on privatization plans (Reuters News, 1992; cited in Dinc and Gupta, 2011), and eventually collide with the labour unions to protest privatisation (Reuters News, 1993; cited in Dinc and Gupta, 2011). In 2004, the Congress Party also campaigned against the BJP’s reform agenda, based on the platform of limited privatization, the Congress party won the election (Dinc and Gupta, 2011).

2. The Role of Political and Financial-Economy Factors in Privatization Decision

2.1. Financial Factors: Firm Size and Profitably

Adverse effect could exist in the quality of companies that decide to publicized, if the issuers have more information than the investors about the company’s value (Leland and Pyle, 1977). According to Chemmanur and Fulghieri (1999), they argued that there is probability for adverse selection cost to be greater for both smaller and younger companies. This is backed by the result of Pagano et al. (1998), who suggested that smaller companies are not likely to be privatised. In the context of privatization, the methods of sales in a cross-country sample of privatised companies were compared together by Megginson et al., (2004). From his analysis, he finds that compared to private capital markets, big companies have the possibility to be privatized over shares sales to the public.

2.2. Political Factors

Theoretically, Persson and Guido (2002) suggested that is likely for the politicians to target public funds to important constituencies with swing voters to succeed in elections. Experimentally, Dahlberg and Johansson (2002) shows that allowance allocation in Sweden is intense in constituencies with more swing voters, and research shows that French companies that are politically associated create additional jobs in politically aggressive constituencies (Bertrand et al., 2007). Shleifer and Robert (1994) argued that interference in the operation of companies by politicians is a major cause of inefficiency in companies owned by the government.

  1. Conclusion

Since most privatizing governments sell companies, owned by the government over time or not at all, we investigate if political and financial-economy factors as well as political objectives are likely to affect government decision to privatized its public utilities. Using Indian as an exemplification, government owned companies which comprises of companies that remain fully government owned and privatized companies were investigated.

Although privatization advantages like efficiency developments are distributed across the community, the costs are probably to be distinctively intense among a small group. Therefore, the voter’s support could be declined for the governing party in constituencies where the company is located. Similarly, the public may have negative opinion on privatization as a diverging transfer to public utilities or assets to private investors. The adverse reaction on outcome of elections in that constituency will be increased if the ruling party encounter a close race with the other political parties.

Finally, the research suggests that selection of companies for privatization is not by chance. Accepting political contest as a tool for privatization decision, the sale of companies owned by the government was found as a facilitator to significance development in efficiency as well as profitability of these companies.

  1. References

Aghion, P., Tirole, J., 1994. The management of innovation. Quarterly Journal of Economics 109, 1185–1209.

Ahmed, S. and Ashutosh, V., 2008, Battles half won: The political economy of India’s growth and economic policy since independence, World Bank Working paper No. 15.

Ansolabehere, S., and James S. J., 2007, Party control of state government and the distribution of public expenditures, Scandinavian Journal of Economics 108, 547– 569.

B¨os, D., 1991. Privatization: A Theoretical Treatment. Oxford University Press, Oxford.

Chemmanur, T. and Fulghieri, P., 1999, A theory of the going public decision, Review of Financial Studies 12, 249–279.

Department of Disinvestment, 2007. Evolution of Disinvestment Policy in India . Government of India. Available at: < http://www.divest.nic.in/evolutionp.htm.>

Dinc, S. and Gupta, N., 2011. The Decision to Privatize: Finance and Politics. The Journal of Finance, LXVI(1), pp 241-269.

Dixit, A. and Londregan, J,. 1996, The determinants of success of special interests in redistributive politics, Journal of Politics 58, 1132–1155.

Gupta, Nandini, 2005, Partial privatization and firm performance, Journal of Finance 60, 987–1015.

Leland, H. and David P., 1977, Informational asymmetries, financial structure, and financial intermediation, Journal of Finance 32, 371–387.

Ministry of Finance, Government of India, 1996, Economic Survey of India (Government of India, New Delhi, India).

Ministry of Finance, Government of India, 2004, Economic Survey of India (Government of India, New Delhi, India).

Pagano, M., Fabio, P. and Luigi, Z., 1998, Why do companies go public? An empirical analysis, Journal of Finance 53, 27–64.

Panagariya, A., 2008, India: An Emerging Giant (Oxford University Press, New York).

Persson, T. and Guido T., 2002, Political Economics: Explaining Economic Policy (MIT Press, Cambridge).

Persson, T. and Guido, T., 2002, Political Economics: Explaining Economic Policy (MIT Press, Cambridge).

Shapiro, K. and Willig, R., 1990. Economic rationales for the scope of privatization. In: Suleiman, E.N.,Waterbury, J. (Eds.), The Political Economy of Public Sector Reform and Privatization. Westview Press, Boulder, CO.

Shleifer, A. and Robert, V., 1994, Politicians and firms, Quarterly Journal of Economics. 109, 995–1025.

A National Government’s Decision to Privatize its Public UtilitiesPage 1

A National Government’s Decision to privatize It’s Public Utilities

Introduction

There has been a prevalent political agreement on improving-benefit effect of private governance in the last decades. More than $1 trillion revenues have been generated for the government on the sale of government-owned firms to private owners. Public executives nowadays evaluate privatization as a suitable tool to implement a rapid growth of promising product innovations, facilitate financial economy development and promote more efficient production technologies. However, substantial figures of firms across the world are still owned by government. (Aghion and Tirole, 1994; Ahmed and Ashutosh, 2008). Having mentioned the privatization benefits, why are there general impediments in the decision process from the government, prioritizing to privatize some firms over the others to private sectors?

In answering this research question, certain firm’s political and financial-economy factors were investigated in the selection of companies for privatization. As supported by literature on private firm decision to go public, financial characteristics of firms that can probably influence the decision to privatize were recognized (Ansolabehere and James, 2007). Arguably, the sale of government owned firms can not only confide in financial-economy factors but also on political settlement and costs.

However, Dixit and Londregan (1996) argued that privatization may be seen as a negative development by the public on the opinion of undemocratic shift of property owned by the government to private investors. This can result in the governing party losing its votes in such region. The position of political patronage in the decision to privatize was considered, such as; hiring decisions of government-owned firms can be influenced by politicians to favour supporters.

Further to the evaluation of political and financial-economy effect on privatization, research was conducted on India Government. This country was used as a case study because it has a huge political competition among its political parties with multiparty democracy (Dinc and Gupta, 2011).

This research contributes to the political and finance-economy literature by investigating privatization effects suggest that selection of companies for privatization are done randomly, but the result presented from Dinc and Gupta (2011) point out that privatization decision is probably endogenous to characteristics of the firm.

The literature is structured as follows; Section one describes the political system in Indian along with its privatization. Section two, discusses the political and financial-economy factors that are possible to affect government decision to privatize its public utilities. While section three, presents the conclusion of this research.

1. Privatization and Indian Political System

1.1. Firms Owned by Government

In Indian post-independence era, firms owned by government were justified by anxiety that projects that involve large investment and time-consuming gestation periods will not be awarded to private sectors. There was rapid nationalization of firms across all sectors between 1960 and 1991, which boost the formation of gross capital in firms owned by the Federal Government to 40% of the entire gross capital establishment in the market economy (Ministry of Finance, 1996).

According to Ministry of Finance (2004), the wages of government companies’ workers are higher compare to private companies’ staff and overstaffed usually occur in government companies. For instance, federal government firms employed over 10% workers from various structured sector in 2003, and their wages were averagely double that of private sector (Panagariya, 2008). This huge difference in their wage recommends why government workers vigorously disagree with government decision to privatization.

1.2. Political System

India has a legislative system where representatives are directly elected from 543 single member constituencies dispersed across 35 states, while the national government was formed by alliance of parties or political party that wins most of the constituencies. About 450 political parties participated in five elections to the federal government, held since the commencement of privatization program in 1991. These elections are 1991, 1996, 1998, 1999 and 2004. It is important to recognize the establishment of alliance among national political parties, before the commencement of election so as to inflate their probability of acquiring the majority (Dinc and Gupta, 2011).

The Congress Party initiated the economic reforms that won the 1991 elections with the support of its allies and remain in as the ruling party until the 1996 election. After 1996 election, there were successive short-lived governments that later collapsed as a result of support deficiency from affiliated members (Dinc and Gupta, 2011).

1.3. Privatization Process

In 1991, Indian created sweeping economic reforms which comprises of privatization and deregulations, as a reaction to balance payment crisis. 50 companies out of 280 nonfinancial companies that are owned by the Federal Government were privatized between 1991 and 2006. The decision to privatized list of companies was takes at the Cabinet level where every government produce its own list. The Congress government commenced the privatization in 1991, and later continued in 1999 by the BJP administration after a brief interruption by the successive government (Dinc and Gupta, 2011).

Comparatively, privatization is not famously practiced in India unlike United Kingdom (UK) where almost all government-owned firms are been privatized such as British Gas, Transport for London (TFL), British Airport Authority. Since Congress and BJP parties have engaged in privatization, neither any of them as an intellectual obligation to privatization, as both parties have campaigned against each other using anti-privatization rhetoric (Dinc and Gupta, 2011). For instance, the Congress government were attacked by the BJP conservatives on privatization plans (Reuters News, 1992; cited in Dinc and Gupta, 2011), and eventually collide with the labour unions to protest privatisation (Reuters News, 1993; cited in Dinc and Gupta, 2011). In 2004, the Congress Party also campaigned against the BJP’s reform agenda, based on the platform of limited privatization, the Congress party won the election (Dinc and Gupta, 2011).

2. The Role of Political and Financial-Economy Factors in Privatization Decision

2.1. Financial Factors: Firm Size and Profitably

Adverse effect could exist in the quality of companies that decide to publicized, if the issuers have more information than the investors about the company’s value (Leland and Pyle, 1977). According to Chemmanur and Fulghieri (1999), they argued that there is probability for adverse selection cost to be greater for both smaller and younger companies. This is backed by the result of Pagano et al. (1998), who suggested that smaller companies are not likely to be privatised. In the context of privatization, the methods of sales in a cross-country sample of privatised companies were compared together by Megginson et al., (2004). From his analysis, he finds that compared to private capital markets, big companies have the possibility to be privatized over shares sales to the public.

2.2. Political Factors

Theoretically, Persson and Guido (2002) suggested that is likely for the politicians to target public funds to important constituencies with swing voters to succeed in elections. Experimentally, Dahlberg and Johansson (2002) shows that allowance allocation in Sweden is intense in constituencies with more swing voters, and research shows that French companies that are politically associated create additional jobs in politically aggressive constituencies (Bertrand et al., 2007). Shleifer and Robert (1994) argued that interference in the operation of companies by politicians is a major cause of inefficiency in companies owned by the government.

  1. Conclusion

Since most privatizing governments sell companies, owned by the government over time or not at all, we investigate if political and financial-economy factors as well as political objectives are likely to affect government decision to privatized its public utilities. Using Indian as an exemplification, government owned companies which comprises of companies that remain fully government owned and privatized companies were investigated.

Although privatization advantages like efficiency developments are distributed across the community, the costs are probably to be distinctively intense among a small group. Therefore, the voter’s support could be declined for the governing party in constituencies where the company is located. Similarly, the public may have negative opinion on privatization as a diverging transfer to public utilities or assets to private investors. The adverse reaction on outcome of elections in that constituency will be increased if the ruling party encounter a close race with the other political parties.

Finally, the research suggests that selection of companies for privatization is not by chance. Accepting political contest as a tool for privatization decision, the sale of companies owned by the government was found as a facilitator to significance development in efficiency as well as profitability of these companies.

  1. References

Aghion, P., Tirole, J., 1994. The management of innovation. Quarterly Journal of Economics 109, 1185–1209.

Ahmed, S. and Ashutosh, V., 2008, Battles half won: The political economy of India’s growth and economic policy since independence, World Bank Working paper No. 15.

Ansolabehere, S., and James S. J., 2007, Party control of state government and the distribution of public expenditures, Scandinavian Journal of Economics 108, 547– 569.

B¨os, D., 1991. Privatization: A Theoretical Treatment. Oxford University Press, Oxford.

Chemmanur, T. and Fulghieri, P., 1999, A theory of the going public decision, Review of Financial Studies 12, 249–279.

Department of Disinvestment, 2007. Evolution of Disinvestment Policy in India . Government of India. Available at: < http://www.divest.nic.in/evolutionp.htm.>

Dinc, S. and Gupta, N., 2011. The Decision to Privatize: Finance and Politics. The Journal of Finance, LXVI(1), pp 241-269.

Dixit, A. and Londregan, J,. 1996, The determinants of success of special interests in redistributive politics, Journal of Politics 58, 1132–1155.

Gupta, Nandini, 2005, Partial privatization and firm performance, Journal of Finance 60, 987–1015.

Leland, H. and David P., 1977, Informational asymmetries, financial structure, and financial intermediation, Journal of Finance 32, 371–387.

Ministry of Finance, Government of India, 1996, Economic Survey of India (Government of India, New Delhi, India).

Ministry of Finance, Government of India, 2004, Economic Survey of India (Government of India, New Delhi, India).

Pagano, M., Fabio, P. and Luigi, Z., 1998, Why do companies go public? An empirical analysis, Journal of Finance 53, 27–64.

Panagariya, A., 2008, India: An Emerging Giant (Oxford University Press, New York).

Persson, T. and Guido T., 2002, Political Economics: Explaining Economic Policy (MIT Press, Cambridge).

Persson, T. and Guido, T., 2002, Political Economics: Explaining Economic Policy (MIT Press, Cambridge).

Shapiro, K. and Willig, R., 1990. Economic rationales for the scope of privatization. In: Suleiman, E.N.,Waterbury, J. (Eds.), The Political Economy of Public Sector Reform and Privatization. Westview Press, Boulder, CO.

Shleifer, A. and Robert, V., 1994, Politicians and firms, Quarterly Journal of Economics. 109, 995–1025.

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