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The political economy of privatisation

There are compelling reasons for Bangladesh to expedite the process of privatisation of state-owned enterprises. However, it should be based on a well-conceived plan of action which should take into account the nature of the enterprises and potential impact of privatization on economic efficiency, income distribution and government budget.

Mirza Azizul Islam
PRIVATISATION of state-owned enterprises is an important item on the policy agenda of many countries. This is because of an ideological shift in perception of the role of the state vis-A-vis the role of the private sector in economic management as well as appreciation of the economic logic buttressed by inefficiency of SOEs.
US President Reagan and UK Prime Minister Thatcher, who believed in getting the government off the back of business, contributed to an ideological shift in the perception of the role of the state. Nearly simultaneously, the role of private sector as the engine of economic growth was embodied in the "Washington Consensus."
In the developing world, many of the leaders who fought for and assumed power at independence had strong socialist orientation. They were followed by leaders who were much more receptive to the role of the private sector in economic development, and who reduced the role of the state. This ideological shift was complemented by “ empirical experience.
The countries belonging to former USSR, and other COMECON countries, decayed under a socialist regime dominated by SOEs. At the same time, China, Vietnam, and Asian tigers were achieving newer heights in economic development driven largely by the private sector. These factors brought about a shift in ideology regarding the roles of the state and private sector in economic development.
Economic logic
Why is privatisation necessary on economic grounds? First, SOEs typically perform miserably in terms of efficiency. Why is it that the SOEs tend to be inefficient? Because the incentive structure generated or inherent in SOEs is not conducive to efficiency, and because of what is termed in economics as "principal?agent problem."
In the private sector, the principals are the owners or the shareholders, and the agents are the management. The management is fully accountable to the shareholders and, subject to the replacement in case they fail to perform.
In the SOEs, we don’t have that kind of incentive structure. The owners, theoretically, are the people of the country. Obviously, they can’t exercise control on
a regular basis over any particular enterprise, either directly or through their elected representatives.
The next level is the concerned ministry, which, in a sense, represents the owners. Why should the officials of the ministry care if the enterprises fail to perform satisfactorily? They will neither be rewarded if the enterprises perform well, nor be punished in the event of failure, and the perks they enjoy are usually unrelated to performance. This applies to the enterprise officials as well.
The other stakeholders are the workers who, with assured pay and job security, are not particularly anxious to improve efficiency. The combination of these adverse incentives leads to inefficient operation of SOEs, as well as opposition to privatisation by these interest
groups.
Such inefficiency causes huge financial losses, which have to be financed. Governments are either forced to impose higher taxes or go for deficit financing, which has other adverse implications.
Second, perhaps the reason why many argue against privatisation is that SOEs serve some equity considerations. There is the presumption that goods and services have to be provided to the people at affordable prices and, therefore, even if an enterprise runs at loss, it should continue to function under state ownership. But the benefits are largely appropriated by the rich, rather than the poor. Therefore, this justification for maintaining SOEs is very weak.
Third, what prompted the establish-
ment of SOEs in earlier days was that, in the immediate post-independence years in most developing countries, the private sector was either unwilling or unable to undertake many activities that required heavy investment. But that situation has also dramatically changed. Today, we have many entrepreneurs who are willing to assume risk and able to undertake activities in areas where the state sector was dominant.
Bangladesh scene
Before independence, most large enterprises were owned by Pakistanis. The g government took over these establish-S ments after independence, and adopted g a nationalisation program leading to a | sizable expansion of government owner-| ship.
§ Soon thereafter, successive governments supported privatisation, as reflected in the establishment of Disinvestment Board in 1974, Privatisation Board in 1993, Privatisation Commission in 2000, and in some industrial policies. The compelling need for expediting the process is vindicated by the losses of SOEs, amounting to Tk. 21,210 crores over the period FY99-00 to FY07-08. Debt Service Liability of these enterprises, as of June 30, 2008, amounted to Tk. 66,553 crores (SOEs receive loans at a subsidised interest rate). Their dues to banks, as of February 15, 2008, reached Tk. 16,749 crores. And they received Tk. 3,536 crores as subsidy during the period FYOO-Oltd FY07-08.
However, privatisation is not a panacea, and we should pursue it on the basis of a well-conceived plan. We need to determine carefully which sectors we should
privatise. It may not be desirable to privatise some of the entities in some transpor-tation/service activities with strong positive externalities. Once we do that, we need to sequence them properly. There are limitations that will not permit all enterprises to be privatised simultaneously.
The third issue is choosing appropriate methods of privatisation, which may include anything from simple leasing to outright sales.
Fourthly, it is important that we undertake careful ex?ante impact assessment. The assessment should be done in terms of efficiency, employment, income distribution and implications for the government budget.
Fifthly, it is important that, particularly in public utilities where the market structure typically does not allow competition, an appropriate regulatory framework be put in place before privatisation in order to provide adequate safeguards against monopolistic abuse.
One complaint frequently heard is that privatisation should not be undertaken in Bangladesh because many privatised SOEs have ceased to exist, or no longer operate in the same field. To me, that does not validate the case against privatisation.
It is quite possible that the field in which an enterprise was set up was one where the country does not have an advantage and, therefore, it may be in the public interest to close it down. We must not harbour the notion that once an enterprise has been established, it has to live permanently. There is something called an exit and that exit must be planned.
Mirza Azizul Islam is former Adviser, to the Caretaker Government, Ministries of Finance and Planning.