Privatization in developing and xUSSR countries as a special case of corruption

Jarrah, your analysis applies well to many parastatals (marketing boards, land development boards, etc) in developing countries, used to appropriate agricultural surpluses and distribute them to the political elite.

Many of them were used primarily to create jobs for the boys and contracts for the cronies. However they were at least notionally subject to the laws that created them (e.g., land development boards set up to develop land for poor smallholders) and therefore potentially subject to reform. Ironically, the privatization bandwagon has frequently been used to hand over valuable public assets to clients of the political elite, further concentrating wealth and placing the management of those assets beyond public scrutiny. Witness the massive redistribution of public wealth in Malaysia through less than transparent privatization processes. For example, I have studied the fate of the Sarawak Land Development Board whose valuable oil palm holdings were privatized through the creation of Sarawak Plantations Ltd, owned by a few cronies.

Sarawak Plantations has an enigmatic motto that can serve as a catch cry for the privatization ideologues - “we can do better” !! The question is “for whom?


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Refuted economic doctrines #2: The case for privatisation By jquiggin

January 3, 2009

This is the second in a planned series of posts assessing the implications of the global financial crisis for the economic ideas and policies that have been dominant for the past few decades. The large-scale privatisation of publicly-owned enterprises both in capitalist countries like the UK and Australia and in formerly communist countries after 1989 played a big role in promoting the kind of triumphalism that characterised much commentary about free-market capitalism in the 1990s and (to a somewhat lesser extent) in the years leading up to the crisis. How well do arguments for privatisation stand up in the light of the financial crisis.

The case for privatisation had two main elements.

The fiscal case for privatisation must be assessed on a case by case basis. It will always be true for example that if a public enterprise is operating at a loss, and can be sold off for a positive price with no strings attached, the government's fiscal position will benefit from privatisation. Various early ventures in public ownership, such as the state butcher shops operated in Queensland in the 1920s (apparently a response to concerns about thumbs on scales) met this criterion, and there doesn't seem to be much interest in repeating this experiment. However, for most recent privatisations in developed countries, the sale price has been less than any plausible estimate of the value of future earnings, discounted at the government bond rate. The fiscal case for privatisation therefore rests on the claim, derived from the efficient markets hypothesis, that the correct discount rate to use is one based on the private sector cost of capital and therefore dominated by the expected rate of return to equity capital.

The choice of discount rate makes a difference because the rate of return to equity has historically been much higher than the rate of interest on government bonds, a gap that can't be explained by standard economic arguments about risk premiums. Although many explanations of this 'equity premium puzzle' have been offered, for present purposes they can be divided into two classes

(i) those which assume that the EMH is true, and imply that the equity premium is a correct reflection of economic risk, independent of equity markets

(ii) those in which the risk premium for equity reflects failures in equity markets that lead people to prefer holding bonds

In the light of the GFC and the events leading up to it, the case for explanations of type (ii) is overwhelmingly strong

The dynamic case for privatisation is based on the idea that the allocation of investment will be better undertaken by private firms than by government business enterprises. This claim in turn relies on the assumption that the evaluation of risk and returns undertaken by investment banks, with the assistance of ratings agencies, and the availability of sophisticated markets for derivatives like CDOs will be far superior than anything that could be obtained by, for example, using engineering calculations of the need for investment in various kinds of infrastructure, and seeking to implement the resulting investment plans on a co-ordinated basis. The GFC has shown that, for most of the past decade, market estimates of the relative riskiness and return of alternative investments have been entirely unrelated to related. For infrastructure in particular, the decision processes of Byzantine creations like Macquarie and Babcock and Brown have determined the allocation of investment. Unsurprisingly, the result has been a mess.

I've been making this argument for some time, so I can anticipate the immediate response that, if the case for privatisation developed in the 1980s were invalid, it would be necessary to advocate public ownership of all enterprises. I'm never quite sure if those putting forward such arguments are as ignorant of marginal cost and benefit calculations as they appear to be, or whether it's simply meant as a debating trick. But it should not be hard to see that, if the public sector has lower costs of capital, while the private sector has (at least in a wide range of activities) lower operating costs and greater responsiveness to consumer demand, the optimal economic structure will involve public ownership of some firms and private ownership of others, that is, a mixed economy.

Topics: Economics - General |

  1. Jarrah (formerly fatfingers) Says:
    January 3rd, 2009 at 5:21 pm

    I realise you are approaching this from an economic perspective, but there are other reasons (that are perhaps more political in nature) why privatisation may be the best option in some or most cases.

    One is the occasional tendency for a government to use state-owned enterprises primarily as dividend dispensers, rather than producing/servicing entities. This can lead to underinvestment, or diversion of funds from productive investment into favoured projects or porkbarreling.

    Another is the kinds of protection a politically well-connected SOE can get, like subsidies and tariffs and competition prevention. This has obvious downsides.

    I would continue, but dinner's ready. I'm sure your readers can think of more.

  2. charles Says:
    January 3rd, 2009 at 7:59 pm

    I would argue government enterprises should be sold to suckers, sorry capitalist in the good times to suck money out of the system and brought back in the bad times to put money back into the system. Big mistake to have the future fund holding all those Telstra shares in the good times.

  3. Ikonoclast Says:
    January 3rd, 2009 at 8:12 pm

    It may be a bit old fashioned of me to say this. Surely, government ownership is warranted in cases of natural monopoly. Major utilities (water, power, communications) and transport infrastructures (rail) usually fit this bill.

    Major national utilities and infrastructure are "strategic" in every sense of the word. The power to plan strategically for social, economic and military requirements must remain in the hands of the democratic national government.

  4. TerjeP (say tay-a) Says:
    January 3rd, 2009 at 9:05 pm

    John,

    Q1. According to your case by case criteria was Margaret Thatcher right to sell the British coal mines?

    Q2. Was the corporatisation of Australia Post in 1989 the right thing to do?

    Q3. In a sector, such as banking, where there are many successful and popular private operators what is the merit of the government also being a supplier? And which bank should it buy?

  5. Donald Oats Says:
    January 3rd, 2009 at 10:28 pm

    Luv PPPs. The Cross-City Tunnel in Sydney was eclipsed only by the Lane Cove Tunnel (and here). But that was another world away…Murray Bridge being the current abode.

    Anyway, since we seem to be posing questions, here is mine:
    Should the military be privatised? The government could use a tender process for supply of troops, equipment, logistics, etc. For example, the government could have used contracts to supply troops to Iraq, Afghanistan, various Pacific Islands, and other exciting places. Much cheaper than having a bunch of soldiers, tanks, subs and so on sitting around during the quiet times.

    Where does the risk reside, and how does it affect the economic analysis of whether to privatise all or part of the military?

    Personally I feel quite uncomfortable with the idea of privatisation to any degree (Haliburton, Sandline and others come to mind)…yet can an argument be convincingly made for privatisation?

    Anyway - Happy New Year, Prof JQ and bloggers; 2009 should be a doozy!

  6. Sebastian Says:
    January 3rd, 2009 at 10:32 pm

    @Jarrah:
    The political argument is problematic, too, as there is little reason to believe that private companies don't engage in massive corruption, including, of course, in the process of privatization itself. (cf. the corruption under Carlos Menem in Argentina, as a case in point).

    More broadly, the political case for privatization in developing countries often rests on limited state capacity and/or state corruption. And its certainly true that that affects the performance of SOE - but it _also_ affects the ability of the state to effectively regulate and negotiate privatization (which is especially important in difficult cases such as any type of public utility: electricity, water, phone):
    Successful privatization relies on successful regulation - e.g. the spectacular success of German telecom privatization was based on the existence of an extremely powerful and well run regulatory agency - but set up an agency like that in a weak state (think Bulgaria, Ecuador, whatever) and you're going to get a disaster.

  7. gdr Says:
    January 3rd, 2009 at 10:56 pm

    was Margaret Thatcher right to sell the British coal mines?

    John Major, surely? The Coal Industry Act was passed in 1994.

  8. Marginal Notes Says:
    January 3rd, 2009 at 11:02 pm

    Jarrah, your analysis applies well to many parastatals (marketing boards, land development boards, etc) in developing countries, used to appropriate agricultural surpluses and distribute them to the political elite. Many of them were used primarily to create jobs for the boys and contracts for the cronies. However they were at least notionally subject to the laws that created them (e.g., land development boards set up to develop land for poor smallholders) and therefore potentially subject to reform. Ironically, the privatisation bandwagon has frequently been used to hand over valuable public assets to clients of the political elite, further concentrating wealth and placing the management of those assets beyond public scrutiny. Witness the massive redistribution of public wealth in Malaysia through less than transparent privatisation processes. For example, I have studied the fate of the Sarawak Land Development Board whose valuable oil palm holdings were privatised through the creation of Sarawak Plantations Ltd, owned by a few cronies. Sarawak Plantations has an enigmatic motto that can serve as a catch cry for the privatisation ideologues - "we can do better" !! The question is "for whom?"

  9. Jill Rush Says:
    January 4th, 2009 at 12:30 am

    Interesting point Donald Oats. The problem however is that PPPs lack the flexibility that is required by government. The Howard Government in the early years flirted with the idea of the privatisation of Centrelink. It was seen as a way of managing money passed from government to those deemed eligible for a variety of payments. Something that a bank or insurance or finance company could easily manage. However within a short space of time this idea in Australia ceased to be considered because in a PPP certain activities are contracted to be delivered. If circumstances change then a new tender has to be called or negotiations need to be started with the current provider to provide this new service. Neither option is efficient for those caught in floods, fire or hurricanes or industrial meltdown. Thus the PPP is inflexible because each change involves additional costs and time and the public servants developing policy may have no practical experience and therefore fail to predict what is obvious to those delivering the service. It also means that those negotiations are handled by public servants with no idea or consultants who have no incentive to keep costs down as it will affect their fee.

    In a war situation private armies can mean that there are too many factors outside the control of government, which is likely to react sluggishly anyway, with further inefficiency built in because the Private Partner will seek to maximise crisis situations to increase profits. In a war the consequences are likely to be more horrendous than they are currently. It all depends on the results that are desired. If your desired result is to have money transferred from the public to the military industrial arm of the economy it would work well especially if the warfare is on someone else's soil. If the desired result is for peace, there would be no inbuilt mechanism to provide this, as the companies involved need war to make a profit.

  10. Jarrah (formerly fatfingers) Says:
    January 4th, 2009 at 12:46 am

    "here is little reason to believe that private companies don't engage in massive corruption, including, of course, in the process of privatization itself."

    and

    "the privatisation bandwagon has frequently been used to hand over valuable public assets to clients of the political elite, further concentrating wealth and placing the management of those assets beyond public scrutiny."

    That is a very serious problem, to be sure. The famous Russian wealth-grab in the '90s, and many of China's divestment of SOEs spring to mind as well. Also, owners of large companies and big players in important industries are politically well-connected too, so it's not like they suddenly won't get favours anymore.

    Obviously there are good, well-designed privatisations, and there are corrupt, fire-sale, and otherwise bad privatisations (not to mention the different formats - auction, giveaway, privatising management or ownership, etc). So I support Quiggin's call for case-by-case analysis.

    There are also important differences between appropriate strategies for advanced (and not-so-advanced) industrial countries and developing ones, so for simplicity let's stick with the former.

    However, I do think that the Professor is placing too much importance in the GFC as some kind of death knell for privatisation justifications. Systemic mismanagement of risk is a huge component of the GFC, but to blame that squarely on capital markets when government failure played a significant role is not a good basis to extrapolate from. Besides, the theory is that capital allocation will be superior in private hands, not infallible.

    I also think that the overall success (ie improved efficiency and general welfare gains) of privatisation in competitive sectors should give pause to those who want to refute it as a doctrine.

  11. Gordon Pasha Says:
    January 4th, 2009 at 3:01 am

    Hello

    An element to be kept in mind is that private companies fear the government, and therefore can be more responsive to customers' complaints. I have lived in places where utilities were state run. If there was an outage, you had nowhere to turn, no one cared about you. When the same utility is privatized and there is an outage, you always get some government official threatening to impose fines, etc (it looks good politically). The utilities suddenly become much more responsive.

    Regards
    Gordon

The extent of corruption in Europe is "breathtaking" and it costs the EU economy at least 120bn euros (£99bn) annually

February 3, 2014 The Kremlin Stooge
Patrick Armstrong
On a different subject, check this report out, sports fans.
http://www.bbc.co.uk/news/world-europe-26014387

"The extent of corruption in Europe is "breathtaking" and it costs the EU economy at least 120bn euros (£99bn) annually, the European Commission says.
EU Home Affairs Commissioner Cecilia Malmstroem has presented a full report on the problem.
She said the true cost of corruption was "probably much higher" than 120bn. "

Drutten
So, looking at those nation specific percentages and juxtaposing them with the most recent corruption barometer result from the RF that followed the same survey methods, Russia is actually on average less corrupted as far as regular citizens are concerned than a significant part of the European Union as it stands now. I guess that's why Transparency International decided to ditch their Russia surveys last year. Not enough bad news, so to speak.

Funny how it is. Really, this is a true scoop, but it's hardly going to be mentioned by anybody.

marknesop
The really interesting part for me was the analysis, from Brussels, in the bottom-right corner. It reads, in part,

"This report has not been without controversy. Its release was delayed for months, and some countries were critical of the European Commission for interfering in areas which they believed were none of its business.

Originally, the report was also supposed to have included a chapter assessing corruption within EU institutions as well as within member states. But that idea was dropped. "

Delayed for months. But any jackass working for the BBC or The Guardian can comment with authority on the breathtaking level of corruption in Russia, without any substantiation, and it is beamed 'round the world instantly.

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