 Public
Sector
Reform –
Privatisation

(Dr. Christopher Gan)
Why Involve the Private Sector?

The Problem
 Chronic poor performance is the rule
rather than the exception in many
publicly run municipal services
 many households lack good access to
services (especially the poor)
 service is often of poor quality
 service delivery is inefficient

(Source, Penelope Brook, the World Bank)
What is Privatisation?
According to the World Bank,
privatisation “is the transfer of
ownership of State Owned Enterprises
(SOEs) to the private sector by sale
(full or partial) of going concerns or by
sale of assets following their
liquidation”

What is Privatisation?



Privatisation helps establish a free market, as well as
fostering capitalist competition, which its supporters
argue will give the public greater choice at a competitive
price
Privatisation embraces denationalisation or selling-off
state-owned assets, deregulation (liberalisation),
competitive tendering, as well as the introduction of
private ownership and market arrangements in the exsocialist states
Privatisation is a political process and, therefore,
requires political will, commitment and clarity
What is Privatisation?

Consider University education:

Nationalization implies public good

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Everyone pays the cost, because everyone is better off
Privatization implies private good

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Assumes a constituent policy:
Equity before efficiency
Assumes a distributive policy:
Everyone pays the cost, benefits flow to only a few
Admin students moving to Alberta?
Therefore, efficiency-based, user-pays model


Includes higher-tuition
Academic-based/merit funding only
If the Objective is Achieving Maximum
Asset Value

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Grant an exclusivity period before the
introduction of competition
Don’t limit foreign investment
Minimise the obligations on the
incumbent (e.g., for network roll-out,
price cap tariff control)
Sell the company in several stages
including and IPO (timing is important)
(Source: Kelly, 1999)
If the Objective is Maximising Consumer
Welfare



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Introduce competition at the earliest
opportunity in all parts of the Sector
Sell the company as quickly as possible,
including employee share options
Put Universal Service Obligations into
license of incumbent and its competitors
Pro-competition regulation during early
years
(Source: Kelly, 1999)
Privatization Benefits

The global trend toward state-sector
privatization is driven by the recognition that
market-based economies are better suited to
maximizing societal wealth than nationalized
industries and planned economies




Industry privatization and deregulation are necessary
steps toward free market competition
Eliminates conflicts of interests resulting from state
ownership: political versus economic objectives
Promotes efficiency gains through the introduction
of competition
(Source: AEAC, 2002)
Privatization Benefits

Economics Benefits





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Raising revenue for the pursuit of other public
policies through divestiture of government owned
enterprises
Raising external investment capital for the energy
sector
Establishing the basis for growth in taxable income
Efficient allocation of resources (labor, natural
resources, and capital)
The promotion of efficiency and productivity gains
(Source: AEAC, 2002)
Privatization Benefits

Social Benefits:



Commercial control over enterprise (more
disclosure)
‘Private – dividend’ more public money for
programs and services
(Source: AEAC, 2002)
Privatization Benefits
(Source: Bleas, Estache Kaufmann)
Improved Efficiency
Fiscal
Benefits
Improved
Access
Privatization Benefits
Extent of benefits depends on policy
choices on three main issues (Source: Bleas, Estache Kaufmann)
Form and extent of
private involvement
Market structure and
competition
Regulatory approach
Arguments Against Privatisation

Democratic Government Incentive


Public Interests Vs Profit Max



pressure of future elections
satisfy needs of the majority
as instrument to implement government policy
Essential Services Availability

socially necessary but unprofitable services
Arguments Against Privatisation


Profit Contribution To The State
Revenue
 motivation for the government to
improve the performance
 profits directly into common wealth
of the whole country - better equity
Consumer Interest Protection
 low competition, infrequent choices
and lack of expertise
Arguments Against Privatisation


Costs of Privatization:
Economic Costs:


Loss of annual government revenue
Social Costs:



Loss of ‘guaranteed’ jobs
Loss of government influence in market
outcomes (Public Interest)
Loss of government control over provision
of public goods and services
Why Privatisation Fails?


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Lack of strong high-level political commitment to the
privatisation program
Inappropriate design of privatisation strategy (in
terms of scope, technique, sectors and institutional
capability of the government)
Unclear and weak institutional framework:
decentralized (ministerial/ provincial level) or
centralized (such as an independent privatisation
committee under the head of state)
Poor preparation of enterprises for privatisation or
divestiture (such as inadequate accounting and
auditing, treatment of losses, or social and
environmental safety nets)
Why Privatisation Fails?

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Insufficient transparency and flexibility in terms
of the method of privatisation, balancing ownership
and control (corporate governance)
Vested interests of managers, employees and
customers
Lack of appropriate legal frameworks (e.g.,
property rights, foreign ownership, bankruptcy
laws)
Underdeveloped capital markets
Preconditions for Privatisation


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Irreversible political commitment to
economic stabilization and liberalization
The accomplishment of necessary legal and
regulatory reforms, such as the
establishment of property rights,
streamlined investment laws, and enforceable
bankruptcy laws
Structural reforms across all economic
sectors
Privatization Methods
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Service contract
Management contract
Lease
build-operate-transfer (BOT)
Concession
Divestiture
Direct selling of assets
Voucher program
(Source: AEAC, 2002)
Service Contracts

Definition:

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specific tasks are contracted to the private
sector, but overall utility management remains
with the public sector
Typical duration: 6 months - 2 years
Pros: can inject good technical expertise
Cons: unlikely to improve performance
greatly where overall management is weak
(Source: Penelope Brooks, World Bank)
Management Contract

Definition:

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a private company is paid a fee to operate
a set of municipal services
Typical duration: 3 to 5 years
Pros: gains in managerial efficiency
Cons: gains can be difficult to enforce;
city remains responsible for
investment
(Source: Penelope Brooks, World Bank)
Example: Solid Waste Collection

Management contracts for waste
collection are common
 Caracas,

Contractors are often medium-size
enterprises
 100

Seoul, Bangkok, Jakarta, Lagos
contractors in Lagos, 85 in Seoul
Cost savings can be significant
 US
data - private sector is 10-30% cheaper
 UK & Canada data - private sector is 20-40%
cheaper

(Source: Brooks, World Bank)
Lease
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Definition:

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a private company leases the assets of a utility, and
maintains and operates them, in return for the right
to revenues
Typical duration: 10 to 15 years
Pros: commercial risk borne by the private
sector, giving strong performance incentives
Cons: administratively demanding; government
remains responsible for investments
(Source: Penelope Brooks, World Bank)
Build-Operate-Transfer
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Definition:

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private sector develops, finances and
operates bulk facilities
Typical duration: 15 to 30 years
Pros: good way of getting efficient
delivery of bulk services, with private
investment
Cons: not a good solution if supporting
distribution systems are in bad shape, or
traffic levels are uncertain

(Source, Penelope Brook, the World Bank)
Example: Solid Waste in Hong Kong

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DBO (Design-build-operate) for refuse
transfer stations and a chemical waste
plant
for waste plant, capital cost paid over
5 years in monthly installments
DBO for landfills (including restoration
and aftercare)
capital costs paid in lumpsums at
milestones
(Source: Brooks, World Bank)
Concession

Definition:

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city owns the assets, but contracts with the
private sector for operations, maintenance
and investment
Typical duration: 25 to 30 years
Pros: potential for high efficiency in
operations and investment
Cons: requires considerable commitment
and regulatory capacity
(Source: Brooks, World Bank)
Example: Water & Sanitation in Manila

–
–
–
–
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A 25-year water and sewerage concession began
in Manila in 1997
requires increase in water connections from
65% to 100% of households within 10 years
requires increase in sewerage connections from
8% to 83% of households within 25 years
requires decrease of technical and commercial
loss from over 60% to 25% within 25 years
projected to involve total investments in excess
of $7 billion
(Source: Brooks, World Bank)
21
Divestiture

Definition:

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the assets of a municipal utility are sold to
the private sector
Typical duration: indefinite, but may be
limited by a license
Pros: potential for high efficiency
gains
Cons: requires credible regulatory
framework
(Source: Brooks, World Bank)
22
Voucher Programs


In much of Eastern Europe, the only politically
feasible alternative to auctioning off SOEs was to
effectively give the SOEs directly to the nation's
citizens by giving them the exclusive right (and the
means) to purchase shares
These voucher programs had the virtues of speed
and perceived fairness: literally thousands of firms
were privatized in five years or less, and the nondiscriminatory nature of these voucher distribution
programs ensured their popularity
22
Voucher Programs

The principal drawbacks are threefold:

Voucher programs do not raise cash for the SOE
or the government



Voucher privatizations do not result in an infusion
of new technology or managerial expertise.
Vouchers do nothing to establish an effective
monitoring mechanism for newly privatized firms,
and the ownership structure that results from
their exercise is usually highly flawed
22
Direct Selling of Assets

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In a direct sale, all or part of an SOE is auctioned,
either to an existing company (foreign or domestic) or
to a group of investors
They bring in significant revenue for the government;
they frequently inject new technology and expertise
into the SOE's operations; and they solve the
monitoring problems that an atomistic ownership
structure creates
Asset sales also compare favorably with SIPs in terms
of the speed with which direct sales can be arranged,
the ability of governments to sell SOEs piecemeal,
and the fact that the direct sale format means that
buyers are obliged to commit to certain operating
standards of their acquired firms
22
Other Privatization Methods

Contracting Out/Outsourcing
The state enters into agreements with private
vendors to provide services. The state pays
contractors to provide the services
Public-Private Partnerships
 The state conducts projects in cooperation with
private vendors, relying on private resources
instead of tax revenue
 Examples - Management contract, Leases,
Concession, Divestiture, Build-Operate-Transfer
(BOT)

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Privatization - Conclusions

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Do privatised enterprises improve performance
in terms of profitability, efficiency and
investment?
Does privatisation improve government
finances?
What is the social impact for consumers and
employees?
What are the overall effects on the economy?
How do different approaches to privatisation
affect end results, and what lessons can be
learned?
References
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AEGIS Energy Advisors Corp. (AEAC), “State Oil
Company Privatization, “ November 8, 2002
Isabelle Bleas, Antonio Estache, and Daniel Kaufmann,
“Public-Private Partnership in Infrastructure and
Poverty,” World Bank Institute
Penelope Brook, “Private Sector Roles in Delivering
Public Services: Policy Options for Developing Cities, “
the World Bank
Tim Kelly, “Process and impact of
commercialisation/privatisation: Worldwide trends,” CTO
Senior management seminar: Telecoms restructuring and
business change, Malta, 17-21 May, 1999