For Successful Privatisation, Learn from Privatisation Failure

Privatisation is a popular treatment for a range of economic diseases – inefficiencies, market distortions, graft, and corruption. To use a different metaphor, privatisation exorcises the spectre of political meddling from the economy. It also has the added benefit of filling up empty state coffers, which has contributed to its recent popularity in the EU. The transition from planning to implementation, however, has been slow and fraught with problems.

Greece missed its 2013 revenue targets from privatisation despite lowering them twice. More than a handful of deals seemed suspicious. Prosecutors opened an investigation into the largest privatisation to date, the sale of the gambling monopoly OPAP. The sale of further 28 state-owned assets was blocked by the Greek court of auditors. In short, failure to privatise was coupled with privatisation failure, and this was not limited to the Aegean. Slovenia is also slow to privatise while its political elites are notorious for heavy-handed dabbling in state-owned enterprises.  Last spring, the government drew up a list of 15 privatisation targets. To date, the sale has been agreed in only 2 cases.

When thinking about privatisation failure, there are three avoidable pitfalls. The first is the ‘muckraking syndrome’, which usually involves compiling lists of alleged criminal acts. It is an interesting exercise, for sure, but essentially lacking in theory. So it can offer no valid policy lessons.

The second pitfall lurks behind the other corner. From the theoretical high ground, the whole topic appears insignificant – after all, failure could have been predicted by even the simplest of models. Just to give an example, since privatisation is managed by the government, privatisation failure is a simple consequence of an all-common government failure. The paradox is clear: privatisation itself is a policy aimed at preventing government failure. In short, the problem ends up corrupting the proposed solution.

The third pitfall is the checklist approach. It has as a simple way of telling apart failed privatisation and successful privatisation. Simply count the indicators for failure and deduce the number of indicators for non-failure. Unfortunately, the final score is sensitive to the total number of indicators used. Even more damningly, governments are expert at playing such evaluation forms.

What would be a better way of approaching privatisation failure? Privatisation outcomes are a natural starting point. However, privatisation often ends up being treated like a black box. Alternatively, privatisation failure can be defined independently of outcomes: as failure in privatisation method, failure in regulation, and failures in the privatisation process. These different types of failure arise at different points in time – before, during, and after a privatisation campaign – and can be summarised like in the following diagram:

 

Phase of privatisation Type of privatisation failure Agency behind failure
 
Phase 0
privatisation planning
Failure in method Committed by policy makers
 

   Failure in regulation Committed by policy makers
 

Phase 1
on-going privatisation
Failure in process Committed by economic actors; facilitated by policy makers
 

Phase 2
privatisation completed
Failure in outcomes Aggregate responsibility for failure
   

 

In economics, failure is usually defined against various outcomes. If a number of indicators improve in the aftermath of a policy intervention (say, privatisation), the policy is considered successful; otherwise it counts as a failure. For example, privatisation failure can be measured against performance criteria for individual companies, ranging from financial variables (such as return on capital or value added) to distributional considerations (for instance labour shed or added and firm-level income inequality).

Failure in method implies that policy makers have made a less-than ideal choice of the technique of privatisation. There is certainly a lot to choose from; methods of privatisation include public offerings of shares, private placements, and new private investments in state-owned enterprises as well as management and employee buyouts. Unfortunately, the ‘failure-in-method’ approach often requires additional assumptions regarding the optimum outcome. Consequently, such an approach to privatisation failure is reduced to nothing more than a particular explanation for an already known failure in outcome. And besides, the method of privatisation is only one among many factors that can determine its outcome – and these other variables need to be controlled for.

Privatisation can also fail because of internal inconsistencies in the legal framework – because of a failure in regulation. The fault lies squarely with the lawmaker – privatisation fails because of incomplete contracting or incompetent drafting. In short, most actors involved in privatisation have to take failure in regulation as a fact of life. For instance, laws can create competing claims to the assets being privatised, which is especially problematic in over-leveraged companies requiring prior restructuring. Failure in regulation should be distinguished from the related failure in process, which implies errors or outright criminal activity – privatisation is carried out against the law.

To conclude, privatisation failure is much more common and has many more aspects than it is usually given credit for. Moreover, failure will not disappear if we choose to ignore it – it will only strike us when we are unprepared. If privatisation is indeed to work its magic and liberate markets from politicians, predictable mistakes should be avoided. Thinking about privatisation failure can improve privatisation itself.

avatar