Privatization

Talks about privatization had a constant presence in the last decades in the public debate and it is easy to understand why this issue has generated intense political controversy. Privatization is the transfer of ownership of state property to private companies or individuals, partly or wholly. The state property can be a public company or a real estate.

Here we will present the benefits of privatization, some problems that are related to it, as well as its general principles.  Finally, we will examine two examples of countries that have successfully implemented large-scale privatizations, Germany and Slovakia.

In Greece the debate on privatization was intensified after the signing of the Memorandum of Cooperation in 2010 between the Greek Government and the so called Troika, which consists of the European Commission (EC), the International Monetary Fund (IMF), and the European Central Bank (ECB). Back then it was agreed that a percentage of the profits from privatization would be used to reduce public debt. There are various estimations of the amount of money that could be drawn from privatization actions. Both Government and Opposition presented privatization plans in the order of 50 billion Euros, but without presenting technical details of the project. Almost 2 years later, little progress has been made.

Nevertheless, there are certain categories of public companies or public owned land that is crucial to remain under state control. These could be companies, borderlands or certain islands sensitive for the national security.

Benefits of privatization

If designed properly, privatization can lead to substantial increase in productivity and competitiveness. It is important to mention that benefits are not limited to the immediate financial compensation following the awarding of a privatization contract to the highest bidder. Often investors proceed with additional investments in order to modernize production facilities. But the most significant benefit comes from the increased efficiency of the state’s economy as a whole, when unproductive public companies turn into competitive businesses that operate according to the rules of market economy.

This is why one reads in the literature that the direct economic benefits of privatization are just one third of the total long-term benefits. The remaining two-thirds come from the multiplier effect that privatization causes to the national economy. Beyond political considerations, one way to assess specific privatization cases on a technical level is a so-called cost-benefit analysis that compares the total expected benefit from a privatization against the cost of its implementation. In order for such an analysis to be complete, both the social dimension and the social dividend resulting from privatization has to be captured.

Negative consequences and obstacles

Careful planning is essential, especially during the phase of creating the privatization body (a committee or a special purpose company) and its staffing. Ignorance of the rules of the domestic and foreign markets and lack of transparency will most certainly lead to questioning these choices in a political and social level, thus resulting in long delays.

The management of the privatization body will be required to provide specialized solutions to a variety of problems, the most important being the following:

a) Unclear legal status,

b) Ownership issues,

c) Reactions from the unions,

d) Accusations for mismanagement.

Proper design of the body, its operating rules and solutions to the above-mentioned problems will largely determine the success of the privatization program in Greece.

In Greece the respective body is called the Hellenic Republic Asset Development Fund. Despite its foundation in 2011 and the recent change in its management, no real progress has been demonstrated yet.

General principles of privatization

In my opinion, the four most important principles of a privatization program are:

First. Partial or total involvement of private equity

The change of ownership alone is not a panacea. It must be accompanied by an extended restructuring of the organization, along with a complete rearrangement of its strategy and objectives. Even for companies where the majority of the shares remains to the state, there is a potential for increased competitiveness with private participation in the shareholder scheme.

Second. Timing

Timing is one of the most critical factors for success when privatizing an organization. In times of political instability, a lot of investors are reluctant to invest and, even if they do, the price they are willing to pay is far lower than the market value due to the actual investment risk.

Third. Independence and control of the privatization body

The political independence of the privatization body is vital for its regular operation. Its operating framework will have to be approved by the National Parliament, in order to allow for a democratic legitimacy of his actions. At the same time, the body must inform in detail both the Government and the Parliament, about its achievements in the privatization procedure and its future plans. This information is crucial because of the usually large volume of legislative acts and regulations that have to be rapidly promoted by the Government. Ultimately, the transactions of the privatization body have to be closely monitored and controlled by chartered accountants.

Fourth. Transparency

Transparency in the operation of the privatization body is of paramount importance for a smooth privatization procedure. Without strict conditions of transparency, the management of sensitive and high-risk privatization projects will hardly reach high levels of performance and each decision will be disputed. Citizens should be able to know at any time the state of the privatization program.

Case studies

When it comes to privatization Greece does not have to reinvent the wheel. In the following, we present examples of two countries that have implemented large privatization programs, Germany and Slovakia. Although none of them is similar to Greece, however an analysis of the privatization procedures could prove useful and offer important conclusions.

a.        Germany

The agency that undertook the privatization of an entire former state (East Germany) was founded in 1990 and named “Treuhandanstalt”, which roughly translates as «Foundation Trust». The Foundation was governed by a five member Board of Directors, whose actions were controlled by a management council. It is of particular interest that the management of the institution was granted with certain level of legal immunity, in order to proceed with the work of privatization.

The Foundation was dissolved in 1994 and the privatization program continued through a series of specialized bodies, some of which still operate today. The Foundation tried to privatize 14,600 businesses with over 4 million employees and 24 million acres of land. Until 1994 around 8000 companies changed hands, but more than 2.5 million workers lost their jobs. This led to massive protests and social unrest and the assassination of the first president of the Foundation, Detlev Karsten Rohwedder. The immediate profits from this series of privatizations amounted to 60 billion Deutsch Marks (approx. 31 billion Euros), while losses were in the order of 300 billion Deutsch Marks (approx. 154 billion Euros)! This is why both the German Government and the Board of Directors of the Foundation were accused of waste of assets and mismanagement. Overall, 1800 cases were disclosed regarding financial scandals associated with the buying and selling of state assets.

However, the German Council of Economic Experts, often referred to as the Five Sages of Economy, an independent evaluator of the economic development in Germany, commented in 1994 that the “Treuhandanstalt” had a decisive role in shaping a new business landscape in the new German states, without the need for continuing financial assistance and support from the central Government.

b.        Slovakia

Privatizations in Slovakia were undertaken by the National Property Fund (NPF), which was founded in 1991 and dissolved in late 2005. The senior bodies of NPF were the Board of Directors (9 members), the Executive Council (11 members) and the Supervisory Board (7 members).

The privatization process was divided into two segments. In the segment of small-scale privatization, small businesses (industries, hotels, etc.) were sold in auctions. Domestic entrepreneurs had primarily access to this procedure. If there was no domestic investor, a second round with the participation of foreign investors was initiated. Large-scale privatization included the majority of state owned companies and real estate. Both auctions and coupon privatization were used, the latter to promote citizen participation in state assets.

It is worth noting that, in order to restore the confidence of international markets in the Slovak economy, the government called a well known international non-governmental organization, Transparency International, to monitor the auction of mobile-phone licenses. The process took lots of publicity and helped to promote a positive image of Slovakia in the world. The results from the Slovak privatization program are indeed impressive. While in 1990 99% of the Czechoslovak economy was state-owned, 20 years later and after the division of the state into Slovakia and the Czech Republic, over 90% of the state property in Slovakia is privatized and 95% of its (Gross National Product) GDP is generated by the private sector. Minor exceptions can be found in a few banks and in some areas of transport and communications.

The massive privatization program in Slovakia also led to social unrest and, like in Germany, significant financial scandals were brought in connection with it. This firm policy for twenty years seems to bear fruit for this small country with a population of 5,4 million. In 2010 and 2011 the growth of the GDP was in the range of 3-4%.

A model privatization process

A further analysis of these examples divides the process of privatization into five stages:

Stage A. Selection of public companies and state owned real estate assets (in short “assets”) to be privatized and performance of cost-benefit analysis for each case.

Stage B. Classification and ranking of the assets and preparation of the bidding process.

Stage C. Collection of offers and pre-assessment. Short-listing of investors.

Stage D. Folder submission with feasibility studies for the proposed investment.

Stage E.  Bid evaluation and contract signing.

Summary

Regardless of the volume of privatization and the specific process that will be chosen, it is necessary to understand that the main benefit from privatization is not to be found in the price that the highest bidder will pay for the transfer. The added value of privatization comes from the competitive operation of the company and its future profitability, which generates revenues for the state in the form of taxes and new jobs.

Nevertheless, one must be realistic. Even if the potential for raising significant funds exists, few countries have managed to privatize with maximum efficiency even a small part of state property. To focus on the Greek economy, privatization must be carried out as part of a broader restructuring that includes drastic decrease in government spending along with measures to develop the private sector.

SOURCES

 

This is an updated English version of an article that was posted in two parts, on 3 and 17 of July 2011, in the “Neos Agon” newspaper of Karditsa, Greece.

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