Economic Analysis of the Public Sector

Economic Analysis of the Public Sector:

ABSTRACT

The privatization discourse has been revitalized by the extensive privatization programs implemented in developing countries in conformity to the mantra of public administration: “less government better government”. However, very few slogans include the ultimate drivers of privatization which are regulation and competition.

Experience has now shown that privatization that is hurriedly applied without effective guidelines can be detrimental to the social and economic wealth of a nation. The regulatory framework is fine-tuned with time and experience while upholding seamless industry and enterprise transformation and ensuring maximum value for all stakeholders. With these considerations, privatisation is a lot more effective at stimulating significant benefits in developing countries where the regulatory function models privatisation with the inclusion of competition.

Reflecting on published literature, this paper proposes further research on the sequencing of privatisation, competition and regulation reforms in the steel industry. Is there a most effective order of reforming public goods enterprises such as steel industries?

INTRODUCTION

After the 1980s debt crisis, the international financial institutions included privatization as part of their “prescriptive” structural adjustments and conditionality for additional economic assistance to developing countries. Since then, governments in developing countries have drastically reduced their ownership in state owned enterprises (SOEs) (Savas 1987; Boycko et al 1996; Ariyo & Jerome 1999).

Between 1974 and 1990, the Chilean government set-off the privatization rat-race disposing its stake in approximately 550 enterprises. Brazil planned to sell off two-thirds of the country's SOEs by 1995 and cut-down the number of civil servants by 75% (Glade 1991; Molz 1990; Estache et al 2001). By 2005, more than 3,200 projects in more than 139 developing countries introduced private sector participation into SOEs investing about US$964 billion in the process.

As presented in Figure 1 above, Sub-Saharan Africa investment commitments to infrastructure projects with private sector participation in 2007 amounted to almost US$11 billion (the second highest level since 1990) thereby easing budget constraints and recurrent subsidizes, improving the efficiency of infrastructure services and extending service delivery to poor people (PPIP Database; WDI 2007). It is this phenomenon that has continued to lure social scientists into the privatization debate in developing countries (Cook & Kirkpatrick 1988; Commander & Killick 1988; Estache et al 2001).

Thus, these structural adjustments have been rapidly implemented with the state departing from production and operations due to perceived efficiency losses associated with public enterprises as presented in Figure 2 below. The state through its new “policy and regulatory” function sets to providing an enabling environment for the growth and competitiveness of the private sector by promoting dynamic efficiency, competition, strengthen market stability, and protect consumers while achieving social and economic benefits (Clifford 1993; Connolly & Munro 1999).

Russia's mass privatization in 1992–93 was followed by its documented struggle through mid-1998; the emergence of “kleptocrats”, social benefits imbalance, its downward economic cascade and its eventual collapse that was similar to that in 1991–92 prior to privatization. This experience exposed the “driver” of privatization that had been overlooked: regulation (Black et al 1999). With particular focus on the Sub-Saharan Africa privatization experience, Tanyi notes that the region's privatisation process has developed the least when compared to Asia and Latin America. In the region, privatization is perceived as unemployment, reduced government expenditure on social programs and even re-colonization. The presence of immature capital markets, scarce financial resources, and institutional instability exposes the other barrier to optimal privatization: poor prudential regulation (Tanyi 1997).

Consequently, the assessment of regulatory systems and factors that inhibit equitable distribution of privatization benefits merit our discussion. This paper discusses country case studies to provide an analysis of their experience with privatization and regulation. The central feature of this essay is the need for a “competition catalyst” on privatization, its regulation and resulting benefits of privatization. In conclusion, the paper proposes further research on the sequencing of privatisation, competition and regulation reforms in the steel industry.

The rest of this paper is presented as follows:

Section 2: reviews aspects of regulation in privatisation;

Section 3: considers country specific case studies;

Section 4: discusses the implications of regulation on privatisation; and

Section 5: provides the conclusion and potential research avenues

DOES PRIVATIZATION AND REGULATION DELIVER?

a) “Unregulated inefficiency” to “Regulated efficiency”

Literature accords that indeed privatisation rapidly generates revenues and presents future gains for the private sector and public sector respectively (Shirley & Galal 1993). However, the impact of privatization on efficiency measures and distribution of benefits are rarely evaluated (Buchs 2002). More often, for the unique characteristics of Sub-Saharan Africa countries; “No privatization No aid World Bank warns Kenya”, privatization is usually rushed to meet conditions of debt relief and evaluation is based on indicating the numbers of SOEs sold and the proceeds thereof pronounced by the political leadership as a measure of success (Bayliss 2002).

This two-sided motive for privatisation that is, government fiscal budget benefits and consumer benefits aligned with politics coupled with the tendency of ex-post evaluation results in privatization benefits being unequally distributed. This easily obscures the achievement of social benefits which are the ultimate purpose of privatization. For example, while many Sub-Saharan Africa countries have attempted to privatize the water sector, the peculiar characteristics of water supply and the presented outcomes of the privatization process highlight the insignificant social benefits achieved (Mitlin 2002). Miltin et al underline discrepancies in data reports presented by World Bank and UNDP that 99% of the urban population of Zimbabwe has access to safe water while yet a low-income settlement tap water in Zimbabwe serves at least 1,300 people (Miltin et al 2001).

Published literature presents the concern that success stories of privatization in Sub Saharan Africa are rare and that the long-term promise of privatization in sectors posing regulatory complications remains to be established (Ramamurti 1999). In addition, Adam et al in their case study review of adjusting privatization for developing countries have demonstrated that the prescribed privatization processes were marred by errors in implementation, policy design, and inadequate regulatory capacity among other vices (Adam et al 1992).

Notably, while privatization presented a panacea for the dismal performance of SOEs and the huge fiscal budget deficits such findings point to the limits of blanket solutions while highlighting privatization's greatest enemy in weak regulation (Adams 1994; Bitran and Serra 1998; Estache and Gomez-lobo et al 2001; Parker et al 2008). Regulation, more so effective regulation, is now recognized as an important instrument for privatization to support significant benefits (Parker & Kirkpatrick 2003). However, the design of an effective regulatory system is a complex task, marred in error but tweaked with time and experience involving the interaction of rules, instruments, and regulatory entities (Jerome 2004).

b) Facets of regulation – an overview of the cogs

Closer reviews of privatization experiences indicate that there is no clear-cut privatization regulatory framework (Shirley & Galal 1993). The nature of the regulatory framework developed for privatized enterprises in developing countries is affected by each country's capacity to implement a system of regulation and type of market within which enterprises function. In addition, the processes of regulation differ in form, scope and institutional arrangements from country to country (Cook 1999).

Unfortunately, very few developing countries are equipped for successful privatization and an attempt at the “prescriptive” privatization and regulation may simply result in continuing operating inefficiencies with negligible budgetary impact (Ariyo & Jerome 1999; Buchs 2002). Yet again, the mixed motives of privatization, that is achievement of social benefits and fiscal budget benefits may be too much to ask of a single process.

The causality between effectively regulated privatization and significant benefits achieved balance precariously on a tight regulatory rope. Selected literature suggest that micro and macro linkages of privatization and its associated benefits can be achieved by an effective regulatory framework. Therefore, the privatization process should develop visionary plans for overall industry revolution, design creative strategies for specific enterprise transformation and manage economic value and its distribution among the stakeholders (Mac Murray 1993; Hossain & Malbon 1998; Jerome2004).

Industry transformation

Privatization divestiture is one among many other economic development goals that private sector involvement could transform. Benchmarking industrial performance against more advanced countries may assist developing countries rework existing immature capital markets, improve financial instability through increased foreign investments, strength global networks and enhance competition within specific industry through effective price setting and controls over revenues and returns (Mac Murray 1993).

The role of foreign capital and foreign participation in privatization has been substantial, especially in developing countries with weak private sectors. For example, by 1992 in Sudan, global firms dominated as bidders for SOEs slated for privatization under the country's National Economic Salvation program and others provided US$40 million in support of privatization of strategic enterprises in Mauritania. In Mali and Latin America, management cooperation with China and other foreign investors was successful (Ariyo 1996; Jerome 2004; Bayliss 2002). However, foreign participation has not been guaranteed in many privatization attempts especially in Africa where the investment climate in considered risky and uncertain. Instead of encouraging investment, the absence of foreign investors in specific privatization initiatives has held governments at ransom and resulted in the trade of unfavourable concessionaire agreements to lure foreign investors. Such desperate measures result in non beneficial processes such as “cherry picking” by the investor (Bayliss 2002).

While the initial dominant partial liquidation of public enterprises reflects the low value of public assets or the under development of local capital markets, countries such as Chile and Jamaica have eventually developed capital markets as a result of privatization, thereby increasing the number of shareholders and total market capitalization. However, in countries where regulatory absorptive capacity is frail the results are dissimilar (Boubakri & Cosset 1999). Therefore, where regulation sets-on a broader contractual basis and integrates sector strategies, longer-term development perspectives and institutional building lined to regulatory initiatives the privatization, benefits are extensive.

Lastly, Latin American's early successful privatization in various sectors concludes that an efficient enterprise is determined by the regulatory structure and the level of competition under which it operates. Argentina's successful competitive bidding process for a natural monopoly depended much on the regulatory framework and the existing performance enhancing incentives and penalties (Stiglitz 1998; Guislain 1997; Chisari et al 1997).

Enterprise transformation and value management

Policy reforms will more often encounter resistance to the change in status quo hence the subject of conflict resolution should be well addressed during the privatization implementation stage. Kenya's initial attempts to privatization were postponed after majority of potential privatization promoters were thought to come from the economic elite Kikuyu and Asian communities. In Malaysia, fear that sovereignty would be lost to wealthy Chinese or affiliated multi-national companies (MNCs) resulted in hostility (Ariyo 1996).To compliment the industry revolution strategies, enterprise linkages should develop cohesion within the new ownership structures, build social safety nets for workers, support accountability and transparency and discourage objectionable political interference and rent seeking practices.

The presence of different stakeholders in proposed privatization frameworks presents differences in objectives. Poor governance and ownership structures, derisive benefits, and white elephant projects have been associated with infrastructure projects. In addition, agency problems are exposed in the predicament of whether to increase returns for shareholders, improve social welfare, and avert corruption or to achieve all objectives (Connolly & Munro 1999). A critical but often under emphasized complement is the role of the regulatory framework which should ensure transparent governance and educate stakeholders including the public on the role of effective governance and benefits of restructuring (Boycko et al 1995).

The need to mobilize domestic support cannot be over emphasized. Although unemployment concerns due to privatization may be unknown, regulatory measures to facilitate the distribution of social benefits and provide social safety nets should be considered. In Ghana, redundancy costs may amount to 10 years salary compensation while in Argentina, workers in the telecommunications and steel industries received two years' severance payment (Kikeri, 1995; Clifford 1993). In tandem with the implementation of domestic support, regulatory offices should be adequately staffed and well trained to develop and apply expertise in increasing dynamic industries (Jerome 2004; Parker et al 2008).

Lastly, one main objective of privatization has been positive government financial flows. Intuitively, increased tax revenues as a result of increased profitability and efficiency, should improve governments' budgetary receipts. However, private firms may prove more skilful at tax evasion, corruption and other objectable business practices Therefore the positive impact of privatization on government financial flow has been unpredictable (Parker & Kirkpatrick 2003). In the case of Cote d'Ivoire increased profitability of privatized firms led to additional tax revenue but Tanzania illustrates the case of a declining tax base due to the shift in taxable clients: from a large and approachable public sector to a larger unbundled informal private sector (Birdsall & Nellis 2003). Although the tax administration reforms aimed at increasing tax collection may have contributed in positive government financial flows, it would seem indeed significant benefits have been evaded reflecting the fact that privatized firms informally remain outside the tax net or are granted bulk exemptions (Buchs 2002).

COUNTRY SPECIFIC CASE STUDIES

Recent econometric analysis of 63 developing countries concludes existence of a robust partial correlation between privatization and economic growth thereby suggesting that privatization contributed negatively to economic growth (Cook & Uchida 2001). Where rapid privatization exists and includes private sector monopolies coupled with weak implementation of regulation and non-regulated competition, subsequent change in ownership alone would not sufficiently support enterprise and industry transformation to guarantee significant economic growth. Conclusively, reflecting on Cook & Uchida (2001), the combination of weak regulation and high proceeds from privatisation may provide an explanation for the negative economic growth.

The privatization process of the steel industry in Nigeria demonstrates a hallmark case of a noble process marred with grievous shortcomings and backlashes against the privatization slogan. Following the collapse of the prices in the oil markets, a bold privatization process began in Nigeria to ease the current fiscal budgetary deficits and minimize future budgetary transfers to the steel sector and other industries (Ariyo 1996). The immediate privatization benefits such as gross proceeds amounting to 15% of the value of government investment, a remarkable growth in the Nigeria Stock Exchange and reduced civil servant positions were promising (Ariyo & Jerome 1999).

While the government created the desired investment climate including competitive bidding, other expected benefits included implementation of advanced technology, infusion of managerial competence and increased foreign investments. However, selected literature presents a case of catastrophic disasters and an increasing budget deficit (Ariyo & Jerome 1999; Jerome et al 2005; Mohammed 2008). The production capacity under the new ownership was below expected thresholds and has since been negligible. In addition, objectionable engineering practices, political interference and capital flight have resulted in increased federal lending to the steel sector (Mohammed 2008).

Literature flashbacks highlight the lack of efficient and effective regulatory mechanisms to monitor and control the steel implementation agreement. In addition, the agreements were largely slanted in favour of a single concessionaire resulting in the creation of a weakly regulated private monopoly; most conspicuous was the revelation of a different contracted concessionaire with inadequate technical and managerial competence (Ariyo & Jerome 1999; Jerome 2008; Mohammed 2008).

South Africa's privatization of ISCOR, a steel parastatal, resound the importance of mobilizing domestic support, ensuring transparency and creation of social safety nets within the regulatory framework. The widespread allocation of shares including the formation of an employees' shareholding scheme coupled with the vast consultations and publicity of the process earned the much needed domestic support and eventual success of the privatization (Mohammed 2008; Bennell 1997; Jerome 2004). On the contrary, Nigeria's steel privatization lacked domestic support. Distribution of shares was limited to a minority few rich people resulting to a disgruntled majority. The social safety nets of workers who initially relied on welfare safety such as job security was eroded. Inevitably, the trifling severance packages resulted in industrial disharmony and low staff morale (Bayliss 2002; Ariyo & Jerome 1999; Mohammed 2008).

Lastly, the evident lack of competition within the regulatory framework, the creation of a near private monopoly within the steel industry left consumers vulnerable to the malignant high price increases in the face of deteriorating quality of service (Ogunkola 1996; Mohammed 2008; Ariyo & Jerome 1999).

IMPLICATIONS OF REGULATION ON PRIVATIZATION

Experience has now shown that privatization, when hurriedly applied without following the laid down guidelines can be detrimental to a nation's social and economic wealth and may culminate in re-nationalization of enterprises (Okafor 2007). Even in Latin America where regulatory systems have developed, they may not be working effectively. The regulation framework is perfected in time and experience while ensuring seamless industry and enterprise transformation and maximizing value for all stakeholders (Hossain & Malbon 1998; Jerome2004; Cook, 1999).

Notably, few developing countries have the capacity to handle complex regulation policies. For example, Kenya's privatization law only became effective in 2008 and a fully fledged privatization commission constituted to implement the privatization programme (PC[3]). In addition, the choice of an appropriate institutional regulation framework within developing countries seems elusive; for example a choice between multi-sectoral regulatory agencies as demonstrated in Malaysia or a case for single sector regulatory agency as presented in Argentina. While most thoughts are in favour of multi-sectoral regulatory agencies that collectively pool diversified expertise, this may result in resistance to regulatory capture and political interference. Political interference may stem from the involvement of foreigners or minority domestic groups. In addition, public assets put up for sale may be undervalued or strategically allocated to minority elite. (Estache 1997; Shirley 1999; Bayliss 2002).

Peculiar characteristics of steel industries include recruitment of cheap manual labour and labour intensive processes. These create vicious dependence cycles between business investors and their need for cheap labour and between poor workers and their measly pay. The most conspicuous frailty in the Nigerian steel sector privatization experience is the level of regulatory enforcement and its relevance to a peculiar steel sector. The failure of the regulatory process to facilitate domestic and external support, promote foreign investment, create competition, ensure transparency, mitigate negative social impact, minimize political interference and aid corporate governance may have limited the success of the privatization process (Mohammed 2008; Jerome 2008) .

In confident echoes, the lack of competition in the Nigerian steel sector has been related with the disaster of the privatization process. Supportably, even a well regulated Chilean electricity sector privatization process, more committed to vertical disintegration and to a lesser extent competition should have ensured real competition to maximise privatization objectives. Consequently, the conflicts of interest among the stakeholders resulting from the privatization framework have hindered development as different investment groups control the largest generating, transmission and distributions levels (Bitra & Serra 1998). Progressively, building on Chiles' privatization experience, Argentina's privatization process legendary referred to as the “big bang approach” radically restructured and unbundled its electricity sector, restricting cross ownership while maximizing competition. The diversified ownership structure ensured increased competition at the generation level while distribution and transmission became regulated private monopolies. In addition, the retail price index price cap mechanism protected consumers from exorbitant price setting (Joskow 1998).

Finally, a central conclusion to the privatization remedy is that the poor shall eventually gain from increased access of goods and services. However, from the perspective of poor households, affordability can pose a greater barrier than access to utility services. For example, Nigeria's steel privatization resulted to an uncontrolled increase in prices as quality of services deteriorated while in Argentina; government regulatory intervention during the Buenos Aires water concession structured a socially viable “retail tariff”[4] to include the poor who would have otherwise been excluded by the high connection charges (Estache 2005).

CONCLUSION

The level of private sector investments has increased significantly in developing countries. However, literature accords that the high expectations of this “single-bullet” privatization remedy for Africa and developing countries remain unrealized as regulatory weaknesses underscore most failed privatizations. For example, Nigerian public enterprises have been greatly criticized for their inefficiency, political interference, corruption and negligible budgetary contribution.

Whereas the privatization process is tasked to develop visionary plans for overall industry revolution, propose creative strategies for specific sector transformation and manage economic value and its distribution among the stakeholders; the complementing regulation framework should be adapted to fit country and sector unique characteristics while ensuring seamless industry and sector transformation and maximizing value for all stakeholders. The main features of an effective regulatory framework include:

* promoting cohesion of stakeholders;

* ensuring independence, accountability, transparency;

* advancing accessibility and affordability of services to the poor;

* providing for safety nets in place of the existing welfare system; and

* preventing regressive taxation and other objectable business practices.

Selected literature has affirmed that effective regulation enhances privatization benefits and equally distributes the social and economic benefits. With the inclusion of competition the beneficial impact of privatization is extensive. Conclusively, the privatization of the steel industry in Nigeria resulted in the need for effective regulation while effective regulation should have created a competitive market environment. Reflecting on published literature, this summary provokes further research on the sequencing of privatisation, competition and regulation reforms in the steel industry. Is there a most effective order of reforming public goods enterprises such as steel industries (Wallsten 2002; Zhang et al 2005)?

[1] All data from the PPIP Database comes from its website, http://ppi.worldbank.org/ accessed between 15 December 2009 and 15 January 2010.

[2] When firms have monopoly power, prices rise above MC. However outside a competitive environment firms are under no pressure to reduce costs resulting in X-efficiency herein referred to as “lost PS”: lost producer surplus. This inefficiency has led to privatization.

[3] All information from PC comes from The Privatization Commission's website, http://privatisation.mackphilisa.net/ accessed between 15 December 2009 and 15 January 2010

[4] Retail tariffs are regulated through a price cap mechanism (essentially RPI-X, where RPI is the retail price index and X is productivity gains, with X adjusted after five years).

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