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Editor(s):
Saíd El-Naggar
Published Date:
June 1989
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Author(s)
Abdellatif Jouahri

Introduction

While the role of public authorities in the economies of many countries had systematically grown in importance during past decades, the reverse trend seems to have emerged of late. New winds of economic change are blowing in several countries, as the market-based sector of the economy tends to be growing through the sale of public enterprises and companies.

The presentation on the case of Tunisia, with some variations, serves to illustrate the origin, evolution, and the present and future state of affairs of the public sector in many developing countries. The key features of the public sector in our countries are almost identical—as can be seen from the similarities in the following areas:

  • the history of its formation and development;
  • the definite stages of its expansion and the economic and political rationale of its objectives;
  • the process of its development through a tentacular network of subsidiaries with the option to assume the prerogatives of the mother enterprise and thereby escape its control;
  • the absence of a clear-cut strategy; and
  • the fact that the appointment of public enterprise managers was not always guided by considerations of competence.

By the early 1980s, the role of public enterprises in the national economy began to be contested and their efficiency became a subject of controversy. But opponents of the public sector were inspired by an ideology that questioned the concept of the “provident state,” and by a growing criticism of state intervention. These themes found a certain echo among a growing segment of public opinion: first in the United States, and then extending to other developed countries. On the other hand, the trend toward curbing the public sector in the developing countries was firmly established by the debt crisis and the search for ways to cut public expenditure. In the following, I shall attempt to place these elements in their proper perspective.

Upon the attainment of sovereignty, developing countries had to take charge of an economic sector inherited from colonialism and also had to create other enterprises in response to the particular conditions or needs of their populations. Control over the public sector and economic intervention reflected the state’s desire to acquire a tool to accomplish growth and orientation of the national economy and the necessity to sustain a higher growth effort relying mainly on public participation.

Such an orientation was not unrelated to Third World themes that accompanied the accession to independence of many African states, as they turned to economic regimes in which the role of the public sector was directly asssociated with the notion of planned growth for the development of national economies on independent foundations. This behavior reflected not only the then dominant ideological perceptions but also the fact that state control of the public sector seemed to be the only means of safeguarding the newly attained “economic sovereignty” vis-à-vis the menace of neocolonialism. Aside from the political choice pursued by these countries, however, an overall vision of the public sector’s place in a clear-cut growth strategy was missing.

In virtually all developing countries, however, the public sector came to occupy a predominant place in the economy and played a major role in production activities through public enterprises. At times, public enterprises constituted monopolies while at others they operated within a competitive domestic or international environment in the production of a variety of goods and services, some of which were also provided by the private sector. In effect, public enterprises were engaged in activities ranging from the production of power to water supply, from telecommunications and transport to manufacturing and mining, and from marketing of agricultural produce to the financial sector.

In all developing countries, the last two decades have been marked particularly by the rapid growth of state intervention. Such an expansion of the public sector was not a cause for concern; rather it seemed a natural, even healthy, phenomenon of modern economies. During the 1960s, public sector expansion occurred in an economic setting of extraordinary stability and unprecedented growth. In the resulting general optimism, there were expectations that this state of affairs would continue and no questions were raised about the exact role of the public sector or about its economic and financial consequences. The prevalent thinking was inspired partly by the widely held favorable expectation that further expansion of the public sector would produce overall economic growth and partly by the reassuring notion that real income growth would, through additional share revenues, finance higher public expenditures without upsetting the balance between the public and private sectors. Public sector development had at times faced certain difficulties when it became necessary to adjust prices, tariffs, and expenditures to match budget requirements. It was generally believed, however, that the public sector had yet to achieve its optimal size, and that it should expand further, whether to promote growth in several areas of state economic activity or to improve public services and raise the standard of living.

Thus, the debate focused essentially on the form of public sector extension rather than on a review of the rationale for such an extension. The most striking feature of this development was the spread of a tentacular network of subsidiaries, which further blurred the limits of state intervention in the national economy. Several arguments were advanced to justify recourse to subsidiaries: primarily, that such a formula was flexible enough to obviate the need to obtain prior authorization for the formation of such subsidiaries, and consequently provided a means of escaping state control over large areas of public enterprise activities. This situation inevitably led to certain abuses and to the proliferation of public enterprises whose social objectives bore little or no relation to the field of intervention of the mother enterprise. After that, the door was wide open for contradictory objectives and for duplication, with their inevitable corollary of economic waste and misallocation of resources.

The spread of subsidiaries, which took place without almost any state control, paralyzed the organ and procedures that had been established by the state to direct, follow up, and control this sector. This resulted in the dismemberment of economic intervention by the public sector and to the dilution of its responsibilities. In effect, in their concern to exercise “efficient” control over public enterprises, the ministries to which these entities were affiliated sought to put up “safety nets” and to refine the procedures to a point where such excessive control ended up producing adverse effects. The administrators of public enterprises were thus stripped of their responsibilities and had to refer to the supervisory authority in all aspects of administrative work, including the functions of recruitment, salaries, and investments, and management left the scene content with noting the decisions of the public authorities. More often than not, the enterprise was then responsible for the consequences of hasty or immature decisions and was unable to hold anyone responsible.

The choosing of people to head the public enterprises was often done by the political authority, especially in the early years of independence. The choice was made either as a reward for services rendered or as a means of assigning political figures to new positions only to find out—when it was too late—that the persons appointed lacked competence and the necessary qualifications. It should be recognized, however, that the state itself made matters worse and used public enterprises to achieve objectives other than those originally assigned. Thus, it often aimed at realizing contradictory targets (employment, prices, and regional development) or at realizing national gains (foreign exchange and sovereignty).

During the 1970s, however, the debate over the role of the public sector changed direction completely. This swing in emphasis resulted to a large extent from the slow performance of the enterprises in attaining their targeted goals. Signs of tensions emerged and reached their climax during the first oil shock at the end of 1973. This development—which had an impact on the resources available to the state—was accompanied by a variety of others that influenced public opinion all over the world.

In the developed countries, the acccepted notion that the state had the ability to overcome temporary fluctuations through a policy of financial and monetary intervention began to be contested. On the other hand, at the macroeconomic level, concern was voiced about the negative effects that public spending and the tax and subsidy systems could have on resource allocation and optimal utilization. Little by little, the growth of the public sector came to be seen as an obstacle rather than as a contributing factor to a dynamic private sector and to sustained economic growth. Since then, faith in the virtues of market forces and competition has been rediscovered and has restrained the public sector to adapt its size to the overall dimensions of the economy. The rebirth of liberalization and its triumph in international decision-making—though Reaganism and Thatcherism—provided a springboard for a new policy aimed at stripping the state of the functions acquired over years of state intervention in varying degrees in different countries and at different times.

The transformation in economic thought about the public sector’s role obviously had its impact in the developing countries, but it was the deterioration of public finances, the growing budget deficits, the shortage of financing, and the growing burden of state indebtedness that brought into question the usefulness of maintaining and developing the public sector. In fact, the share of public enterprises in the growing public deficits and in the mounting external indebtedness is increasingly considered one of the main problems facing the developing countries. Thus, in the early 1980s an undeniable political will emerged in many developing countries to re-examine the public sector’s role in economic intervention, which coincided with the sudden halt in ambitious development plans that could no longer be financed owing to the scarcity of state resources and the dearth of external financing.

The public sector seemed more and more to be lacking in flexibility, but more important, its structural rigidities were seen as an impediment to the adjustment process and the re-establishment of equilibrium that was urgently needed in most developing countries. The changes that can be introduced in the public sector will naturally vary from one country to another, depending on the traditions and particular situation of each country.

Strategies and Changes

In an attempt to reduce public financing, many countries have undertaken either a reform of public enterprises, or a privatization policy, or both.

Public Enterprise Reform

A better role for the state

Difficulties in the public sector are due mainly to the particular nature of its relationship with the state: this relationship is both stronger and wider than is normal for private enterprises. Improving public enterprises while maintaining state ownership generally aims at readjusting this relationship by using three basic measures:

  • affording the enterprise a higher degree of managerial autonomy;
  • establishing a clear breakdown of state and enterprise responsibilities within a medium-term perspective—which may take several forms, ranging from state guidelines to formal agreements (enterprise or development contracts); and
  • reinforcing management accountability through a system of performance evaluation.

For such a system to be effective, provision should be made for penalties in cases of negative results (including possible management changes). However, it may still be difficult to determine how far any simple sector reform can go toward solving the fundamental problems of public enterprises. In fact, it must be recognized that the repeated attempts have not always been successful, because problems that were thought to have been resolved re-emerged in different forms and at different times.

Privatization Prospects

A lesser role for the state

A change in the system of ownership of public enterprises cannot be justified only on negative grounds, such as the argument that the possibilities for internal reform of the public sector are limited. Few observers would deny the incidence of waste and inefficiency in the public sector, or that a larger exposure to market forces could increase the efficiency of public enterprises. But one should not overestimate the savings that could result from this type of action. It should be emphasized at this stage that if the inefficiency of some public enterprises is due to constraints imposed (such as prices, employment, or location determination) rather than to their being public, privatization risks being a source of only minor savings, if any at all.

Privatization of large sectors of the economy is not therefore a magic formula. It will not produce concrete results unless it is accompanied by a set of measures that afford the enterprise more freedom, and unless it falls within an economic setting that favors the resumption of growth. Such a privatization will be neither feasible nor effective unless it is accompanied by a true revival of the capital market, a prior reform of the financial sector, and a revision of legislation to protect small investors.

Public sector readjustment programs have thus become increasingly fashionable. They affect virtually all countries in Africa and a large number of Latin American and Asian countries, irrespective of their political or ideological orientation. In the major industrial countries, privatizations have inevitably become an integral part of economic policy decisions: the United States, Canada, Japan, the United Kingdom, Italy, Spain, the Netherlands, Sweden, the Federal Republic of Germany, Belgium, and many other countries have adopted this principle.

Formulation and Application of a Privatization Policy

The formulation and application of a privatization program is not an easy task. In the first place, privatization is a political decision that goes beyond the mere technical or financial aspects of this process, which is of course of the utmost importance, but which has to occupy second place in relation to such other decisive options as the choice of a certain social pattern. This process must thus be given the necessary political support and endorsed with a clear-cut legal framework that has transparent rules for its implementation. Such action, where all its components are well defined and published in advance, represents the best means of disarming the “interested” opponents of privatization.

The general impression drawn from the experience of several developed and developing countries is that all seems easy at the principle-definition stage, but as the stage of implementation progresses, one becomes aware of the magnitude and complexity of problems (ideological, legislative, regulatory, financial, fiscal, and social). It is true that several preparatory studies have been conducted to clarify the decision-making process and to avoid improvizations that could harm the national economy. However, numerous uncertainties still remain, including the following:

  • Nationalization and privatization generally fall within the domain of national laws, often in texts as fundamental as the Constitution. A debate should be opened at the level of the national legislative authorities where all arguments on privatization can be heard. Transparency should not end with a vote on legislation, but should be imposed at all subsequent stages.
  • On the political side, even if an absolute majority allows the passing without debate of a privatization law, the largest possible consensus should be sought to ensure smooth implementation of the privatization program desired. It is almost certain that differences will arise, particularly about the magnitude and pace of privatization, even among its “supporters.”
  • The real value of the enterprises to be privatized and whether they will offer sufficient returns to interest eventual buyers should be ascertained.

Experience has shown that even in developed countries with a long-established tradition of structured financial markets, relative labor mobility, and an environment in which enterprises can overcome any detrimental impact from withdrawal of state participation, difficulties have arisen in the implementation of their privatization policies:

  • Equity of the companies to be privatized could be absorbed only on a gradual basis, given the limited capacity of the existing market.
  • The need to satisfy equity demand in significant proportions to interest potential buyers.
  • The development of “hard cores” to avoid control over certain enterprises.
  • Monitoring of stock price developments and the staggering of privatization operations to prevent market oversaturation.

In the developing countries—and the case of Tunisia is a perfect illustration—the budget situation is generally fragile, the policies of adjustment applied place a burden on the living standards of the population, and the social situation is such that it cannot withstand the massive layoffs that could result from privatization of certain enterprises. Furthermore, the early privatizations in the developed countries were in profitable companies. But can we do the same in our countries without privatizing the profits and socializing the losses?

We could for instance envisage establishing an adjustment fund with domestic and external capital to provide financial aid to and to restructure the management of deficit enterprises, to refloat them prior to privatization. But a stockholding community does not exist in our countries and the large circulation of privatized company stocks is likely to be difficult. Should we accept the same old groups as constituting the “hard core”? On the other hand, the magnitude of the public sector and consequently the diversity of the enterprises to be privatized exceed the capacity of the existing groups and banks.

Privatization Methods

The choice of method is generally dictated by the nature of the activity to be privatized (competitive sector, strategic sector, or public service sector). Here, one may discern three concepts:

  • Divestiture, which consists of privatizing public enterprises, that is, transfer to private shareholders of the shares of the state or its affiliates (other public enterprises) and by so doing bring the enterprise under corporate law.
  • State disengagement is more complex, consisting of the rearrangement and redrafting of management regulations in public enterprises, in particular the monopolistic enterprises. The basic idea is to introduce—even in the enterprises whose capital is owned wholly by the state—a private management model (program contracts, determination of contractual objectives).
  • Deregulation, inspired by the United States, is an experience that seeks to deregulate the economy, that is, to liberalize the basic sectors, create a competitive environment, and reinstate price mechanisms. In effect, it suggests a review of monopolies as applied in some countries (review of export monopolies, review of communications and telecommunications monopolies, deregulation of transport, and calling into question restrictive regulations in the financial sector).

Within the framework of these three complementary concepts, one can easily classify the various formulas that have been applied for the restructuring of the public sector.

Which Enterprises Fall Within the Scope of Privatization?

The public sector includes enterprises covering virtually all economic activities; two measures could be used to delineate the new perimeter of the public sector: privatization legislation that would either incorporate an accurate listing of privatizable companies or would indicate those enterprises that are to be excluded from its scope of application. But one should avoid falling into the trap of subordinating the launching of the process to the requirements of a comprehensive listing and an assessment of state ownership. The “negative” definition of enterprises (public enterprises that should remain in state hands) is a much simpler approach. It is easy to make an inventory of public enterprises. Since they are relatively limited in number, these enterprises are by their very nature autonomous, but it is evident that their role is directly linked to the exercise of the public authority (the central bank) and the monopolistic enterprises (railways, power, water supply). Nevertheless, whatever the formula selected to draw the dividing line between the public and private sectors, a privatization program must be gradual. A “smooth” launching of such a program helps to avoid mistakes and the inevitable criticism that ensues.

Enterprise Evaluation and Privatization

Techniques

Any sale of the assets or equity of public enterprises, regardless of the techniques used, and any restructuring thereof requires an economic evaluation of the corporation in question. An initial and important step that should precede assessment of the enterprise’s value and the subsequent determination of its price is the choice of the entity entrusted with such an assessment (auditors, legal counsel, advisory banks). In determining the value of an enterprise, there is always a margin of uncertainty, and the privatization authorities should exercise their responsibilities within a certain range. The two pitfalls to be avoided are assigning either too high a value to attract investors or too low a value, which may be criticized as neglecting the interests of the equity holder, that is, the state. The stock exchanges, where active, can play a determining role in this assessment. But this form of privatization in the developing countries might have its limitations, owing to the small capital markets, as illustrated in the case of Tunisia. There, the banks could play an important role by carrying part of the capital of the companies to be privatized pending the emergence of local buyers, or ensuring the widest possible stock circulation over time. Apart from privatization techniques through the stock market, off-market operations should not be excluded, either through gradual sale or purchase of the company’s shares by its employees.

Fear of success of foreign investors with equity of the privatized companies—fed by the fear of foreign control over certain activities—has been a subject of intense debate. In reality, an unemotional analysis of the situation shows that foreign circulation of equity reinforces the image of both the company and the country whether internally or abroad. Foreign participation in a privatized company could result in the promotion of export-oriented production, productivity improvement, and more effective management; therefore, better profitability.

Furthermore, access by foreigners to company equity does not imply a loss of the national character of the company. The participation of foreign investors in the capital of privatized companies cannot, of course, take place in the same way for all such entities. Several potential formulas are available according to the type of activity, the privatization schedule, and the competitive position of the sectors concerned, both locally and abroad. Besides, it is evident that the risk of foreign control of privatized companies could be largely contained by providing for legal safeguard mechanisms. Several countries have done so with great success.

Conclusions

A demagogic debate should be avoided in the battle between exponents and opponents of privatization which some circles equate with a religious war in which each side sticks to its position without ever being ready to make any concessions. The issue should no longer be expressed in ideological or political terms. This vision is now outmoded. The optimal balance between the different actors, whether public or private, in the national economy, remains to be found. Most developing countries are facing budgetary difficulties. They lack the resources to meet the needs of an ever-growing population. Accordingly, more must be made with less resources. The state should therefore, when it can, remove itself from areas in which other economic agents are better able to perform. Pragmatism should be the guiding rule in all the approaches selected, taking the time factor into account and avoiding haste.

The role and mission of the public sector in many countries have evolved from the interplay of historical, social, and political factors. Thus, in the absence of a strategy at the time of creation of the public sector, we cannot require such a strategy for state disengagement. It should be possible—when circumstances so require and when all the necessary conditions are in place—to withdraw from certain activities that have so far been performed by the public sector. Experience has shown that the only dividing line between companies is one of efficiency; there is no frontier between them when it is a matter of equity ownership. The difference is at the level of management, and often the public sector has to suffer from the constraints imposed by the state without any compensation. Simplistic ideas about the inevitability of bad management in the public sector and the monopoly of good management in the private sector cannot be accepted.

Once the privatization decisions are taken, clear-cut rules must be developed for divestiture, taking into consideration not only the economic and social characteristics but also the cultural characteristics of each country. It is beneficial to draw on the experiences of others and to analyze their strengths and weaknesses, but above all, one should never attempt to transplant these without adapting them to the conditions of each country.

Finally, one should take into account and be aware that privatization of public sector enterprises is only one element in a wider economic policy that includes many other equally important elements, such as reduction of costs of the enterprise, reform of the tax system, liberalization of prices, and removal of exchange controls. The withdrawal of the state will be gradual, it will take time, and it is possible that most endeavors will have to follow a medium-term context favoring a pragmatic and flexible approach to the solution of problems.

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