The change of ownership

Part I of the three part series against the privatisation policy in Pakistan. This appeared on The News on Sunday, November 24, 2013. (http://tns.thenews.com.pk/the-change-of-ownership/)

The state’s role in the economy has been a subject of much controversy in the past three decades. With the advent of neo-liberalism, both as an economic as well as a political project, the voices pointing out the ‘failures’ of the state has only gained strength. During the golden age of capitalism (roughly a time period from late 1940s to early 1970s), the state’s intervention in the economy was considered as an important, if not an essential, ingredient of fostering economic growth and prosperity.

Mainstream economic doctrine always accepted the state’s role in the economy on the basis of market’s failure to provide public goods. Private producers of public goods fail to provide them efficiently (and perhaps inadequately) as markets fail to price such goods properly. The state or the government can then step in to correct such inefficiencies. But the post-World War II time period saw all major countries of the ‘free’ world adopting Keynesian policies that particularly stressed on the government’s role in not just providing public goods but also in ensuring economic growth through demand side management of the economy.

The oil crisis of the early 1970s (and then later in 1979) put considerable pressure on the industrialised economies of the western world. The crisis also resulted in an attack on the Keynesian policies pursued by most industrialised countries and the calls for reducing the government’s role in the economy gained strength. The intellectual foundations for the arguments came from the steady rise of the public choice school in the American academia.

Public choice (the application of economic methods to political phenomena) argued that when non-economic (political) costs of government intervention in the market are accounted for then government intervention results in a political market failure (sic!) of sorts.

The government is found to be just as inefficient in its intervention in the economic sphere when providing public (or other) goods as private producers are in some sectors. The stress was then to minimise the state’s intervention in the economic market. Instead, as a neutral umpire it must provide a bare minimum regulatory framework that allows the impersonal markets to operate and govern provision of all sorts of goods.

Hence, the arguments for privatisation took a whole new shape.

Earlier, privatisation was justified on the grounds of economic efficiency. It was argued that private producers in a competitive environment achieved allocative and productive efficiency and the economy as a whole achieved distributive efficiency. But the possibility of market failure was still recognised and used as the basis of government intervention in certain sectors.

The public choice framework argued that government intervention results in a failure no matter what. The problem lied with the ownership structure and incentives. A public (or state) owned company distorts the incentives of the state-managers, which eventually results in either a loss making state-owned enterprise (SOE) or a welfare loss for the society.

Hence, the conclusion is that the ownership structure of an economic enterprise matters a great deal. Private ownership provides the right type of incentives to ensure profitability and efficiency. The government presence in the market is, therefore, to be shunned at all costs.

The first manifestation of this anti-government/anti-state ideology (captured by public choice theory and neo-liberal economics) occurred in the UK and US in the early 1980s. In both countries, new right-wing governments (in the economic sense of the term) had come into power.

The Thatcher government in the UK launched a privatisation programme that aimed to privatise several state-owned companies and the Reagan government in the US launched further liberalisation of the economy by loosening the regulatory framework that had been in place to check market excesses. Of course, the process of privatisation and deregulation (liberalisation) was not just restricted to these two countries.

In 1989, the programme of economic reforms carried out in the UK and US were enshrined in what popularly came to be known as the Washington Consensus. And privatisation and deregulation were presented among other reforms as crucial to promote growth, prosperity, reduce inequality and — the bane of every government’s existence — fiscal deficits.

From Russia to Latin America, several countries embarked on, with great gusto, the policy of privatisation and liberalisation of their economies under the very visible hands of international financial institutions. In Latin America alone, between 1990 and 1999 over 150 billion US dollars were raised by various countries through privatisation proceeds of the SOEs. Of course, when economic reforms were launched by such fanfare in several parts of the world it also became important to assess them in the post-liberalisation and post-privatisation period.

But before we look at the studies, let us visit another aspect of the economic reforms process. In both the industrialised and developing countries, the Washington Consensus type reform process was also accompanied by a curb on the activities of organised labour. Thus, in the US it started with Reagan’s firing of over 11,00 air traffic controllers who had refused to call off their strike and to back off from their demands. The Thatcher government in the UK refused to budge from its stance after a year-long strike of the miners. The standoff only finished after the miners conceded their demands. In many ways, the actions of the two governments set the tone for governments all around the world where such policies were attempted.

The state-owned enterprises in almost all countries existed with heavy presence of organised labour. In order to push forward the agenda of privatisation and liberalisation, union activity was severely restricted in order to limit union’s ability to protect the rights of the workers they represented. This was achieved either through coercion or by appointing anti-union bosses in the state-run collective bargaining institutions.

Unionised workers were considered to be a major hindrance in hiring cheap labour. The ideology that supported the neo-liberal reform agenda also argued (and of course wrongly) that unionised labour increased wages at the expense of fewer jobs. The other argument was that unionised labour ultimately influences prices making markets inefficient.

Of course, these were mere pretexts and arguably the chief reason behind weakening of unions was to check their political power.

The purpose of the above discussion is to highlight that privatisation and liberalisation policies everywhere were as much a matter of politics as they were of economics but the political (or ideological) agenda was kept hidden by shrouding the arguments for privatisation and liberalisation in a technical language that economics so beautifully lends itself to. Hence, there is no dearth of experts arguing along the lines of ‘efficiency’, ‘profitability’, ‘productivity’, and ‘misallocation of vital or scarce resources’, as if these are the only concerns that matter in running of a state-owned enterprise.

An exhaustive review of studies or the literature assessing the costs and benefits of privatisation around the world is beyond the scope of this opinion piece. Also, I must state in all honesty that there are studies that find privatisation beneficial and there are others that do not. Most have come up with mixed results. In any case it has been very difficult to estimate the true costs and benefits of the privatisation process in their totality.

The Impact of Privatisation: Ownership and corporate performance in the UK (1997) by Stephen Martin and David Parker is a detailed study of 11 firms that were privatised in the UK. The study specifically investigates the relationship between ownership structures and efficiency and profitability among other relationships. It investigates the performance of the 11 SOEs in six different periods — nationalisation, pre-privatisation, post-announcement, post-privatisation, recession and current.

When the authors of the study compare the performance of the firms in the nationalisation period with the pre-privatisation, post-privatisation, recession, and the latest period, they say that it’s impossible to conclude that ownership structure (state-owned or privately-owned) matters. To quote them, “the picture with regard to the impact of ownership on performance is mixed”.

The study finds the performance of the corporations on certain variables improve in the post-privatisation period. They also found the growth in total factor productivity (that is the growth in the efficiency with which all inputs are used by firms) declined in post-privatisation period.

This is a non-trivial and controversial result — since such efficiency improvements are precisely the reason economic theory advances in favour of privatisation and liberalisation policies. Also, the strongest punch that they deliver (and most likely inadvertently) is that it is not possible to conclude a change in the ownership structure (from state-owned to privately-owned) was the only way to improve the performance of the 11 firms. This is particularly important when most of the firms showed considerable improvements in the pre-privatisation period, that is the period during which they were primed up (restructured and made attractive) for private buyers but technically were still under state ownership.

I do, however, invite the readers to look at this work and draw their own conclusions.

The results discussed above are not entirely surprising. Kate Bayliss (2006) argues the studies that show privatisation works don’t necessarily have strong evidence to back their claims. She points out methodological constraints make it extremely difficult to prove it is the change in the ownership that brings improvement in the performance of the privatised SOE.

But at a more general level, Bayliss argues that studies assessing the impact of privatisation are biased towards the private owner.

This, she says, happens when one tries to focus on indicators like profitability, efficiency to measure the performance of a firm. This point needs emphasis. When performance is measured against such indicators, it has already been assumed that the only purpose of any economic activity’s (say production of goods) sole purpose is to maximise profits and do it in an efficient manner. This precludes that an economic activity can be organised for any other purpose. So, according to Bayliss, a bias is already present when one tries to compare the performance of private and state-owned firms working in the same sector or analyse the performance of the same firm in pre- and post-privatisation period.

The discussion so far has focused on providing the historical background in which privatisation and economic liberalisation emerged the world over. We have contrasted the theoretical foundations of the arguments for privatisation and briefly saw how it translated into practice in the real world.

It is pertinent now to focus our discussion on Pakistan’s experience with privatisation. This is important in the current context when calls for mass scale and full rather than partial privatisation of SOEs has been gaining momentum.

One frequently quoted figure is Rs500 billion that the government spends in subsidising various SOEs each year. Some analysts employ a more catching way to put this number. We are told how much the government spends per month, week, day, hour, and second to keep these SOEs afloat. The argument essentially says that the SOEs have now become a fiscal burden and the sooner we get rid of them the better. The freed up resources can then be spent elsewhere.

The fiscal burden argument for privatisation emerged after persistence of fiscal deficits in most developing countries in the 1980s and the 1990s. The push for privatisation and liberalisation became stronger when the policy was seen as an easy way to ease the deficit burden. Again, whether privatising SOEs have resulted in that remains a debatable point. What the evidence does point towards is that fiscal burden was eased off by cutting down social sector spending in various developing countries.

In Pakistan as well some economists have argued that deficit burden was eased off due to cuts in social sector spending and institutional changes governing centre-provincial fiscal relations. Even in theory, the fiscal burden argument for privatisation is used with some caution since privatisation is essentially justified on the grounds of improving efficiency of the economy in general and of the SOE in particular.

Therefore, the privatisation argument holds even when the SOE is making profits. When faced with a loss making SOE, the ultimate decision to privatise must not be made solely on the fiscal burden argument. Agenor has argued that social returns to transfer of resources from public to private sector must be taken into consideration. Again, such comprehensive social cost-benefit analysis has been difficult to prove empirically.

In any case, governments all over the world have had considerable difficulties in privatising loss making SOEs. I will discuss this fiscal burden argument in the context of Pakistan in some detail later but before that it is important to discuss what privatisation and liberalisation policies have meant in Pakistan.

In Pakistan, the privatisation of state-owned enterprises (SOE) accompanied by liberalisation of various sectors of the economy is an on-going process since the early 1990s. The first Nawaz Sharif government had privatised around 90 SOEs in its tenure from 1990-1993. This PML-N government had promised to carry out a similar exercise in its election manifesto for May 2013 elections.

International Monetary Fund’s conditionalities came later but have now linked resolution of our looming balance of payment crisis and persistent fiscal deficits with the implementation of this promise. Hence, the government’s decision to privatise more than 100 SOEs is as much a blast from the past as it is an outcome of the pressure from international lending institutions.

(to be concluded).