Privatisation myths and realities

There is no economic topic, perhaps, on which misconceptions are as pervasive as privatisation.

Let me address a few:

i. Private firms are always more efficient that state-owned enterprises (SOEs): Not really. Comparative performance depends on a number of things- regulated versus competitive industries, developed countries versus less developed countries, 100 per cent SOEs versus listed SOEs. In regulated industries, many studies show no difference in performance. In advanced countries with developed capital markets and good governance structures, private firms do better but not  so much in less developed countries. Again, many of the comparisons where SOEs fare poorly relate to 100 per cent government-owned entities. Where the government exposes SOEs to competition and subjects them to market discipline through listing on exchanges, SOEs fare much better. In India, many SOEs showed an improvement in performance consequent to listing.

ii. Under-performing SOEs should be sold off to private parties, then performance will improve: Not true. A change in ownership by itself may not translate into improvement in performance. The valuation of the SOE has a bearing on the outcome. Let us say a listed SOE is sold below its correct value at a time when stock market prices are generally depressed. The new owner has merely to wait for the market to recover to meet his return threshold. He does not have to exert in order to improve firm efficiency. The method of sale or the design of privatisation is thus critical to the outcomes that follow.

iii. Improved performance of SOEs post privatisation shows private ownership is superior: Wrong. SOE  performance often suffers for want of capital- governments facing fiscal constraints are unable to provide the capital needed for modernisation and growth. When the firm is transferred to a private owner, capital comes in and performance improves. Managerial competence is not the factor. Then, privatisation of SOEs is often a long drawn-out process. During the period, managers have little incentive to perform. Once sold, managerial focus returns and performance improves. It is not the change of ownership per se that has contributed. Many SOEs shed flab and streamline operations in order to make themselves attractive to private owners. The results show up over time - and are incorrectly ascribed to a change in ownership.

iv. Auctions automatically result in the sale to the highest bidder and hence ensure improvement in performance post privatisation: Well, no. Much depends on whether the auction is efficient. This requires numerous conditions to be satisfied: multiple bidders, the absence of collusion, opening up to domestic as well as international bidders, etc. In practice, these conditions are rarely satisfied. The auction is not efficient and the firm does not necessarily past into the hands of the most deserving private party. As a result, improvement in firm efficiency may not happen nor will the government have succeeded in maximising revenues through privatisation.

v. What applies to non-financial firms applies to banks as well: Wrong. One of the important considerations in selling off SOEs is that they will then cease to make demands on government capital. In banking, however, the government remains responsible for rescuing all but the smallest of banks. The considerations that apply to privatisation of non-financial firms do not, therefore, apply to banks. Bank privatisation requires to be handled with a great deal more caution.

More in an essay on privatisation I have penned for The India Forum.