Selling the Family Silver

The philosophy of privatization stems from the role of state in economic life. The thinking of the international financial institutions and free market economists is that, as in USA and now in Pakistan, the state should confine itself to regulation only and the operation and ownership of industrial enterprises and utilities should be left to the private sector.

The famous saying of a former prime minister that “the government is not in the business of business,” was the battle cry for the sale of some of the finest state owned enterprises regardless of the fact whether these were making profit or losses.

Privatization in Pakistan is seen as the strategy that will correct all past wrongs of the public sector. But two questions arise: is the wholesale privatization that we have embarked upon good for the country in the long run and whether there is a role for public sector enterprises in the Pakistan of tomorrow.

There is an opposite view to that which prevails in the decision making circles of Islamabad which argues that in those states which started late in the race of development, like Pakistan, the public sector has to play a vital role in accelerating the pace of economic growth. As is in developing countries, the private sector is shy, inexperienced and not equipped to embark on rapid industrialization. This is where the larger public sector enterprises come in.

Along with other developing countries, Pakistan also did follow this role in the 70’s and to some extent in the 80’s because of which the state of industrialization and the rate of industrial growth in some sectors have been comparatively high.

The second main thrust for privatization is the belief that private sector units are more efficient than public sector units. This is not true across the board. Studies from across the world show us that when a comparison is made between public industrial enterprises and private firms producing similar goods, changing the ownership of industry from public to private is neither a necessary nor a sufficient condition for more efficient operation of specific industrial enterprises.

This also brings into question the motives behind privatization. On the one hand, the sale of state assets results in lessening of a burden on the government, as it does not have to subsidize losses of the public sector enterprise. On the other, the social cost involved is high as well. There are the inevitable job losses as well as other cost saving measures.

It is often argued that due to political interference and over-staffing, the efficiency of the public sector units is greatly reduced. This is very true of the banking sector in Pakistan, which saw both bad loans and employee payrolls rise phenomenally in the 80’s and 90’s.

Another issue with privatization is its fiscal impact. The favourable fiscal impact of privatization is expected from the sale proceeds being used to retire national debt, as well as elimination of losses of the public sector units as the losses were being financed from the budget. The opposite view is that the public enterprises after nationalization in 1973 doubled the payment of their taxes as compared to the pre-nationalization period.

Moreover, if the public sector enterprises are making profit and giving the government higher return than the rate at which it is borrowing from the market, the privatization of profitable enterprises would have an adverse impact on the budget.

The fourth argument for privatization is to foster competition and to strengthen capital markets. If all the units in certain sectors like cement are owned by the state and these are sold to different parties, there would be healthy competition. However, if the market situation is such that there are public sector units as well as private sector units for the same commodity there will be no further fostering of competition by privatization. This is the case for Pakistan. In fact, what we are seeing now is that cement producers are seen to be entering into a cartel like arrangement whereby they have resisted government attempts to reduce cement prices.

The capital market is strengthened if the government share holdings are sold in the market. However, these markets are not strengthened at all if one public sector unit is handed over to the private party without some of its shares being offered to the public. This was the case in the initial stages of the privatization process in Pakistan. Now this situation has been corrected and a number of offerings are given through the capital markets.

At the same time, it is necessary for strengthening and deepening of capital market that some percentage of the shares of public enterprises is sold to the public through stock exchange. The question here that some analysts ask is whether the stock market has the depth that is required as well as the appetite for such consistent offerings in the market. This should also be considered in light of the fact that at present the KSE is almost entirely driven by domestic investors.

Another objective of privatization is to encourage direct foreign investment. The direct foreign investment in profitable public units is not likely to be beneficial for the economy, as against the benefit of an initial purchase price, one has to calculate the recurring remittance of profit in foreign exchange for years and decades to come. Direct foreign investment therefore should be attracted by policy and design into new and risky ventures rather than through the purchase of profitable enterprises.

In fact purchase of existing operational units by foreign buyers is not an addition to the capital stock of the country.

Privatization is a complex exercise with multifaceted implications and has to be conducted with a number of caveats. The first is that it should be absolutely transparent process with full legal safeguards and watertight procedures, otherwise the valuable public assets may be sold at throw away prices and causing a huge loss to the national assets.

It has also been observed that privatization should avoid crony capitalism as in Chile and Argentina, it has been associated with giving away expensive public assets at cheap rates to political cronies. Thankfully, the process in Pakistan has not been mired by such scandals, at least not to that level.

At the same time, privatization gives tremendous patronage to the government in power which may be exercised to favour vested political interests rather than to serve long run national objective, negating the basic objective of improving efficiency in the economy. This is something that should be guarded against.

Another imperative of privatization is sequencing and timing. It is essential that all the assets should not be sold in a short period, because in the short period the buying power of private sector may not be adequate to offer the correct prices for all the privatized assets. It may crowd out fresh foreign investment and lead to reduction in the rate of investment in the economy. This is a real problem in Pakistan.

The success of privatization is that the economy should be deregulated and unnecessary restrictions and procedures for industrial enterprises should be done away with. Privatization should therefore be part of a process to strengthen the private sector by giving it assets as well as improving regulatory framework for their operation. To give units to the private sector but to keep it throttled by massive regulations would not improve the operational efficiency. Hence the sale of privatized units should be staggered over time.

There should also be a preference to privatize first the loss making assets, then the less profitable and finally the more profitable. In case the loss making units could not be sold independently these could be bunched with a profitable public enterprise.

The investment climate must also be kept into view. Privatization after 11 th September, 2001 was not an opportune time because the international stock markets slumped and the investor’s confidence slided sharply. As a result of terrorist activities in Pakistan and given the fact that Pakistan having a long border with the Afghanistan, the investment climate in Pakistan deteriorated more sharply than in other countries.

Finally it must be ensured that the party which is buying the industrial units does not use it for stripping the assets and selling the real state because if the party does this, there will be a serious loss of out put, employment and taxes to the national economy.

There have been two tides of privatization in Pakistan. The first tide is from 1992 to 1994 and the second tide from July 2001 to October 15, 2002. In the first period assets worth Rs.120 billion were divested and in the second period assets worth Rs.65 billion were divested.

Consultants engaged by Asian Development Bank conducted a thorough study of the first period. It is a detailed report which clearly indicates that only 22% of the privatized units were performing better than in the pre-privatization period, 44% approximately the same and about the third i.e 34% worse than before. It is quite clear that the compelling reason for privatization that of improving the efficiency of the units, was only attained by about 1/5 of the units, whereas the rest were working with the same efficiency or worse than before. This is an eye opener for all concerned.