The harsh truth about privatisation

Past instances suggest privatisation of SOEs does not result in lower prices

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KARACHI:

Privatisation is in vogue. Political leaders, commercial and investment bankers, and international financial institutions such as the International Monetary Fund (IMF) deem it a magical panacea, especially for ailing, less developed economies. But is it really a panacea? Does it make sense for poor, developing countries to divest vital and sometimes strategic national assets?

In examining these questions, a distinction needs to be made between nationalised industries, which are manufacturing companies, and other government assets such as public utilities and transportation companies.

Nationalised industries now owned by the government were appropriated from their owners in the early 1970s. This was a catastrophic mistake. Some would argue that it caused irreparable damage to Pakistan's economy, from which it has still not recovered.

The fact is that there is very little logic or justification for the government—any government—to be in the business of operating factories, especially those involving small to moderate levels of capital intensity. The Pakistani government would do well to return these units to private ownership if that is still possible—the sooner, the better. This process is better described as "de-nationalisation."

Privatisation is another matter. It calls for the transfer of public service companies that have always been government-owned to private ownership. The justification for such divestment is straightforward and oft-repeated: privatisation will promote competition, resulting in lower prices, better efficiency, and improved customer service. Additionally, the government will receive a large one-time injection of cash to meet, in Pakistan's case, its escalating debt obligations.

The term "public service companies" is used here broadly to include public utilities such as power generation and distribution and public transport systems like railways and urban mass transit.

In general, these companies tend to be what economists call "natural monopolies." An example would be an electricity distribution company such as K-Electric (KE), which is now privately owned, or a gas distribution company such as Sui Southern Gas Company (SSGC). The rationale that privatisation will expose such companies to more competition and result in lower prices is a nonstarter. For example, a competitor for KE would need to lay its own cables to every house and building to enter the electricity distribution business. The same applies to a potential competitor to SSGC. Clearly, in a given urban space, it does not make economic sense to have more than one set of wires or gas lines going into every house and building.

And if proof is needed that privatisation does not result in lower prices, look no further than KE. Since its privatisation, electricity prices have not only failed to decline but have soared to record levels.

The model often cited for successful privatisation is the large-scale divestment of public service companies during Margaret Thatcher's tenure as Prime Minister of the UK. She believed, almost as a matter of blind faith, that monopolies were inefficient and that competition would drive them to improve. Thus, her government privatised railways, electricity, gas, and even the water and sewerage industries.

Now, in hindsight, it is clear that this was a disaster. The British rail system, for example, is today a hodgepodge of companies running (usually) late with obsolete rolling stock on dilapidated, possibly dangerous tracks at speeds well below their continental competitors.

This is a far cry from the days of the unified British Rail, when it was said that you could set your watch by their schedule. Meanwhile, (still) nationalised European railway companies such as Deutsche Bahn and SNCF (Société nationale des chemins de fer français) now operate trains at speeds approaching those of airliners. The same applies across the spectrum of privatised public service companies.

It should be clear that private investors who acquire a government-owned public service company do so with the intent of making a profit. This inevitably means raising prices charged to consumers. Simply improving efficiency by cutting headcount and streamlining operations is not usually sufficient to generate a market-based rate of return on investment while maintaining historical service levels.

In a (still) rich country such as the UK, with a per capita income of around $50,000, even a substantial increase in the cost of certain public services—such as electricity or a railway ticket—has only a marginal impact on consumers.

In Pakistan, with a per capita income of around $1,600, a similar increase can mean a family going without electricity or being forced to forgo even essential travel.

In poor developing countries such as ours, a strong case can be made that public service companies should not be operated for profit but rather to provide the majority of the population with essential services they would otherwise not be able to afford. If these services are provided efficiently and intelligently—without waste, pilferage, or misfeasance—there is a good chance they can be run without loss to the exchequer.

Even if some losses are inevitable, the government must assume responsibility and make choices. Governments are empowered to use the fiscal system to redistribute income equitably among all citizens. What they cannot do is throw up their hands, abandon their obligations to the public, and say: "Privatise."

There is another factor that those who thoughtlessly jump onto the increasingly rudderless bandwagon of privatisation need to consider: the asset values of Pakistani public service companies are very large compared to the typical asset values of private sector industrial and commercial companies.

Compounded by the small size and limited sophistication of existing capital market intermediaries, such as local stock exchanges, it becomes clear that any substantial privatisation cannot be funded from domestic resources. Money for privatisation must come from foreign investors.

This is a matter of concern. In addition to providing public services at affordable rates, these companies serve as tools through which the government can develop, control, and implement industrial and development policy. If a particular industry is deemed important, it can be given concessional power rates to encourage its development. If the government determines that a remote region should be developed for political, economic, or strategic reasons, rail service can be extended there.

Clearly, such actions cannot be undertaken by foreign owners, who are interested in maximising profits—not in providing loss-making services to support the host government's broad national objectives.

It is disturbing to see the alarming haste with which vital, strategic national assets are being prepared for disposal to foreign owners. It is difficult to overstate the extreme danger in ceding these assets to foreign control. The government, whether it realises it or not, is in the process of auctioning off our sovereignty.

THE WRITER IS CHAIRMAN OF MUSTAQBIL PAKISTAN AND HOLDS AN MBA FROM HARVARD BUSINESS SCHOOL