IMF, privatization and Sri Lanka

by Kanes
Developing countries such as Sri Lanka have recently been under strong pressure by the IMF to privatize state-owned enterprises mainly to remove the state from economic activities and partly to eliminate government subsidies to loss making units and reduce budget deficits. In demanding privatization the IMF gives no consideration to the costs and benefits of alternative policies, the social role public enterprises are discharging and the capabilities of the private sector. Furthermore, the IMF demands privatization of all state-owned business units whether they are efficient and profitable or not. There may be some state enterprises which are not performing any major social role and are losing money year after year that could be privatized, but most of the state-owned enterprises are not in this category and have been created to serve an important social objective such as the development of a disadvantaged region or establishment of a new economic activity which is shunned by the private sector or to create employment or to check the ruthless practices of private companies or to retain control over production or import and distribution of critical products such as oil or staple foods. Thus, in Sri Lanka, state enterprises like the CWE, Salu Sala, Pharmaceutical and Petroleum have been set up to supply essential Food, Textile, Drugs and fuel at reasonable prices, Cement, Paper, Chemicals, Sugar to develop backward regions and to fill the gaps left by private enterprise, Textiles to create employment, Banks to fund indigenous business and low-income groups and Insurance to stop malpractices and conserve foreign exchange. It may not be practical or desirable to privatize these undertakings, which are of strategic importance for the economic development process and social welfare.

Privatization assumes that the private sector will perform better than the public sector. The IMF simply assumes that markets arise quickly to meet every need, when in fact, many government activities arise because markets have failed to provide essential services. Thus, privatization very often leaves a big gap and the public is denied the services they had earlier from public enterprises. Privatization of education, resulting in school fees for instance led to a decline in enrolment in Uganda and cutting health expenditure (to privatizing health care) under IMF pressure has led to an increase in HIV/AIDS in Africa. Secondly, when privatization is pushed through before adequate regulatory or competition framework is put in place, it results in private monopolies and/or rise in prices. When marketing boards were abolished in West African countries under IMF pressure, local monopolies took their place and lowered producer prices. In Sri Lanka, the closure of the Marketing Department and the Paddy Marketing Board resulted in such low producer prices for paddy and vegetables and widespread farmer discontent that the government was forced to intervene by using the CWE to perform the role of the two former institutions.

Thirdly, the new private owner, instead of improving the enterprise, may strip it, sell the assets and throw the workers out of jobs. This happened in Russia on a large scale and in Sri Lanka to some extent when some privatized factories were stripped. Fourthly, privatization tends to be associated with bribery and corruption where Ministers and public servants are bribed by those who want to purchase public firms on favourable terms; in fact, privatization is called "briberization" in some countries. In Zambia, the privatization programme was described as a "looting exercise" and "a case of many hands in the barrel". In Sri Lanka too, some of the privatized ventures were grossly undervalued by reducing their sale price considerably and some were sold with the buyer advancing only a small proportion of the sale price, the rest being granted as loans from the state banks or from the state coffers. A number of these ventures went bankrupt and the government was compelled to pay wages to their workers. Fifthly, privatization frequently results in creating unemployment as private owners began to maximize their profits by cutting down expenditure.

This is a major social cost as developing countries do not yet have social safety nets like unemployment insurance, and it is a social cost not taken into account by private firms. Sixthly, in addition to unrest among workers who are being retrenched or are being threatened with retrenchment, there is often opposition from the public to sale of national assets to foreigners. In Thailand, for instance, over 300,000 workers in state-owned enterprises opposed sale to foreigners through privatization; they also thought the government was privatizing more for financial reasons than for improving their efficiency. The new Thai government has stopped privatization, contrary to IMF advice. There was similar opposition by workers to privatization in South Korea. In Sri Lanka too, trade unions have been demonstrating against privatization, particularly of banks and insurance recently. India has also postponed the privatization of two petroleum producing firms owing to strong opposition within the Cabinet.

Public corporations

East Asian countries do not see any conflict between encouraging private enterprise and maintaining state-owned business undertakings. Malaysia, one of the most rapidly developing economies in the world, had more than 800 state firms in the mid-1980s; Indonesia has 164, South Korea 141 and Thailand 67. In Taiwan some of the largest banks and industries are state-owned. In Singapore about 60 per cent of GDP is generated by state-owned and state-linked firms. The great majority of the state-owned enterprises are efficient and operate at a profit. Singapore Airlines is regarded as the most efficient airline in the world and Pohang Steel Works in South Korea is classified as the most efficient steel mill in the world. The country with the highest economic growth in the world and the largest inflow of foreign investment among developing countries — China -has the largest public sector in the world. The oft repeated IMF statement that the public sector needs to be reduced to attract foreign capital and promote economic growth has no foundation.

In Sri Lanka those who point out the inefficiency and losses of state-owned enterprises, conveniently ignore the profitable ones. For example, there are several of them which have been operating at high profits such as Bank of Ceylon and Sri Lanka Insurance Corporation; the People’s Bank made profits every year except 1999 and 2000 when politically directed loans caused huge losses. A large number of corporations are inefficient and loss-making mainly because of politicization or political interference by the government, in particular, the Ministers in charge. They can be made efficient and earn profits as in East Asia, if such political interference is removed. It is not government ownership which has made them liabilities but inefficient management due to political interference.

Theoretical and empirical research on privatization does not provide clear and definite support to the IMF view that privatization of state enterprise increases efficiency and contributes to rapid growth. Studies of Stephen Martin and David Parker (The Impact of Privatization: Ownership and Corporate Performance in the UK 1997) conclude: "In sum, the international studies do not provide unequivocal support for privatization programmes". John Weiss who studied 500 largest enterprises in Mexico (Mexico: Comparative Performance of State and Private Industrial Corporations) concludes: "In terms of the influence of ownership, which is the main focus of analysis, there is no support for the view that state ownership per se implies poor performance... The results give no support for privatization of the remaining enterprises on efficiency grounds".

Privatization in Europe Loses Steam

Many countries of the world — both developed and developing — have followed the privatization trail blazed by Margaret Thatcher in Britain after 1979 in the belief that privatization would provide a cure for their economic ills. It is assumed that by shifting assets from public sector control to the disciplines of private ownership and capital markets, huge economic efficiencies could be unleashed and what is more large sums of money could be raised for state coffers. Privatization was very popular in Europe about a decade ago and it effected dramatic changes. In the UK, for example, public ownership accounted for 12 per cent of GDP in 1979 but it had been reduced to only 2 per cent by 1997. Other European countries such as France, Germany, Italy, Spain, and Portugal too followed Britain and privatized some of their large state-owned enterprises. Receipts from privatization in Europe between 1990 and 2002 amounted to an impressive $ 675 billion. It is estimated the role of state-owned enterprises in all the rich countries has shrunk from around 8.5 per cent of GDP in 1984 to less than 5.0 per cent now. The developing countries followed the developed countries, and mainly on account of the pressure from IMF/World Bank, began to privatize their government-owned business units.

The momentum of privatization in Europe however has slowed in the last three years. In several countries like Germany and Netherlands planned privatization of infrastructure — postal systems, airports and railways — have been postponed or cancelled. The value of completed European privatizations reached its peak in 1998 with $104 billion, but it began to decline thereafter — to about $80 billion each in 1999 and 2000 and to only $38 billion in 2001; the figure for 2002 is estimated to be even lower. One major reason for the slow down in privatization is the weak stock markets especially the bursting of the bubble in telecom and technology shares. Unloading shares in this context would result in poor cash receipts. Another is the growing investor skepticism. The fall in share prices of privatized ventures causing losses to investors has shaken their confidence and made them reluctant to buy again. For example, France Telecom Share price has dropped from about Euro 225 in 2000 to about Euro 10 at the beginning of 2002 while Deutsche Telecom share price has fallen from about Euro 110 to about Euro 10 in the same period.

Both the governments and the investing public have also been rattled by the failure of privatized railways in Britain and privatized energy distribution in California, USA. The poor maintenance of the rail network under private management, it is reported, caused several train accidents and loss of lives in Britain. The public outcry was such that the British government has virtually decided to renationalize the railway. Electricity supply under private ownership — particularly by Enron — resulted in price hikes and blackouts in California. The Newsweek of December 10, 2001 refers to Enron’s management of energy supplies as follows:

"It claimed it would revolutionaize life and commerce by substituting the efficient hand of the market for the clumsy hand of government regulation. But Enron’s leaders proved to be every bit as bungling as any government bureaucrat..."

Britain’s second thoughts on privatization after the failure of privatized railways and dither on further privatization is an important factor for the slow progress in Europe. The Economist explains it as follows:

"The lack of activity is partly due to a subtle but noticeable shift in European attitudes to privatization. Britain the pioneer, is seen as having gone too far with its sale of railways and its questionable "private finance initiatives" in the country’s health service and transport industries. The partial sale of air-traffic-control system was also controversial. A symbolic moment was the British government’s decision last October to place Railtrack, which owns the rail networks, into bankruptcy — in effect renationalizing it. There is also the postponement of plans to privatize Britain’s financially troubled Post Office, the last big and important state-owned industry in the country. The question this raises in the rest of Europe is: if privatization has found its limits in the country that pushed it furthest, should others be more leery of it in future?"

Governments want to retain Control

Perhaps the most important reason for the slackened pace of privatization in Europe is the desire of governments to retain control over the privatized enterprises and the reluctance of private investors to purchase such enterprises when their control is with the government. Governments tend to regard privatization as a good way of raising cash without losing control. Governments in Western Europe alone have raised more than $400 billion from asset sales since 1990 but in many cases they have retained control either by selling only below 49 per cent of the shares or by retaining "golden shares" that give veto rights against a takeover of the enterprise. In Italy only one-third of the total assets privatized were freed from state control.

Generally governments in Europe have rarely forfeited control and remained inclined to meddle in privatized firms. Although the role of state-owned enterprises has shrunk from 8.5 per cent of GDP to less than 5.0 per cent of GDP between 1984 and now, as shown earlier, the tentacles of governments are more entwined in business than these figures suggest. France is the best example. It has privatized several enterprises but the state still owns stakes in numerous privatized firms, many of which are listed in the stock exchange; for example, the state owns 55.5 per cent of France Telecom, 56.0 per cent of Air France, 33.0 per cent of Thales (a defence and electronics company), 25.0 per cent of Renault and 10.0 per cent in Credit Lyonnaise. The French state also owns large non-listed companies across a wide array of industrial sectors, from chemicals to transport to energy. In Italy, the government recently imposed new managers of its choice at privatized Enel and ENI. Strikingly, no fewer than 24 of Europe’s biggest companies by market capitalization have some shares owned by a government. This suggests that privatization is not always as clear-cut as it seems.

European governments are reluctant to privatize state undertakings fully except a few, because they do not trust the private sector to act with social responsibility. They fear that private businesses in pursuit of profits will neglect their moral obligations to the community. They do not expect self-regulation of business to protect and promote community interests. For example, eight Austrian banks were found to be involved in the most shocking cartel ever uncovered by the European Commission a few months back. The banks’ bosses met frequently at a Vienna hotel to fix charges and rates. The Commission levied fines totalling $118 million on them. They are shocked by the malfeasance of large American transnational corporations, which had no scruples in inflating their figures of profits to mislead the shareholders as well as the public and conniving at the fraudulent practices of their chief executive officers. They are aghast at the world’s leading accounting firms, which helped these errant firms to cook their balance sheets. It is therefore with some justification that European governments want to retain control even over privatized firms — in order to ensure that they behave properly. Prince Sadruddin Aga Khan the former UN High Commissioner for Refugees expressed his views on the matter as follows in an interview with the Newsweek of September 2, 2002.

"I’m not against corporations or businesses. The concept of self- regulation worries me; it‘s a bit like leaving it to motorists to decide what constitutes speeding. It’s also a disincentive to abide by the spirit of the rules: the good guys realize the ones who violate them are making more money. So why shouldn’t they do the same?"

The Newsweek of December 10, 2001 commenting on Enron’s bungling of power supplies in California stated:

"leaving vital necessities like electricity and natural gas to the tender mercies of the market is too risky. Especially when a big player like Enron can vanish overnight".