metadata: authors: 0: author: Kikeri,Sunita
1: author: Nellis,John R.
count: World
docna: 0: docna: Privatization in competitive sectors : the
            record to date
docty: Policy Research Working Paper
subtopic: State Owned Enterprise Reform,Public Sector Administrative & Civil
            Service Reform,Railways Transport,Food Security,Privatization,Employment and Unemployment,Energy Privatization,Democratic Government,Economics and Finance of Public
            Institution Development,Public Sector Administrative and Civil
            Service Reform,De Facto Governments
teratopic: International Economics and Trade
abstracts: cdata!: The paper reviews recent evidence on the
            impact of privatization. It focuses on traditional
            privatization efforts involving firms in competitive
            markets. It shows that privatization improves firms'
            financial and operating performance, yields positive fiscal
            and macroeconomic benefits (proceeds are saved rather than
            spent, transfers decline, and governments start collecting
            taxes from privatized firms), and improves overall welfare.
            The popular view that privatization always leads to layoffs
            is unfounded. While highly protected firms have seen
            significant declines in net employment, competitive firms
            generally experienced slight declines if any.
            Privatization's effects on wealth and income
            distribution have only recently been receiving the attention
            of analysts, and research is just getting underway. The
            paper highlights the conditions for successful
            privatization: strong political commitment combined with
            wider public understanding of and support for the process;
            creation of competitive markets through removal of entry and
            exit barriers, financial sector reforms that create
            commercially oriented banking systems, effective regulatory
            frameworks that reinforce the benefits of private ownership;
            transparency in the privatization process; and measures to
            mitigate adverse social and environmental effects.
repnme: repnme: Privatization in competitive sectors : the
            record to date
display_title: Privatization in competitive sectors
            : the record to date
listing_relative_url: /research/2002/06/1953633/privatization-competitive-sectors-record-date
topicv3: Agriculture and Food Security m1326205 435,State Owned Enterprises m1326323 721,Privatization m1327236 1283,Railways m1327400 166,Unemployment m1504051 2747
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: International Economics and Trade
origu: Private Participation in Infrstr (INFPI)
no_of_pages: 60
author_keys: 0: author_key: 91940
1: author_key: 92255
model_extractions: Pot i *y Ris 5Ai(CH WXO RKIMN IA,F Pi< 2860

# **Abstract**

The paper revscvi s rc.cint evidciic<sup>**O0n**trh.iilplactoI</sup> privatization. It focuses<sup>onl</sup> traditioial<sup>priv satitioll</sup> n1anIVst. cfforts invols iiig firimis In compe titive nitr;kcts.<sup>Irsiows</sup> that pris atizarion Inimprmo es fir-is' fi nan. al anid opcratinog performanicc yields positivc fiscal<sup>andmacrocconomic</sup> heniefits (pr-occeds are _saved_ rateirc-<sup>thanspent,transfcrs</sup> dcclinc, anid gos erniicits start **.11. .'0** r\aes froiil privarized firmis), anild improves overall<sup>wvelfare.The</sup> poptIlar viev that privatization alwa\s<sup>leadstolayoffsis</sup> tonfoL1nded. V/hleC hii`hl\ protecred<sup>firmshia\csccii</sup> s,ignifiant dcclinls in niet employment,<sup>competitivefirilis</sup> genierally cxpericiceci sight dcclines if an. Privatiziation's cffects on svealth aid micome distrihiitioii hiavc onl! re-rcently cn receiving<sup>thicattciitiollof</sup> an1d rcscarrClil ILIst gertitg dllLemdrs av. -T-lic paper Iigllights the coniditionis for<sup>sticcessfn l</sup> pri **v** riiatioll strong Political coimi mitmnet<sup>conihi ned</sup> with \s idcr phic ICinderstanlding of aid sLpport<sup>for-rIte</sup> proccss; creationl of competitive markets<sup>tIhroLogI</sup> removal Oit entr and cxit harriers, filjacial sec(tor refol-ilms that create conmiiircialkI oriented<sup>bankinig</sup> systclims cffcct\ve r egnlatorv framesviorks<sup>thatreilifol-cc</sup> lie henefits of private owiinership; transpareicy<sup>inthe</sup> privatization process; and nicastires<sup>romitigateadverse</sup> s(cial _nlld_ nviron-(meIjItal effects This paper-a pr'oCdL Lt **if** tl Pr-ls vate Pro\ siomi of PuIblic Sersc'ies Divisioiin,<sup>Pris atiSectoiAdvisoiiryScr\ icesD)pr</sup> crimentIs part of a la-gcr effort in t lie department<sup>toaialyze atcl</sup> n lissclniiate r ecenit Iindings in priv'ate<sup>sCct(oldeeloiipmentiCopies</sup> of the paper aLre avaiahlbe free<sup>froiinithe\WorldBank,II 81-1</sup> Strecet N\, \ashlinigton, I . 2043 **3.** Please contact Rosario .atrtoli lme, room 19-05 1 , telephone 2021-473-5703, fa\<sup>202-5 2-34',1 , emilml addrcssrhartolonime(iworldhanl-org.Policy</sup> Re scarch Working Paper;s are also posted<sup>onthe\VehathTrphie'eco.svorldh'ikC)lg'Ie</sup> authors mias he conitacted at skiker(V svoriirldhaik.org or nellisI(/ starposver.rnt.<sup>jlIon2002.(.(OpaLges)</sup> _I-/JL P'<l' Keseh Ww',k,,- 1'.7/,(,CS_ iced **by** the _Irsimidmiis_ Rksea,,rth Adisir _,_ taff _om,s{z,c 1/ ,, cxcbm7 tdc,, ab(a_ Porodurcedt I)v til. RCCItareLI Adivisor\v St7ff
## PRIVATIZATION IN COMPETITIVE SECTORS:

# THE REcoRD **To** DATE

Sunita Kikeri* John Nellis

* The authors would like to acknowledge research support from Bita Hadjimichael and Peter Kelsey, and production support from Rosario Bartolome. Michael Klein, Neil Roger, and Warrick Smith provided valuable comments and inputs.
## PRIVATIZATION IN COMPETITIVE SECTORS: THE REcoRD To DATE

# Contents

|1.|INTR<br>|ODUCTION............................<br>1<br> <br>|
|---|---|---|
|2.|PRIV<br>|ATIZATIONTRENDS...........................<br>2.,......2<br> <br>|
|3.|IMPA|CTOFPRIVATIZATION ............................<br>6<br>|
||(i)<br>|Enterpriseperformance ............................<br>7<br> <br>|
||(ii)<br>|Macroeconomicandfiscaleffects...........................<br>13<br> <br>|
||(iii)|Welfareconsequences...........................<br>15<br>|
||(iv)<br>|Employmenteffects...........................<br>17<br> <br>|
||(v)<br>|Wealthand incomedistribution...........................<br>19<br>|
|4.|FACT<br>|ORSFORSUCCESSFUL PRIVATIZATION<sup>..........................................................20</sup><br> <br>|
||(i)|Commitmentandownership.............................................................<br>20<br> <br>|
||(ii)|Ownershipandcompetition.............................................................<br>21<br>|
||(iii)<br>|Transparency.............................................................<br>25<br>|
||(iv)|Mitigatingthe socialimpactofprivatization.............................................................<sup>27</sup><br> <br>|
||(v)<br>|Environmentalimplications .............................................................<br>29<br> <br>|
|ANN|EXA|:Studies onPrivatization<br>..<br>31<br>|
|BIB|LIOGR|APHY<br>..<br>43|

|FIG|URES<br> <br>|
|---|---|
|1|GlobalPrivatizationProceeds..............................................................<br>3<br> <br>|
|2A|PrivatizationProceedsbySector,1990-99..............................................................<br>3<br> <br>|
|2B|PrivatizationProceedsbyRegion,1990-99..............................................................<br>3<br>|
|3|GrossBudgetaryTransfers andSubsidiestoPublic<sup>EnterprisesforSelectedCountries.....13</sup><br> <br>|
|4|Welfare EffectsofSellingState-owned Enterprises.....................................<br>16|

TABLE 1 Change in SOE's Activity as a Percentage of GDP .6

### BOXES

|I|SOEReforminChina........................................|5<br>|
|---|---|---|
|2|RussianPrivatization........................................<br>...........<br>|,,.12<br>|
|3|PrivatizationandEmploymentinCote<sup>d'Ivoire......................................</sup>|17<br>|
|4|IsOwnership Change Enough?.....................................|23<br>|
|5|PrivatizationofBanks.....................................<br>|25<br> <br>|
|6|PrivatizationandCorruptioninTransition<sup>Economies .............................</sup><br>|<sup>........</sup><br>27<br><br>|
|7|DealingwithLaborRedundancies<sup>inBrazilRailways.............................</sup><br>|<sup>........</sup><br>28<br><br>|
|8|Improved Environmental Performance in Mexico<sup>....................................</sup>|<sup>.</sup><br>30|
**PRIVATIZATION IN COMPETITIVE**<sup>**SECTORS:**</sup> THE RECORD To **DATE**

# **1. INTRODUCTION**

**1.** In the last fifteen years privatization<sup>hasbecomeacentralelementofthestructural</sup> reform agenda in developed and developing<sup>countriesalike.Indeed,itisnowquitedifficultto</sup> find a country that has not embarked<sup>onaprogramtodivest someorallofitsstate-owned</sup> enterprises (SOEs) or to involve<sup>the privatesectorintheirmanagement,ownership, and</sup> financing.

2. The reasons for the rise of privatization<sup>arewell-established.In general,SOEsperformed,</sup> and continue to perform, poorly. They<sup>proved wasteful and inefficient,tendingto producegoods</sup> and services of low quality and high<sup>cost.They becameseriouslyoverstaffedasgovernments</sup> used them to generate and maintain<sup>employment. Shelteredfrom competition,SOEs often were</sup> instructed to keep their prices low,<sup>resultinginmounting financiallossesthatinsomecases</sup> amounted to as much as 5 to 6 percent<sup>of GDP.Thisled tobailoutsandfiscalstrains,firston</sup> government budgets and latterly on<sup>the bankingsystem.CoveringSOElosseswithfiscal</sup> transfers required governments to finance<sup>larger fiscaldeficits and increase tax revenuesor, more</sup> commonly, reduce public expenditures<sup>inotherareas,orboth.ThefinancingofSOElosses</sup> through the state banking system<sup>increasedintermediationcosts, reduced theprivatesector's</sup> access to credit, and threatened overall<sup>financialsectorviability.Increasingly constrained</sup> governments also became incapable<sup>of providingcapitalto theirSOEs,even theprofitableones,</sup> for maintenance and repair, much<sup>less badly-needednetworkexpansionandre-tooling.</sup> 3. Numerous attempts through the<sup>1970sand 80sto reformSOEsby imposinghard budget</sup> constraints, exposing them to competition,<sup>andintroducing institutionalchanges(e.g.,in the</sup> selection and qualifications of the<sup>BoardofDirectors, inthetrainingandremunerationof</sup> managers, in "contractualizing" the<sup>relationship betweenthegovernment andthefirm,etc.)</sup> produced meager results. In instances<sup>wheretheinitialresultsof suchreformwerepromising,</sup> the achievements proved unsustainable;<sup>back-slidingwas common.Bytheendof the 1980s,</sup> Government ownership itself increasingly<sup>cameto beseenasa principalreasonfor theinability</sup> to effect major and enduring SOE<sup>reform.The perceptionarose thatthemeritsofpublic</sup> ownership and management of productive<sup>assetshad beenoversold,andthatthepotential for</sup> introducing private entry and participation<sup>hadbeen underestimated.Thisshift accompaniedthe</sup> early privatization programs in Great<sup>Britain and a fewother OECD countries, whichthen served</sup> as a powerful demonstration effect<sup>for countries worldwide. Privatizationthuscameto be widely</sup> accepted as a tool to improve SOE<sup>performanceand reducethebudgetaryburdencaused by their</sup> inefficiencies.

4. Despite the extensive adoption of<sup>privatization,ithas fromtheoutsetbeenhighly</sup> controversial and politically charged.<sup>First, there arethose who claimthat privatizationdoes not</sup> produce financial and operational benefits,<sup>or atleast not enough tooffsetthe socialdislocationit</sup> causes. Second, there is an acute and<sup>pervasivefear thatprivatizationleadsto layoffs, firstin the</sup>
2 short-term in the firms divested, and then in the longer-run and in the economy at large. Third, there is a widespread belief that even if privatization enhances efficiency, the bulk of its benefits accrue to a privileged few-shareholders, managers, domestic or foreign business interests, those connected to the political elite-while the costs are borne by the many, particularly workers and consumers. In addition, many are concerned that lack of transparency and corruption in the privatization process itself has minimized the intended gains and led to or deepened broader problems of governance.

5. This paper takes stock of the empirical evidence on privatization outcomes, and-on the basis of this evidence-highlights the conditions for success. The paper deals mainly with traditional privatization efforts involving enterprises operating in competitive markets; it does not cover infrastructure enterprises (which are the subject of a separate background paper),' though a number of general issues arising from infrastructure privatization are mentioned. Section 2 provides a brief review of overall privatization trends over the past ten years. Section 3 reviews the literature on the micro- and macroeconomic impacts of privatization, and also examines the employment and broader distributional impact. Section 4 highlights the key factors for successful privatization.

# **2. PRrVATIZATION TRENDS**<sup>**2**</sup>

6. Privatization activity has grown in the past ten years, both in terms of number and value of transactions. In the 1980s there were only a few transactions on average per year, but by the late 1990s the annual average rose to about 500. Between 1990 and 1999, total global proceeds amounted to US$850 billion, growing from $30 billion in 1990 to $145 billion in 1999 (Figure 1). Developed countries account for the bulk of the proceeds, mainly from public offerings of large firms in countries of the European Union (Mahboobi, 2000).

> ' Gray 2001.

> 2 Global data on numbers of enterprises privatized are not readily available. Compiling this information from country level data is a difficult task given problems of consistency and comparability; for example, some countries include the privatization of small retail outlets in their figures while others exclude them. Data on global privatization proceeds are available from the World Bank's Global Development Finance, 2001, on which this section is based. The data is on an announcement basis rather than on the basis of actual flows of receipts, which means that privatization commitments do not reflect receipts in a particular year, as transactions may be paid for over several years. Data on privatization revenues should be viewed cautiously as they can be concentrated in a few large public offerings and thus do not reflect the scope or progress of a country's overall program. The discussion here is mainly intended to provide an overview of broad trends rather than comprehensive coverage of privatization activities to date.
3 <!-- Start of picture text --> Figure 1: Global Privatization Proceeds<br>(US$ billon)<br>150<br>-<br>50 I I :<br>1990 1991 1992 1993 1994 1995 1996 1997 1998 1999<br>*MNon-OECD Countiies *OECD Countries OTotal<br>Source: Mahboobl, 2000.<br><!-- End of picture text --> 7. Privatization activity in developing countries<sup>hasbeen growing. While noaccurate</sup> account is available, it is safe to say that tens of<sup>thousandsof enterpriseshave beensold. A rough</sup> estimate is that $250 billion in revenues were<sup>raisedbetween1990-1999.Proceedsincreased</sup> four-fold since 1990, reaching $44 billion<sup>in1999after apeakof$66billionin1997.The</sup> revenues are largely accounted for by infrastructure<sup>privatization,mainlytelecommunications</sup> and power, followed by the primary sector,<sup>includingpetroleum,mining,agriculture,and</sup> forestry. Recent large sales have<sup>beenconcentratedintheoilandgassectors</sup> in Argentina, Brazil, India, Poland and Russia. Manufacturing<sup>privatizations raised about16percentof total</sup> developing country proceeds between<sup>1990-99,mainly fromsalesin Eastemand Central Europe</sup> and Latin America (Figure 2A).

<!-- Start of picture text --> Figure 2A: Privatization Proceeds by Figure 2B: Privatization Proceeds by<br>Sector, 1990-99 Region, 1990.99<br>(USS billions) (US$ billions)<br>50 so1s9 5 _ I IIl1S9<br>kVma,~. mwnaacuAt PRVs." 80dm FbMW, Ot,. Ea As. SoM Asia Europd Leti Mis Eastd SubSawa<br>mad PacBc Cw&i Asia Amaca and nd Nooit aM=c<br>Iii Attic<br>Source: Global Development Finance 2001 Source: Global Development Finance 2001<br><!-- End of picture text --> 8. In regional terms, Latin America accounted<sup>for a large shareofnon-OECDprivatization</sup> activity, particularly in terms of revenues<sup>(Figure2B).CountriessuchasArgentina,Brazil,</sup> Bolivia, Chile, and Mexico sold small and medium<sup>sizedfirmsat first, butrapidly expandedtheir</sup>
4 programs to include large infrastructure and energy firms; the largest contributions in recent years came from the sale of infrastructure and/or energy firms in Brazil, Argentina and Mexico.

9. Eastern Europe and Central Asia sold the most number of firms as a result of mass privatization programs which, mainly prior to 1995, divested thousands of enterprises in Russia, the Czech Republic, Kazakhstan, Lithuania, Moldova and Mongolia (among others). But the revenues raised were minimal due to the use of vouchers.<sup>3</sup> Since 1995, however, privatization revenues have been growing as countries such as Estonia, Hungary, Poland, Russia, Slovakia, and others began case-by-case sales, including large firms in banking, transport, oil and gas, and infrastructure. In 1999, the region accounted for 24 percent of developing country privatization proceeds compared to 18 percent in 1994.

10. Prior to the financial crisis of 1997, East Asian countries opted for a different strategy, concentrating on opening up their economies to new private entry, rather than privatizing existing enterprises. This approach was workable, given-outside of China-the region's comparatively smaller reliance on SOEs as agents of economic policy, and the success of China's evolutionary approach to property reform (Box 1). However, the altered circumstances post-crisis, and the need in China to face the burgeoning financial problems of the largest SOEs, led to a renewed emphasis on privatization; some of the larger companies are now being privatized. The region accounted for 12 percent of total proceeds in 1999, with the sale of minority shares in two large enterprises in China accounting for half of all regional activity, followed by Thailand and Indonesia.

11. Privatization revenues in the Middle East and North Africa have been modest, but growing in recent years, largely as a result of Morocco's telecom sale and the privatization of cement and other medium to large sized companies in Egypt. In South Asia, Sri Lanka has had an active program covering virtually all sectors (including infrastructure) but, in terms of revenues, India accounted for the bulk of regional revenues in the past few years as a result of minority share sales in large companies. (The extent to which such minority sales effect efficiency and operating results is questionable, particularly since most of the sales have been to financial institutions that are themselves state-influenced or controlled; see para. 25 below.) The number of sales in Sub-Saharan Africa has risen greatly over the past five years, from 175 in 1990 to over 400 in 1996.4 By 1998, over 3,000 transactions had been completed, mainly in Mozambique, Angola, Ghana, Zambia, Kenya, Tanzania, and Guinea (Campbell White and Bhatia, 1998). But the relatively small size of the divested firms limited the financial impact: African sales accounted for 3 percent of total developing country proceeds between 1990 and 1999.

> 3 In East Germany, which also privatized a large number of firms, revenue generation was decidedly secondary to finding good owners; the seller accepted lower prices in return for investment and employment commitments from the new owners.

> 4 This number includes the sale of small retail units and establishments and the sale of minority shares.
# Box 1: SOE Reform in China

China launched a major economic reform and liberalization program in the late 1970s that transformed the productivity of the Chinese economy. China's approach to ownership change in industrial firms has evolved slowly and in a piecemeal fashion over the past twenty years; but its reform of ownership in agriculture took place early in the reform process, and was more widespread and swifter in pace. Starting in 1978, government allowed the previously collectivized farmers to retain and sell more and more of their production in increasingly free markets. By the early 1980s, all farmland was "de-collectivized," and allocated to family units, a massive privatization, or re-privatization, process affecting 800- million people. Not all prices were immediately fully freed, the state retained a role in marketing and credit at least until the early 1990s, and one could not freely buy and sell the land allocated. These reforms were revolutionary, affecting the lives of a populous sector, still-in 1978-accounting for 71 percent of employment in China.

SOE productivity in the industrial sector was increased by gradually freeing prices and decentralizing economic decision-making. At the same time, government created forms of industrial ownership, particularly at the subnational level, that successfully combined elements of collective and private property. Latterly, new private entry and foreign direct investment were permitted. All of this proved efficacious and changed China's economic landscape. In 1998, the non-state sector (including private agriculture) accounted for 62 percent of GDP, while the share of SOEs in industrial output declined from 78 percent in 1978 to 28 percent in 1999.

Since 1987, there have been numerous privatizations of small collectively owned township and village enterprises, and further experimentation with ownership forms at the local level. Small privatizations created managementemployee buyouts, known as "joint stock cooperatives": Many of the resulting entities were saddled with heavy debt burdens, excessive employment, and social obligations, and were thus non-viable; in 1995, 72 percent of such firms were in the red. In the mid-1990s, government tried to improve their performance by creating limited liability companies giving managers a larger stake (so as to hold them accountable) and through sales, mergers, and takeovers of SOEs by private firms. Implementation of the Bankruptcy Law also led to some 3,400 SOE bankruptcies since 1996. But few outright sales of medium or large SOEs were allowed.

In the last few years, as long-simmering pressures on the banking system have grown acute, the government has announced its intent to clean up and privatize large SOEs. Many such firms carved out their better assets to set up new companies for initial public offerings on the stock market in which they became the largest controlling shareholder. There has been some dilution of shares over time, but mostly to other state entities with the majority of shares still remaining in state hands. While less concentrated ownership has led to private takeovers in some cases, full privatization continues to, move at a slow pace. Most Chinese SOEs being overstaffed and heavily burdened with social welfare responsibilities, authorities are reluctant to take steps that would result in large layoffs, add to unemployment, and perhaps provoke social tension. They do not wish to move in the absence of severance and retirement packages, unemployment insurance schemes and training programs. These take time to build. In the interim, for the largest firms-both in terms of turnover and employees-the Chinese continue to search for mid-way mechanisms that will raise profitability and efficiency without full privatization. Their own experience to date, and the experience of many other countries that followed a similar path, suggests that it will not reap the full benefits from SQE reform unless it limits the state's role in their operations. Economic reforms coupled with privatization would lead to even-greater-performance improvements.

While China's SOE problems grow increasingly acute (badloans of'SOEs are, crippling the commercial banks), many countries in transition or elsewhere" would welcome themz-if'they could.be.assured that they would-be accompanied by the country's impressive growth and,production record. The Chinese experience shows the importance and utility of policy pragmatism, and the maintenance of a capacity within the state-to formulate and enforce the policies chosen.

Source: Nolan, 1995; International Finance Corporation, 2000; Zhang, 2001.
6 12. Foreign participation as a share of total developing country proceeds has been increasing over the years, mostly as a result of sales in sectors such as oil and gas, telecommunications, and banking, and largely in Latin America, Eastern Europe, and East Asia. The foreign share reached 76 percent of total proceeds and generated an estimated $32 billion in foreign exchange in 1999. Foreign direct investment accounted for 80 percent, and portfolio investment for the rest.

13. These trends in privatization activity contributed, along with new private entry, to a substantial decline in the relative share of SOE value added in GDP. Sheshinski and LopezCalva (1998) show that the share of SOEs in industrialized countries declined from an average of about 6 percent of GDP in 1980 to 5 percent in 1997. The decline for low-income countries is steeper, falling from a high point of 15 percent of GDP in 1980s to 3 percent in 1997, while middle-income countries also experienced significant reductions (Table 1). Since the upper and lower middle-income groups include the transition economies of Central and Eastern Europe, this decline was expected given the high levels of state ownership to begin with and the use of mass and rapid privatization techniques in a number of these countries.

**Table 1. Change in SOE's Activity as a Percentage of GDP (Decrease In percentage points of GDP)**

|**Countries**<br>**(byIncomeGroups)**|**1980**<br>(%)|**1997**<br>(%)|**Change**<br>(%)|
|---|---|---|---|
|Low IncomeCountries|15|3|-12|
|LowerMiddleIncomeCountries|11|5|-6|
|UpperMiddleIncomeCountries|10.5|5|-5.5|
|HighIncomeCountries|6|_5_|-1|

Source: Sheshinski and Lopez-Calva, 1998.

# 3. IMPACT OF **PRIVATIZATION**

14. Sufficient time has elapsed since the start of reforms to allow an initial assessment of the extent to which privatization has met its intended economic and financial benefits. There are to date well over 100 studies that do so, covering privatizations in all sectors through a variety of methods in a large number of developed, developing and transition countries (selected studies are summarized in Annex A). The impacts, and supporting studies, can be grouped into five categories:

- First, most assessments of privatization have looked at financial and operational performance at the enterprise level, comparing productivity and profitability before and after sale, and changes in output, investments, capacity utilization, and the like. These studies provide ample evidence that, when done right, privatization improves performance in many different settings in many different ways.

- Second, there is a limited but growing body of work about the fiscal and macroeconomic effects of privatization showing positive fiscal benefits and a high correlation between privatization and growth.
7

- Third, the broader welfare and economic consequences of<sup>privatizationare notas widely</sup> studied, though the few rigorous evaluations show that<sup>privatizationhasdonewell,and</sup> that the welfare effects when compared to realistic<sup>counterfactualshave beenpositive,</sup> often substantially so.

- Fourth, growing analysis of the employment and broader<sup>labor market impacts showsthat</sup> privatization does not always lead to unemployment,<sup>but thattheoutcomesaremixed,</sup> reflecting country and industry differences. When evaluated<sup>againstthecounterfactual,</sup> privatization has often led to employment increases<sup>at boththeenterprise andindustry</sup> level.

- Fifth, the effects of privatization on income and<sup>wealth distributionaretheleaststudied</sup> aspects of privatization-though considerable<sup>workonthese questionsisnowin</sup> progress.

# **(i) Enterprise performance**

_15._ There is now a wealth of information from a wide<sup>rangeofcountriesshowing that</sup> privatization is associated with improvements in the firm's<sup>financialand operatingperformance.</sup> Following privatization, profitability usually increases,<sup>often substantially,asdoesefficiency</sup> (expressed as real sales per employee), output, and<sup>investment.These resultsareparticularly</sup> robust for privatized firms operating in sectors where<sup>effectivecompetitionreigns, suchas</sup> manufacturing, agro-industry, oil and gas, and mining.<sup>Assummarizedbelow, these outcomes</sup> are seen in cross-cutting studies covering both developed<sup>anddevelopingcountries,aswellas</sup> case studies of developing and transition economies.

# Cross-cutting studies

16. Megginson and Netter (2001) have carried out the most<sup>recentand thoroughsurvey of the</sup> studies evaluating empirically the impact of privatization<sup>onfirm performance.</sup> The most comprehensive of these (Megginson, Nash and van<sup>Randeborgh,1994;BoubakriandCosset,</sup> 1998; D'Souza, Nash and Megginson, 2000) use<sup>a similarmethodologytocomparepre-and</sup> post-privatization financial and operational performance<sup>measures(over threeyear periods)of</sup> large numbers of companies privatized, through<sup>publicshareofferings,indevelopedand</sup> developing countries. As summarized in Megginson<sup>and Netter(2001),these studiesgenerate</sup> similar results. Weighted averages of the mean values<sup>from the studiesshowthat:profitability,</sup> defined as net income divided by sales, increases from<sup>anaverage valueof 8.6 percent before</sup> privatization to 12.6 percent thereafter. Efficiency,<sup>definedasreal(inflationadjusted)salesper</sup> employee, increases from an average of 96.9 percent<sup>intheyear of privatizationtoanaverage</sup> level of 123.3 percent in the post-privatization period;<sup>between79and86percentof firmssee</sup> output-per-worker increases. Most of the studies also<sup>conclude that therewere economicallyand</sup> statistically significant post-privatization increases<sup>in output(realsales),aswellas significant</sup> decreases in leverage. Capital investment spending<sup>slightlyincreased,while employment</sup> changes are ambiguous (see section (iv) below for<sup>moreonemployment). Themainfactors</sup> accounting for the performance improvements are<sup>changes intheincentiveand management</sup> structure coupled with improved corporate governance.
8 17. Sheshinski and Lopez-Calva's (1998) evaluation of the empirical evidence<sup>alsosupports</sup> the view that privatization has positive effects on enterprise profitability<sup>andefficiency. They</sup> found that: (i) privatized firms improve profitability after sale irrespective of market<sup>structure,</sup> though competitive firms show higher productivity increases compared<sup>to firmsin more</sup> concentrated markets. In the latter, deregulation policies, which the authors<sup>relate to privatization</sup> programs, are shown to speed up the convergence process of firms to industry standards;<sup>and(ii)</sup> fully privatized firms perform better than partially privatized firms. In<sup>their older, seminalstudy,</sup> Boardman and Vining (1989) provide evidence to support the latter<sup>finding.</sup> Analyzing the performance of the 500 largest non-U.S. industrial firms in 1983, they show<sup>that state-ownedand</sup> mixed ownership enterprises are significantly less profitable and productive<sup>thanareprivately</sup> owned firms. They conclude that mixed enterprises are no more profitable<sup>thanSOEs,and</sup> suggest that full private control, not just partial ownership, is<sup>importantforachieving</sup> performance improvements.

18. It can be argued that there are difficult methodological problems<sup>withcross-cutting</sup> studies of the above mentioned type that might lead them to be biased in<sup>favorof privatization.</sup> First, there is a problem of selection bias. Firms sold by public offering will be<sup>the "creamof the</sup> crop;" i.e., to meet stock exchange listing requirements they will have been<sup>profitablefor some</sup> time, possess up to date and accurate accounts, and in general will be<sup>the largestandamongthe</sup> best performing firms sold in the privatization program. Thus there is the possibility<sup>that itisnot</sup> privatization that causes performance improvements, but rather it is that<sup>thehighestpotential</sup> firms are privatized. In addition, because of data limitations, developed countries<sup>areover</sup> represented in the samples of such studies, leading to further possible<sup>selectionbias.Second,</sup> there are data constraints as well that some argue influence the findings.<sup>Comparingaccounting</sup> information across different countries and at different points in time can be<sup>difficultandfraught</sup> with problems. Most of the studies do not account for changes in the macroeconomic<sup>or business</sup> environment over the given time period, both of which influence the<sup>outcomesof privatization,</sup> and it could be argued that a rising economic tide lifted all firms, and not just the privatized<sup>ones.</sup> And third, using profitability as an indicator of improved performance<sup>isflawedastheprivate</sup> sector by definition is profit maximizing while profit is not likely to<sup>beagoalinthepublic</sup> sector.

19. Despite these drawbacks, these studies are the few that directly compare large<sup>samplesof</sup> firms from a range of industries and countries over different time periods,<sup>and they consistently</sup> suggest that privatization does improve firm performance, not just in terms of<sup>profitability</sup> changes but also efficiency improvements. Moreover, some of the methodological<sup>drawbacks</sup> have been addressed in other studies. Boubakri and Cossett (1998),<sup>for example,analyzed the</sup> performance of 79 newly privatized firms in 21 developing countries<sup>thatexperiencedfullor</sup> partial privatization between 1980 and 1992. The sample was diversified, with wide geographical dispersion and different levels of country development, and<sup>firmsof differentsize</sup> and in different industries and market structures. They too found<sup>significantincreasesin</sup> profitability (up on average by 124 percent after privatization), operating<sup>efficiency(real sales</sup> per employee up by 25 percent on average and net income per employee<sup>upby63percent),</sup> capital investment spending (up 126 percent), and employment (up 1.3 percent), and<sup>a declinein</sup>
9 leverage and an increase in dividends. The changes in both profitability and efficiency were larger for firms in middle-income countries than for those in low-income countries.

20. One of the biggest issues in evaluating privatization, both in the cross-cutting studies as well as the country studies discussed below, lies in comparing the outcome of privatization with the counterfactual, i.e. what would have happened in the absence of privatization. There is the possibility that performance improvements would have happened without a change of ownership-if general economic conditions improved and boosted all firms, or if public sector managers and owners were able to put in place and sustain reform measures. Omran (2001) argues that this was the case in Egypt. He reviewed indicators in privatized and remaining stateowned firms in the 1990s, and found that all firms improved, regardless of ownership typeconcluding that general liberalization was more important than privatization in explaining firm behavior. But it could also be argued that previous liberalizing reforms without privatization had accomplished little in Egypt; and that only when privatization was a realistic option and credible threat did remaining SOE managers take seriously the calls for reform. Few studies evaluate the counterfactual in any systematic way, the most notable being that of Galal, Jones, Tandon, and Vogelsang (1994); this study is discussed in further detail in section (iii) below.

21. A final issue is one of timing, again applying to both cross-cutting and country/enterprise level studies. Dewenter and Malatesta (1997) and Hodge (2000), while supportive of the positive effects of privatization, argue that some of the performance improvements occur before privatization due to the "announcement" effect, rather than to privatization per se. True, many of the most difficult reforms have often been made in the run-up to privatization but in most of these cases the announcement was accompanied by: (i) a change of management; (ii) large layoffs and other cost-cutting measures; and (iii) other departures from previous inefficient procedures. And these measures were implemented with the clear threat of privatization. Moreover, the extent to which these improvements could have been sustained in the absence of eventual divestiture is highly questionable, and many have argued and there is evidence to show that privatization was necessary to "lock-in" the gains and prevent backsliding (World Bank, 1995).

# Developing countries

22. Most (not all) of the growing body of work assessing the impact of privatization in developing countries shows that privatization has improved enterprise performance. For example, La Porta and Lopez-de-Silanes (1997), in a study of all 218 non-financial firms privatized in Mexico in the period 1983-1991, show that SOEs, in competitive and noncompetitive sectors, went from being highly unprofitable before privatization to being profitable thereafter, closing the performance gap with control groups of similar firms in the private sector. Output (inflation adjusted) increased 54.3 percent, sales per employee roughly doubled, and profitability increased by 24 percent. Controlling for changes in the macro environment, they found that improvements were due mainly to productivity gains resulting from better incentives and management associated with private ownership, and partly to lower employment costs resulting from labor reductions.
I0 23. In Brazil, privatization improved SOE efficiency<sup>andprofitability(Macedo,2000).</sup> Between 1981 and 1994, before the start of<sup>theprivatizationprogram, SOEs performedpoorly.</sup> The ratio of profits to net assets during the period<sup>was,onaverage,anegative2.5percent, and</sup> fell to negative 5.4 percent towards the end.<sup>Significantgains wereachievedafterprivatization;</sup> for example, the large steel mill (CSN) which had<sup>been incurringheavy losses became profitable</sup> and investments increased dramatically. Higher profits are bringing more tax revenues<sup>to</sup> government, and the company began paying<sup>dividendstoshareholders.</sup> In another study, Pinheiro (1996) analyzed the performance of<sup>50BrazilianSOEsbeforeandafterprivatization</sup> (using a methodology similar to the Megginson<sup>studies).Heconcludedthatprivatization</sup> significantly improves SOE performance, particularly<sup>when thereisachangeof controlrather</sup> than when only a minority stake is sold. The results<sup>arealsostrongerforcompaniesthat have</sup> been recently sold, indicating that privatization<sup>works betterwhencombinedwithliberalization</sup> measures, including removing barriers to entry<sup>andexit,imposing positive interestrates, and</sup> reducing access to budget resources (for more<sup>on this point,see section4 (ii) below).</sup> 24. Most success stories come from high or middle<sup>incomecountriesbutprivatizationhas</sup> yielded positive benefits in low-income<sup>countriesfacedwithdifficult marketconditionsand</sup> wary investors. Privatized companies in sub-Saharan<sup>Africaincreasedcapacity utilization</sup> through new investments, introduced new technology,<sup>and expandedtheir markets(Campbell</sup> White and Bhatia, 1998). In Ghana, sales of privatized firms increased<sup>by71percent;in</sup> Tanzania, ten privatized firms made investments<sup>that were2.5 timesgreater than17 non-divested</sup> companies. A separate study of pre- and<sup>post-privatizationperformanceof16Africanfirms</sup> privatized through public share offering during<sup>1989-96 finds asignificant increaseincapital</sup> spending by privatized firms-but only insignificant<sup>changesin profitability,efficiency,output</sup> and leverage (Boubakri and Cossett, 1999).

25. Some governments have in the past tried to raise<sup>revenuesor obtainsupport by divesting</sup> minority stakes through share issues, to state-controlled<sup>financialinstitutions(in India),to</sup> workers (in Egypt), or to the public at large<sup>(Bangladeshbanks).</sup> None resulted in major performance changes. In general, government<sup>retentionofmajorityshareshasnotresultedin</sup> improved firm performance. The problem is<sup>minimalchangesinthecorporate governanceof</sup> these firms. However, partial privatizations<sup>inMalaysiayieldedpositive results (Galaletal,</sup> 1994), largely because through commercialization<sup>managersweremademore responsiveto</sup> market pressures and because private shareholders<sup>forcedgovernmenttoshifttowardsmore</sup> economically rational decisions. Majority<sup>or fullsaleof sharestostrategicinvestorsavoidsthe</sup> incentive and contracting problems associated<sup>withminorityprivatization.Suchsalescan and</sup> have been combined with share sales to employees<sup>andthegeneralpublicinanefforttoshare</sup> the wealth and win popular support for privatization.<sup>This approach has worked well ina variety</sup> of settings, from Chile to Jamaica to Estonia.

26. To summarize, empirical evidence from non-transition<sup>economiessuggestsstronglythat</sup> privatization has a beneficial impact on enterprise<sup>performance. While therearemethodological</sup> issues involved in carrying out impact evaluations,<sup>thereisbynow sufficientandcompelling</sup> evidence from a wide range of countries<sup>andsectorsthatprivatizationofenterprisesin</sup> competitive markets leads to significant improvements<sup>inefficiency,profitability, output,and</sup> capital investment spending.
# Transition economies

27. Assessing the impact of privatization on enterprise performance is particularly difficult in transition economies; the concurrent sweeping economic and social changes make it more difficult to separate privatization's effects from other factors. Further, information and analytical shortcomings are particularly acute in the transition economies, and especially those formerly part of the Soviet Union. Several recent assessments are beginning to overcome these difficulties. They generally show that privatization has yielded positive effects-though there is a marked difference between countries in Central and Eastern Europe (CEE), which includes the Baltic states, and those of the former Soviet Union (FSU) (the Baltic states excluded).

28. Djankov and Murrell (2000) have conducted the most comprehensive and rigorous review of 125 empirical studies of transition economies. Based on composite evidence that reflects the results of individual studies, they conclude that there is strong evidence that private ownership produces more restructuring (changes that prepare a firm to survive and thrive in a competitive market economy) than state ownership in just about every transition country. But sub-regional differences are acute: the privatization effect in CEE countries is more than twice the size of that in FSU countries.

29. One explanation for the varying regional results is the type of owners produced by different sales methods. CEE countries (such as Estonia, Hungary, and Poland) that privatized largely through trade sales on a case-by-case basis ended up with concentrated strategic owners, often foreigners, who have been found to be much more productive than diffused domestic owners. FSU countries relying principally on mass privatization through vouchers tended to have less positive results. Such methods led to a large amount of insider ownership by managers and employees, and/or widely diffused shareholding among small, first time equity holders. Yet, even in these cases, there is little evidence that privatization harmed firm performance, with the very important possible exception of one form of privatization in Russia, where firms privatized to workers appear to be doing even worse than SOEs (Box 2). In general, privatized companies run by insiders are least efficient, but even these do better than state-run companies, although commercialized enterprises with changed management and/or an independent board of directors perform somewhat better than SOEs. (Note that everywhere in transition the best performers of all are new private entrants; i.e., those setting up "greenfields" operations that were never in state hands.) Method of sale is not the whole of the story; another important part of the explanation for the varying regional results are differences in levels of institutional development and policy approaches with respect to new entry and hard budget constraints (see section 4 (ii) below).

30. Another survey of outcomes of privatization in transition was conducted by Havrylyshyn and McGettigan (1999). They dispute the notion that ownership change is not central for restructuring and improved firm performance, and that exposure of firms to competition<sup>and</sup> hard budget constraints is more important. Their key findings are: (i) private enterprises almost invariably outperform state enterprises; i.e. any privatization is better than none (note again the possible and important exception of one form of insider privatization in Russia to this finding), but the form of privatization matters as do pressures of competition and hard budget constraints;
12 and (ii) new private companies are the best performers,<sup>followedby newly privatizedfirms run</sup> by outsiders (local or foreign).

# **Box 2: Russian Privatization**

In Russia, over 70 percent of enterprises became<sup>insider ownedfollowingvoucherprivatizationin1992-94.The</sup> hope and expectation was that these inside owners<sup>wouldopen theirfirms tooutsidersendowedwith moneyand</sup> expertise. Newly formed investment funds were expected<sup>to assistin thisprocess.Butinsidersproved reluctant</sup> to give up control, and outside investors were in<sup>anycase highly waryin thedeeplyunsettledandoftenlawless</sup> circumstances. As a result, neither new investors<sup>norRussianinvestmentfundssucceededinchanging and</sup> concentrating ownership in the secondary market.<sup>Theupshotwaslimited restructuring. Subsequentandnon-</sup> transparent cash sales of the larger enterprises in Russia-the<sup>notorious "loans-for-shares"program-assistedor</sup> actually created a "kieptocracy," meaning many<sup>high potentialfirms weretransferredtoasmallgroupof</sup> investors at low prices (Black, Kraakman and Tarassova,<sup>2000).</sup> Some analysts (Barberis, Boycko, Shleifer, and Tsukanova, 1996; Earle, 1998; Earle and Estrin, 1998)<sup>nonethelessconclude that privatizationled to performance</sup> improvements in Russia, at least in firms where outsiders<sup>succeededagainstoddsinsecuringcontrol,though</sup> they too acknowledge that many of these new<sup>owners did not payanythingneara reasonablepricefor the firms</sup> obtained; and the sales methods were non-transparent..

What can one say with certainty about the difficult<sup>andcomplexRussiancase? Itisclearthatprivatization,</sup> competition and hardening of budget constraints<sup>allimproveefficiencyinRussia.Increasesinprivateshare</sup> ownership raises real sales per employee, while<sup>subsidiesreducethepaceofrestructuring(Djankov,1999a).</sup> Significant foreign ownership (greater than 30<sup>percent),ispositively related torestructuring.</sup> Managerial ownership is positively related to restructuring at low<sup>levels(lessthan10percent)andhighlevelsof ownership.</sup> Had Russia been able to auction off transparently<sup>moreof itshighpotentialassetstocore, preferablyforeign</sup> investors, the economy would have been better off<sup>today,wouldprobablyhavereturned topositivegrowthearlier</sup> than it did, and might have avoided some of<sup>theacutepainsufferedbylargeelementsof thepopulation.</sup> Whether or not that course of action was possible is<sup>hard todetermineevenin retrospect</sup> Two questions ultimately arise: (i) did privatization<sup>leadtoincreased efficiency?and(ii)diditlead toincreased</sup> equity and/or welfare? All observers agree that Russian methods of privatization<sup>dramatically</sup> increased inequity. But what was the reasonable alternative?<sup>Continuedstateownership?Onecanmakeacasethatthe</sup> very corrupt and unfair "loans-for shares" privatizations<sup>inRussia eventuallyresultedinincreased efficiencyin</sup> the ftrms taken over. How so? The managers put in<sup>placeby the"oligarchs"areshowing themselves to bebetter</sup> managers than those provided previously by the<sup>state.</sup> The owners and managers of these firms have now become-after their initial and unjust acquisition of<sup>assetsandsomeyearsof "wildeasf'behavior-more</sup> interested in profits and protecting the long-run<sup>healthof theassetsthroughorderlyandlegally regulated market</sup> behavior. Recent evidence suggests that almost all<sup>thefirmsprivatizedthroughloansforsharesarenowrunning</sup> profits and are much healthier than they were as SOEs.<sup>True,the presentownerspaidvery littlefor thesevery</sup> high potential assets, meaning that the state-and<sup>thetaxpayers-obtainedverylittleinthe transfer.Moreover,</sup> the experience soured the Russian public on reform, privatization,<sup>andthehonestyandcompetenceof both</sup> officials and the private sector in general.

The overall point is that Russian privatization should<sup>ideally havebeenbetter managed,and that themanner in</sup> which much of it was carried out entailed high social<sup>andpoliticalcosts,the ramificationsof which are stillbeing</sup> worked out. Nonetheless, to conclude that Russia should<sup>not have privatized,that itshould have retaineda mass</sup> of firms in state hands while it tried to reform slowly<sup>andcreatean institutionalsettingmoreconduciveto decent</sup> transactions, may well have been an unrealistic alternative,<sup>as evidenced by thepoor andunsustainablerecordsof</sup> Belarus and Uzbekistan-countries that tried the "go slow"<sup>approach.</sup> Source: Nellis, forthcoming
13 31. In the main, the economic and financial effects of privatization in transition have been positive. As elsewhere, private owners in transition are more efficient and effective than the state. There are some caveats to this conclusion, but on average, the finding is robust.<sup>One need</sup> only look at those transition countries that have delayed or avoided privatization (and other reform) to see the limits of the alternative approach. However, the vast scope and rapid pace of privatization in transition-much of it taking place in countries with ineffective<sup>public</sup> administrations, weak legal systems, and embryonic regulatory capacities, particularly concerning financial and capital markets-led to much corruption, injustice, asset-grabbing, insider trading, and defrauding of minority shareholders, particularly those who had<sup>obtained</sup> their shares in give-away, voucher schemes. This has proven costly socially and politically.<sup>In</sup> sum, the shift to private ownership was necessary, but it should ideally have been<sup>better</sup> managed.

# **(ii) Macroeconomic and fiscal effects**

32. Recent work on the fiscal and macroeconomic effects of privatization (Davis,<sup>Ossowski,</sup> Richardson, and Barnett, 2000) indicates large, significant and positive benefits<sup>from</sup> privatization. Governments tend to be financially better off after privatization than before. Proceeds from privatization have been substantial, amounting to 2 percent of GDP in<sup>a sampleof</sup> 18 countries reviewed. The fiscal situation tends to improve over time, as receipts of privatization are saved rather than spent.<sup>5</sup> Privatization produces positive impacts upon government revenue by means other than sales proceeds. Transfers decline substantially following privatization (Figure 3) and broader indicators of consolidated SOE accounts<sup>for some</sup> countries indicate a large decline in deficits.

<!-- Start of picture text --> Figure 3: Gross Budgetary Transfers and Subsidies to<br>Public Enterprises for Selected Countries<br>(in percent GDP)<br>5<br>3-<br>2<br>o~~~~~ 0 SE .i~ lO , 4'<br>'Excludes Petr6leos Mexicanos. Includes some decentralized govemment agencies.<br><!-- End of picture text --> <!-- Start of picture text --> Source: Davis, Ossowski, Richardson and Bamett, 2000.<br><!-- End of picture text --> 5 Most of the countries covered in the study had an IMF program in place, and consequent limitations<sup>onthedeficit</sup> may have influenced this finding.
14 33. In terms of growth, private firms are found to be more efficient than state enterprises, especially in competitive industries. A range of policy variables-fiscal discipline,<sup>priceand</sup> trade liberalization, deregulation, privatization, clarification of property rights-are important<sup>for</sup> determining growth. Taken individually, they may have only a limited<sup>effectongrowth,but</sup> together they are strongly associated with rapid expansion. The data<sup>forthedevelopingand</sup> transition case study countries in the IMF study support these findings,<sup>showingastrong</sup> correlation between growth and privatization. While privatization alone is not<sup>thecauseof the</sup> increases in growth rates in the study, it is likely that privatization serves<sup>asa proxyfor the range</sup> of structural reform measures. The study also shows that privatization<sup>isviewedbyinvestors</sup> and markets as the principal signal of reform credibility and seriousness,<sup>alesstangible but</sup> important macroeconomic effect.

34. Sheshinski and Lopez-Calva (1998) also find that privatization improves<sup>thepublic</sup> sector's financial health. Budget deficits decline during the reform period. Low-income countries which are less aggressive privatizers have a more significant<sup>deficitonaverage.</sup> In high-income and middle-income countries, privatization reduces the net<sup>transferstoSOEs,and</sup> the transfers become positive when the government starts collecting taxes<sup>from privatized</sup> firms-another contributor to positive macro effects. In most cases, the<sup>post-saletaxesarefar</sup> more than the pre-sale dividends, if indeed any dividends were ever paid. Despite<sup>concernsabout</sup> the difficulties of tax collection, there is evidence of increased downstream<sup>revenuesto</sup> governments through higher taxes, in, for example Africa (Campbell White<sup>andBhatia,1988),</sup> Brazil (Macedo, 2000), Argentina (Shaikh, 1996), and Mexico (La Porta<sup>and Lopez-de-Silanes,</sup> 1997).

35. An important macroeconomic/fiscal issue in privatization is the use of<sup>proceeds. The</sup> more the net proceeds (that is, gross proceeds minus the costs of sales,<sup>whichinclude financial</sup> clean-up, severance costs, advisory costs) are devoted to retiring debt,<sup>both domesticand foreign,</sup> the better, as it stimulates widespread economic benefits. If the proceeds<sup>are largeandthe</sup> amount of debt retired significant, this application helps lower interest<sup>rates,reducesborrowing</sup> and inflation, and boosts overall growth. Four countries covered in the<sup>IMFstudy-Argentina,</sup> Egypt, Hungary and Mexico-had an initial stock of registered public debt ranging from<sup>40</sup> percent to 130 percent of GDP. The use of privatization proceeds, along<sup>with other factors,led to</sup> a sharp decline in the debt between the year before the period of most active privatization<sup>andthe</sup> last year of active privatization, and contributed to the strengthening and<sup>stabilizationof the</sup> economy. The problem is that there are many other claimants to the<sup>proceeds,and governments</sup> are sometimes obliged to balance the economic ideal with the<sup>politicallyfeasible.Many</sup> governments (Bolivia, Estonia, Hungary) have devoted a portion of the proceeds for covering pension costs (though they are a form of debt retirement since they are obligations of<sup>thestate),</sup> or-a risky one-to the restructuring of some key SOEs prior to or even<sup>insteadof privatization</sup> (Czech Republic). Experience cautions against the use of proceeds to finance current expenditures given the temporary and one-time nature of proceeds and<sup>theriskthatspending</sup> may become entrenched at unsustainable levels.
15

# **(iii) Welfare consequences**

36. Studies that examine the impact of privatization<sup>on enterpriseperfornancecontain</sup> limited, if any, discussion of the effects of the sale on actors<sup>other thanowners,or thoseoutside</sup> the firm, in particular consumers. Since most of<sup>theevidence indicatesimprovedinternal</sup> efficiency and higher returns to owners following privatization,<sup>thereisanimplicitassumption</sup> that the economic welfare of society in general has been<sup>made better off by the privatizations.</sup> 37. But the welfare improvements are implied only, and<sup>not proven,evenin countrieswhere</sup> numerous privatizations have consistently yielded better firm<sup>performanceandincreasedbenefits</sup> to the shareholders. It is possible for a transaction to benefit<sup>afirmandits ownerswhilenot</sup> affecting or, worse, decreasing the total amount of benefits<sup>availabletoallaffectedactors,and</sup> the society at large. The standard example is the privatization of<sup>aninefficientpublicsector</sup> monopoly to a private and unregulated owner. The result<sup>couldandalmostcertainlywouldbe</sup> increased firm profitability, higher returns to the new shareholders,<sup>evenperhapshighersalaries</sup> for workers and expanded job opportunities, and greater<sup>returnstogovernment. However,these</sup> gains could be outweighed by the "welfare losses" that might<sup>be imposedon consumersand the</sup> economy as a whole due to inadequate access or sub-optimal<sup>supplyof productsandservices</sup> and/or their excessively high price. In such cases, the overall<sup>welfareconsequencescouldbe</sup> negative.

38. Determining the broader welfare gains and losses among<sup>allaffected actors-consumers,</sup> government, buyers, workers, competitors-is a complex<sup>andexacting exercise,requiringthe</sup> comparison not simply of what happened before and after the sale,<sup>butalsothecomparison of</sup> what happened after the sale to a "counterfactual" case-that is, an<sup>estimate of whatwouldhave</sup> happened had the firm stayed in state hands. This<sup>approach demandsanenormousamountof</sup> information about firm performance before and after<sup>theprivatization, requireshighlyskilled</sup> analysts, and is subject to considerable debate as to the realism<sup>of the counterfactual.It has thus</sup> successfully and rigorously been carried out in only a few cases, mostly,<sup>though not exclusively,</sup> involving infrastructure firms.

39. Most notable is the seminal study by Galal, Jones, Tandon,<sup>andVogelsang(1994).Their</sup> study of the welfare consequences of privatization in<sup>12</sup> mostly<sup>infrastructure enterprisesin four</sup> developed and middle-income countries provides evidence<sup>of privatization'seffects on enterprise</sup> efficiency, on subsequent investment, and<sup>on consumerwelfare.Theyexaminetheimpactonall</sup> actors and compare performance before and after<sup>privatization,aswellasthe"after"</sup> performance to a hypothetical scenario of<sup>continued, andreformed,stateownership.Unlike</sup> many other analyses, they also isolate the effects of<sup>privatizationfrom other broader economic</sup> and sectoral changes. They found that divestiture substantially<sup>improved economic welfarein11</sup> of the 12 cases (the exception being Aeromexico),<sup>mainlydue toadramatic increasein</sup> investment, improved productivity, more rational<sup>pricingpolicies,and,importantly,increased</sup>
16 competition and effective regulation (Figure 4).6 Despite assuming that public managers<sup>would</sup> adopt new technology and more rational procedures they also concluded that privatized firm performance was superior to the alternative of continued state ownership.

**Figure 4: Welfare Effects of Selling State-owned Enterprises**

<!-- Start of picture text --> Me=can Alin155<br>Aerornidca<br>Medoo Telmax .| c ~ .s sw B<br>Spons Toto<br>Kdang Conth rTearminaln_<br>Britsh odrlohlmmRS<br>-10 0 10 20 30 40 50 s0<br>Percent<br>N. W�Nb .gN. - p-Ndo - t -W sa les D. tt 1y bd.- p t.U.U-<br><!-- End of picture text -->

Source: Galal, Jones, Tandon and Vogelsang. 1994.

40. Perhaps due to the complexity of the approach, and the lack of reliable data and skilled analysts, there has been but a single application of the welfare methodology in low-income countries. One of the originators of the method, Jones, along with Jammal and Gokur (1998), applied it to 81 privatizations in C6te d'Ivoire, covering not just infrastructure firms but a range of firms already operating in competitive markets (in agriculture, agro-industries, tradable<sup>and</sup> non-tradable sectors). For the entire privatized sector, they concluded that there were substantial benefits: (i) the firms performed better after privatization; (ii) they performed better<sup>thanthey</sup> would have had they remained under public ownership; and (iii) the set of transactions<sup>asa</sup> whole contributed positively to economic welfare, with annual net welfare benefits equivalent<sup>to</sup> about 25 percent of pre-divestiture sales. These results stemmed from a number of effects, including increases in output, investment, labor productivity, and intermediate-input productivity.

41. All in all, the broader welfare consequences of privatization, and how "fair"<sup>a</sup> privatization transaction or program is perceived to be by the most affected segments<sup>or indeed</sup> the general population of a country, is critical to its acceptance and success. More studies of<sup>the</sup> welfare consequences type are needed.

**6** Aeromexico was sold to a buyer who made a number of unwise decisions, and lost a lot of money before the company was sold and eventually turned around. This illustrates the point that private managers<sup>makemistakes just</sup> as public ones do, but under private ownership losses are limited by bankruptcy and<sup>restructuring,whereasunder</sup> public ownership such losses are tolerated indefinitely. This point is discussed in greater detail in Jones, Jammal and Gogkur, 1998.
17

# **(fv) Employment effects**

42. Stale enterprises tend to be overstaffed, sometimes severely so as governments used them for purposes of employment generation and maintenance. Some examples:<sup>inSriLanka,</sup> average redundancy in eight of the largest fims (electricity, railways, shipping,<sup>sugar,cement</sup> and petroleum) was 53 per cent (Salih, 2000); state-owned Air Afrique has 4,200 employees and eight aircraft, while industry leader, and privately owned, Ryan Air maintains<sup>a</sup> staff<sup>of 1,400 for</sup> 21 planes; prior to privatization, Argentine railways employed over 90,000 people and had a wage bill equivalent to 160% of the firmn's total revenues. Many similar examples could be given. These levels of overstaffing contributed to the financial weakness of SOEs. Excess labor is one of t1e first cost areas addressed either by reforming governments or new private<sup>owners.</sup> The saliency of the issue has led to widespread concern that privatization<sup>inevitablyleadsto</sup> unemployment and loss of benefits; this in tum has sparked opposition to privatization<sup>from</sup> trade unions, workers, and academics.

43. The view that privatization always leads to layoffs is unfounded. True, highly protected and deeply politicized enterprises have seen significant declines in net employment, usually before but also after privatization: 80, 72, and 50 percent respectively in Argentina's railways, petroleum, and electricity enterprises; 82 percent in Brazil railroads; 42 percent in Manila<sup>water;</sup> 50 percent in a study of Mexican firms. Moreover, while D'Souza and Megginson's 2000 study of 78 privatized firms in 25 countries found insignificant employment declines for the<sup>groupasa</sup> whole, there were significant reductions in a sub-group of non-competitive firms. The<sup>bulkof</sup> these reductions occurred largely in the run up to privatization as governments prepared enterprises for sale; in a few cases they were accompanied by further reductions<sup>bythe new</sup> owners/concessionaires. But much of this shedding was due to the need for<sup>restructuring</sup> irrespective of privatization and to general economic conditions rather than privatization per se (Box 3).

# Box 3: **Privatization** and Employment in C6te d'Ivoire

Jones, Jamal and Gogkur (1998), in their study of COte d'lvoire, analyzed the effects of privatization<sup>on labor.</sup> They found that the privatized sector as a whole indeed shed labor prior to privatization. But it shed less than the economy as a whole, suggesting that layoffs were a response to weak economic conditions rather than to divestiture itself. In fact, they argue that privatization may have reduced labor shedding,<sup>possiblyto mininize</sup> labor opposition to privatization. Moreover, the privatized sector maintained Ivoran employment unchanged through 1994, and in this regard did sipificantly better than enterprises as a whole. In privatized firms, total employment increased by an average of 3.9 percent per year after pTivatization while falling by 1.9 percent per year before privatization, which meant that tue firms added an average of 741 jobs per year after privatization while shedding 456 jobs per year prior to it. The authors believe that it would have risen still more without privatization, because, as profitabilty returned after the recession, the public sector would have reveited to<sup>its</sup> previous habit of over-employment. Looking at employee compensation, real wages per worker and total employee compensation per worker grew at an annual rate of 8.5 percent and 6.8 percent respectively after privatizadon while falling i-n the years before; and there was wage convergence between<sup>the lowestpaidand</sup> highest paid workers.

Source. Jonus, Jwnal, and Gogur, 1998.
18 44. In contrast, competitive firms with relatively efficient pre-privatization staffing levels, as well as firms in high growth sectors such as telecommunications, have frequently experienced slight if any decline in employment. Often they have been sold with their labor force intact to private buyers who judged that they could employ all previously existing workers, or they were willing to take on surplus labor that they estimated could be absorbed by new investments and expansion. New investments and growth post-sale in fact increased employment in a good number of privatized firms (Galal, Jones, Tandon, and Vogelsang, 1994; Megginson, Nash, and van Randenborgh, 1994; Boubakri and Cosset, 1998; Kikeri, 1998). In a study of East European countries, the overall level of employment declined prior to and at privatization, but increased over time (Estrin and Svejnar, 1998). In a review of 17 privatizations, Van der Hoeven and Sziracki (1997) found job increases in four (averaging 23 percent) and no change in six; job losses occurred in seven cases (averaging a substantial 44 percent of the pre-sale workforce), though these involved highly overstaffed enterprises in protected sectors such as tobacco, water supply, and electricity.

45. Moreover, in many instances, and contrary to popular perception, those who retain their jobs in privatized firms receive higher wages, sometimes substantially so. In Brazil, employment reductions were sizable in large firms privatized in the 1990s (48 percent on average); but resulting productivity improvements from restructuring meant higher wages and performancebased incentives for workers who remain (Macedo, 2000). Similar evidence is also seen in Mexico (La Porta and Lopez-de-Silanes, 1997), Argentina (Ramamurti, 1997), and Malaysia (Galal et al, 1994).

46. Critical perceptions notwithstanding, privatization does not appear to be a main cause of perceived overall increases in unemployment and wage differentials. Data from Argentina, for example, suggests that privatization was not a major contributor to the rise in unemployment between 1993 and 1995, but the "Tequila Effect"-the interest rate shock-was (Chisari, Estache, Romero, 1999). In the early 1990s in Poland and Hungary, despite the slow pace of privatization, official unemployment grew rapidly, reaching 16.7 percent in Poland in 1993-94 (down to 9.6 percent in 1998), and 14.1 in Hungary-another cautious privatizer at the outset-in 1993 (down to 10.8 in 1996); lack of rapid and mass privatization thus did not prevent large unemployment increases (Nellis, 1999). Most persuasively, Behrman, Birdsall and Szekely (2000), in an econometric study of the impact of liberalizing economic reforms on wage differentials in Latin America, concluded that privatization was _negatively_ correlated with such increases. That is, privatization per se did not contribute to the growing wage inequality seen in reforming Latin American economies. Rather, privatization actually was mitigating the "disequalizing effects" of liberalizing reform in the financial sector, the tax regime, and capital markets. (This paper also indicates that the largest relative job losses due to privatization are found in the middle management ranks, and not in the classic blue collar positions, a finding encountered in other regions.) 47. The overall point is that the success or failure of a privatization program cannot be measured simply on the basis of whether the post-sale employment levels in the affected firms match those of the pre-sale period. Much of the shedding is due to the need for restructuring irrespective of privatization and to general economic conditions. Privatization must also be viewed as part of an overall reform program that stimulates competition, growth and productivity
19 in the economy, including in parts of<sup>theeconomy that wereneverunderstatecontroland</sup> ownership. When properly carried out,<sup>privatizationandtheaccompanyingreformsleadto</sup> employment gains elsewhere in the economy<sup>asunproductivelaboris</sup> released for more productive activities. This can and should far outweigh the<sup>losses sufferedintheprivatized</sup> firms. Continued government support for<sup>stateenterprisesandtheiremployeesbenefitsasmall</sup> number of citizens and comes at the<sup>expenseof societyasawhole.Rapidprivatizationanda</sup> focus on creating productive jobs through<sup>the privatesector-ratherthanonpreservingjobsin</sup> less efficient areas-are important for<sup>securingeconomy widegrowth.</sup>

# **(v) Wealth and income distribution**

48. The question of privatization's effects<sup>onwealthandincome distribution,asubjectof</sup> intense public debate and many assertions<sup>and claims,isonly recentlyreceiving theconcerted</sup> attention of analysts. Knowledge of this<sup>issue isevolving,and the initialfindingsare as follows.</sup> 49. First, studies (cited above) that have<sup>measuredthewelfareconsequencesconcludethat</sup> privatization generally increases the total<sup>resources available in theeconomy. Second, thesame</sup> studies conclude that while a few<sup>privatizationsresultinwelfaregainsforalltherelevantand</sup> interested actors and stakeholders (sellers,<sup>buyers,consumers, workersand competitors), many</sup> produce gains for some and losses for others,<sup>dependingon how the transactionisstructured,and</sup> the level of institutional development<sup>andcompetencein theeconomy.</sup> For example, government sellers often underprice<sup>sharesof SOEsinordertoensurethatthesale proceeds</sup> swiftly and successfully, and that lower<sup>incomefirst-timeshareholdersarenotpricedoutof the</sup> market. This results in gains for the shareholders,<sup>new orotherwise,but oftenconstitutesa loss</sup> for the seller-and the taxpayers.<sup>Third,theincomedistributioneffectsof theprivatizationof</sup> infrastructure firms have been shown<sup>todependcruciallyonthefairness andcapacityof the</sup> regulatory system put in place prior<sup>tooratthetimeofthetransaction (Chisari,Estache,</sup> Romero, 1999).

50. The most salient aspects of the distribution<sup>issueareemployment,access,priceand</sup> ownership effects. The effects of privatization<sup>onemployment,bothintheprivatizedfirmsand</sup> in the economy at large, are discussed<sup>insection(iv)above.Regardingaccess,recentworkin</sup> infrastructure (covered in detail in<sup>theseparatebackground paperon infrastructure,seeGray</sup> 2001) points to a highly positive<sup>impactfromprivatization,asincreasedinvestmentleadsto</sup> expansion, and as sales contracts<sup>often requirethatthis expansionbe aimedatleastpartlyat</sup> previously unfavored groups or regions.<sup>Prices,asnoted,oftenrisefollowingprivatizationto</sup> offset below cost tariffs, but the effects<sup>ondistributionareoften mutedorskewedby regulatory</sup> frameworks aimed at protecting the<sup>less favored(forexample,theGovernmentofChile</sup> subsidized telephone costs in rural<sup>regions).</sup> Determining whether the gains from<sup>accessare</sup> more or less than the losses from price<sup>increasesisa primaryobjectiveof current research(see</sup> for example, Torero and Pasco-Font,<sup>2001).</sup> 51. Finally, despite innovations aimed<sup>atspreadingequityholdings-suchasvoucher</sup> schemes in transition economies, "capitalization"<sup>inBolivia,andtheawardingorsellingof</sup> shares to workers in privatized firms-there<sup>isawidespreadperception,evenamongobservers</sup> sympathetic to divestiture, that the<sup>effectsof privatizationon wealthand ownershipmay proveto</sup>
20 be negative in distribution terms, at least in the short run, in the sense that the upper income categories will gain far more in equity shares than those in the lower income deciles. However, almost no rigorous analysis of this question has yet been completed, and one must await the conclusion of some research efforts presently underway.<sup>7</sup>

# **4.** FACTORS FOR SUCCESSFUL PRIVATIZATION

52. Privatization is neither a simple nor a uniform process. Starting points differ; countries have varying objectives, face a wide and shifting range of problems and obstacles, and thus need to adopt different strategies and tactics to achieve their privatization objectives. There is no universally applicable approach to privatization, and the attempt to apply a "one size fits all" approach has proven ineffective and counterproductive. Nonetheless, worldwide experience does provide some guidance on the factors critical to the success of privatization.

# **(i) Commitment and ownership**

53. Privatization requires strong political commitment. Privatization is almost never painless. Most transactions produce winners as well as losers (though "win-win" situations occur frequently). Privatized firms sometimes fail and go out of business. Significant redundancies have been involved. And often, assets must be sold at less than book value which, though economically justified, leads to allegations of giveaways. The fact that the gains are usually diffused and in the longer-term while the costs are short-term and borne, or appear to be borne, by organized and vocal groups, such as labor, leads to an intense politicization of the issue. This requires careful handling from the political and administrative leadership to explain alternatives, build coalitions for change, and deal with the disaffected. All this in turn requires high-level decisions on to whom to sell assets, at what prices, under what terms and conditions, and with what arrangements to bring the general citizenry and the directly affected parties on board. As the experience of countries such as Argentina, Bolivia, the Czech Republic, Mexico and others shows, resolving these questions necessitates good technicians and dealmakers, fully backed by sustained and dedicated commitment from the top in tackling the numerous vested interests that threaten to slow or derail the process.

54. While necessary, top-level political commitment alone is not however sufficient either for privatization to take place, or for it to be successful. The building of widespread public understanding, if not active support, for this intensely political process among a larger group of stakeholders is also essential. In this regard, the availability of information is key. Many countries have found public information campaigns to be helpful, as they can explain: (i) the very large and usually hidden financial and economic costs of unreformed SOEs; (ii) the direct and indirect benefits of privatization; and (iii) address the principal fears and concerns of the citizenry regarding privatization. Such campaigns are particularly effective when combined with

> 7 At least three research projects are presently underway to look at various aspects of the distribution effects of privatization: the first at the Inter-American Development Bank, focusing on Latin America; the second at the Center for Global Development in Washington D.C., looking at the question in a wide range of developing and transition economies; and the third at WIDER in the United Nations University. All expect to provide results in 2002.
21 mechanisms to ensure broad-based participation<sup>andmitigatepoliticalandsocial costs(e.g.</sup> procedures for transparency, labor programs, share<sup>ownershipprogramsin firmsbeingsold; see</sup> below). Explaining the objectives and strategy of the<sup>privatization programitselfalsohelps</sup> create greater acceptance and ownership among<sup>key stakeholders.</sup> 55. The experience of countries such as Russia-where,<sup>attheoutset,fartoomuchwas</sup> promised of privatization, making the subsequent<sup>disappointmentsevenlesstolerable-show</sup> that such campaigns are not always easy to implement<sup>andthatsuccessful efforts requirea clear</sup> and well-thought out strategy, flexibility in implementation,<sup>sufficientattentiontolocal</sup> conditions, and the importance of building-in genuine<sup>feedback mechanisms. Most important,the</sup> promises usually made in these campaigns-that<sup>goodassetswillbesoldinanopen,</sup> competitive, transparent manner-have to be kept.<sup>Thekeyistohaveapublicinformation</sup> program, not just a public relations campaign.

# **(ii) Ownership and competition**

56. After 20 years of privatization experience, there is<sup>stillvigorousdebateconcerningthe</sup> extent to which ownership matters. Economic theory<sup>issomewhatagnosticontheeffectsof</sup> ownership; it regards market structure and the<sup>degreeto which a firmis subjectto competitionof</sup> equal or greater importance. In terms of empirical<sup>evidence, sinceprivatizationisnormallyone</sup> component in a larger set of liberalizing, competition-enhancing<sup>reforms,some thinkthatit may</sup> be the increased exposure to competition that accounts<sup>formostof thepositivechangesseenin</sup> privatized firms.<sup>8</sup> Indeed, some cases indicate that competition<sup>is more important than ownership</sup> change in bringing about efficiency gains.<sup>9</sup> 57. At the same time, if competition and market restructuring<sup>are soefficaciousontheir own,</sup> the question is why they so rarely occur<sup>in theabsenceof ownershipchange.Indeed,thepoor</sup> experience with SOE reform in the 1980s and before<sup>shows the difficultiesandlimited resultsof</sup> reforms short of ownership change. Despite<sup>concertedand varied efforts to introducecompetitive</sup> and other reforms, SOEs proved stubbornly resistant<sup>to change.10Thiswasnotbecause the</sup> solutions to SOE problems were not known. Rather<sup>it was becauseof governments'inability or</sup> unwillingness to apply fully the needed package of<sup>reforms(e.g.,exposeSOEsto competition,</sup> require them to access private capital markets<sup>forinvestmentfunds, createamarketfor</sup> managers, etc.), or to leave the package in place<sup>forsufficienttimeto change incentivesand</sup> behaviors. Even in cases where performance may<sup>haveimproved(Chinabeingararecase,see</sup> Box 1), reforms did not endure and backsliding occurred,<sup>usuallyduetorenewedpolitical</sup> interference (World Bank, 1995; Majumdar, 1996;<sup>ShirleyandXu,2000).Inparticular,</sup> governments could almost never bring themselves to<sup>allowinsolventand evenbankruptSOEsto</sup>

> 8 Tandon (1995) argues: "...there are, of course, many cases where<sup>privatizationappearstohave'resulted'in</sup> efficiency improvement; in most of these cases,<sup>however,theprivatization appearsto havebeen contemporaneous</sup> with deregulation or other types of competition-enhancing<sup>measures."</sup>

> 9 In reviewing the liberalization and privatization of<sup>theBritishelectricitysector,Newberry(1999)arguesthat</sup> "...competition rather than privatization improved<sup>performance...."He showsthatinthose partsof thesectorthat</sup> were privatized but not liberalized, or as liberalized<sup>asother partsofthesystem,theefficiencygainswere</sup> considerably less.

**10** The range of reforms short of ownership change<sup>aresummarized byShirley,1983andinNellisand Shirley,</sup> 1991.
22 fail and go out of business. Instead, soft budgets continued. Where direct transfers were<sup>reduced,</sup> they were often replaced by government guarantees and concessionary credits from the banking sector. Indirect support through deferment of tax payments, dividends, and custom<sup>duties was the</sup> norm. In the absence of exit options, there were few meaningful pressures and incentives<sup>on</sup> government officials, managers, and workers to reform.

58. Shirley and Walsh (2000) analyze and sum up the ownership debate based on<sup>areview of</sup> some 50 empirical studies covering a variety of countries and sectors (competitive<sup>and</sup> noncompetitive). They found greater ambiguity about ownership in theory than in the empirical literature, the latter being skeptical of SOEs as a tool to address market failures<sup>for thereasons</sup> outlined above. The majority of empirical studies conclude that privatized-and private-firms perform better than SOEs, a finding that is robust across all sectors and market<sup>structures.Better</sup> private performance is evident in both developed and developing countries; while<sup>afewstudies</sup> show better public performance in developed countries in infrastructure sectors, in developing countries there are no studies where SOEs do better in any sector or market situation.<sup>Private</sup> firms do better in fully competitive markets. This advantage persists but is less<sup>pronouncedin</sup> monopolistic markets where the evidence is less conclusive; however, no studies in<sup>developing</sup> countries find that public ownership does better in potentially competitive industries.

59. The difficulties of SOE reform and the substantial empirical evidence on<sup>privatization</sup> strongly supports the importance of ownership. Ownership change is<sup>neededtomake</sup> competition effective. But competitive markets are also important if privatized-and privatefirms are to perform well. Privatization realizes its full potential when competition<sup>is promoted.</sup> Competition means free entry and the freedom to fail. Privatization allows inefficient<sup>firms that</sup> cannot compete-and that would otherwise have been kept alive-to fail. Removing these barriers to exit also means removing barriers to entry. Private firms will not enter if inefficient firms are not allowed to fail and if there is no level playing field. Subsidizing<sup>such firms and</sup> keeping them in operation also makes it harder for private firms to access credit<sup>andtoenter</sup> markets. The issue is thus not one of privatization vs. competition. Privatization<sup>and pro-</sup> competition policies are in fact complements that are mutually reinforcing.

60. Thus, alongside privatization of existing assets, removing entry barriers is key for the development of dynamic and competitive private sectors. In tradable sectors,<sup>this involves</sup> simplifying procedures and licenses required to start and register a business, eliminating<sup>import</sup> restrictions, and deregulating pricing. In infrastructure, maximum economic benefits are realized when privatization is combined with new entry, the break up of large entities, and price deregulation with development of regulatory frameworks. Galal et al (1994)<sup>showthat,while</sup> ownership matters, competitive markets reinforce the benefits of private<sup>ownership.Divesting</sup> into competitive markets may reduce the revenues from sale, but efficiency, not<sup>revenues,should</sup> be the primary objective of privatization.

61. Removal of entry barriers is particularly important in transition economies<sup>where state</sup> enterprises dominated all markets and where legal and other restrictions on private<sup>participation</sup> and entry were powerful (Box 4). For example, in Poland, privatization of<sup>large SOEsinitially</sup> proceeded slowly (though most small firms were quickly sold off). However, entry was permitted and vigorously encouraged, and harder budgets were imposed on most SOEs that
23 remained. Competition increased in all sectors of the<sup>economy,andassetstrippingwas</sup> minimized. Thus, when it was finally decided to privatize<sup>thelarger enterprises,therewas</sup> something left to sell, and market conditions were generally competitive-all<sup>of whichledto</sup> positive outcomes. China's success is also in good part due<sup>to openingentrytodomesticquasi-</sup> private enterprises and to foreign investors. In changing the<sup>public-privatemix, privatizationwas</sup> for long less important than the emergence of new private<sup>businesses.</sup>

# **Box 4: Is** Ownership Change Enough?

Sachs, Zinnes, and Eil'at (2000) examine the emnpirical evidence across<sup>24transition economies andconclude that</sup> ownership alone is not enough to generate economic performance improvements.<sup>It is whenownershipchangeis</sup> combined with institutional reforms-aimed at removal of barriers<sup>toentry andexit,improvingprudential</sup> regulation and corporate governance, hardeniing. budget constraints, and<sup>developing capitalmarkets-thatone</sup> sees large and enduring progress.

Maximum impact is produced when market competitiveness, hardened:<sup>budgetconstraints,andimproved</sup> regulatory frameworks coincide with privatization. Thie higher<sup>the levelof institutionalreforms,, themore positive</sup> the economic performance impact from a change of.oownership. In, fact,<sup>thestudyfindsathtesholdlevelof</sup> reforms in order for privatization, to have positive eco'nomnic-outcornes.<sup>At Ihe sametime,institutionalreformsdo</sup> not guarantee performance improvements unless there is a<sup>minimuimlevelof ownership:change.</sup> The authors insist that economies must have private ownershipmanpro-competition,policies<sup>to progess;theygohandin hand</sup> with one another. While ownership-matters, policies-and institutions<sup>matter justas much.</sup> Source: Sachs, Zinnes, **and** Eilat, 2000 62. Ultimately, competition means freedom to fail. As allowing closure<sup>andexitisclear</sup> evidence of mismanagement, governments the world over have proved<sup>reluctanttoalloweven</sup> obviously non-viable firms to fail. Instead, they continue<sup>tosubsidize and support them,even</sup> when they are candidates for privatization. In some countries<sup>(Turkey'sinitial privatization</sup> efforts, for example), loss-making and unviable enterprises<sup>in theprivatizationportfoliocontinue</sup> to be subsidized and kept alive, leading to continued inefficiencies<sup>andfinancialdrain.Funds</sup> that could be used to pay for items facilitating privatization, e.g.<sup>severancepay,aredivertedto</sup> meeting current operational costs of firms on the sale bloc, such<sup>assalariesofworkersand</sup> managers. This delays sales; and assets deteriorate further, reducing<sup>their valueand making them</sup> even harder to sell. By contrast, effective exit mechanisms<sup>andhard budgetconstraintswere</sup> another and important factor explaining the (eventual) success<sup>of privatizationinPoland(Pinto,</sup> 1993).

63. Privatization has sometimes led to the liquidation or exit of nonviable<sup>firms.In anumber</sup> of cases, purchasers have incorrectly estimated the market<sup>or theirabilitytorestructurefirms.</sup> Closures and liquidations have resulted, and private<sup>ownerswere abletodo what publicowners</sup> could not. Critics have seized on such cases (in places as<sup>differentasArmeniaandGuinea)to</sup> claim that privatization is a failure. But closures do not indicate that privatization was necessarily misguided, or that the policy failed. Had<sup>these firmsbeen retainedby thestate it isa</sup> near certainty that they would have continued<sup>to receiveaflowofnon-productiveand</sup> unsustainable subsidies, using scarce resources with<sup>highopportunitycosts.Giventhe political</sup> difficulties associated with closure of SOEs, privatization<sup>isa key mechanismallowing the</sup> liberation and transfer of assets from problematic management<sup>in thepublicsectortobetter</sup>
24 management and more productive use in the private sector. While the closure of<sup>SOEs canbe</sup> painful and costly (for the government, employees, creditors), it nonetheless<sup>producesbenefits</sup> for the economy and society at large as employees and other assets<sup>arebetterusedafter</sup> restructuring.

64. Privatization can lead to poor outcomes when there is slow and halting progress<sup>on hard</sup> budget constraints from the financial sector. This problem is acute and most evident<sup>in transition</sup> economies, for example, in the Czech Republic, Slovakia and countries of<sup>theformer Soviet</sup> Union, particularly in the mid-1990s. It is often argued that in these countries<sup>insider or diffused</sup> ownership resulting from the voucher method of privatization led to poor results,<sup>while transition</sup> economies such as Hungary and Poland that by contrast sold enterprises to<sup>concentratedowners</sup> did much better. Performance thus became linked to whether ownership<sup>wasconcentratedor</sup> diffused.

65. While there is indeed a close correlation between the use of voucher privatization methods and poor privatization outcomes (in the short term, at least), the underlying<sup>issueis</sup> that of the quality, pace and scope of financial sector reforms. Poor performance<sup>inthe FSU</sup> countries and others such as the Czech Republic and Slovakia resulted partly because<sup>inadequate</sup> managers/owners were handed the assets, but mainly because financial<sup>sector reformswere</sup> lacking that would have forced even bad managers to take the right steps-or leave<sup>the way clear</sup> for other owners. The Czech Republic is an illustrative case in point: through<sup>the1990s,the</sup> state dominated commercial banking, with a majority interest in half of the<sup>sector and essentially</sup> a controlling interest in all of it. Explicit and implicit pressure from government<sup>allowedbank</sup> borrowing by weak firms, led by sometimes corrupt firm managers, to continue<sup>at arapidand</sup> unsustainable rate. Much of the debt proved to be non-performing, and a<sup>fairpercentage was</sup> stolen (Cull, Matesova, and Shirley, 2001). The credit did not restructure the firms, weakened the commercial banks, and made the eventual bail-out one of the biggest<sup>ever in the region.</sup> 66. By contrast, Estonia, Hungary and Poland were far more successful in privatization precisely because they: (i) implemented their bank restructuring/privatization<sup>programsearlyin</sup> the transition; (ii) dealt with the bad debt problems faster than other countries;<sup>(iii)tackled</sup> difficult legal and institutional reforms, such as bankruptcy and protection of<sup>minority</sup> shareholders, before the others;' and (iv) received more inflows of FDI in<sup>the1990sthanthe</sup> other countries. These factors, along with their favoring of core, concentrated owners,<sup>are what</sup> produced positive privatization outcomes.

67. In short, financial sector reform and the creation of a competitive and<sup>commercially</sup> oriented banking system is important for successful privatization. Privatization of<sup>banksisitself</sup> part of the solution. The recent World Bank research report on finance and growth<sup>(World Bank,</sup> 2001) shows that the lower the income of a country, the higher the proportion of<sup>its bank assets</sup> that will be state-owned. The argument is that state owned banks will better<sup>distributecapital to</sup> more productive investments, provide greater access to credit for deserving<sup>sectionsof society,</sup> and be less prone to crises. In practice, these objectives are almost never achieved.<sup>It has proven</sup> difficult to design incentives that will guide even private sector bankers<sup>towardsefficient</sup>

> 1 lIn Poland, where voucher privatization was limited, there was far more stringent<sup>initialregulationof securitiesand</sup> there have been many fewer reports of investor dissatisfaction.
**25**

> resource allocation; when-as in state-owned banks-these incentives are weakened or absent, for political and other reasons, the results are far worse. Thus, although poorly regulated private banks have incurred large losses, some of the largest losses of recent times have been incurred by state banks. Evidence shows that state ownership tends to reduce competition through higher spreads on interest rates, leads to less stock exchange activity and non-bankn credit, and results irn

> greater concentration of credit allocation, usually to the largest 20 firms, often inefficient SCEs.

68. Persistent poor performance of state-owned baniks has led governments to turn to privatization. The experience of countries such as Argentina, Chile, Mexico and others demonstrates the special case of bank privatization-and the need to phase and coordinate such efforts with the development of regulatory frameworks (Box 5).

IEnx g: ]?rinivsammqtoim OfEBu Bank privatization has produced substantial savings and gains for a number of governments-though their experience generally reveals the complexity and difficulty of such reforms and reveals lessons on how it might be better conducted. Argentina reduced state ownership of banking assets from 50 percent in 1990 to half that by 2000, motivated mainly by the high costs of maintaining state ownership. The savings from privatizing tie provincial banks are impressive, amounting to one-third of a typical province's public expenditure. Prior to privatization the banks had a high percentage of non-performning loans (50 percent in 1991), which were removed from the balance sheet as part of a clean-up prior tQ sale. Following divestiture, the share of non-performing loans then rose again, but this time to levels comparable with the better private banks in Argentina. Moreover, costs to revenue ratios and the terms of credit extendaed to SOEs by these newly privatized entities more closely reflected that of other, better-performing, private banks.

Banks are very special cases, in that their problems can broadly affect other firms and portions of the economy. In weak regulatory environments, poorly designed and irnplemented bank privatization have provoked crises (e.g. Chile in the late 1970s, and Mexico in the early 1990s). While these rapid and insufficiently thought-out privatizations were undesirable, extended state ownership can have an equally detimental impact, as the Czech case, noted above, illustrates. The dilemma is that although hasty privatization in weak environments can lead to problems, excessive delays can undernine real sector reforns and lead to high costs.

Privatization of banks remains the preferred strategy, but it requires far more care, caution and preparation than for the normal commercial firm. The Argentine case, and that of Hungary, shows the need for sequencing the phasing out of state ownership over time with improvements in the regulatory environment. One mechanism aimed at maintaining value in the rmn-up to sale is to link manager compensation to the post privatization value of the bank (e.g. through stock options as happened in Poland). Involving reputable and experienced foreign owners is very often part of a successful strategy. They can bring the necessary skills, products and training to the host country and provide better allocation decisions.

|**SourocWorldBank 2001**|
|---|

(m~ Tranaparaemy 69. Lack of transparency leads to allegations of corruption and provides ammunition to political and other opponents, creates backlash from investors and the public at large, and threatens to halt privatization and liberalizing reform in general. In Argentina, and Latin America
26 in general, a recent survey shows a substantial recent<sup>declineinsupportof privatization,mainly</sup> due to weak economic conditions but also as a result of<sup>the waysin whichtheprocesshasbeen</sup> operating in practice and increases in corruption.'<sup>2InRussia, the massprivatizationprogram</sup> pernmitted insiders to engage in extensive "self-dealing",<sup>whilethesubsequentprivatization</sup> "auctions" were a massive giveaway of the most important<sup>assetsatbargainpricestoahandful</sup> of well-connected oligarchs, who, in the absence<sup>ofadequate legalandinstitutional</sup> arrangements, continued to act that way (Black,<sup>Kraakman,andTarassova,2000).Asaresult,</sup> the public came to oppose privatization, associating<sup>it withcorruptionandwealthforachosen</sup> few.

70. Putting transparency into place requires a host of<sup>measures.Speed andfulltransferof</sup> assets, without special privileges and concessions for<sup>insiders,iscrucial,particularlyinthecase</sup> of competitive enterprises. Evidence from Mexico,<sup>Bulgaria,South Africaandelsewhere</sup> indicates that, once a firm is slated for privatization,<sup>delaysincompletingthe transactionlead to</sup> a decline in operations, asset stripping, and a lower<sup>salesprice.'3Ultimately,fewbuyersmay</sup> come forth and, rather than liquidating such<sup>firmswhichis therighttechnical approachbut</sup> politically unpalatable, special deals may need to<sup>benegotiated,increasingthechancesfor</sup> intransparencies. On the other hand, selling firms, particularly<sup>infrastructurefirms,in the absence</sup> of efforts to enhance competition and regulation,<sup>andthus enhancetransparencyandprotection</sup> of consumers against the abuse of remaining monopoly<sup>power,canproveextremelycostly. The</sup> general rule should be to move swiftly on the privatization<sup>of firmnsoperatingincompetitiveor</sup> potentially competitive markets, but get the market<sup>structureright inprivatizinginfrastructure</sup> firms.

71. An effective institutional framework is needed,<sup>though callingforithasproveneasier</sup> than putting it into effect.'<sup>4</sup> This involves creating<sup>somesort of focalpoint for privatizationwith</sup> minimal bureaucracy, direct access to and support<sup>of thehighestpoliticalauthorities,and</sup> adequate resources and flexibility to hire the many-and<sup>expensive-privateresourcesneededto</sup> prepare and complete the sale. (Independent<sup>financialadvisorsandqualifiedexpertsplayan</sup> important role in the process, particularly in carrying<sup>out independent, market-basedasset</sup> valuations to ensure that prices are realistic, fair-and<sup>politicallydefensible.)</sup> Leaving privatization to sector ministries can work where<sup>thereisahighdegreeof politicalcommitment</sup> and adequate administrative capacity (for a time Bulgarian<sup>sector ministries privatizedas well or</sup> better than the national Privatization Agency), but<sup>suchconditionsaretypicallylackinginmost</sup> countries. Having a variety of sale points causes concerns<sup>aboutconsistency and transparency,</sup> and raises the issue of how to find and reward the<sup>scarceresourcesrequiredin oneprivatization</sup> agency, much less many.

72. Promoting competition in the transaction process itself<sup>isperhapsthe most effectiveway</sup> to obtain transparency; as well, it yields the maximum<sup>economicandfinancialbenefits. Clearly</sup> defined competitive bidding procedures for calling,<sup>evaluating,andawardingoffersare</sup> important, including the public opening of bids (in Bolivia,<sup>this was doneon nationaltelevision).</sup>

> **12** The Economnist, July 28-August 3, p. 38.

> 13 In his study of Mexican SOEs, Lopez de Silanes<sup>(1997)foundthatnetrevenuesforgovernmentdropped24</sup> percent for each additional year that privatization<sup>was delayed.</sup>

> 14 The full range of institutional options and the<sup>tradeoffsinvolvedare discussedin detail in Guislain,1997.</sup>
27 In some cases, negotiated sales may be the only option, but in general, the greater the openness and competition in the selection process the greater the likelihood that transparency will be achieved-and the higher the price paid. In his study of Mexico, La Porta and Lopez-de-Silanes (1997) found that an additional bidder participating in a tender increases the net revenues to government by 12 percent. Public offerings or share issue privatizations are widely regarded as the most transparent and lucrative to the seller, but again, many client countries do not possess the capital markets, quality firms, or business environments to apply (very often) this method.

73. While there has been much concern about corruption in privatization, Kaufman and Siegelbaum (1996), in their work on transition economies, argue that although there has been an increase in corruption as privatization has progressed, it does not necessarily follow that privatization is the cause of that corruption. Different privatization approaches have affected the incidence of corruption, depending on the scope of control rights over economic activity retained by politicians and bureaucrats (Box 6). While privatization itself is a way to address corruption, the development of a legal and institutional framework is needed to limit the ability of insiders to self-deal.

# **Box 6. Privatization,and Cor,ruption4inT-ransition Economies**

Privatization-with all its inadequacies--is preferabledto.its absence: Kaufinann and' Siegelbaum show that the .incidence of corruption is, or would be, larger without privalization, and'that-corruption'is more.prevalent in nonprivatized sectors. Furthermore, there is evidence to suggest that kextralegal .aid unofficiai- activities are more prevalent in countries that privatized.less. And'there.is incipient evidence pointing to a positive.association between privitization and some hardening of the budget constraint (i.e< less discretionary handouts. or tax exemptions), as well as between privatization and market liberalization (i.e. less discretionary licenses in the -hands of politicians and bureaucrats). Finally, in some countries, corruption1has:been^fueled by the lack of privatization in agriculture in parts of.thelenergy-sector. 'In these areas, the study advocates fasterprivatization. Source: Kaufnann and Siegelbaun,- 1997.

## **(iv) Mitigating the social impact of privatization**

74. Where restructuring requires sizable labor force reductions, the process will always be contentious-but problems can be reduced if government, and sometimes the private buyers, dialogue with labor early in the process, and jointly work out an acceptable approach. Sometimes, this dialogue can go to extraordinary lengths. For example, in China, a Norwegian private firm entered into a joint venture with a Chinese SOE producing steel. The Norwegian investors worked closely with SOE officials and municipal authorities to determine not simply how many workers would be required in the remodeled firm, but also to ensure that the effects of layoffs were spread equitably among the workforce. Wherever possible, they made sure that when someone was dismissed, another family member was retained. Not surprisingly, the workers and the locality strongly supported this approach. In Morocco the purchaser of an SOE cement company agreed to retain all employees, even though there was an estimated 8 percent surplus. The new Managing Director indicated that he hoped that expanding business would soon make these extra people useful, and that even if business remained steady the firm would absorb the extra cost to maintain social peace and stay in good grace with the government. However, the
28 Director insisted that if demand declined greatly,<sup>thefirmwould renegotiate theirdealwiththe</sup> seller.

75. The most common method to deal with workforce<sup>reductionsistheprovisionof</sup> retirement and severance benefits to encourage<sup>voluntarydeparturesand compensatefor layoffs;</sup> governments generally greatly prefer the formrer<sup>tothelatter(Box7).Suchprogramsappear</sup> quite costly in the short run. For example,<sup>Indianlaborleadersareaskingforfiveyears</sup> severance pay for dismissed employees over<sup>40andwith20yearsormoreofservice;and</sup> packages near this size have been awarded<sup>inSriLankaandPakistan.Butsuchprogramsare</sup> politically and socially acceptable, and the<sup>financial and economicreturnscan be high; in recent</sup> World Bank projects that financed severance,<sup>thereturnsrangedfrom22to44percentin</sup> countries as diverse as Brazil, Croatia, India,<sup>Mozambique,Tunisia,and Togo.Yet, care must be</sup> taken to avoid overly generous packages that<sup>resultinunsustainablecosts, leadtoproblemsof</sup> adverse selection, and, in the case of early<sup>retirement payments,createundue burdenonthe</sup> social security system (Kikeri, 1998; Rama,<sup>1999).Selling or awardingsharestoemployees(and</sup> sometimes retirees) in the newly privatized<sup>firmisanother wayof compensatingworkersand</sup> allowing them to share in the gains of privatization.

# Box 7: Dealing with Labor Redundancies in<sup>Brazil Railways</sup>

Addressing overstaffing was a critical issue<sup>in the privatizationof BrazilRailways.The governmentstarted labor</sup> restructuring prior to privatization in order<sup>toattract investorsand mitigatethesocial impact.Nearly40 percent of</sup> the original workforce of 42,000 left on<sup>a first-comefirst-served basis throughacombinationof early retirement</sup> and voluntary and involuntary separations.<sup>Closeto12,000employeesoptedforearly retirement,whileabout</sup> 6,000 chose voluntary separation. The number<sup>of earlyretireeswasmuchhigherthantheestimatednumberof</sup> 5,000. During the program, social security<sup>reform waspassedwhich impliedthatentitlement toretirement would</sup> no longer be based on the number of years<sup>worked buton agemostly,providinganincentivefortheaverage</sup> worker with 18 years of experience who would<sup>otherwisehavestayedonto retire.Involuntaryseparation,based</sup> on performance, was appliedto 400 employees<sup>at80percentof thevoluntaryseparationpackage.On average,</sup> the financial package equaled -22-months of<sup>salaryas comparedtothe legalrequirementof 10months. The total</sup> retrenchment cost, financed by the govermment<sup>and intemationalinstitutions,amountedtoUS$365millionasof</sup> February 1998, with a 40 percent economic<sup>rateof return.The concessionairessubsequentlyretrenchedan</sup> additional 17,000 people through involuntary<sup>separationof which70percent wereretrenched withinone yearof</sup> operation. The concessionaires were required<sup>fora periodof oneyearafter theyassumedoperationstopay the</sup> same financial packages as paid by the<sup>govenmment.By May2000more than80%of theinitialworkforcehad</sup> been retrenched since the start of the privatization.

In addition to severance packages, retraining<sup>supportandoutplacementserviceswereprovided.Actual</sup> participation in training and outplacement<sup>programswassignificantlylowerthaninitialestimates.Thelow</sup> attendance was mainly caused by delays<sup>infinalizingimplementation arrangementswith thevariousservice</sup> providers. The cost of training and outplacement<sup>was approxirmatelyUS$12 million.</sup> Source: Estache, Sydenstrickeri and Schmitt de Azevedo,<sup>October2000.</sup> 76. Compensation packages have often been<sup>combined withretrainingtohelpworkers</sup> reintegrate into the labor market. While popular<sup>with governnentsand donors alike,evaluations</sup> question their cost effectiveness. Targeted,<sup>demand-drivensupport onapilotbasiswith</sup> competition and performance-based arrangements<sup>forservicedeliveryhaveabetterchanceof</sup> succeeding, while counseling and job search<sup>assistancearefoundtobemore costeffective.</sup>
29 Contracting arrangements are another option; in Argentina, 5000<sup>surplusYPFworkers started</sup> 200 private businesses providing YPF with various contract<sup>services;thisapproachhas been</sup> tried in Egypt and Algeria as well. In an electronics SOE in Alexandria, carpentry and maintenance services were contracted out, with those previously<sup>employedin thesetasksgiven,</sup> free, the tool and workspace to do the job as private suppliers.<sup>Theywerealso given,without</sup> bidding, one or two year contracts to provide the service, before<sup>thecontractswouldbe re-bid</sup> competitively. This gave the former workers a chance to learn<sup>thebusinessand competewith</sup> more experienced bidders.

77. In countries with rapidly growing economies and a well-developed<sup>privatesector,</sup> measures such as severance pay and employee share ownership<sup>schemesmightbeallthatare</sup> needed. By contrast, in low-income and transition economies where<sup>stateenterprisesdominate</sup> the labor market and where alternative employment is hard to find,<sup>thekeyistoimprovethe</sup> overall investment climate, including labor market reforms, so as to<sup>generategrowthand private</sup> sector job creation, thereby facilitating the needed adjustments<sup>andthemovementof redundant</sup> workers to other jobs.

# (v) **Environmental implications**

78. Wasteful resource use and the poor financial situation of<sup>SOEshasmeanthigher</sup> abatement costs, less investment in both modern technology and<sup>pollutioncontrol,andhigher</sup> pollution intensity. Recent research indicates that SOEs pollute more<sup>thanprivatefirms(Wang</sup> and Wheeler, 1996; Dasgupta, Huq, and Wheeler, 1997). A four-country<sup>survey of pulpmillsin</sup> Thailand, Bangladesh, India, and Indonesia shows that state-owned<sup>plantsmake far lesseffortto</sup> abate pollution than their private counterparts (Hartman,<sup>Huq,and Wheeler,1997).</sup> 79. Efforts to improve the environmental performance of state<sup>enterpriseshavebeenmade,</sup> but, as in most other SOE reforms, back-sliding is common. Cash-strapped<sup>SOEskeepusing</sup> older and dirtier equipment. Moreover, SOEs escape environmental<sup>regulationand enforcement</sup> to a greater extent than private firms. For example, in<sup>Indonesia'sProgram for PollutionControl,</sup> Evaluation and Rating (PROPER) program, SOEs were more compliant<sup>thanprivatefirmswhen</sup> the program began, but after 18 months the record of the two types of<sup>enterprisesdid notdiffer</sup> significantly. As SOEs are less susceptible to outside<sup>pressure,publicinformationexerts less</sup> influence on their behavior. State-owned enterprises can thus be<sup>expectedtolagbehindother</sup> firms participating in PROPER in the coming years (Hartman, Huq, and<sup>Wheeler,1997).</sup> 80. Recent research shows that privatization offers<sup>anopportunityforenvironmental</sup> improvements (Box 8). Private firms tend to invest in<sup>newtechnologytoimproveefficiency,</sup> comply with regulations, and respond to pressures from<sup>variousstakeholdergroups. Torealize</sup> the full environmental benefits of privatization, governments<sup>needtoincorporateenvironmental</sup> considerations into privatization transactions and<sup>developpolicyandregulatorysystemsthat</sup> ensure compliance and continued improvements (Lovei, 1999).<sup>Concernsaboutsubsequent</sup> delays in the privatization process must be weighed<sup>againstthe factthatsuch effortsclarifythe</sup> risks and potential future costs and treatment of any liabilities, particularly<sup>insectorssuchas</sup> mining, chemicals, and petroleum refining. Privatization and environmental<sup>agenciesgenerally</sup> lack experience in this regard. As much as possible, the work<sup>shouldbeoutsourcedto</sup> consultants and mechanisms for including regulatory<sup>authorities established.</sup>
30

# **Box 8: Improved Environmental Performance in**<sup>**Mexico**</sup>

Altos Hornos de Mexico (EHMSA), an integrated steel<sup>mill,was sold toaconsortiumofintemationaland</sup> domestic investors in 1991. The Mexican govemment had expected a higher sale<sup>priceif environmental</sup> requirements were clearly expressed at the time of the sale.<sup>Therefore,anenvironmentalauditwascarriedout,</sup> and its results were used to agree on a three-year environmental<sup>complianceplan.Between1991and1995the</sup> company decreased its dust emissions by more than<sup>70percentandtotalwaterdischargesbymorethan60</sup> percent, reduced the amount of solid waste generated per<sup>unit of production,and,introduced programs toimprove</sup> the surrounding environment. The improvements came from process changes and<sup>upgrades,environmental</sup> investments, and changes in plant management.

Source: Lovei, 1999
31 Annex A: Studies on Privatization

|Authors|**Methodology**|MainFindings|
|---|---|---|
|**A.General**|||
|Bamet.Steven.<br>2000."Evidence<br>onthe FiscalandMacroeconomic<br>Impactof<br>Privatization.'<br>_IMF_<br>_Working_<br>_Paper_<br>_WP/00/130._<br>Washington<br>D.C.:<br>Intemational<br>MonetaryFund.<br>htt):I/www.imf.oralextemal/oubs/ftJw<br>D/2000w"00130.odt|Thestudyinvestigatestheimpactof<br>privatzation<br>on<br>fiscal<br>and<br>macroeconomicperformance.|Privatizationproceeds transferredtothe budget<sup>are</sup><br>largelyusedtoreducedomestcfinancing,<sup>withlitte</sup><br>evidence thattheyareused to finance<sup>alarger</sup><br>deficit.<br>Theprivatzationprocessisstrongly<br>correlatedwithanimprovementinmacroeconomic<br>performanceintheformofhigherrealGDP<sup>growth</sup><br>andlower unemploymentrates.The<sup>estimates</sup><br>suggestthataonepercentofGDP<sup>privatization</sup><br>corresponds to 0.5percentage pointincrease<sup>in</sup><br>contemporaneousrealGDPgrowthandafurther<sup>0.4</sup><br>percentage point increaseinthe followingyear.<sup>The</sup><br>point estimatesalsosuggestthataone percent<sup>of</sup><br>GDPprivatizationisassociatedwithadeclinein<sup>the</sup><br>unemploymentrateofjustlessthan_/._<sup>of</sup>a<br>percentage pointintheyearofprivatization<sup>anda</sup><br>further/.percentagepointin thefollowing<sup>year,</sup><br>resultinginatotalimpactofaround%<sup>ofa</sup><br>percentagepoint|
|Boardman,AnthonyE.,andAldan<br>R.Vining.<br>1989.'Ownershipand<br>Performance<br>in<br>Competitive<br>Environments:AComparisonofthe<br>PerformanceofPrivate,Mixed, and<br>State-OwnedEnterprises."<br>Joumal<br>_ofLawandEconomics._32: 1-33.|Contains<br>a<br>comparlson<br>of<br>the<br>performanceofthe500largestnon-US<br>industrialfirmsin1983.<br>Resultsare<br>comparedforprivatecorporations,mixed<br>enterprisesandstate-owned enterprises.<br>Thecomparisonisonthebasisoffour<br>measures<br>ofprofitability:<br>return<br>on<br>equity,return onassets,retum onsales<br>andnetincome.<br>Also includestwo<br>measuresofX-effidency:sales<sup>per</sup><br>employeeandsalesperasset|Theauthorsfindthatstate-ownedand<sup>mixed</sup><br>ownershipfirmsaresignificantlylessprofitable<sup>and</sup><br>productive than privately-ownedcompanies.<sup>To gain</sup><br>efficiencyfullprivatizationisneededbecause<sup>mixed</sup><br>ownershipsfirms arenomore profitablethan<sup>those</sup><br>ownedwhollyby the state.|
|Boubakri,Narjess,andJean-Claude<br>Cosset<br>1998.'TheFinandaland<br>OperatingPerformanceofNewly<br>PrivatizedFirms:EvidenceFrom<br>Developing Countries."<br>Joumalof<br>_Finance._53:1081-1110.|Thestudyexaminespost-privatizabon<br>financial andoperatingperformanceof<br>79 companiesin21developing countries<br>and32industriesbetween198g01992.|Thestudyconcludesthatthereareeconomically<sup>and</sup><br>statisticallysignificantpost-privatization<sup>increasesin</sup><br>output(realsales),operatngefficiency,<sup>profitability,</sup><br>capitalinvestrnentspending,dividend payments,<sup>and</sup><br>employmentaswellas significant decreases<sup>in</sup><br>leverage.About 60percentofsamplefirmsshowed<br>anincreaseinemploymentof5-10percentafter<br>privatization.Realsalesperemployeeincreased<sup>by</sup><br>27percentUnadjustednetincomeperemployee<br>increasedonaverageby63percent|
|Davis, Jeffrey, RolandoOssowski,<br>ThomasRichardsonandSteven<br>Bamett.<br>2000.<br>'Fiscal<br>and<br>Macroeconomic<br>Aspects<br>of<br>Privatization.'<br>_IMF_<br>_Occasional_<br>_PaperNo.194._<br>WashingtonD.C.:<br>IntemabonalMonetaryFund.|Thispaper separatesthepossiblefiscal<br>and other macroeconomic impacts<sup>of</sup><br>privaization.|Thestudyfindsthatreceipts**of**prtvatzaton<sup>are</sup><br>savedratherthanspentOvertimethe<sup>fiscalsituation</sup><br>Isimprovedbyprivatizabon<sup>withposiSveimpacts</sup><br>uponrevenueandforsomecountriesa<sup>argededine</sup><br>Indefidts.Intermsofgrowthprivatefirms<sup>**am**found</sup><br>tobemoreefficientthanthoserunby<sup>thestate,</sup><br>especiallyin competitiveindustrbies.<sup>Thestrong</sup><br>correlation<br>that<br>exists<br>between<br>growth<br>and<br>privatzabonmay bebecauseprivatkationisa<sup>proxy</sup><br>forthemoregeneralfactorof'favorableregime<br>change'.Theauthorsalsofindthatunemployment<br>falls<br>after privazatbon,<br>butthatitmay have<br>detrimentalimpactsonpariculargroupsofworkers.<br>Overalltheposibiveeffectsofprivatizationongrowth<br>and employmentholdforallcountriesexamined,<br>althoughtoalesserextentintransitlon<sup>economies.</sup>|
32

|**Authors**|**Methodology**|**MainFindings**|
|---|---|---|
|Dewenter,<br>Kathryn,andPaulH.<br>Malatesta.<br>1997.'PublicOfferings<br>of<br>State-Owned<br>and<br>Privately-<br>Owned Enterprises:AnIntemational<br>Companson.<br>_JoumalofFinance,_<br>52:1659-1679.|Usesdatafrom 8countries(Canada,<br>France,<br>Hungary,<br>Japan,<br>Malaysia,<br>Poland,ThailandandUK) tocompare<br>initial retumsfor109companieswith<br>nationalaverage<br>retums.<br>Alsotests<br>whetherPIPOsaremoreorless under<br>pricedthanprivatesectorIPOs.|Resultsvary according tocountry: theUKshows<br>significantlyhigherinitalretums on PIPOsthan<br>pnvatesector1POs,while Canadaand Malaysia<br>point<br>to<br>the<br>opposite<br>case.<br>Also<br>PIPOs<br>in<br>unregulatedindustriestendtobelessthanthose for<br>regulatedindustries.Thereistherefore noevidence<br>thatgovemmentssystematicallyunderpncePIPOs.<br>Relatively primitive capitalmarkets(inthis case<br>Hungary,Malaysia, PolandandThailand)leadstoa<br>tendencyforhigherinitial retumsthanoffersin<br>countneswith moredevelopedcapitalmarkets.The<br>authorssuggestthatthisisduetoan increased<br>uncertaintythataboutthevalueofpnvatzationoffers<br>leadingtolowerofferprices.Another suggestionis<br>thatthosecountrieswithrelativelyprimitivecapital<br>markets may trytobroadenprivateshareownership<br>by decreasingtheinitial offerprice.|
|Dewenter,Kathryn, and PaulH.<br>Malatesta.<br>Forthcoming.<br>'State-<br>OwnedandPrivately-OwnedFirms:<br>AnEmpirical AnalysisofProfitability,<br>Leverage,andLabourIntensity."<br>_American EconomicReview._|Thisstudy testswhetherprofitability,<br>laborintensityanddebt levelsofSOEs<br>variesfromthat ofprivatelyowned firms.<br>Theauthorsuseasampleofthe500<br>largestnon-US firmsin1975,1985and<br>1995.|Aftertakingintoaccounttheeffectofbusiness cycles<br>itis foundthatprivatefirmsaresignificantlymore<br>profitablethanSOEs,andhavelowerlevelsofdebt<br>andlesslaborintensiveproduction.|
|D'Souza,<br>Juliet,<br>andWilliam<br>L.<br>Megginson.<br>1999.'TheFinancial<br>and<br>Operating<br>Performance<br>of<br>Newly<br>Privatized<br>Firms<br>in<br>the<br>1990s."<br>_JoumalofFinance._<br>54:<br>1397.|Thepaperdocumentsofferingterms,<br>methodofsale,andownershipstructure<br>resulting<br>from<br>privatization<br>of<br>78<br>companies<br>(mostly<br>from<br>telecommunicationsandotherregulated<br>industries)from10developingand15<br>developed countries overtheperiod<br>1990-1994.|Thestudycomparesthree-year<br>averagepost-<br>pnvatizationfinancialand operatingpe;formance<br>ratiostothethree-yearpre-privatizationvalues fora<br>sub-sampleof26firms.Itcondudesthatthere were<br>economically<br>and<br>statistically<br>significant<br>post-<br>privatization<br>increases<br>in<br>output<br>(real<br>sales),<br>operatingefficlency,andprofitability,aswellas<br>significantdecreasesinleverage. Capital investment<br>spending<br>slighty<br>increased,<br>whileemployment<br>declinedsignificantly.|
|D'Souza, Juliet,RobertNash,and<br>William<br>L.<br>Megginson.<br>2000.<br>'Determinants<br>of<br>Performance<br>Improvement<br>in<br>Newly-Privatized<br>Firms:<br>Does<br>Restructuring<br>and<br>Corporate<br>Govemance<br>Matter?'<br>Working<br>Paper.<br>Norman,<br>OK:<br>UniversityofOklahoma.<br>Httoi//facult-<br>staff.ou.edu/MNVIIIvam.L.Meocinson-<br>1Iorvsources.odf|Usingasampleof118firms(from29<br>countriesand28industries)that were<br>privatized throughpublic chareoffering<br>between1961and1995 theauthors look<br>at<br>operating<br>performance<br>of<br>the<br>enterprises.|Theyfindthattherearesignificantincreasesin<br>profitability,<br>efficiency,<br>output,<br>and<br>capital<br>expenditure,<br>while<br>leverage<br>also<br>decreases<br>significanty.Lookingatthedeterminantsof these<br>improvementstheyfindthatstrongerprofitability<br>gainscome<br>from<br>firmswith<br>loweremployee<br>ownershipandhigherstateownership.Outputgains<br>arestrongerincompetitivemarketsandwherethe<br>economyisgrowingfasterandefficlencygainsare<br>higherwhenforeign ownershipishigh.|
|Galal, Ahmed, LeroyJones, Pankaj<br>Tandoon,<br>and<br>Ingo<br>Vogelsang.<br>1994.<br>_WeffareConsequencesof_<br>_Selling_<br>_Public_<br>_Enterprises:_<br>_An_<br>_Empirical_<br>_Analysis._<br>Washington<br>D.C.:WorldBank.|Thestudymeasures<br>theeffectsof<br>divestiturebycomparingactual post-<br>privatization performance of12large<br>firms<br>(in<br>aviation,<br>energy,<br>telecommunications,transportabonand<br>shipping)inChile,Malaysia, Mexico,and<br>U.K.withtheirperformancepriorto<br>divestiture.|The<br>authors<br>find<br>thatdivestiture<br>substantially<br>improvedeconomicwelfarein11ofthe12cases.<br>Thegainsweremainly duetoadramaticincreasein<br>investment,<br>improved productivity,morerational<br>priclng policles,and increasedcompetitionand<br>effectiveregulaton.<br>Despiteassuringthatpublic<br>managerswouldadoptnew technologyand more<br>rational<br>procedures<br>theyalso<br>concluded<br>that<br>privatizedfirmperformancewassuperiortothe<br>altemativeofstate ownership.|
|Jones,<br>Steven<br>L.,<br>William<br>L.<br>Megginson,RobertC.Nash, and<br>JeffryM.Netter.1999.'ShareIssue<br>Privatizations asFinancialMeansto<br>Polifical<br>and<br>Economic<br>Ends.|Thestudyfocusesonhowpoliticaland<br>economicfactors influenceinitialretums<br>ofSIPsusinga sampleof630SIPsfrom<br>59countriesbetween1977-1997.|Themeanlevelofinitialretumsarefoundtobe34.1<br>percentforSIPsand9.4percent for seasonedSIPS.<br>Theauthorsdonot compareSIPs withprivate sector<br>IPOsbecauseoftheirbeliefthatanyunderpriclngis<br>caused bydifferent factors(politicalconsiderations|
33

|**Authors**|**Methodology**|**MainFindings**|
|---|---|---|
|_Joumal_of_FinancialEconomics._53:<br>217-253.||and<br>asymmetric<br>information<br>respectively)<br>and<br>thereforedoes notleadtoanymeaningful<sup>insights.</sup><br>Thestudyalsofindsthatinibalretumson<sup>SIPsare:</sup><br>(i)positivelyrelatedtothefractionof<sup>theSOE on</sup><br>offer,(ii)positively relatedtotheincome<sup>inequalityin</sup><br>thecountry,and<br>(iii)notinverselyrelatedtothe<br>marketvalueoftheformer<sup>SOE.</sup>|
|Megginson,William,RobertNash,<br>andMatthiasvan Randenborgh.<br>1994.'TheFinancialandOperating<br>Performance<br>ofNewtyPrivatized<br>Firms:AnIntemationalEmpirical<br>Analysis."_JoumalofFinance._49:<br>403-452.|Compares<br>both<br>pre<br>and<br>post-<br>privatization<br>3-year<br>average<br>performance ratiosfor61firmsin 18<br>countriesovertheperiod 1961-1989.|Significantincreasesinoutput,operating<sup>efficiency,</sup><br>profitability,<br>capital<br>investment<br>spending<br>and<br>dividendpaymentsarefound along<sup>withsignificant</sup><br>decreasesinleverage.The changesinemployment<br>afterprivatizationarefoundtobeinsignificant|
|Megginson,William, RobertNash,<br>JeffryNetter,andAdamSchwartz.<br>2000. 'The LongTerm<br>Retumto<br>Investors<br>in<br>Share<br>Issue<br>Privatizations.7<br>_Financial_<br>_Management._29:67-77.|Overtheperiod1981-1997this study<br>examinestheperformanceof158PIPOs<br>form33countries. Theauthorscompute<br>1,3and5-yearretumsinbothlocal<br>currencyandUSdollarsandcompare<br>resultstointemational<br>and<br>national<br>indicesas well asmatchingfirmtypes.|First yearmeanholding-periodretumsforthe<sup>SIPs</sup><br>arefoundtobe25.1percent,which<sup>compares</sup><br>favorablytothemean localcurrencyhome<sup>market</sup><br>retums(13.2%), FTworldIndex (13.1%)<sup>andS&P</sup><br>500Index(17.6%).TheHPRforindustry<sup>matching</sup><br>firmsisalsolessthanthatfortheSIPs(15%).<sup>This</sup><br>resultisstatistically significant forallofthe<sup>indices</sup><br>used. Similarresultsarefoundafter<sup>3 and 5years,</sup><br>withexcessretumsexceeding 80percent<sup>formost</sup><br>indices.|
|Megginson,WilliamL.,andJeffrey<br>M.Netter.<br>2001.'FromStateto<br>Market:<br>ASurvey<br>ofEmpirical<br>StudiesofPrivatization.'<br>_Mimeo._<br>ForthcominginJoumalofEconomic<br>Uterature.<br>httDo//www.aei.brookinas.ora<br>oulicatioWslrelated/rivatization.odf|Thepaper surveystherapidlygrowing<br>literatureonprivatzation,attemptsto<br>frameandanswerthekeyquestionsthis<br>streamofresearchhasaddressed,and<br>thendescribessomeofitslessonson<br>the promiseandperilsofstate-owned<br>assets.|The paper idenbfiesthe followingmainlessons<sup>from</sup><br>theliteratureonprivatization:<br>Theprivatizabonprogramsofthelast20years<sup>have</sup><br>reducedtheroleofSOEsintheeconomiclife of<sup>most</sup><br>countries.Mostofthisreducton<br>indeveloping<br>countrieshastaken placeonlyinthe1990s.<sup>The</sup><br>SOEshareof'globalGDP"hasdeclinedfrom more<br>than10percentin1979toless than6<sup>percenttoday.</sup><br>Privatelyownedfirmsaremoreefficientand more<br>profitablethancomparable state-owned<sup>firms.There</sup><br>islimitedempiricalevidence,especiallyfrom<sup>China,</sup><br>thatsuggeststhatnon-privatzingreform<sup>measures-</sup><br>suchaspricederegulabon,market liberalizabon,and<br>increaseduseofincenbives- can improvethe<br>efficiencyofSOEs,butitalsoseemslikely thatthese<br>reformswould beevenmoreeffectiveifcoupled with<br>pnivatzabon.|
|Nellis, John.1994.'isPrivabtzaion<br>Necessaryr<br>_PublicPolicyforthe_<br>_PrivateSectorNote_17.Washington<br>D.C.:WorldBank.|Inthis studytheauthorarguesthat<br>privabzabonisnecessary.Heargues<br>thatthereareseveralreasonswhy<br>privatefirmsperform<br>betterthanSOEs.<br>ThereIsamarketformanagersthat<br>leadstohigherqualitymanagement;<br>capitalmarketssubjectprivate firmsto<br>greaterscrutiny;they aremuchmore<br>subjecttoexitthanSOEs;politicians<br>interfere lesswiththeirrunning;and<br>private<br>firms<br>are<br>owned<br>by<br>self-<br>interested<br>shareholders<br>rather<br>than<br>'disinterestedbureaucrats'.|Thereareanumberofreformsthat could<sup>helpto</sup><br>combattheseproblemsthat donotinvolvechanging<br>theownershipofthefirm,andthereis some<br>empirical evidencetosuggest thattheycan<sup>be</sup><br>successful.<br>However<br>the<br>author<br>argues<br>that<br>ownership<br>isstill<br>the<br>bestway<br>to<br>improve<br>performance.Whileitisseenthat there<sup>maybe</sup><br>someovedapintheperformanceofprivate firmsand<br>SOEs,ingeneralprivatefirmsoutperform<br>SOEs.<br>Empirical evidence alsobackthisupwiththemajority<br>ofpre<br>andpost-privatzabon<br>studiesshowing<br>significantimprovementsinvariousfactors<sup>after</sup><br>privatzalon.Lastly. theauthor arguesthatpartial<br>reformsimplementedbygovemmentsoften amount<br>to nomore thanacompromiseandthattheyare<br>oftenpronetoreversingpolicy decisions orrelaxing<br>them. Thisissomethingthatcanbeavoidedif<br>privatizationisconducted.|
34

|Authors|Methodology|MainFindings|
|---|---|---|
|Sheshinski,Eytan andLuisFelipe<br>Lopez-Calva.<br>1999.<br>'Pnvatizabon<br>and<br>itsBenefits:<br>Theory<br>and<br>Evidence.'<br>_Development_<br>_DiscussionPaper698._Cambridge,<br>MA:Harvard<br>Insttute<br>for<br>Intemabonal Development.<br>htto:llwww.hiid.harvard.edu/oroiectl<br>.compa<br>httc://www.hild.harvard.edu/froect<br>caer/oapers/paper35.Ddf|The<br>paper reviews<br>themicro<br>and<br>macroeconomic effectsof privatzabon<br>basedonasurveyoftheempirical<br>literature.<br>red|The evidence showsthatpnvatizedfirms improve<br>their profitabilityafterthesale,evencontrolling for<br>macroeconomicandindustry specificfactors. This<br>result<br>holds<br>for<br>different<br>market<br>structures.<br>Deregulabonpolicies speeduptheconvergence<br>processoffirmsto industrystandards.<br>Partial<br>pnvatizationhasalowereffectonprofitabilitywhen<br>withfullprivatzabon.<br>Microeconomic<br>evidence confirmsthattheintroductionofcompebtion<br>enhances<br>productvity<br>gains.<br>Firms<br>in<br>more<br>concentratedand regulatedmarkets, thoughthey<br>alsogothroughanimportantrestructuring afterthe<br>sale,<br>showlowerincreasesin<br>productivityas<br>comparedtothosethatareundermarketdiscipline.<br>Eliminatingrestrictionstoforeigndirectinvestment<br>andtradebarriers, and govemmentcontrolson<br>prcesandquantbesfuelsthecatch-upoffirmsto<br>competbive standards.<br>Thebudgetdeficitshowsa<br>posibvetrend,i.e.,itdeciinesduringthereform<br>period.|
|Shirley,Mary,andPatrickWalsh.<br>2000.'Publicvs.PrivateOwnership:<br>TheCurrentState of theDebate."<br>_WorHd_<br>_Bank_<br>_Policy_<br>_Research_<br>_WorkingPaper2420._Washington,<br>D.C.:<br>World<br>Bank.<br>htto://econ.worldbank.ora/files/1175<br>wDs2420.odf|Thepaperreviews thedebateoverstate<br>ownershipbysearchingtheoretcaland<br>empiricalstudiesforanswersto the<br>followingquestions: (i)Doescompetibon<br>mattermorethanownership?<br>(ii)Are<br>SOEsmoresubjecttowelfarereducing<br>interventonsbygovemmentthanprivate<br>firms?<br>(iii)DoSOEs suffermorefrom<br>corporate govemanceproblemsthan<br>privatefirms?|Theoreticalstudiesareambiguousabouttheeffects<br>ofownership. Empiricalliterature, however,suggests<br>thatwhilemarketstructurehasapositiveimpacton<br>performance,thisimpactfailstodominatethe<br>ownership<br>effect.Thearguments<br>thatmarket-<br>structuredominatesrestsoncasesinwhichpublic<br>and<br>private<br>firms<br>in<br>compebtiiveenvironments<br>performequallywell,andthesecases arerare.Both<br>thetheoretcalandempiricalliteratureare ambiguous<br>abouttheeffectsofownershipinmonopolymarkets.<br>Theories<br>that<br>assume<br>a<br>welfare<br>maximizing<br>govemmentsuggest thatSOEscancorrectmarket<br>failures,butpublicchoicetheoriesareskeptcalof<br>these<br>type<br>govemment<br>models.<br>Corporate<br>govemance<br>theories<br>suggest<br>that<br>even<br>well<br>intenbonedgovemmentsmaynotbeabletoassure<br>thatSOEmanagers do theirbidding.Theempirical<br>literature favorsthelatter viewofSOEs.Instudiesof<br>industrialized countries,wherewemight expectmore<br>developedpolitcalmarketstomotivategreater<br>govemment concemwithwelfaremaximizationor<br>betterinformabon<br>and<br>incenfivestoovercome<br>corporategovemanceproblems,privatefirmsstill<br>have<br>an<br>advantage.<br>Theoretical<br>critiques<br>of<br>privatzabon suggestthatdistortedobjectves,market<br>failuresandpoorinstitutbonswilllead tocostly<br>failures.<br>Someofthesestudiessufferfromthe<br>absenceofarealisticSOEcounterfactualorare<br>extrapolatingfromafew,prominentcases,suchas<br>Russia.The21empiricalstudiescitedinthispaper<br>suggestthat mostfirmsdo betterandallfirmsat<br>leastaswellafterprivabzabon.Noneofthestudies<br>find thatperformance wouldbebetterhadtheynot<br>been privatized.|

# B. Developing Countries

Bemal, Richard L., and Wihsome J. This study analyzes privatization Overall, privatizabon has had positive effects in the Leslie. 1999. 'Privatzation in the inibatives in the English-speaking Caribbean. English-Speaking Caribbean: An Caribbean. It examines the various Assessment'" _CSIS Policy Papers_ modalities which countries have ublized There have been net gains in tems of employment on _the Amencas._ X(7). for private sector involvement in the Inibal divestment of agricultural lands in Jamaica, for state sector and examines the impact on example, resulted in employment increases of 150 http hwcsIs.ora/americas/oubs/o employment economic efficiency, and percent As a result, the trade unions have been pPrivAssessmentDdf **Ith -m*1,NWy nf** **_n,c-, -I_** generally supportive of the govemments efforts.
35

|Authors|Methodology|MainFindings<br>|
|---|---|---|
||theavailabilityofgoodsandservices.|Efficiencyandcompanyperformancehaveimproved.<br>Inthe hotelsectorinJamaica,forexample,<br>occupancylevelsinprivatzedhotelsare nowover<sup>85</sup><br>percent.asaresultofaggressivemarketng<br>strategies,<br>tghter<br>management,<br>and<br>physical<br>refurbishing.<br>Privatzation<br>has<br>contributed<br>significantlytothereductioninfiscaldefidts,not<sup>only</sup><br>because oftheinitialinjectonoffunds aftersale,<sup>but</sup><br>alsoduetotheeliminationofgovemmentfinancing<br>forunprofitableenterprises.Privatizationhas<sup>also</sup><br>brought foreignexchangefromforeignaswell<sup>as</sup><br>localinvestors.|
|Boubakri, Narjess,andJean-Claude<br>Cosset.<br>1998.'TheFinancialand<br>OperatngPerformanceofNewly<br>PrvatzedFirms:EvidenceFrom<br>Developing Countries.'<br>_Joumalof_<br>_Finance._53:1081-1110.|The studycomparesthree-yearaverage<br>post-privatizationfinancialandoperating<br>performancerabostothethree-yearpre-<br>privatizationvaluesfor79companies<br>from21developing<sup>countriesand32</sup><br>industries over theperiod 1980-1992.|Thestudyconcludesthatthereareeconomically<sup>and</sup><br>statistcallysignificantpost-privatizationincreases<sup>in</sup><br>output(realsales),operatingefficiency,<sup>profitability,</sup><br>capital investmentspending,dividendpayments,<sup>and</sup><br>employmentaswellas significant<sup>decreasesin</sup><br>leverage.|
|Boubakri, Narjess,andJean-Claude<br>Cosset.<br>1999.'DoesPrivatizaton<br>MeettheExpectaUons?<br>Evidence<br>FromAfricanCountries."<br>Working<br>Paper.Montreal:EcoledesHEC.|Thestudy examinespre-versus post-<br>privatzatonperformanceof16African<br>firms privatizedthroughpublicshare<br>offeringduring theperiod1989-1996.|Itfindsasignificantincreaseincapital<sup>spendingby</sup><br>pnvatizedfirms,but only insignificantchanges<sup>in</sup><br>profitability, efficiency,outputandleverage.|
|Jones,Leroy,YahyaJammal,and<br>NilgunGokur.<br>1999.'Impactof<br>Privatizaton<br>in<br>COte<br>D'lvoire."<br>_Mirneo._<br>Boston<br>Insttute<br>for<br>DevelopingEconomies.|The<br>study<br>covers<br>the<br>welfare<br>consequences of81privatizatonsin<br>COte<br>dilvoire,<br>covering<br>not<br>just<br>infrastructurefirmsbutarangeoffirms<br>alreadyoperaUngincompetivemarkets<br>(inagriculture,agro-industries,tradable<br>and non-tradablesectors).|Fortheentreprivatizedsector,theyconcluded<sup>that</sup><br>thereweresubstantialbenefits:<br>(i)thefirms<br>perfofmed<br>better<br>after<br>privatizaton;<br>(ii)<br>they<br>performedbetterthantheywouldhave<sup>hadthey</sup><br>remained underpublicownership;and(iii)<sup>thesetof</sup><br>transactonsasawhole contributedpositvely<sup>to</sup><br>economicwelfare,withannualnetwelfare<sup>benefits</sup><br>equivalenttoabout 25percentofpre-divestiture<br>sales. These resultsstemmedfromanumber<sup>of</sup><br>effects, includingincreasesinoutput, investment,<br>labor<br>productivity,<br>and<br>intermediate-input<br>productvity.|
|LaPorta, Rafael, andFlorencio<br>Lopez-de-Sibanes.<br>1997.<br>'The<br>Benefit~ofPrivatizaton:Evidence<br>from<br>Mexico.<br>_NBERR_<br>_Working_<br>_Paper6215._<br>Cambridge,<br>MA:<br>National<br>Bureau<br>of<br>Economic<br>Research.<br>http:/lraers.nber.ora/panersiW621<br>5Ddf|Critcismsofprivatzatonhavecentered<br>aroundthepossibilitythattheobserved<br>higher<br>profitability<br>of<br>privatized<br>companiescomesattheexpenseof<sup>the</sup><br>restof society.Inthispaper, theauthors<br>focusontwoofthemostlikelychannels<br>forsociallosses:a)Increasedpricesas<br>fimiscapitalizeon the marketpower;<br>and b)layoffs andlowerwagesasfirms<br>seektoroll<br>backgenerous<br>labor<br>contracts.This study usesdataforall<br>218non-financialprivatzatlonsthattook<br>placeinMexicobetween1983and1991.|Theauthorsfindthatprivatized<sup>fimnsquicklybridge</sup><br>thepre-privaizatonperformance gap<sup>withindustry-</sup><br>matched control groups.Forexample,<sup>privatzaonis</sup><br>followedbya24 percentagepoint<sup>increaseinthe</sup><br>ratioofoperatingincome tosales.<sup>Thosegainsin</sup><br>profitabilityareroughlydecomposedas<sup>follows:10</sup><br>percentoftheincreaseisdue tohigher<sup>product</sup><br>prices;33percentoftheincreaserepresents<sup>a</sup><br>transfer from laid-offworkers;andproductivity<sup>gains</sup><br>accountfor the residual57peroentTransfers<sup>from</sup><br>societytothefirmarepartallyoffsetbytaxeswhich<br>absorbslightlyoverhalfthegainsin<sup>operatng</sup><br>income. Finally,theyalsofind evidence<sup>indicatng</sup><br>that<br>deregulaton<br>is<br>associated<br>with<br>faster<br>convergencetoindustrybenchmarks.|
|Macedo,<br>Robert.<br>2000.<br>'Privatzatonandthe Distribubonof<br>Assets<br>and<br>IncomeinBrazil."<br>Working<br>Paper.<br>Camegie<br>EndowmentforIntematonalPeace.|Thispaperfocuseson the Brazilian<br>privationprogramundertakeninthe<br>1990s.|The paper concludesthat privaization<sup>contributedto</sup><br>softeningboththe fiscalandthe extemal<sup>constraints,</sup><br>by allowinganenlargedpublicdebt<sup>and aggravating</sup><br>foreignImbalances.<br>Becauseofmacroeconomic<br>mismanagement,theobjectives<sup>ofreducingthe</sup><br>public debtwasnotachieved.Inspiteofthesize<sup>of</sup><br>theprogram,<br>the govemment<br>ended upwith<br>increased<br>liabilItes.<br>Withrespecttoincome<br>distributon,thepapercondudes thatitwas<sup>also</sup><br>aggravated,sincethe poorestgroups<sup>didnothave</sup><br>accesstotheassetsand thegains<sup>ofprivatizadon,</sup>|
36

|**Authors**|**Methodology**|**MainFindings**|
|---|---|---|
|||andwillintheend shareinthepayment ofan<br>increasedpublic debtandofalarger interestbill.<br>Thebetteroff,onthe contrary,reapedthebenefitsof<br>pnvatizaton,andofthe largerinterestratespracticed<br>bythegovemment.<br>Somecorrectonofthese<br>distortionsmight occurdependingonhowthe<br>govemmentspendsthehigher tax receiptsitis<br>collechngfromtheformerSOEs,asthey become<br>moreefficient andprofitable,aperformance also<br>supportedbytheevidencepresentedinthe paper.|
|Majumdar,<br>Sumit<br>K.<br>1996.<br>'AssessingComparative Efficiency<br>oftheState-Owned,Mixed, and<br>Private SectorsinIndian Industry."<br>_PublicChoice._96:1-24.|Thestudy looks intotheperformanceof<br>Indian<br>SOEs,<br>mixed<br>ownership<br>enterprises<br>and<br>pnvatefirmsduring<br>1973-1989.|Industry-levelsurveydatarevealsefficiencyscores<br>averaging0.975forpnvately-ownedfirms, whichis<br>significanUyhigherthanbothmixedownershipfirms<br>(0.912)<br>and<br>SOEs<br>(0.638).<br>Any<br>state sector<br>improvement<br>iscausedbyconcerted<br>efficency<br>drives,"butquicklydeclinesafterwards.|
|Shirley,MaryM.<br>1998.<br>'Why<br>PerformanceContractsforState-<br>Owned<br>Enterprises<br>Haven't<br>Worked."<br>_Public Policyforthe_<br>_Private_<br>_Sector_<br>_Note_<br>_150._<br>WashingtonD.C.: TheWorldBank.<br>htto://www.worldbank.ora/html/fpd/n<br>otes/150/150shirl.odf|A<br>study<br>of<br>performance<br>contracts,<br>lookingat12enterprisesin6developing<br>countries|This study showsthatonlyafew casesactually<br>improvedperformance(intermsoflabor productivity<br>and<br>total<br>factor<br>productivity)<br>after<br>signing<br>performancecontracts.Onthewholeperformance<br>was unchanged,withafew enterprisesactually<br>showingdecliningperformance. Thecontractsare<br>foundtohavemany flawsinthat theyassignsoft or<br>inappropriatemeasuresofeconomicperformance<br>(e.g.output- whichtakesnoaccount forproductivity<br>and canthereforeleadtoinefficiencyinachievingthe<br>goal).<br>Tocombattheseproblemscontracts mustreducethe<br>informatonadvantageofmanagersoverowners,<br>andthusleadtoappropriatetargetsbeingset<br>Incentivesprovidedtomanagersmustalso motivate<br>them. Manycontractsinthestudydonot include<br>either<br>bonuses<br>or<br>punishments<br>for<br>under-<br>achievement.Lasty,thebonusesthatare included<br>mustbeenforceable.Contractsinthestudythat<br>includedbonusesdid notallowthe managerstotake<br>thestatetocourtiftheyfailedtopay.Oncethese<br>threeitemsareincludedinacontractithasbeen<br>shown thatperformanceimproves.|
|USAID.<br>2000.<br>'The<br>Post<br>Privatization<br>Development<br>of<br>FormnerLaw 203 Companies:<br>15<br>Case Studies."<br>SpecialStudyfor<br>USAIDbyCARANACorporabon.<br>Washington<br>D.C.:<br>United<br>States<br>Agency<br>for<br>Intemabonal<br>Development|This<br>study<br>evaluates<br>the<br>post<br>privatzationperformanceof15former<br>SOEsinEgypt,examiningthe degreeto<br>whichthefirmsareindependentofthe<br>stateafterprivatizabon.|Threeofthe12companieswerenoticeablyreformed<br>afterprivatzationascontrol waspassed tothe<br>private<br>sectorandcorporate<br>govemance<br>was<br>improved.Six firmsareinatransitonalphasewith<br>newshareholders having implemented changesin<br>business<br>strategies,<br>though<br>the<br>essential<br>management<br>structure<br>and<br>corporate<br>culture<br>remainedfundamentallyunchanged.Theremaining<br>sixremainedunderstate controldespiteprivatzation.<br>Themainreasonforthe mixedperformanceofthe12<br>companies isthatwhile51percent ofmoreequity<br>wassold,thestatestllremained as the largest single<br>shareholder<br>in<br>the<br>enterprise,<br>giving<br>it<br>a<br>disproportonatelylargevoiceindecision-making.|

C. Transition Economies Barbens, Nicholas, Maxim Boycko, The study surveys 452 Russian firms The authors find that new owners and managers Andrei Shleifer, and Natalia that were sound at the beginning of the increase the chance of restructuring that Increases Tsukanova. 1996. 'How Does 1990s and attempts to measure the value. They emphasize the importance of new Privatization Work? Evidence From relabve importance of the channels human capital in the restructuring process and find the Russian Shops.' _Joumal of_ through which privatization can promote that equity incentives do not improve performance. _Po/Rical Economy._ 104: 764-790. restructuring.
37

|**Authors**<br>|**Methodology**|**MainFindings**|
|---|---|---|
|_PoliticalEconomy._104:764-790.|||
|Black,Bemard,ReinierKraakman,<br>and AnnaTarassova.Forthcoming.<br>'Russian<br>Privatization<br>and<br>CorporateGovemance:WhatWent<br>Wrong?'_StanfordLawReview._|Adescriptivesurvey ofthehistoryof<br>privatzationinRussia. Severalspecific<br>casesareanalyzedinmore detail.|The authors findthatprivatizabonhascreateda<br>'kleptocracy"<br>andhasfailed.They emphasizethe<br>importanceofdecreasingincentvesforself-dealing<br>whenprogramsofprivatizabonaredesigned.|
|Brada,JosefC.1996.'Privatization<br>isTransition-Orisit?'<br>_Joumalof_<br>_EconomicPerspectives._10:67-86.|This study setsoutthedifferentmethods<br>ofprivatization.|Privatizationcanoccurinanumberofways, through<br>resUtution,saleofstateproperty,massorvoucher<br>privatzationandprivatizatonfrombelow. Theauthor<br>finds thatthereare twokeylessonswhenlooking<sup>at</sup><br>privatzationintransitoneconomies.<sup>Firstythe</sup><br>methodofprivatizabonmust vary according<sup>tothe</sup><br>specificSOE and no'granddesign"can<sup>be</sup>drawn<sup>up</sup><br>forpnvatizingahostofenterprises.In<sup>somecases</sup><br>themajorityofSOEs canonlyberealistically<br>privatzedby givingthem away.The second<sup>lessonis</sup><br>thatitisdifficultto achieveownershipbyoutsiders.|
|Claessens,<br>Stijn,<br>and<br>Simeon<br>Djankov.<br>1999a.<br>"Enterprise<br>Performance<br>and<br>Management<br>Tumoverin theCzechRepublic.'<br>_EuropeanEconomic_Review.<br>43:<br>1115-1124.|Thestudy usesasampleof706<br>privatzedCzechfirmsduring1992-1997<br>toexaminetheeffectofmanagement<br>tumoveronchangesinprofitabilityand<br>laborproductvity.|When newmanagersareappointedbyprivate sector<br>ownersthereisasignificant improvementin<sup>profit</sup><br>marginsandlabor productivity.New managers<sup>that</sup><br>areappointedbytheNabonalPropertyfund<sup>also</sup><br>improveperformancebut notbyasmuch.|
|Claessens,<br>Stijn,<br>and<br>Simeon<br>Djankov.<br>1999b.<br>'Ownership<br>Concentration<br>and<br>Corporate<br>Performance<br>in<br>the<br>Czech<br>Republic."_JoumalofComparative_<br>_Economics._27:498-513.|Usingthe samesampledataasabove<br>thisstudylooksat therelatonship<br>betweenownershipconcentrabonand<br>profitabilityandlaborproductivity.|Concentrated ownershipisfound tobe linked<sup>with</sup><br>higherprofitability andlaborproductvity.Theauthors<br>alsofind thatnon-bank-sponsoredinvestment<sup>funds</sup><br>improveperformancemorethanbank-sponsored<br>funds.|
|Djankov,<br>Simeon.<br>1999a.<br>'Ownership<br>Structure<br>and<br>Enterprise<br>Restructuring<br>inSix<br>Newly<br>Independent<br>States."<br>_Comparative_<br>_Economic_<br>_Studies._<br>41(1):75-95.|Theauthorexaminestherelationship<br>betweenownership structureandfirm<br>restructuringforGeorgia,Kazakhstan,<br>KyrgyzRepublic,Moldova,Russiaand<br>Ukraine. Thesample contains960firms<br>privatized between1995and1997in<br>these countries.|It isfoundthatwhen foreignownershipissignificant<br>(greaterthan30percent),itispositivelyrelated<sup>to</sup><br>restructuring.<br>Managerialownership ispositively<br>relatedtorestructuringatlowlevels(lessthan<sup>10</sup><br>percent)andhighlevelsofownership, but<sup>isnegative</sup><br>inbetween.<sup>Employeeownershipisfoundtobe</sup><br>insignificant exceptatlowlevelsofownership<sup>where</sup><br>ithasa positiveeffect.|
|Djankov,Simeon.<br>1999b.'The<br>RestructuringofInsider-Dominated<br>Firms:A ComparatveAnalysis.'<br>_EconomicTransition._7(2):467-479.|Usingthesamesurveydataasabove<br>thisstudylooksattheeffectsofdifferent<br>privatzationpattemsonthe processof<br>restructuring.Georgia(92firms)used<br>voucher<br>privatizaon,<br>while<br>most<br>Moldovanfirms(149firms) wereeither<br>purchasedbyinvestment fundsorsold<br>forcashtomanagers.|Managementbuy-outsarepositivelycorrelated<sup>with</sup><br>enterpriserestructuring.Firmsthatare<sup>privatized</sup><br>throughvouchersdonotrestructureanymorerapidly<br>thanstateowned firms.Thisimplies that incentives<br>torestructureareweakerwhenmanages<sup>aregiven</sup><br>firmsforfree,sincetheir incomeisnotwholly<sup>based</sup><br>onthesuccessofthe firm.|
|Djankov, Simeon,andPeter Murrell.<br>2000.<br>_The_<br>_Determinants_<br>_of_<br>_Enterprise_<br>_Restfucturing_<br>_in_<br>_Transition:AnAssessmentofthe_<br>Evidence.<br>WashingtonD.C.:The<br>World Bank(seealsoDjankov,<br>Simeon,andPeterMurrell.2000.<br>'Enterprise<br>Restructuring<br>in<br>Transition:AQuantitatieSurvey."<br>WashingtonD.C.:TheWorld Bank).|Theauthorsidentfiedmorethan125<br>empiricalstudiesthatexamine<br>the<br>determinantsofenterpriserestructuring.<br>Thepaperprovidesacomprehensive<br>reviewoftheempirical<br>results<br>of<br>privatizationin<br>transitOneconomies<br>usingthedatageneratedby these<br>studies.|Privateownershipproduces morerestructuring<sup>than</sup><br>state-ownershipinCentraland EastemEurope.<sup>In</sup><br>contrast, evidenceismixedfor theCommonwealthof<br>IndependentSates(CIS)countries. Theprivatization<br>effectinthenon-CIScountriesismorethantwice<sup>the</sup><br>sizeofthatintheCIScountrles. Privatization<sup>to</sup><br>foreign ownersisten timesasproductive<sup>as</sup><br>privatkationto diffuse indMdualowners.<sup>State</sup><br>ownershipwithintraditionalstatsfirmsisthe<sup>least</sup><br>effectivetypeofownership.<br>State ownershipin<br>commercialized<br>enterprises,<br>however,<br>isquite<br>effective.Productmarketcompetitionhas beena<br>majorforcebehind improvements<br>inenterprise|
38

|Authors|Methodology|MainFindings|
|---|---|---|
|||productvityintransitoneconomies.Privatzabon,<br>hardenedbudget constraints,andproductmarket<br>competitionallappeartobeimportantdeterminants<br>ofenterpriserestructuringinnon-CIScounbies,while<br>theyareless obviouslysointheCIS.Theevidence<br>suggeststhatthedifferenceinimpactisdueto the<br>varying degreeofinstitutionaldevelopmentbetween<br>theregions.|
|Djankov,<br>Simeon,<br>and<br>Gerhard<br>Pohl.1997.'Restructuringoflarge<br>FirmsinSlovakia.'<br>The William<br>DavidsonInshtuteWorkingPaper<br>No.73.The UniversityofMichigan<br>BusinessSchool.|Thispaper recordstherestructuring<br>actionsandownershipchangesoffirms<br>inSlovakia. Thecase studieswere<br>selectedtogiveawiderangeofinitial<br>conditions,andprivatizabontechniques.|TheauthorsfindthatthemajorityoflargeSlovak<br>firmshavesuccessfullyrestructuredwithouttheneed<br>for<br>foreign<br>investors<br>and<br>govemment-led<br>restructuring<br>programs.<br>Also<br>they<br>find<br>that<br>privatizabonto insidersdidnothamperrestructuring<br>asthemanagers investedheavilyinnew technology,<br>laidofflargenumbersofworkers, lookedforforeign<br>partners and wereprepared tosellcontrollingstakes<br>to outsidersin retumfornewfinancialresources.<br>These findingssupportthe viewthatprivatzabon<br>programs<br>should<br>aim<br>to<br>speedily<br>transform<br>ownershipandnotbeoveriyconcemed withthe<br>selectionofperfectowners.|
|Earle,<br>John.<br>1998.<br>'Post-<br>Privatizabon<br>Ownership<br>and<br>Productivity<br>inRussianIndustrial<br>Enterpnses.<br>_SITE WorkingPaper_<br>_127._<br>Stockholm,<br>Sweden:<br>Stockholm<br>InstituteofTransibon<br>Economics.|Looksintotheownership structureand<br>its impactuponlaborproductivityin<br>Russian industrialfirms.Thesurvey<br>sample<br>indudes86 firmsthatwere<br>100%<br>state-owned,<br>299<br>that<br>were<br>partiallyprivatizedand45thatwere<br>newlycreated.The1994surveydata<br>examinestheimpactsofinsider,outsider<br>or<br>state<br>ownership<br>upon<br>the<br>performanceofthefirm.|Theauthors use ordinaryleastsquaresregressionto<br>showapositveeffectofincreasedprivateownership<br>uponlaborproductivity.<br>Howeveronlyoutsider<br>ownershipissignificantiyrelated withsuchchanges.<br>The authorsconcludethatplacinginsidersin control<br>ofafirm hasnegativelong-runimplicabonsfor<br>restructuring.|
|Earle,JohnS.,andSaulEstrin.<br>1998.'Privatization,<br>Competition,<br>andBudgetConstraints:Disciplining<br>Enterprises<br>in<br>Russia.'<br>_SITE_<br>_WorkingPaper128._<br>Stockholm,<br>Sweden:<br>Stockholm<br>Institute<br>of<br>TransitionEconomics.|Theauthorsuseda 1994survey datato<br>examine<br>whether<br>privatization,<br>competitionandhardeningof budget<br>constraints<br>play<br>efficiency-enhancing<br>rolesinRussia.|They findthat10percentagepointincreaseinprivate<br>share ownership raisesrealsalesper employeeby<br>3-5<br>percentage<br>points.<br>Subsidies(soft<br>budget<br>constraints) reducethepaceofrestructuringinstate-<br>ownedfimis.|
|Dyck,<br>I.J.<br>Alexander.<br>1997.<br>'PrivatizationinEastemGefmany,<br>Management<br>Selection<br>and<br>EconomicTransition.'<br>_Amrencan_<br>Economic_Review._87:565-597.|This study looks intotheTreuhand'srole<br>inrestructuringandprivatizingeastem<br>Germany's<br>SOEs.<br>The Treuhand<br>is<br>uniqueinthatitprivatizedmorethan<br>13,800firmsandpartsoffirms andhad<br>the resourcestopayfortherestructuring<br>itself,but neveractuallydidso.Insteadit<br>soldquicklytoexistingwestem firms<br>ratherthangivingtheSOEsawayor<br>sellingthemtocapitalfunds.|Theauthorattemptstorabonalizethis approachand<br>findsthatthosefirms ownedbywestemfirmswere<br>much morelikelytobringinwestem managersinto<br>key positionthanSOEs.Treuhand isalsofoundto<br>haveattemptedtoopensalestoallbuyersrather<br>thanfavoringeastem<br>Germans.<br>Incondusion<br>privatization plansthatareopentowestembuyers<br>andallowmanagementchangearemorelikelyto<br>exhibitimprovedperformanceinthefirm.|
|Fischer,Stanley,andRatnaSahay.<br>2000.'TheTransitionEconomies<br>AfterTenYears.'<br>_IMFWorking_<br>_PaperWP/O/30._WashingtonD.C.:<br>IntemabonalMonetaryFund.|Thepaper<br>summarizes<br>the<br>macro-<br>economicperformanceofthetransition<br>economies,accountingforthewidely<br>differing outcomesinthe25countries<br>coveredinthestudy.|Themostsuccessfultransitoneconomiesarethose<br>that havebothstabilizedand undertakencon-<br>prehensivereforms,andthemoreandfasterreform<br>isbetterthanlessandslowerreform.<br>Thestudyconcudesthatbothstabilizationpolices<br>andstructuralreforms,inparticularprivatization,<br>contributetogrowth.|
|Frydman,<br>Roman,<br>Cheryl<br>Gray,<br>Marek<br>Hessel,<br>and<br>Andrej<br>Rapaczynski.<br>1998.'TheUmitsof<br>Discipiine:<br>Ownershipand<br>Hard|A<br>sample<br>of<br>medium<br>sized<br>manufacturing<br>firms<br>in<br>the<br>Czech<br>Republic,Hungaryand Polandisusedin<br>ordertodiscovertheimpactoffinancial|SOEs are foundtorepresentsignificantlyhigher<br>credit risksthan privateorprivatizedfifnsdueto<br>inferiorrevenueperformanceandthesofterbudget<br>constraintstheyface.Sincebothofthese factorsact|
39

|Authors|Methodology<br>|MainFindings<br>|
|---|---|---|
|BudgetConstraintsintheTransiton<br>Economies.'_Mimeo._<br>htto:/Iwww.ihs.ac.at/oublications/tecj<br>te-5.od|discipline<br>on<br>govemance<br>related<br>defidencies.Theauthors arguethat<br>although<br>financial<br>discipline<br>restrict<br>waste<br>and<br>force<br>better<br>cost<br>management,thereis alimitto whatit<br>canachieve.Instead theyputforward<br>thatthefirm's ultimate successisdueto<br>thelevelofinventiveness,creatvityand<br>readinesstoacceptrisk.|intandemitis notsimplyenoughtoimposeharder<br>budget constraints while the SOEissUIllnotable<sup>to</sup><br>generateenough revenueto repayobligations.<sup>The</sup><br>authorsthereforerecommendthatbudgetconstraints<br>shouldonlybehardenedifaccompaniedby<sup>speedy</sup><br>privatizabon.|
|Frydman,<br>Roman,<br>Cheryl<br>Gray,<br>Marek<br>Hessel,<br>and<br>Andrej<br>Rapaczynski.<br>1999.VVhenDoes<br>Privatization Work?TheImpactof<br>PrivateOwnershiponCorporate<br>Performance<br>in<br>Transition<br>Economies."<br>_QuarterlyJoumal_of<br>_Economics._114(4):1153-1191.|Compares theperformanceofprivatized<br>andstatefirmsintheCzechRepublic,<br>HungaryandPolandusingasampleof<br>218mid-sizedmanufacturing firms.90of<br>these firms wereunderstatecontroland<br>128hadbeenprivaUzed.Thereport<br>focusesonfour aspects ofperformance:<br>sales<br>revenue,<br>employment,<br>labor<br>productivity,and<br>laborandmaterial<br>costs.Theauthorsemploypaneldata<br>regression<br>in<br>order<br>tosingle<br>out<br>ownership effects.|Theevidenceinthereportsuggeststhatfirmsthat<br>areprivatizedandcontrolledbyoutside owners<br>experience enhanced revenueand productivity,while<br>those controlled<br>byinsidersdo notseeany<br>significant difference.<br>Domesticfinancialcompaniesandforeignowners<br>add18and 12percentagepoints respectively<sup>tothe</sup><br>annualgrowthrateofthefirm.Outsideownersalso<br>add9percentagepoints toproductivitygrowth.Other<br>findings concludethatthesegains donotcomeat<br>the expense of increasedunemploymentandthat<br>insidercontrolledfirmsaremuchless likelyto<br>restructure.|
|Frydman,Roman, MarekHessel,<br>and AndrzejRapaczynski.<br>2000.<br>'Why<br>Ownership<br>Matters?<br>Entrepreneurship<br>and<br>the<br>Restructuring<br>of<br>Enterprises<br>in<br>CentralEurope."<br>_TheCenterfor_<br>_Law andEconomicStudiesWorking_<br>_Paper172._<br>NewYork:Colombia<br>UniversitySchoolofLaw.|Thestudy looksatsurveydata from506<br>manufacturing<br>firms<br>inthe<br>Czech<br>Republic,<br>Hungary<br>and<br>Poland.<br>Comparesoutsider,insider, andstate<br>ownership effectson entrepreneurship<br>by lookingatabilitytoincreaserevenues<br>inprivatzedfirms.|Theauthorsfindthatallstateandprivatized<sup>firms</sup><br>conductsimilartypesofrestructuring.Firmsowned<br>by outside investors havesignificantlybetter<sup>results</sup><br>whenconductingproductrestructuring. Theauthors<br>concludethatoutsiderownedfirmsare<sup>more</sup><br>entrepreneurial duetoincentive,rather thanhuman<br>capita,effects thatarebroughtaboutbypnvatizaon.|
|Frydman, Roman,CherylW.Gray,<br>Marek<br>Hessed,<br>and<br>Andrzej<br>Rapaczynski.<br>1997.<br>'Private<br>Ownership<br>and<br>Corporate<br>Performance:SomeLessonsFrom<br>Transition<br>Economies.'<br>_Policy_<br>_Research_<br>_Worling_<br>_Paper1830._<br>WashingtonD.C.:WorldBank.<br>httn://econ.worldbank.orn/docs/628.<br>Ddf|The studyIsbasedonalargesampleof<br>mid-sizedfirmsintheCzechRepublic,<br>HungaryandPoland.<br>Itcomparesthe<br>performanceofprivatizedandstate<br>firms.|Thereisstrongevidencethatprivateownership-<br>except workerownership-dramatically<sup>improves</sup><br>corporate performance.Privatzatonis<sup>associated</sup><br>withemplomentIncreases.|
|Groves,Theodore, Yongmiao Hong,<br>JohnMcMillan,andBarryNaughton.<br>1994.'AutonomyandIncentivesin<br>Chinese<br>State<br>Enterprises."<br>_QuarterlyJoumalofEconomics._<br>109:183-209.|This<br>studylooksatchanges<br>that<br>occurredInChinesefirmswhenoutput<br>decisions<br>were<br>shifted<br>from<br>the<br>govemment tothefirm,andwhen firms<br>were allowedtoretainmoreoftheir<br>profits.|Theyfindthatthisledto managerspayingmore<sup>in</sup><br>bonusesand hiringmoreworkerson<sup>fixed-term</sup><br>contracts.Theseincentivesledtoan<sup>increasein</sup><br>productvity.Thegreaterautonomytherefore<sup>raised</sup><br>workers' wages andinvestmentinthefirm.|
|Havrylyshyn,Oleh,<br>andDonald<br>McGettigan.<br>1999."Privatizationin<br>TransitionCountries:ASamplingof<br>theLiterature.-_IMFWorkingPaper_<br>WPW99/6.<br>Washington<br>D.C.:<br>IntemationalMonetaryFund.<br>httoJ/twww.imf.orafextemaUlubslftw|The paper reviews aseleclonofstudies<br>onprivatizationexperiencesintransition<br>countries.Astransitonhascontnued<br>andas moreempiricalstudieshave<br>beenundertaken,itappearsthatthe<br>viewthatprivatization wasnotcentralfor<br>restructuring and firmperformance has<br>beenlargely discredited.|Twodearlessonsemergefromthe literature:<br>Privateenterprisesalmostinvariablyoutperform<br>state-run<br>companies,<br>In<br>other<br>words,<br>any<br>privatizationisbetterthannone, regardlessof<br>whetherastable, competidveenvironment has<sup>been</sup><br>establishedfirstornot,<br>Privatecompaniesthatstartedfromscratch rankas<br>thebestperformers,followed bynewly privatized<br>firmsrunbyoutsiders, eitherlocalorforeign.<br>Privatzedcompanies dominatedbyinsiders are<sup>least</sup><br>effidentandproductive,buteventhese regularly<sup>do</sup>|
40

|Authors|Methodology|MainFindings|
|---|---|---|
|||betterthanstate enterpnses.<br>Itis temptingto conclude thatthe general marketand<br>compettiveenvironmentismoreimportantthanthe<br>methodofprivatzabon.Eventually, evidencemay<br>supportthis,butthe research sofardoesnotpenmit<br>suchaconclusion.Twofindingsargueinfavorofit:<br>(I)start-up firms outperform othersnomatterwhat<br>prvatizationmethodisused; and(ii)thesuccessof<br>CentralEuropean privatesectordevelopmentrelabve<br>totheformerSovietUnioncountriespartlyreflectsa<br>betterpropertyrights businessenvironmentPerhaps<br>themostImportantlessonafteradecadeoftransition<br>inthecentrallyplannedeconomiestomarket-<br>oriented systemsisthat pnvate sector development<br>cansurelyberatedasuccess.Despiteahandfulof<br>reversalsas wellasslowdownin1998,most<br>transiboncountriesarenowrecordingposibivegrowth<br>inoutput-thebottomlineindicatoroftrendsin<br>efficlency.|
|Komai, Janos.2000.'TenYears<br>after'TheRoadtoaFreeEconomy':<br>The<br>Authors<br>Self-Evaluation."<br>_WorkingPaper._<br>Cambridge,MA:<br>Harvard University.<br>http)://www.woridbank.or/research/<br>abcde/washinaton12/Idffiles/10ve<br>ars.odf|Looks atthepnvabzabonprocessin<br>Hungary.|The authorsuggeststhathardbudgetconstraintsare<br>justas important aspnvatzation,liberalizabonand<br>stabilization.<br>He<br>argues<br>that<br>harder<br>budgets<br>constraintsactasaselectionprocess. Thosethatare<br>profitablecanbesold,whilethosethatarenotmust<br>beallowedtogobankrupt ratherthanbegivenaway.|
|Lizal, Lubomir, MiroslavSinger,and<br>Jan<br>Svejnar,<br>2001,<br>'Enterprise<br>Break-upsandPerformanceDuring<br>theTransitionfrom PlantoMarket,"<br>_Review_ofEconomics_and_Statistics.<br>83(1):92-99.|Thisstudylooksattheeffecton<br>performanceeffectsthatthebreakupof<br>CzechoslovakSOEshadincludingboth<br>themasterfirmandthespin offs.The<br>samplecontains635 firmsfrom1991<br>and1992.|In1991itisfound thatthebreak-upshadposibve<br>effectsstraightawayforbothmasterandspinoffif<br>thefirmwaseithermediumorsmallinsize.Larger<br>firms sufferednegative effects.Therearesimilar<br>results forthe break-upsthatoccurredin1992 but<br>theyarenotstatisticallysignificant|
|Nellis, John.1999.'TimetoRethink<br>Privatzation<br>in<br>Transiton<br>Economies?"_IFCDiscussionPaper_<br>38.WashingtonD.C.:Intemabonal<br>FinanceCorporabon.<br>httD:/ww.ifc.or/economics/Dubs/d<br>D38/dr38.pdf|Thepaperreviewstheaccomplishments<br>andshortcomingsofprivabtzabon<br>in<br>transitioneconomies.|CountriesinCentralandEastemEuropeand the<br>Balficstates- closergeographically,historicallyand<br>culturallytoWestemcommercialtraditions<br>and<br>markets- havegenerallyprivatzedmoreswiftlyand<br>withmuchbetterresults than theirmoreEastem<br>counterparts.Toomuchwas expectedandpromised<br>ofprivatizationininstitubonallyweaktransibon<br>economieswherethespeedy,massive,insider-<br>orientedformsofprivatizabon havegenerallynot,so<br>far, ledto the restructuringrequiredtoallow firmsto<br>surviveandthriveincompebtive marketoperabons.<br>Re-nabonalizationwould beadesperatemeasure,<br>withahighlikelihoodoffailurebecause theforces<br>andcondibonsthatleadgovemmentstofailin<br>privatzabonarethesamethatprevent effectiveand<br>efficientSOEmanagement|
|Pinto,Brian,<br>Marek<br>Belka,and<br>Stefan<br>Krajewski.<br>1993.<br>"TransformingStateEnterprisesin<br>Poland: EvidenceonAdjustmentby<br>ManufacturingFirms."<br>Brookings<br>_Papers_onEconomic_Activity._<br>1:<br>213-270.|Thisstudysurveys<br>75SOEsfrom<br>Poland from5differentmanufacturing<br>sectorscoveringtheperiod1989-1992.<br>Thisperiodlooksatthe6monthspriorto<br>thereformprogramandtwoandahalf<br>yearsintoit.Atthestartofthesurveyall<br>ofthefirms**were**SOEs.By1992,3had<br>beenprivatized and24commercialized.|TheexperiencesofPolandshow thatrapidchange<br>ofownershipcanhavevaluable effectsbygiving<br>unambiguoussignalschangingrelative pricesand<br>indicatingacommitment tohardbudgets. Thestudy<br>alsoshowsthatrestructuringbeforeprivatzationcan<br>haveanimpactthatisjustasgreat.|
|Pivovarsky,Alexander.2001.'How<br>Does<br>Privatzaton<br>Work?|This paperusesdatafrom376medium<br>and<br>large<br>Ukrainian<br>enterprises<br>to|Theauthorsfind thatownership concentrationis<br>positivelycorrelatedwithenterpriseperformancein|
41

|Authors|Methodology|MainFindings|
|---|---|---|
|Ownership<br>Concentration<br>and<br>EnterprisePerformanceinUkraine."<br>IMF<br>Working<br>Paper<br>WP/01/42.<br>Washington<br>D.C.:<br>Intemational<br>MonetaryFund.|investigatethe relabonship<br>between<br>ownership concentrabonand enterprise<br>performance.|Ukraine,andthatownershipbyforeigncompanies<br>and banksisassociatedwithbetterperformance<br>over domesticowners.|
|Pohl,Gerhard, RobertE.Anderson,<br>Sbjn<br>Claessens,<br>and<br>Simeon<br>Djankov.<br>1997.'Privatzatonand<br>RestructuringinCentralandEastem<br>Europe:<br>Evidence<br>and<br>Policy<br>Options."<br>_WorldBankTechnical_<br>_Paper368._WashingtonD.C.:World<br>Bank.<br>htto://www.worldbank.oro/ecspflfinal<br>/htmll/aDers/entr509.htrm|Thestudyanalyzesthefinancialand<br>operabng data (1992-1995)formore<br>than6,300 industnal firmsinseven<br>countries:<br>Bulgaria,Czech<br>Republic,<br>Hungary,<br>Poland,<br>Romania,<br>Slovak<br>Republic,andSlovenia. Aneconometric<br>analysismeasuringchangesintotal<br>factorproductivityisusedtoidentfythe<br>govemment<br>polides<br>that<br>most<br>encouragedfirmsto restructure.|Privatizabonhasalarge impactonrestructunng.On<br>average,afirmthathas beenprivahzed forfour<br>yearswillincreaseproductivity3-5tmesmorethana<br>similarfirmthatisstilinstateownership.|
|Sachs,Jeffrey,CliffordZinnes,and<br>YairEilat<br>2000.'TheGainsfrom<br>Privatzation<br>in<br>Transition<br>Economies:<br>Is<br>Change<br>of<br>Ownership<br>Enough?"<br>_CAER_<br>Discussion_Paper_63.Cambridge,<br>MA:<br>Harvard<br>Institute<br>for<br>IntemationalDevelopment.<br>httn://www.hiid.harvard.edu/caer2/ht<br>mlcontentl)aoers/confoubs/laoer63<br>/paoer63.pdf|The authors<br>examinetheempirical<br>evidence<br>across<br>24<br>countnes<br>to<br>determinewhetherchange-of-btlealone<br>hasbeensufficienttoachieveeconomic<br>performance<br>gainsorwhetherother<br>factors<br>(e.g.<br>institubons<br>toaddress<br>agency<br>issues,<br>hardening<br>budget<br>constraints,market compebtiveness,and<br>depolitisizabonoffirmobjectivesaswell<br>as<br>theimplementabon<br>challenge<br>of<br>developinginsfitutionsandaregulatory<br>framework<br>to<br>address<br>them)<br>are<br>important|Privatzatoninvolvingchange-of-titlealoneisnot<br>enough<br>to<br>generate<br>economic<br>performance<br>improvements.Whilereformsdirectedatprudental<br>regulation,<br>corporategovemance,<br>hardeningof<br>enterprise<br>budget<br>constraints,<br>management<br>objectves,anddeveloping capital marketscontribute<br>toeconomicperformanceontheirown, therealgains<br>toprivatzaboncomefromcomplementingtheabove<br>with change-of-Utlereforms. Thehigherthe levelof<br>prerequisitereforms, the<br>more posibveisthe<br>economicperformanceimpact fromanincreasein<br>change-of-tite privatzabon.Infactthestudyfindsa<br>thresholdlevelofreformsinorderforchange-of-tiUle<br>privatization<br>to<br>have<br>a<br>posibve<br>economic<br>performanceresponse.Theconclusionisthat while<br>ownershipmatters,insttubonsmatterasmuch.|
|Shirley, MaryM.,andUxinCoinXu.<br>2000.<br>'Empirical<br>Effects<br>of<br>Performance Contracts: Evidence<br>fromChina.'Paperpresentedata<br>Senior<br>Experts'<br>meeting<br>on<br>Corporate<br>_Govemance_ofState-<br>_owned Enterpnses_<br>_inChina_in<br>Beijing, onJanuary18-19.2000.|Thisstudyexaminestheperformance<br>contracts issuedinChinaandtheir<br>effectsonproductvity.|The large sampleofmanufacturingfirms shows that<br>on<br>average<br>these<br>contracts donotimprove<br>performance. Howeverimprovementsdidoccurin 38<br>percentofthefirmsinthestudy,and theseoccurred<br>wheretheperformancecontract providedsensible<br>targets, strongerincentives,longerterms andwere<br>basedinmorecompetitive industries.|
|Smith,StephenC.,Beon-CheolCin,<br>and<br>Milan<br>Vodopivec.<br>1997.<br>'PrivatizationIncidence, Ownership<br>Forms,<br>and<br>Firm<br>performance:<br>EvidenceFromSlovenia.'<br>_Joumal_<br>of_Comparative_Economics.<br>25:<br>158-179.|Thisstudy examinestheimpactof<br>foreignandemployee ownershiponfirm<br>performanceusingasampleof22,735<br>firm-yearsofdatafromSlovenia(1989-<br>1992).|The authorsfindthataone percentagepoint<br>increaseinforeignownershipbringsabouta 3.9<br>percentincreaseinvalue-added, while employee<br>ownershipadds1.4percenttovalue-added. Firms<br>withhigher revenues, profits andexportsarealso<br>foundtobemorelikelyto haveforeignandemployee<br>ownership.|
|D.DevelopedCountries|||
|Allen,Franklin,andDouglasGale.<br>1999.'Corporate Govemanceand<br>Competition.'<br>Working<br>Paper.<br>Philadelphia,PA Wharton School,<br>TheUniversityofPennsylvania.<br>htto:/ffic.wharton.upenn.edufficlwfic;/<br>vaoers/99/9928.0df|Anoverviewoftheeffectivenessof<br>different<br>corporate<br>govemance<br>strategiesandcompetiion.|Thecorporategovemance systemsoperaingin<br>differentcounbriesaredistinct.IntheU.S.and U.K.it<br>isoftenarguedthatthethreatoftakeoverensures<br>managersactintheshareholders'interests.In<br>countriessuchas Germany, Japan,and Franceitis<br>suggestedbanksandotherinstitutionsactas<br>monitors.Thereissomeevidencethatneither<br>systemisparticularlyeffectve.Theauthors argue<br>thatcompetitonamong firmsmaybemoreeffective<br>thaneitherofthese mechanismsinensuring that<br>resourcesareusedefficenUy.|
42

**Authors Methodology Main Findings** Boardman, Anthony E., Claude This study looks at the performance<sup>of</sup> Retum on sales or assets more<sup>thandoubleafter</sup> Laurin, and Aidan Vining. 2000. nine Canadian firms privatized between privatzabon and efficiency, sales and capital Privatization in Canada: Operating, 1988 and 1995. A variety of 3-year post spending also increase significantly.<sup>Leverageand</sup> Financial and Stock Price privatzation ratios are compared<sup>to5-</sup> employment decline significantly as well.<sup>Overlong-</sup> Performance With intematonal year pre pnvatizabon values. Long-run term periods the privatzed firms outperform<sup>the</sup> Comparisons.' _Working Paper._ stock retums are also calculated<sup>forthe</sup> Canadian stock market University of Britsh Columbia, divested firms. Vancouver. Davidson, Richard. 1998. 'Market The author examines SIPs from Austria, The results show a long period of market Analysis: Underperformnance Over?' France, Italy, Spain and the UK,<sup>looking</sup> underperformance (1-1.5% p.a.)<sup>untilthelast12</sup> _Privatisation Intemational_ Yearbook. partcularly at 1, 3, 5, and 10 year<sup>market</sup> months of the study where SIPs outperform London: IFR Publishing. adjusted retums. The study focuses<sup>on</sup> European market averages. the period up unbl March 1997. Kay, J.A., and D.J. Thompson. An overview of privatizabon in Britain. This report concludes that while<sup>privatizabonin</sup> 1986. 'Privatisabon: A Policy in Britain has been the most popular<sup>wayinwhichto</sup> Search of a Rationale.' Economic boost the performance of previously<sup>state-owned</sup> _Joumal._ 96:18-32. enterprises, the promoton of<sup>compebboncanhave</sup> effects that are just as beneficial. This is<sup>particularly</sup> true if a natural monopoly exists within a<sup>particular</sup> industry. Franchising in particular is an effective<sup>way</sup> of introdudng competbon. The main difficulty<sup>in</sup> achieving this is resistance from the<sup>incumbent</sup> management which, the authors argue,<sup>iswhy</sup> privatizabon has become such a widespread<sup>means</sup> of improving SOE performance.