Transitional privatization

Jorn writes*

Privatization has occurred in many countries and throughout different types of economies, but is most prominently featured in transitioning economies that move from a planned system to a market-led one. There are multiple ways to go about privatization. Which methods are employed determines for a large part which types of stakeholders are advantaged. This impacts ownership structures and consequently efficiency. The goals of economic growth and development are often at odds when choosing between methods.

This post first discusses common privatization methods. Secondly, it addresses the main considerations for governments deciding between these methods. Finally, it highlights the tension between growth and development.

Common forms of privatization are the public sale of shares and auctions of whole companies. The former enables more citizens to take part in the privatization, but risks dispersion, which tends to inhibit restructuring efforts. The latter is expected to create the highest value for the government and more efficient business governance, as ownership is with a large party that can easily replace inefficient managers.

When companies have a strategic importance, states often privatize via public tenders or direct negotiations. Their benefit is the control the government exerts over assets vital to the country and the guarantee that companies will have large ownership blocks, allowing for restructuring. It is also easier to limit foreign influence via these methods. A downside is that these processes are easy to be politicized, which creates advantages for the incumbent political elite.

A final method, employed especially in former Soviet and other Eastern European countries, is the use of voucher sales [pdf]. This process entails handing out vouchers with which citizens/employees can obtain ownership of companies. Many former Soviet states chose this method because most citizens possessed too little capital to obtain shares via other methods. The advantage therefore is that equality is promoted. The disadvantage is that the market process has no influence here, thus companies may not be obtained by the most efficient owners.

The dominant literature on privatization argues that private ownership is more efficient than state ownership; management ownership more than employee ownership; outsider ownership more than insider ownership and foreign ownership more than domestic ownership. See for more information this EOCD report on privatization in the Baltics [pdf].

Employees have incentives that collide with profit-maximization, such as the will to retain jobs and high wages. Managers have these incentives to a smaller extent, while the incentives of outsiders are likely to align most with profit maximization. In the case of poorer countries with weak institutions, foreign ownership provides a large advantage to enterprises. The foreign owners have better access to capital, management skills, and international business networks. However, political issues matter too. For privatization efforts to be feasible, they needs support from powerful groups in society and to some extent the population. Moreover, a government may be reluctant towards foreign ownership of its companies, as economic power often leads to political influence.

There thus exists a tension between development-oriented method and growth-oriented methods. The former stimulate for instance employee or management ownership, a form of more equitable, but less efficient ownership. The latter create ownership structures driven by primarily foreign investors. Although these are expected to be more efficient and thus stimulate economic growth in terms of production, they grant less benefits to ‘ordinary’ citizens and may slow down a country’s development.

Bottom line: The choice between methods of privatization is crucial, because it has a large impact on the ownership structure and subsequent development of enterprises. In many instances, growth and development will be at odds here.

* Please help my Growth & Development Economics students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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