Impact of Privatisation on the Poorest in Society

Topic: Discuss the view that ‘privatisation is bad for the poorest in society’ – refer to specific developing country examples, and explain the role of regulation.
Introduction
Since the early 1980s, Privatisation has been
pursued by many developing countries. This pursuit was often the result of Privatisation
being a condition for granting of much needed aid funds. However, there were
instances in which governments simply could not afford to keep subsidizing
State Owned Enterprises (SOE), and were unable to find the capital needed for
expansion. Hence, Privatisation gained favour as a means to reduce subsidies,
utilize private sector capital to fund expansion, and even benefit from
revenues raised by divesting assets, and in the longer term from tax revenues
from the now private enterprises. These cost savings and revenue additions may
then be used by governments to fund social spending to society’s benefit,
moreso the poorest. Notwithstanding, Privatisation can also have a negative impact
on the wider society, especially the poorest, contingent on how it is gone
about. For instance, it may leads to retrenchment and unemployment, or worsening
of distribution if the process is undermined by corruption, and state assets
gifted to small band of actors.

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Hence, it is important to examine the effect of Privatisation on developing societies’ poorest. The timely establishment of an effective regulatory environment can contribute significantly to how successful Privatisation is, both in terms of equity, and post-Privatisation firm performance. In this essay, theoretical arguments on the merits and demerits of Privatisation are first examined, after which three country cases are investigated, in the context of regulation’s impact on overall outcomes in Privatisation. Recommendations and Conclusions complete the exercise. Privatisation of public utility and infrastructure enterprises is the primary focus herein.
Literature Review
Privatisation became
the caveat of most international lending institutions, after the World Bank
voiced dissatisfaction with the performance of public sector enterprises,
especially those of Africa. Privatisation became seen as a way to sustain the
gains from public sector reform programs, because of how difficult it is to
reverse. (Bayliss, 2002).
The World Bank (2000,
p. 144) also assert that the provision of utilities such as power, water, and
telecommunications requires immense investment. Privatisation provides a means
for much of this funding to come from the private sector. Additionally, private
sector development should lead to increased revenues accruing to the state,
through taxation and the sale of assets, as well as through the reduction of
the obligation to invest in utilities provision.
Bayliss (2002) posits
that private sector development indeed aids economic growth, which is a
prerequisite for poverty alleviation, but claims there is no guarantee that Privatisation
would lead to private sector development.
Nonetheless, Bayliss
(2002) posits that Privatisation can yet significantly impact poverty, because
of it usually being a condition tied to aid funding release.
International financial
institutions such as the World Bank and the IMF (International Monetary Fund)
have historically ignored poverty impacts of Privatisation. This poverty
impacts slight is noteworthy, given the prominence of Privatisation in the structural
adjustment programs these institutions once championed; programs aimed at
alleviating the economic burdens of poor and heavily indebted countries.
However, around the
dawn of the 21st century, there was a shift to greater emphasis, at
least nominally, on the effects of Privatisation on poverty. This shift is
evident in the World Bank’s move from structural adjustment to poverty
reduction strategies, and the IMF’s replacement of Enhanced Structural
Adjustment Facilities (ESAFs) with Poverty Reduction and Growth Facilities (PRGFs),
in 1999. (Bayliss, 2002)
Notwithstanding,
Bayliss (2002) argues that the policies of these international financial
agencies remain staunchly neo-liberal in their orientation, prioritizing a
market-oriented economic approach. The characteristics of the new
poverty-centric programs remained strikingly similar to the previous structural
adjustment ones. The motivation behind these neo-liberal policies was the
belief that the pursuit of macroeconomic efficiency goals will see a concomitant
reduction in poverty.
Cook and Uchida (2001)
Argue that, contrary to the international lending agencies’ belief, the impact
of Privatisation on poverty is yet to be established empirically.
Birdsall and Nellis (2003) also challenge the rationale of international development financing institutions, and opine that the overarching goal of Privatisation is to secure efficiency gains. Any consideration of the distributional and poverty impacts of said Privatisation are addressed only in the context of making Privatisation more politically palatable. They argue that distributional and poverty issues are addressed specifically through fiscal actions of government, such as spending and taxation, as well as regulation.
In Privatisation,
distributional effects pertain to the welfare impacts on different income
groups or households. These groups would be affected through the price levels
they face, access to services, and their income streams, all variables affected
by Privatisation.
Birdsall and Nellis
(2003) employ a framework that juxtaposes the divergent pursuits of
distribution and equity, through an efficiency-equity trade-off. The framework
posits that a perfectly competitive economy operating at its production
frontier, can only efficiently redistribute resources through lump sum
transfers which do not affect incentives, prices, and other economic
considerations. Ceteris Paribus, a movement along the frontier in the direction
of greater efficiency will necessarily result in reduced equity and vice versa.
(See Figure 1 in
Appendix). However, the economies of most developing and transitioning
countries do not operate as efficiently as the more industrialized developed
nations; they do not ordinarily operate very close to their production
frontier.
Hence, the dual goals
of increased economic efficiency and increased equity may be simultaneously
pursued (See Figure 2
in Appendix). This implies that in developing countries, Privatisation can be a
win-win for private interests and society’s poorest.
The distributional
impacts of Privatisation depend on the nature of the enterprises being
privatized. If the privatizing enterprise provides a utility service, then
there are potentially great impacts on the quality of lives the poor lead,
since access to these services would be controlled by private hands, whose
primary motivation is profit maximization. Hence, examination of Privatisation’s
distributional impact is essential to determining whether Privatisation helps
alleviate, or exacerbate poverty (Bayliss, 2002).
Birdsall and Nellis
(2003) identify three determinants of the distributional impact of Privatisation;
the initial conditions, the sale event, and the post-Privatisation political
and economic environment. They also caution that the distributional impact of Privatisation
may be determined by the juncture at which the impact was measured. Hence,
generalizations about the distributional effects of Privatisation across countries
and over time are difficult. It is necessary for such conclusions to be
influenced by case examinations of events before, during, and after Privatisation,
in the context of the political and economic environment in which events
unfolded. With that being said, there is evidence that Privatisation in
developing countries can often both increase efficiency and equity, depending
on how effectively post-Privatisation considerations such as regulation and
competition are addressed.
Unfortunately, due to its
frequent placement as a conditionality for aid funding disbursement, Privatisation
is often rushed in developing countries. Competitive processes such as bidding
are often flouted, and the formation of a robust regulatory environment in a
timely manner, neglected. Emphasis is placed on ‘securing the deal’ vis a vis
ensuring the interests of all stakeholders are protected (Bayliss, 2002).
Privatisation and poverty
Bayliss (2002) argues
that Privatisation may adversely affect the poor because of the profit
motivation of private investors. This may result in investors ‘cherry picking’
which aspects of a utility service to invest in, and which customers to serve.
For instance, high value customers may be readily served, but expansion of
service to poorer communities could either be lethargic or non-existent
altogether. Hence, improvement of the living standards of the poor may be
stymied by private profit interests.
Also, donor funded Privatisation
is often accompanied by subsidy removals, since the goal is to engender fiscal sustainability.
These subsidies may have been serving the purpose of keeping prices low. Hence,
from a utility service perspective, removal may mean a hike in tariffs so that
the entity may be economically viable for private investors (Bayliss, 2002). In
addition, poor residential areas may not have the necessary network
infrastructure to facilitate utility service delivery. Further, the
installation of such networks can be prohibitively costly. Thus, the poor face
continuous exclusion because of their inability to afford the set-up/connection
tariffs. (Bayliss, 2002).
Birdsall and Nellis
(2003) have a more optimistic disposition on Privatisation’s impact on access. They
posit that Privatisation of utilities often leads to a rapid increase in
access, especially for the urban poor; the rural poor usually face continued
exclusion even after Privatisation. This increase in access results from the
strategic decision of private interest to expand market reach, in order to
boost revenues. Another potential reason for post-Privatisation expansion is
the inclusion of service and network expansion clauses in the sale contracts to
private investors. From a Latin American perspective, Privatisation in all of
Peru, Mexico, Argentina, and Bolivia, resulted in increased access to the poor (Birdsall
and Nellis, 2003). In cases where an increase in access isn’t followed by steep
increases in price, Privatisation has a positive distributional impact.
However, Birdsall and
Nellis (2003) agree with Bayliss (2002), in acknowledging the potentially
hazardous effects of Privatisation-related price increases on the poorest. Such
increases usually result either because it is imperative for the private owner
to hike tariffs to levels that allow cost recovery, or because of poor and
ineffective regulation. Steep price increases worsen distribution in the
society, and increase inequity, as was the case in Peru (Birdsall and Nellis,
2003). In addition, post-Privatisation crack downs on illegal connections
represent a significant welfare loss to society’s poorest, assuming they used
the majority of the illegal connections. This was evident in the Case of
Argentina, where 436,000 of the 481,000 new electricity subscribers were from
those who held illegal connections prior (Delfino and Casarin, 2001, p. 23).
Most empirical evidence
suggests that Privatisation very often results in labour retrenchment and an
increase in unemployment, at least in the short run. The tendency is for
private investors to maintain the same level of output with less staff, in an environment
sans trade unions (Bayliss, 2002).  
As it pertains to
employment, Birdsall and Nellis (2003) noted a study of 308 privatized firms, in
which 78.4% of them saw post-Privatisation reductions in their staff complement,
with only 21.6% of them recording either no job losses or job gains. It was
concluded that in a general sense, the net effect of Privatisation on
distribution of income is negative, at least in the short run, thereby affirming
the submission of Bayliss (2002). Birdsall and Nellis (2003) also note that Privatisation
is usually accompanied by an increase in working hours, reduction in fringe
benefits, and vitiation of the security of tenure.
Lower skilled, lesser
paid employees may likelier be retrenched than higher paid, more skilled
workers. Even in the event that higher paid employees are retrenched, they may
find it easier to secure alternative, high paying employment, than their lesser
skilled counterparts. In the event that the aforementioned occurs, poverty and
inequality may increase.
Notwithstanding, Privatisation
advocates argue that restructuring and the resultant job losses are a temporary
cost, which would be repaid handsomely in the likely event that Privatisation
and economic reform lead to increased efficiency, output, investment, job
expansion and economic growth. Previously unemployed, low skilled workers may
then regain employment, at better rates. The long term socioeconomic effect
would be reduced unemployment and poverty, developments that would be
especially beneficial for the poorest in society (Birdsall and Nellis, 2003)
Developing country
governments often have inadequate social safety nets. As a result, de facto
measures such as allowing of illegal connections, and having an inflated public
sector staff complement are common. These are practices stridently criticized
by aid funding agencies such as the World Bank and the IMF. However, the
eschewing of such practices through Privatisation and other structural
adjustment initiatives, represents a significant welfare loss to the poor
(Bayliss, 2002).  
According to Birdsall
and Nellis (2003), if the assumption that private ownership results in
increased efficiency holds, then Privatisation can increase the returns to
physical capital, or profits. This increase can serve as a powerful incentive
to engender greater entrepreneurship, and the attendant benefits of increased
employment, higher incomes and innovation. However, if private interest focuses
more on ‘asset stripping’ than efficiency and innovation, the effects could be
negative, due to reduced profitability and firm closures. Megginson and Netter
(2001), in a review of 65 empirical studies that ranged across many sectors and
countries, asserted that privately owned firms are more profitable and
efficient than their state owned counterparts.
In the short run, Privatisation
effects government revenues through the receipt of funds from the sale of
assets. However, it is in the longer term that more substantial, lasting
benefits are accrued, such as increased tax revenues, and savings from no
longer having to subsidize state owned firms. Given that public expenditure in
developing countries is usually progressive, the savings and revenues that
result should lead to some amount of spending that benefits the poor.
 From a Fiscal standpoint, Privatisation may
affect the level of income in an economy through a differential reduction in
the society’s tax burden, and increase differential benefits through greater
expenditure on services such as education and healthcare, with funds previously
allocated to subsidies. The additional funds to education and healthcare could
also have been accumulated through tax revenues from now private enterprises. These
benefits would likely benefit the poor on a greater scale than the rest of
society (Birdsall and Nellis, 2003).
Privatisation and Regulation: Case Studies
Regulation is a
critical element of Privatisation. According to Bayliss (2002), a weak
regulatory environment, or the absence of regulation altogether, debilitates to
the government’s ability to sanction private sector excesses, and creates a
pathway for market abuses.
Bayliss (2002) asserts
that “it is not privatisation that will develop the private sector; rather it
is the government, through effective regulation”. Birdsall and Nellis (2003)
conform to the above assertion and claim that “The better the regulatory
regime, the better has been the distributional outcome from Privatisation of
electric power, telephones, water and sanitation”.
Cook (1999) notes that Privatisation
does not necessarily lead to competition, because new entrants may not be able
to achieve the economies of scale necessary for successful integrated service
provision, such as for telecommunication and power generation services. Hence,
regulation plays a critical role in preventing exploitation of consumers by
monopolies, while simultaneously encouraging efficiency of those entities.
Types of regulation
include price caps, which stipulate a maximum price that a service provider can
charge. Other types of regulation include rates of return and profit caps
(Cook, 1999). According to the World Bank (1995), price cap mechanism have been
instituted in the telecommunication industries of Argentina, Mexico, Venezuela
and Malaysia, while Chile adopted profit benchmark regulation. Jamaica adopted
a rate-of-return approach to the industry’s regulation.
Newbery (1994)
establishes two criteria for judging the effectiveness of a regulatory regime;
the extent to which it allows a utility to raise finance for investment at an
acceptable cost, and the extent to which it provides incentives for efficiency
in operation, pricing, investment and innovation.
Cook (1999) notes that
it is an uphill task for developing countries to implement regulation which
effectively governs prices, service quality and competition. Conversely, the Privatisation
aspect is usually much easier, as monopolies and anti-competitive practices are
commonplace in developing countries.
The three case studies
below, concerning Privatisation in Venezuela, Argentina and Chile, were
referenced from Cook (1999), to investigate the extent to which these
countries’ paths to Privatisation conformed to theoretical prescriptions.
Venezuela – Telecommunications
In the Case of
Venezuela, State-Owned CANTV provided telecommunications services from the
early 1950s, when it was nationalized. During the 1980s, there was a halt in
service expansion despite increasing demand, and a reduction in service
quality. Despite spiraling costs during the 1980s, tariffs remained stagnant.
The result was a decline in financial performance, and a state of affairs
whereby only 47% of the demand for new connections was met. There was also a
waiting period of 8 years for applications for new connections, 50% of public
phones were non-functioning and 19% of international calls succeeded.
The telecommunications
company underwent Privatisation through a process of competitive international
bidding, and was bought by an international consortium comprising both local
and international investors. A 40% stake was purchased for $1.885 billion,
which came with the rights to appoint 5 of the 9 board members. In a bid to
make the sale more palatable, the government of Venezuela agreed to assume 500
million dollars in Long term debt and interest fees.
Two steep increase in
tariffs just before Privatisation meant that the rate per line increased from
$275 in 1990 to $500 in 1992. Clear performance targets were established in the
sale contract, and a regulatory body (CONATEL) set up to monitor the
achievement of objectives.
CANTV’s early post-Privatisation
performance was deemed successful. There was an expansion target from 1.6
million lines in 1991 to 4.4 million by 2000. A preliminary target on the way
to that ultimate goal was achieved in 1993. During the 1992-1993 period,
413,000 new digital lines were installed and 210,000 new customers were
recruited. 18,400 new lines were installed, and the amount of lines out of
service fell by 70%.
Chile – Electricity
Before Privatisation,
electricity generation in Chile was done by a vertically integrated
monopolistic company. High transmission and distribution losses, and power
outages were commonplace. There was regulatory agency, but it was not politically
independent. Government was required to provide enormous subsidies to the
sector to ensure its continued existence. This figure reached levels of
approximately US 200 million, at about the 1970s.
Chile astutely
undertook regulatory reforms prior to electricity Privatisation, so that when
it came on-stream between the 1986-1989 period, there was already the
institutional framework in place to govern generation, transmission and
distribution of electricity. These oversight duties were to be performed by a
special regulatory body called the CNE. In addition, competition was encouraged
by breaking up the vertically integrated monopoly into smaller service
providers along the value chain. This entailed having separate companies for
generation, transmission and distribution.
Post-Privatisation,
electricity prices in Chile were regulated based on customer size. Distributors
were allowed to freely negotiate prices with large consumers, with demand of
more than 2 megawatts. Prices for smaller users were regulated by the CNE, as a
means of protecting the welfare of those without tremendous economic clout.
Electricity Privatisation in Chile led to efficiency gains, improved service
quality and reduced prices. The cost to consumers in 1981 was more than the
level at 1989, suggesting that efficiency gains were passed onto consumers. The
electrification drive gained momentum with the advent of Privatisation, such
that, by 1989, 97.9% of Urban Households and 62% of rural ones had access to
electricity. It was concluded that the benefits accruing to all stakeholders in
the electricity sector of Chile were attributable to regulatory reforms, as opposed
to Privatisation itself.
Argentina – Water
As at 1947, coverage
for water distribution in Buenos Aires (Argentina) stood at an impressive 97%
of households. However, the state owned enterprise responsible for water at the
time, found it difficult to meet increasing demand as time progressed. By 1980,
less than 60% of households had a water connection, and water quality was
spiraling downwards.
The government of
Argentina decided to privatize as a means of increasing efficiency, and to
pursue the expansion necessary to fulfill burgeoning demand.
However, before this
was undertaken, the necessary regulations were formulated, to protect the
interests of both the investors and consumers. 
These regulatory undertakings came at a cost of US$4 million dollars,
and took more than two years to complete. Finally, in 1993 the government
auctioned the water service delivery.
The winning investor
agreed to reduce prices by 27% from levels under public ownership, while investing
US200 million annually over the first 5 years. This figure represented an
astronomical increase from the levels under public ownership, which ranged
between US20 million to 40 million. Stipulations regarding expansion targets
were included in the service contract. After taking over the reigns, the
private investor embarked on a process to streamline operations and reduce
costs, which saw a 45% reduction in staff.
Discussion
In each of the
aforementioned cases, trying economic circumstances preceded Privatisation. The
circumstances bore implications on access to, and quality of service in all
three cases, as well as fiscal implications, as seen with the enormous
subsidies in the case of Chile. In all three cases, the governments’ rationale
for Privatisation centred around increasing efficiency, reducing fiscal burden,
and pursuing the needed investment capital for expansion.  
All three countries
were prudent in ensuring regulatory infrastructure was in place before
embarking on Privatisation, so that there would always be a watchdog to ensure
equity prevailed, and incentives for efficiency and performance were provided.
This regulatory step was in line with the recommendation of both Birdsall and
Nellis (2003) and Bayliss (2002). The implementation of these regulatory
regimes wasn’t a costless task; in the case of Argentina, it came at a price of
US4 million and two years. However, it was a small price to pay in the grand
scheme of things.
The state’s intention
to optimize revenues from the divestitures was evident in all three cases; each
country undertook a competitive process to effect the sale.
As it pertains to
access, again each country ensured that the interest of the poorest wasn’t
subordinated to private ownership’s profit interests, through the use of sale
contracts. These contracts stipulated specific expansion targets, so as to
ensure increased access, moreso to poorer communities. However, the concern of
continued rural exclusion to access, as outlined by Birdsall and Nellis (2003),
was evident in the Chilean experience.
With respect to prices,
in Venezuela’s case, the common practice of effecting a price increase just
prior to Privatisation, was employed. The likelihood of such an outcome was
addressed by both Bayliss (2002) and Birdsall and Nellis (2003). This was
probably done as an inducement to potential buyers. In the other two cases,
consumers saw a price reduction after Privatisation. One instance was due to
increased efficiency, and the other through Privatisation negotiations.
Overall, in the three
cases presented, Privatisation attained the objectives set out. The attainment
of these objectives was directly attributable to the prior creation of
regulatory environments, which promoted equity and, wherever possible,
competition. However, there were costs to be borne, such as the cost of
regulatory establishment, and job losses. In the case of the latter, standard
operating procedures of Privatisation suggest it wasn’t an altogether
surprising outcome. The extent to which these short term costs will be
indemnified depends the long term performance of the now private enterprises,
and the ability of the retrenched to find alternative employment of comparable
or superior compensation. In addition, government may have a role to play in
providing assistance to the now unemployed, until they manage to secure another
job.
Recommendations and Conclusion
In conclusion, there is
no straightforward proclamation one can make, as to whether or not Privatisation
is bad for the poorest in society. Whether or not it is, depends on the initial
conditions prior to Privatisation, how the process of Privatisation was
undertaken, and the political and economic environment that prevailed post-Privatisation.
Regulation and
competition, rather than Privatisation, lead to private sector development and
an environment in which equity prevails. There are cases where natural
monopolies result from Privatisation, because of significant barriers to market
entry, such as economies of scale. In such instances, it is even more important
to ensure that robust and autonomous regulatory institutions are forged prior
to Privatisation. This way, the price and expansion decisions of the investor
will align with the social goals of increased access to the poor, and ensuring
prices are not beyond their reach. In order to yield optimum benefits from Privatisation,
the following recommendations are suggested:
The transfer of assets from
state entities to private hands should be a transparent exercise, undertaken
through a process of competitive bidding. This way, the state will get the best
deal possible.Effective regulatory bodies
should be established before the Privatisation sale, to ensure prices and
service quality of private firms are fair, and to promote competition where
possible. A regulatory authority may also serve to ensure tax compliance of the
newly privatized firm. The tax revenues from the now private entities could
greatly aid government’s ability to fund anti-poverty social programs. Such
programs may even be of benefit to victims of Privatisation, who lost their
jobs as newly privatized entities restructured.Additionally, sale contracts
for utilities should ideally contain service expansion and price control
clauses, so as to ensure increased access and affordable pricing for the
poorest in society. In addition to protecting the interest of the poorest,
price controls may serve as an incentive for the now private firm to be as
efficient as possible, thereby maximizing their profitability. Profit
maximization of these firms is likely to result in business expansion, thereby
having a positive impact on utility services access to the poor, and tax
revenues which government can use to fund anti-poverty initiatives.
References
Bayliss, K. (2002). Privatisation and poverty: The distributional impact of utility privatisation. St. Louis: Federal Reserve Bank of St Louis. Retrieved from https://manchester.idm.oclc.org/login?url=https://search.proquest.com/docview/1697510149?accountid=12253Birdsall & Nellis (2003). Winners and Losers: Assessing the Distributional Impact of Privatisation. World Development, 31(10), pp.1617–1633. Cook, P. (1999). Privatisation and Utility Regulation in Developing Countries: the Lessons So Far. Annals of Public and Cooperative Economics, 70(4), pp.549–587. Delfino, J. A., & Casarin, A. A. (2001). The reform of the utilities sector in Argentina. UN University WIDER Discussion Paper No. 2001/74, June. Megginson, W. L., & Netter, J. M. (2001). From state to market: a survey of empirical studies on Privatisation. Journal of Economic Literature, 39(2), 321– 389 NEWBERY D. (1994). Regulatory Policies and Reforms in the ElectricitySupply Industry’. DAE Working Paper No. 9421, Cambridge. Department of Applied Economics. University of Cambridge. World Bank, (1995) Bureaucrats in Business: The Economics and Politics of Government Ownership, Washington DC, World Bank and Oxford University Press. World
Bank (2000) Can Africa Claim the 21st Century World Bank, Washington
D.C.
Appendix

Figure 1
depicting the position of developing countries (C) and developed countries (D),
based proximity to the production frontier.
Source: Birdsall and Nellis (2003)

Figure 2 depicting
the ability of developing countries to simultaneously pursue efficiency and
equity goals, because of a further proximity away from the production frontier.
Source: Birdsall and Nellis (2003)