Straight No Chaser
Privatisation is not the only answer for state-owned firms
November 8, 2005
By Jabulani Sikhakhane
Reducing the reliance of state-owned enterprises (SOEs) on government funding and forcing them to compete with private companies can deliver as much improvement in their performance as selling these firms to private investors, a study by two US academic economists has found.
The study challenges conventional thinking about privatisation, which has dominated economic policy since the Reagan/Thatcher era of the 1980s, that state-owned companies can only be rehabilitated if they are sold to the private sector.
The study has a particular relevance for South Africa, where the government has chosen not to privatise transport group Transnet, Eskom (electricity) and Denel (defence technologies) but to use them to drive economic growth
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"We have also clarified what it is we expect of the SOEs. While these enterprises have to meet strategic economic goals, they have to raise their finance in the capital markets off sound balance sheets and with good ratings. Accordingly, we expect high levels of operational efficiency, exemplary corporate governance and sound financial management," Alec Erwin, the public enterprises minister, said in a speech to the American Chamber of Commerce in South Africa in September.
As part of their role in underpinning economic growth, Transnet and Eskom will invest more than R136 billion over the next five years in projects that will help reduce the cost of transporting goods and increase the country's electricity generation capacity as well as keep electricity tariffs among the lowest in the world.
In addition, the government is creating competition for Eskom by opening up the electricity generation market to private companies, which will generate 30 percent of the required new capacity.
Ann Bartel and Ann Harrison say in their paper, Ownership versus Environment: Disentangling the Sources of Public Sector Inefficiency, that the often-quoted reason for selling state-owned companies to private investors is that privatisation improves the performance of these companies.
Bartel is a professor of economics at Columbia Business School and Harrison is a professor of agricultural and resource economics at the University of California at Berkeley.
The conventional view is that the inefficiency of state-owned companies is caused by the failure by the government, as the owner, to supervise the people who manage these companies properly.
But Bartel and Harrison see things differently. They argue that much of the poor performance of state-owned companies is explained by the environment within which these companies operate.
This includes a lack of competition for state companies and their reliance on government funding.
Using data for public and private sector manufacturing companies in Indonesia from 1981 to 1995, they calculate that a full sale of a state-owned company to private investors will increase its productivity by 1.6 percentage points.
"The same results, however, could be achieved by manipulating the environment. Specifically, our results show that if the role of the state development banks in financing public sector investment by public enterprises is reduced, public sector performance improves," they say.
Their study focuses on three factors: government funding of state-owned companies, protection of these companies from imported goods, and their partial ownership by foreign investors.
They say that increasing import penetration by 3 percentage points, reducing government funding from 100 percent to 70 percent, or increasing foreign ownership of a state-owned company by 0.75 percentage points will each increase productivity by the same amount as full privatisation.
The analysis by Bartel and Harrison shows that ownership of a company by the state is by itself not a good predictor of performance.
In combination with soft budget constraints or trade protectionism, however, state ownership does have a significant negative impact on productivity. In other words, while government as a shareholder may be unable to properly supervise the performance of companies, the problem manifests itself only when the
government provides subsidies or shields state-owned companies from import competition or foreign ownership.
Many of the privatisations in Indonesia between 1989 and 1995 involved the sale of portions of state-owned companies to private investors. But these deals generated much smaller improvements in the performance of these companies than reducing funding by government and increased competition, they conclude.
The findings by Bartel and Harrison sound similar to the plans by the government for state-owned companies. By increasing government capacity to supervise these firms, by restricting access to government funding, and by forcing them to fight for business like private sector companies, Erwin hopes to improve the performance of the SOEs at the same time as they drive economic growth and development.
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