Privatisation and the Poor: Lessons and Evidence from Around the World

During the 1980’s, many developed countries witnessed a significant departure from economic policies that called for nationalisation and stringent economic regulations, which had ruled most developing countries, to privatisation and trade. This fundamental change in development strategies was a result of the challenges faced by many developing countries during this period, including, widening current account and balance of payment deficits, high inflation, increased foreign debts, wastage of public resources, and their inability to adapt to changing economic environment (Obaidan 2002). As a result, privatisation has been implemented in different forms, depths and breadth in the developing world as part of neo-liberal policy reforms since the late 1970’s. The Economist described the trend as the “greatest exchange ever between private citizens and their governments” (Economist 1985, pp 71).

The new paradigm held that public ownership and management of assets were liable for economy-wide and enterprise level inefficiencies. It was argued that such public ownership encouraged rent seeking by bureaucrats and civil servants, distorted incentives, asset values and resource allocation, and inhibited competition. Public ownership not only adversely affected growth prospects in many countries, but it also led to wastage of state resources (Dagdeviren 2006). Super (2008) highlighted that governmental managers lacked access to the draconian sanctions with which private employers motivated their employees to maximize performance. According to Banerjee and Rondinelli (2003), governments are more likely to adopt and implement privatisation policies immediately after a severe economic or financial crisis, and in countries where the public sector is a large part of the national economy. Moreover, the fiscal pressure applied on developing countries by international donor organisations, such as, the World Bank, United States Agency for International Development (USAID) and the International Monetary Fund (IMF), also enforced privatisation as part of a package of economic reforms (Aylen 1987, Babai 1988 cited by Ramamurti 1992). Richer countries continue to provide loans, grants and technical assistance for privatisation in developing countries, and require governments, through loan conditionality, to sell loss-making State Owned Enterprises (SOEs) (Rondinelli and Priebjrivat 2000).

The World Bank (2007) defines privatisation as, “the transfer to private parties of operational control of a public enterprise or a substantial part of its assets”. The IMF claims that privatisation is a powerful instrument “to redeploy assets from the public sector to the private sector, where they are expected to be used more efficiently’’ (MacKenzie 1997, pp 1). The International Finance Corporation (IFC) promotes privatisation as means of increasing access of developing countries to technology, international markets and creating stronger corporate governance (Donaldson and Wagle 1995).

Privatisation has been a primary element of donor-funded aid programmes since the 1980s. The initial focus was on reform of the public sector but increasingly frustrated with recidivism, policy makers began to view privatization as a means to lock in the gains from reform. Thereafter, privatisation is often a condition for the disbursement of aid funds and has been tied to eligibility conditions for debt relief by the WB and the IMF. Privatisation also features in the conditions set for poor countries to qualify for debt relief under the Heavily Indebted Poor Countries (HIPC) initiative. The World Bank has been increasingly focusing its resources on governments that agree to implement its privatization and liberalization policies.

However, critics argue that the IMF in certain instances requires governments to take measures that greatly limit the ability of local governments to deliver public services. For instance, following its institutional priority to ensure macro-economic stability, it may force central governments to reduce or eliminate budget subsidies and domestic credit to services (Kessler and Alexander 2004). Considerable independent research confirms such conclusions. In Cartagena, Colombia, privatisation was reinstated on the policy agenda, despite the state’s opposition towards it, in order to receive aid funds (Bayliss 2002). The World Resource Institute (WRI) in the electricity sector confirmed in a study of six countries that reforms in the power sector were solely driven by the immediate need for capital, as the result of the withdrawal of international donor support. Similarly, in Argentina, the World Bank withheld assistance to the provinces until they agreed to adapt to federal pricing requirements.

Privatisation and the Poor

Economic growth is generally considered to be a necessary condition for alleviating poverty (Bhagwati 1985). Yet it has been increasingly recognised in the past two decades that growth alone may not be sufficient to bring about substantial reductions in levels of poverty (Chenery, et al., 1974, Stewart 1985). Thus, in many developing countries, growth-promoting policies are supplemented with policies specifically designed to improve the lot of the poor. This focus on poverty inevitably leads to the question of who the poor are, particularly the issue of how poverty is defined. The “best”definition of poverty remains a matter of considerable academic and political argument. According to the World Bank (2015), “poverty is pronounced deprivation in wellbeing”. In this context poverty is viewed a multi-dimensional phenomena and refers to hunger, lack of shelter, being sick and unhealthy, inability to read or write, joblessness, fear for the future, lacking access to clean water, political and social exclusion etc. According to Davis et al (2000, pp 23), “…there is a strong correlation between privatization and economic growth… privatization is not the cause of the large increases in growth rates but it is likely that it serves as proxy in these regressions for a range of structure measures that may be characterised as a change in economic regime.” One of the rationale of privatisation in the case of loss making enterprises, is to reduce the fiscal drain on the state, so as to release resources for more important expenditure in physical and social infrastructure. This objective has a direct impact on poverty reduction in terms of the extent to which resources are released by privatisation, depending on if employed in more socially necessary investments (World Development Report, 2001 and Fay 1995). Moreover, privatisation may impact growth and poverty reduction by increasing the return to private capital accumulation, increased participation in provision of services, easy access, but however it can have negative implications, if economic efficiency is not increased or if the quality of human capital is adversely affected.

Privatisation is justified by the theory that financial results of publicly owned firms are worse than those of private ones. The agency and the property rights theory support this view. These theories focus on the significance of private property rights in providing optimal incentives for principals to monitor the behaviour of their agents in the presence of incomplete information, contracts and markets. The impossibility of exercising ownership rights (which are vaguely defines and dispersed) worsens the problem of supervision in the case of state owned firms.

We observe through illustrating cross country evidence that privatisation has adversely affected the poorest through higher prices, job losses, corruption, accelerated economic costs, restricting competition and we also observe that private providers usually are reluctant to serve the poor.

1. Higher Prices: It is often argued that private sector involvement raises the prices for essential goods and services, especially in the water, sewerage, electricity and transport sector, as privatization inevitably commercializes prices through establishing user fees. Whereas, under state ownership, many governments set utility prices at less than cost-covering levels (Nellis 2006). Improved quality standards may also lead to an increase in the cost of production (Fay 1995). In the absence of a subsidy mechanism, the poor will be unable to afford essential services, resulting in greater poverty and decline in public goods provision. In Zimbabwe, in 1999, the UK based Biwater withdrew from a proposed private water project because the project’s intended beneficiaries (consumers) were too poor to pay a tariff to accommodate the profit margin that Biwater was seeking. Moreover, while subsidies often contribute little to poverty reduction, user fees themselves may contribute little to financial viability of essential services, especially in the very poor areas. For instance, while analysing the health care cost recovery experiences in African countries, it has been revealed that the average fees yield only around 5 per cent of operating costs. In Tanzania, the administration of the user fee program cost more than the user fees revenues (Kessler and Alexander 2004). According to the World Bank (2002), “…getting the private sector to focus on the alleviation of poverty and to design tariffs in a way that does not discriminate against the poor has proved hard to achieve in practice…” In developing countries, where the institutional and regulatory framework of the state is weak, the government is usually unable to control the price increase. Also, in the absence of well-developed financial markets, domestic privatisation may only be beneficial to a few high-income groups or probably the same elite that controls the government (Saha and Parker 2002).
2. Unemployment: Privatisation is also widely linked with labour layoffs and retrenchment, contrary to the World Bank’s objectives of eradicating poverty. It is suggested that private companies lay off workers in order to provide greater returns to shareholder. International Labour Organization (1998, pp 1) states, “…privatization and restructuring process in water, electricity and gas utilities resulted in a reduction of employment…employment increase after privatization are rare and usually follow periods of large scale retrenchment.” Unemployment has a direct bearing on poverty and inequality, and it places great strain on other aspects of the economy as more workers look for opportunities in the ‘informal sector’. According to Nixon and Walters (2006), there is abundant evidence that privatization of Small and Medium Enterprises (SMEs) led to a fall in employment, contributing to increased income inequality and rise in poverty. In Mongolia, privatized corporations witnessed more than fifty per cent downsizing and according to the poverty studies, sixty percent of unemployed people were poor. Thus, privatisation played a significant role on the impact of poverty (Khashchuluun and Soyolmaa 2004). Ramamurti (1997) looked at the restructuring and privatisation of Argentina’s national passenger and railway service, and discovered that the enterprise reduced employment by seventy nine percent. A decrease of more than ninety thousand from peak employment levels, was observed in the case of privatisation of Brazil’s railway service and in Ghana, seventy per cent formal sector unemployment was observed post privatisation (Bayliss 2000, Parker and Kirkpatrick 2000).
3. Corruption: Privatising a hitherto public monopoly can change the status of a firm to a private monopoly and so without the prevalence of a sound regulatory framework, consumers can be in a worse off situation than prior to the privatisation (Bayliss 2000). The opportunity to use privatisation to earn economic rents is encouraged where there are lack of investors outside the political elite (Walle 1998). A number of privatisations in Uganda (Tangri and Mwanda 2001), Zambia (Craig 2002), Burkina Faso (Sawadogo 2000) and Cote d’Ivore have involved the transfer of assets to politicians, their families and their associates on favourable terms. Zambia’s programme of privatisation has been acclaimed a model for the rest of Africa for organisations like the World Bank (White and Bhatia 1998), but Craig (2000) suggests that the programme has been majorly flawed, allowing the corrupt acquisition of assets by those linked to the ruling political party. In Mexico, the privatization of banks allowed drug traffickers to buy bank stocks and seek selection to bank boards (cited by Kirk and Kirkpatrick 2003). Furthermore, a large proportion of the country’s most valuable assets were sold off to political insiders for a fraction of their worth (Johnson 1997, pp 150).
4. Lack of Interest to Serve the Vulnerable: It is often advocated that corporations have little incentives to invest in unprofitable people. Especially in the case of utilities it has been widely observed that private providers prefer to increase household access or expand services in urban areas, primarily where middle class demand more and better services. Thereby, they are less motivated to go into peri-urban, slum or rural areas, where topography is more difficult, per capita consumption is less and most importantly, where incomes are much lower. Since the poor tend to live in remote rural areas, the unit costs of providing them with utility services may be higher in comparison to wealthier people living in big cities (Kessler and Alexander 2004). This is also referred to as “cream skimming or “red lining” (Ademola and Afeikhena 2004). For e.g. in the case of the energy sector in Africa, private firms opted to supply high load industrial consumers and this resulted in increased costs of serving the remaining customers, with higher costs and lower system reliability to be borne by the economy (Chiwaya 1999). Hall and Lobina (2006) suggest in the case of the failure of water utilities privatisations in Sub-Saharan Africa, most private contracts involved no investment by the private company in extensions to poor unconnected households. The commitments agreed when these contracts were made were perpetually revised, abandoned or missed (cited by World Bank 2006).
5. Competition for all….but for whom? It is widely claimed that for services with low barriers to entry, the rationale for privatisation is to provide the public with a greater choice of services at a competitive price and quality. But however, evidence suggests that expanding private provision in competitive services can increase choice, but not necessarily for all consumers (Kessler and Alexander 2004). Privatisation can create an environment where the private sector will attempt to stifle competition and flout regulation where possible in order to maximise profits, in the absence of effective regulations (Bayliss 2002). In Guinea, the price of water substantially increased after privatisation, mainly due to the weak regulatory capacity of the state in terms of monitoring the prices. The price increase led to higher commercial losses as tariff increases led to more defaults on bills and stronger incentives for illegal connections, and in 1996, fifty eight percent bills were unpaid (Cowen 1999). Privatization advocates suggest the health sector as an area in which competition can generate greater efficiency and superior services. An IMF(2000) researcher states, “…allocation cannot be based solely on cost effectiveness…markets alone cannot produce efficient outcome in the health sector, which suffers from serious market failures due to asymmetric information…imperfect agency relationships…doctors have tremendous power to induce consumption…” Further to this, evidence in numerous countries indicates cases in which long term power contracts with governments have proven to be a failure, and the companies have been extracting financial benefits through higher prices or selling unneeded energy. Such contracts have been renegotiated or cancelled in Indonesia, Croatia, Hungary, Costa Rica and the Dominican Republic (Kessler and Alexander 2004).
6. Insufficient Financial Gains: The common rationale for privatisation is that the revenues generated through sale off public assets generate fiscal space for other public programmes that may be better targeted towards the poor. But unfortunately, in practise this rationale has been used to privatize even well-functioning services. From a private bidder’s point of view, services that have a vast customer base are likely to be more attractive. Thereby, corrupt governments seeking large revenue gains, may be tempted to trade away viable and effective services, at the expense of the general public (Kessler and Alexander 2004). In addition, many state owned enterprises have substantial debts, and these are offset against revenues. During the privatisation of water services in Buenos Aires and later in Manila, the government increased prices prior to privatisation in order to attract potential investors (Ademola and Afeikhena 2004).
7. Burden on State: In support of privatisation, Stigler’s (1975) model of regulatory failure or Wolf’s (1979) of nonmarket failure, identified that inefficiencies were a result of public intervention in the economy and it was argued that privatisation will reduce them through optimal use of resources within the enterprise after divestiture. But however, Mansoor and Hemming state, “Allocative efficiency is a function of market structure rather than ownership”. Privatisation by itself will not change the nature of the market in which the firm operates, and the environment which shapes its pricing decisions. Greenridge (1997, pp 109), after examining the experience of twenty seven privatisations in Guyana, South America states, “the privatized entities, while more efficient than their public sector counterparts, have not been able to overcome the environment in which they operate” (Parker and Kirkpatrick 2003). Fernandez et al. (1999) demonstrated that privately owned port facilities in developing countries have led to significant economic costs in the forms of congestion, discriminatory pricing and a failure to develop economies of scale. These countries lacked sound regulatory agencies to tackle abuse in sectors such as telecommunications, power, and water, post privatisation (Pamacheche and Koma 2007). In Senegal, the privatisation programme only got underway when protectionist measures, removed under liberalisation, were instated to allow investors to achieve greater profits (Bayliss 2000). On the contrary, Galal and Nauriyal (1995) acknowledged that countries that were able to develop effective regulatory regimes to address service and pricing issues (e.g. Chile) were able to perform better than those that did not (e.g. Philippines). Stronger regulations can result in lower prices but at the expense of a higher costs to the private sector. In the UK and Hungary, sound regulatory environments enabled the governments to force the private sector to keep water prices low and thus make lesser profits at the expense of the general public. Regulations safeguard the interests of the poor by restricting higher prices, non-payment of taxes, transfer-pricing, poor service quality and service cut backs.

Some Gains from Privatisation

On the other extreme, privatisation in developing countries in few cases has proven its worth and has incontestably produced substantial economic benefits by raising profitability and efficiency in firms, by providing financial resources to strapped governments, and by signalling to creditors, investors and donors the seriousness and credibility of a governments shift in economic regime. For instance, it widely led to the strengthening of capital markets and ownership of capital in the privatisation of Senegal’s Sonatel, when two-thirds of the total shares were reserved for Senegalese nationals and institutions (Nellis 2006). Through privatisation, many Latin American countries have also attracted significant amounts of Foreign Direct Investment (FDI). A World Bank study by Frank Sader (1993) highlighted the significant impact of financial and infrastructure privatisation on FDI (Pamacheche and Koma 2007). A study in 2001 by Appiah-Kubi (2001) reviewed 212 privatizations in Ghana and revealed that privatisation eased pressure on balance of payments, through increased efficiency, stimulated local capital markets, enhanced flow of Foreign Direct Investment (FDI) and increased employment (Nellis 2006, Pamacheche and Koma 2007).

To sum it up, we have observed in our analysis that privatization has been beneficial only to the elites and in cases where the government’s failure to privatise exceeds poverty, it has led to some undesirable consequences. Developing countries are usually characterized by poor accountability and transparency mechanisms, inefficient bureaucracies with high levels of corruption, poor economic growth, lack of rule of law and regulatory environment, and lack of political will, etc. Thereby, enforcing privatisation in the presence of these conditions is likely to result in the creation of private monopolies, unemployment, increase in prices of basic utilities and services, corruption and exploitation of state resources.