Privatization is the transfer of government owned assets to the private sector. As a result of changing economic policies, privatization took place at a significant pace around the world during the last decade of the 20th century. Ranging from the desire to downsize government in developed countries, to the demise of communism in Eastern and Central Europe, and to the opening of the economies of various Latin American countries, privatization has significant direct and indirect effects on international business and international law.
Privatization opens unprecedented opportunities for investment throughout the world. Thus, it is a major force in the globalization of business, and it is of great interest to investors and businesses around the world.
Privatization is taking place in various kinds of economies. Prior to revolutions during the late 1980s and early 1990s, private ownership of property was not allowed in the communist countries of Eastern and Central Europe. In accordance with Marxist theory, communist governments owned virtually everything. Privatization is, therefore, a necessary tool for those countries converting to market-based economies. As a result, in the 1990s, the formerly communist countries of Central and Eastern Europe have been engaged in an unprecedented number of transfers of assets to private persons and entities.
In Latin America, a parallel movement has taken place. As early as the 1930s and again during the 1960s and 1970s, huge segments of the economies of various Latin American countries were nationalized. Segments of the economy that were reserved to government included electric power, telecommunications, and development of natural resources. One result was that international investors were kept out of major segments of the economies of Latin American countries. Yet, from the perspective of the Latin American countries, nationalization was not a success. A majority of the nationalized industries were inefficient and caused a severe drain on the countries' finances. Latin American governments were compelled to subsidize the industries, which, in turn, caused the governments to fall more deeply in debt internationally. For example, the World Bank calculates that in the early 1990s, state-owned businesses were responsible for about 60 percent of the external debt of Latin American countries. As a result of heavy debt loads, various Latin American countries defaulted on their loans to international banks. Huge restructuring programs and bailout programs were negotiated. In turn, international lenders were hesitant to extend additional credit to Latin American countries. As a result, Latin American economies became stagnant; they could not attract significant amounts of long-term capital investment. In response, in the 1990s, Latin American governments turned to privatization and actively sought investment by foreign businesspeople and organizations.
Reasons for privatization vary and depend on the history, politics, and needs of each country involved. It is helpful, however, to look at whether a country is developed or undeveloped. In addition, its history as a capitalistic, communist, or closed economy affects the decision to privatize.
Although privatization is most frequently discussed with respect to developing countries, it is also taking place in developed, democratic, market-oriented countries. Privatization was conceived by Great Britain's Thatcher government, and it has many advocates in other developed countries such as the United States. In the United States, privatization is seen as a mechanism to be used to "downsize" government, cut costs for government, cut taxes for citizens, and promote balanced government budgets. Thus, in the United States, on a federal level, there is pressure on government from some parties (not including environmentalists) to sell oil drilling rights to federal lands and on offshore fields. In addition, there are proposals that the federally run air traffic control system be privatized. On the state and local levels, in some states and municipalities there has been privatization of garbage collection, health care, and ambulance services, usually under contracts between the government and a privately owned business. In some states, the government contracts to place prisoners in privately owned and operated detention facilities. Schools have been another target for privatization in the 1990s. Demand for spaces in public schools decreases when government-subsidized vouchers are given to students who, in turn, use them at private schools. Or, for example, privately run charter schools in Michigan receive government funding under the theory that they can provide more choice and better education to students than that which is offered through the public schools.
In developing countries, privatization is creating unprecedented opportunities for investment by businesses and businesspeople from around the world including, but not limited to, those based in the United States. In formerly communist countries of Eastern and Central Europe, conversion to a market-based economy, with privately owned and operated businesses, has resulted in massive privatization programs. There are multiple benefits of such privatization, including the following eight. First, sale of government-owned businesses can generate cash for the government. Second, following sale of an unprofitable business, the government can discontinue subsidies to it. A third, related benefit is that the government gets rid of inefficient labor and "hidden" unemployment. Communist governments were obliged to retain nonproductive workers and operate inefficient facilities in order to provide employment, but privately owned businesses have incentives and opportunities to release nonproductive workers. Fourth, privatized businesses can provide employment for workers released from inefficient state-owned businesses. Fifth, privatized businesses can become tax-paying entities, which, in turn, generate sorely needed funds for local and national governments. Sixth, privatized businesses promote competition. Seventh, as government-owned monopolies are privatized and competition increases, the public gains access to higher quality goods and services at lower prices. Eighth, privatization can facilitate foreign investment and trade. (Or, in the alternative, through laws allowing the sale of formerly government owned businesses, privatization can be used to promote domestic investment and restrict the inflow of foreign business.)
Various Latin American countries chose to privatize state-owned businesses during the last two decades of the 20th century as a way to revitalize debt-ridden and stagnant economies. Countries in which substantial numbers of businesses have been privatized include Argentina , Chile, and Mexico . For example, throughout most of the 20th century, Mexico operated a state-dominated economy using an "import substitution" model. Mexico closed its doors to foreign investment in many sectors of its economy, such as energy, natural resources, and telecommunications. In other areas, foreign investment was severely restricted. In addition, heavy tariffs were used to discourage imports. For example, tariffs on automobiles, auto parts, and light trucks were as high as 100 percent in the early 1980s. The Mexican government expected Mexican businesses to produce the goods needed by Mexicans. The result was, however, that Mexican-made goods were often of a poor quality, and many products were unavailable. Only the wealthiest citizens could afford imported goods with high tariffs. High quality clothing, electronics, and other goods were hard to obtain and extremely expensive. In addition, certain services such as telephone services were costly and hard to obtain. For example, it often took years to get a telephone installed in a home. As a result, in the mid- to late 1980s, Mexico's leaders decided to shift away from the import-substitution model of production and away from government ownership of major businesses.
Simultaneously, Mexican leaders were aware of the growing movement toward the globalization of business as they watched the expansion of international trade alliances such as the European Union (EU, then called the European Community) and the U.S.-Canadian Free Trade Agreement . Mexico's leaders decided to open Mexico's economy in an effort to stabilize it. One major step was Mexico's decision to join the General Agreement on Tariffs and Trade (GATT) in 1996. Another was negotiation of the North American Free Trade Agreement (NAFTA) with the United States and Canada, which took effect on January 1, 1994. Pursuant to NAFTA the three countries are phasing out nearly all tariffs among themselves over a 15-year period ending in 2009. Another major tool for opening Mexico's economy is the privatization of government-owned businesses.
The benefits of privatization for Latin American countries parallel the reasons of formerly communist countries. Mexico provides a good example. From 1989 to 1994, President Carlos Salinas privatized 252 state companies including major banks and TELMEX, the government-owned company that monopolized telephone services. Sales of Mexican businesses have generated sorely needed funds for the Mexican government, which faced a major debt crisis in 1995-96. Mexico has been able to discontinue subsidies to unprofitable state-owned businesses. Companies have been restructured, getting rid of unneeded employees. Privatized businesses are becoming taxpaying entities. And privatized businesses, such as in telecommunications, have encouraged competition. In turn, at least in some areas, prices are down and quality is improving. For example, the quality of telephone services in Mexico has improved dramatically since 1994, while prices have been cut significantly. In conjunction with the provisions of NAFTA, privatization has led to foreign investment by U.S. and Canadian firms in areas including, but not limited to, telecommunications, certain types of energy production such as cogeneration power plants, pharmaceuticals, agriculture, automobile manufacturing, and automobile parts. Foreign investments in various areas have allowed Mexico to convert from a country that relied on oil exports (from Pemex, the state-owned oil monopoly) for 78 percent of its foreign income in the early 1980s, to a country that, in the early 1990s, was receiving at least 80 percent of its foreign income from the export of manufactured goods produced by privately owned businesses.
Pressure from international organizations has been another force leading to privatization. The International Monetary Fund (IMF) and the World Bank have required privatization of unprofitable government-owned businesses as a prerequisite to obtaining loans sought by debt-ridden governments. In the early 1980s the Mexican government controlled sugarcane production, milling, and selling through a state-owned company called Colima. The company, however, was supported by substantial state subsidies. In 1988 Mexico privatized Colima's sugarcane mills when the World Bank pressured it to do so as a precondition to receiving loans. Similarly, the EU requires that countries applying for membership in the EU divest themselves of unprofitable government-owned businesses as a means of demonstrating the economic reform and stability required. Thus, various Central and Eastern European countries including, but not limited to, Romania and the Czech Republic, are privatizing state-owned businesses as they prepare for membership in the EU.
Because the focus of this article is on international privatization, this section does not include discussion of mechanisms used for privatization in the United States. Included are examples of privatization in formerly communist countries and in Latin America.
The Czech Republic was the first of the formerly communist countries to begin to convert to a market-based economy through extensive use of privatization. It deserves study, because it has served as a model for other formerly communist countries.
Privatization in the Czech Republic has had far-reaching effects on that country's economy. In 1989 the private sector accounted for less than 1 percent of the gross domestic product in the Czech Republic in 1989. That figure had reached 22 percent by the start of 1993 and 44 percent by the start of 1994.
The Czech Republic instituted a four-part privatization program. First, more than 100,000 properties that had been confiscated by the government since 1948 were returned to their former owners. The properties included houses, retail shops, farmland, and small factories. Second, a "small" privatization plan was instituted. It began with a five-year auction of leases on about 22,000 stores and workshops to private bidders. Foreign buyers were not allowed. In addition, as a second step in this part of the program, health care facilities are being sold to staff members. The staff members are assisted with subsidized loans. Third, the Czech government lifted the prohibition on private enterprise that had been in place under communism. Soon, over 1.1 million people (about 10 percent of the population) registered as self-employed. Most of these people are in retailing and services.
The fourth and most significant part of the privatization program was a plan to sell large state-owned enterprises. Starting in 1992, each of about 3,500 state-owned firms was required to prepare its own privatization plan. One of three avenues could be chosen. First, there could be direct sale to a foreign or domestic buyer. Second, there could be a public auction. Third, sale could be through use of vouchers (explained below). In response to the plan prepared by a firm, others (e.g., groups of managers within a plant) could submit rival plans. A newly established Ministry of Privatization selected the "winning" plan to be implemented for each firm.
The voucher system was innovative and has been used as a model by other formerly communist countries, including Russia and Romania. Under the Czech voucher program, the finance minister issued vouchers for the relatively nominal sum of 1,000 crowns (about US$33). Vouchers could be pooled to bid on blocks of shares. The program has had mixed results. About 72 percent of vouchers issued ended up being invested with about 220 investment funds. (The funds were able to buy significant numbers of vouchers by offering up to 15,000 crowns—the equivalent of about US$500.) Czech banks, which were themselves privatized using the voucher system, ended up owning five of the six largest investment funds. The end result is that many privatized firms are owned by investment funds, which, in turn, are owned by banks. Thus, ownership of these firms is concentrated in the hands of a limited number of banks, and many of the firms remain heavily in debt. On the other hand, the successful side of the story is that the program succeeded in transferring ownership of firms from the state to private entities.
Russia modeled its privatization program after the Czech experience. The program began in 1992, and, like the Czech program, it has four parts. First, Russia privatized about 102,000 small businesses, including shops and restaurants. About 73 percent were purchased by employees at nominal prices. Second, mass privatization was ordered in July 1992. About 25,000 firms were ordered to convert to "joint-stock" companies, and they were ordered to draw up plans to distribute shares. Third, in November 1992, the government ordered that 148 million vouchers be issued, each with a nominal value of 10,000 rubles. The vouchers were issued to Russian citizens and could be sold or used to buy shares in companies. (They sold for about US$10.) There were problems with the program. By May 1994 it appeared that not enough shares were being issued to meet the supply of outstanding vouchers. Therefore, the government pressured various companies, including oil, gas, and electricity companies, to make some of their shares available in exchange for vouchers. The voucher program for privatization ended on June 30, 1994. The fourth part of the Russian plan involved sales to workers. Firms were given the option to sell 51 percent of their shares to workers, and about 75 percent of firms opted to do so. In firms in which 51 percent of shares went to workers, another 20 percent went to the Russian Property Fund (a state-owned fund), and 29 percent remained to be auctioned to those holding vouchers.
Comparing the Russian program to the Czech program, each had strengths and weaknesses. The Czech government installed a sophisticated computerized program for distribution of vouchers. Thus, vouchers were distributed more evenly in the Czech Republic than in Russia, where, regionally, elite parties were able to control distribution. The Russian program for worker ownership made it easier for managers to gain sufficient equity in their firms to control them, while the Czech program lacked provisions that provided specifically for worker ownership. On the other hand, public interest in the Czech program was greater because the cash value of the vouchers reached US$300 to US$500, while the cash value reached only US$10 to US$20 per voucher under the Russian program.
In Latin American countries, privatization plans are, generally, more simple in their design and implementation than in formerly communist countries. Firms are sold by the government to private investors and the funds are returned to the government. For example, the 252 companies privatized by Mexico between 1989 and 1994 were sold to private individuals and firms; some of them were Mexican-owned and others were foreign-owned. The sales produced more than US$23 billion that went into government reserves. In addition, the government was able to reduce or eliminate its massive subsidies to those firms.
Not all privatization in Mexico has been of privately owned businesses. Under Mexico's 1917 constitution, peasants, their children, and their grandchildren, have lived on cooperative farms called ejidos Under the constitution, the farmers had lifelong rights to use of the ejido property; those rights could not be sold, leased, or rented. Under reforms designed to facilitate domestic and foreign investment, the Mexican government amended the constitution in 1992 to allow for sale, rental, or lease of the ejido properties. This privatization is good for investors who need land for industrial projects or large-scale farming. It is also viewed as a positive step by those economists who believe that eJidos have resulted in inefficient use of land. Families that have lived on ejido lands, however, are being compelled to move elsewhere, and the compensation they receive is usually insufficient to buy land or homes elsewhere. Thus, privatization of ejidos is highly controversial.
Privatization has led to challenges and problems. One set of challenges involves the need for bodies of contract law, real property law, and personal property law. Problems stem from corruption and abuse that have arisen in some countries engaged in privatization.
First, rules of law must be changed to accommodate new ways. Foreign investors buying assets from a foreign government want a solid legal structure on which to rely. Many assets being sold by governments in Latin America and in formerly communist countries were expropriated from private parties earlier in the 20th century. Therefore, a legal mechanism to ensure that clear title is conveyed to the new investor is crucial. Under communism, the concept of ownership of private party contradicted the foundations of the economic system. Therefore, privatization in a formerly communist state requires an entirely new body of law as well as legal mechanisms for enforcement of that body of law. New laws must cover acquisition and transfer of title to real and personal property; filing systems to register mortgages and other interests in real property; finance regulations; and numerous other areas. In addition to property laws, contract laws are needed.
Further, lawyers and judges who are trained in administering the new laws are needed. This has been a particular problem in Russia, where businesspeople complain that the courts have been unprepared to enforce the new laws passed in connection with Russia's efforts to convert to a market-based economy.
Unfortunately, privatization has resulted in abuse and scandal in various developing countries. Self-dealing and corruption in Russia, India, Pakistan, and Mexico have caused the governments (and people) of those countries to lose billions of dollars and to halt some projects. For example, in 1993 in Russia, there was a major scandal in connection with plans to transfer a 51 percent voting share in Norilsk Nickel to Uneximbank, the fourth largest financial institution in Russia. In India, a planned privatization of telecommunications was halted in the early 1990s as a result of allegations of attempted bribery and other corruption.
It is recognized that the conversion of state-controlled monopolies to private enterprise has created the potential for abuse. Free markets need restraint. Therefore, as we enter the 21st century institutional changes and careful surveillance are needed to curtail abuse as communist and other closed economies are converted to market-based economies.
This essay has provided examples of privatization in various areas of the world including North America, formerly communist countries (using the Czech Republic and Russia as examples), and Latin America (using Mexico as an example). Yet, privatization is taking place throughout the world. Studies have been published discussing privatization in various regions of the world, including Eastern Europe (e.g., Poland and Hungary), Asia (e.g., India and Pakistan), Latin America (including Chile and Argentina), and Africa. And much remains to be observed and studied. Therefore, this essay serves only as an introduction to the privatization movement. Privatization will continue to have significant effects on the global economy as we enter the 21st century.
[ Paulette L. Stenzel ]
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