August Issue 2015
The Two Sides of Privatisation
The advocates of privatisation argue that the private sector is more efficient in the allocation and utilisation of investment resources as it encourages greater competition leading to a higher rate of income, employment and GDP (Gross Domestic Product) growth. As loss-making public sector enterprises are handed over to the private sector as a result of privatisation, the fiscal deficit is reduced and the state stands to gain even more as more taxes start accruing from more profitable privatised units. And finally, the process strengthens and enlarges the stock market by broadening its base through the gradual sale of shares of public sector units.
However, as Dr Akhtar Hasan Khan points out in his book, The Impact of Privatisation in Pakistan, “Privatisation can be a sustained source of reducing fiscal deficit only if loss-making units are sold.” Otherwise, the sale of profitable units would provide just one single injection to the public purse at the cost of a sustained source of income in the shape of dividends and profits in addition to taxes.
But then governments in poor countries, especially those which are energy-deficient and dole-dependent, and which are in the process of graduating from a mixed economy to a market economy, need to be as business-minded as any professional entrepreneur.
They would need to match the wits of the international oil market sharks to be able to keep their annual fuel import bills within reasonable limits (by keeping a close watch on world oil price fluctuations of as little as a minimal fraction of a cent), possess up-to-date information about what is happening in global trade so as to be able to avert the possibility of donors taking back the entire dole in the form of consultancy fees, shipping charges and import bills and further they would need to be able to make a distinction between an enterprise that would yield profits of immense social value and one that would yield purely financial profits.
To clarify, reproduced below is a relevant quote from the article, ‘Why Governments Should Not Be Run like a Business,’ by John T Harvey in Forbes Magazine:
“The problem in a nutshell is that not everything that is profitable is of social value and not everything of social value is profitable. Reality TV, fashion, sports and gambling are all of questionable social value, but each is quite profitable and exists in the private sector. Meanwhile, few would argue that the army, navy, air force, marine corps, coast guard, police department, fire department, libraries, parks and public schools are of no social value, and yet, they could not exist if they were required to be profitable. To reiterate, the key issue is this: not everything that is profitable is of social value and not everything of social value is profitable. The proper role of government is the latter.”
For example, no matter how you run the Pakistan Steel Mills, at the annual production capacity of 1.1 million metric tons against our annual consumption of steel products ranging between 6-7 million tons, it can never be an economically viable unit even if you reduce its work-force by more than half. Its social value is too dubious to merit any consideration. So the best option is to sell it at whatever price it can fetch today (the land in its possession should, however, be sold at market rates) because every passing day would only add to its losses and increase the burden on the national budget. This is true for most of the items earmarked by the government for privatisation and disinvestment.
But there is a long list of public sector enterprises whose privatisation would only end up causing the country a lot of social losses. This list would include PIA, Pakistan Railways, power generation and distribution entities, the Oil and Gas Development Company Limited (OGDCL), Pakistan State Oil, the utility stores, National Bank of Pakistan, Civil Aviation Authority, Pakistan National Shipping Corporation, Karachi Port Trust, Port Qasim and government shares in privatised commercial banks.
In rich countries perhaps these entities would be better off in the private sector. But in poor countries like Pakistan, these entities have as much social value as the armed forces, security agencies, libraries, parks, public schools and public health institutions.
A government without business know-how would hardly be able to maximise social benefits of a public sector entity at a minimum financial cost. In most developed societies, this is done by having a strong regulatory frame work which curbs the ravenous profits private companies can make when the enjoy natural monopolies.
And even after such mechanisms are developed, air, road and rail transport, energy-related units, public schools and public health institutions, at least up to primary levels, would need to be kept under government control, no matter what the costs.
Still, only a business-minded government would know which entity to sell and which to keep.
A big chunk of unnecessary financial losses that these public sector entities of social value are incurring currently can be eliminated by cutting down on waste and replacing inefficient managements with efficient ones. Also, their burden on the budget could be significantly eased if the government were to collect the taxes that are due to it from all its citizens who earn taxable incomes.
Take for example the OGDCL which, according to Omar Zaheer Mir (‘Is Privatization right for Pakistan?’ — The Nation — March 2, 2015), has generated a profit of approximately Rs 91 billion in the last fiscal year while providing gas at 40 to 50 per cent of the prices offered by the private sector in the international market. Another example is Pakistan State Oil (PSO) generating an after-tax net profit of approximately Rs 12 billion in the year ended June 30, 2013, a 39 per cent increase from the previous financial year. Privatising such institutions would not only lead to a loss of billions to the exchequer but also an increase in the comparatively cheaper prices currently offered to the masses.
Another case in point is the handing over of PTCL’s control to Etisalat by the Musharraf regime. A minority shareholder effectively got all of PTCL for US$ 1.8 billion paid in instalments, which are still partially outstanding. Mir further claims that the PTCL, which was generating profits of billions of rupees, is now reporting heavy losses despite increased tariffs and with a falling standard of customer service often complained about.
Similarly, KESC was sold on the hopes of a turnaround with substantial investments expected in infrastructure by the private party. Unfortunately, it has instead become a much bigger white elephant, requiring continuous financial rescue by the government while the new private owners, registered in the Cayman Islands (too dubious an address), continue to remit their profits abroad. Their failure to invest even in the necessary infrastructure maintenance has lead to undue load-shedding over and above that necessitated by load-management. K-Electric is said to be one of the focal points in the intractable problem of circular debt. Previously, KESC’s losses were borne by the federal government, but now K-Electric’s debts running into billions of rupees are owed to PSO and SNGPL and the government has to own the debts to different organisations in order to clear up the circular debt.
According to Dr Akhtar Hasan Khan, the decision to privatise banks was correct, and the results after privatisation clearly support this conclusion. However, the process of privatisation was not transparent. The banks were sold cheaply to foreign parties which had no banking experience and the privatisation procedure, especially with respect to the largest commercial bank, HBL, was allegedly not totally transparent. The sale of three banks to foreigners, i.e. Habib Credit converted to Al Falah, UBL and HBL and therefore their conversion from domestic to foreign banks, has led to heavy remittances of profits, which would be a constant drain on Pakistan’s shaky current account balance. The main reason why our banks have become so attractive for foreign investors is that the margin for banks in Pakistan is currently about six to seven per cent, which is very high as compared to the international norm of two percent. This is also the reason why our service sector has been showing such high growth rates when all other sectors have been taking a nosedive.
In 1998, the Asian Development Bank (ADB) conducted an impact analysis of privatisation in Pakistan. The analysis indicated that 20 per cent of the privatised units were performing better than the pre-privatisation period. Approximately 44 per cent performed the same, and 35 per cent were worse than before. This proves the contention of many in Pakistan that at least in our country privatisation did not support the argument that the private sector was more efficient than the public sector.
The impact of privatisation on fiscal deficit, industrial efficiency and promotion of industrial investment was analysed by AR Kamal (1997) and it was found that in 1990-93, a period when a large number of manufacturing units and two banks were privatised the fiscal deficit increased sharply. The cumulative privatisation receipts that did not exceed Rs 59 billion in this period, compared to a deficit of Rs 2.5 trillion during the same period, is too small an amount. Moreover, the limited impact on debt servicing (if any) was more than neutralised by the fall in dividends from privatised units.
If the total value of 100 privatisation units in the 1990s was a mere Rs 59 billion, the aggregate sum realised from 60 units sold up until 2013 was Rs 416 billion because most of the items sold in the 2000s were pricier. The recently sold shares of HBL (US$ 1.2 billion) and UBL (US$ 387 million) together have brought in about US$ 1.6 billion into the KHY while those of ABL and PPL fetched about Rs 32 billion. These incomes seem to have made hardly any difference to outgoing years budgetary burdens.
There are an estimated one million shareholders of publicly quoted companies in Pakistan. Market capitalisation of US$ 70 million is part of the wealth of these one million individuals. Family ownership of companies still dominates the corporate world, making them too vulnerable to the vagaries of the market. These wholly family-owned corporate entities, in order to offset the effects of such risks to their incomes and assets, indulge in tax evasion and pilferage of public utilities. The process of privatisation has added to the assets and incomes of a handful of our enormously rich families but their fear of the market risks continues to force them to pilfer national wealth rather than reinvest. Lobbyists of big business houses buy political influence to ensure that successive governments keep making ‘business-friendly’ taxation policies.
Continued faith in privatisation is more likely to end up threatening the very foundations of the state because why would any citizen of Pakistan, other than the few rich islands floating in a sea of poverty, feel a sense of belonging to the state if the state continues to fail in its basic responsibility of providing universal access to affordable education, health and credit and continues to refuse affordable transport, communications, energy and housing to most of its population while it keeps handing over most of the productive and profit-making units to a handful of the privileged?
For Pakistan, the choice now is no longer between a ‘big’ or ‘small’ state, but how to build a ‘smart state’ capable of keeping a balance between its social responsibilities and its task of making enough money to enable the nation to gradually reduce its dependence on politically-attached foreign dole.
As Joseph Stiglitz said in his book, Making Globalisation Work, “Trade and market liberalisation were two key components of a broader policy framework, known as the Washington Consensus — a consensus forged between the IMF (located on 19th Street), the World Bank (on 18th Street) and the US Treasury (on 15th Street) — on what constituted the set of policies that would promote development. It emphasised downscaling of government, deregulation, and rapid liberalisation and privatisation. By the early years of the millennium, confidence in the Washington Consensus was fraying and a post Washington Consensus was emerging. The Washington Consensus had, for instance, paid too little attention to issues of equity, employment and competition, to pacing and sequencing of reforms, or to how privatisation was conducted. There is, by now, also a consensus that it focused too much on just an increase in GDP, not on other things that affect living standards and focused too little on sustainability — on whether growth could be sustained economically, socially, politically, or environmentally.”
This article was originally published in Newsline’s August 2015 issue.