PSD Blog - The World Bank Group

Latin America: From disappointment with privatization to innovation in PPP’s

Editor's Note: Bernardo Weaver is a Wharton MBA in Finance Candidate and a consultant at the World Bank working on Public Private Partnerships.

Privatizations in the 80’s and 90’s in Latin America proved to be disastrous by many accounts. The success of the Thatcher administration in the United Kingdom did not transfer well to the other side of the Atlantic, at least south of the US. Many Latin American politicians found an easy target in privatizations: The sale of state-owned assets at sub-par value.

Politicians also conveyed the idea that the state and the citizens are identical. As a result, the population thought that their assets were sold at fire sale prices to big international companies. These international companies—often connected with aggressive animals like sharks and lions (and even monsters)—became vilified. Governments did not respect clauses and tariff readjustments, and the famous instability of the region was again reconfirmed.

Privatization: Soft budgets vs. soft price regulations

Public sector firms face a “soft budget” constraint in the sense that the government can bail them out for the losses they incur. Hence, managers can follow their own interest or favor special interest groups without worrying much about the costs of such actions. In short, soft budgets tend to promote corruption.

One solution to this soft budget driven corruption is privatization with a firm pre-commitment on the part of the government to not bail out the firm in the future. So, we should expect greater satisfaction with privatization among consumers in countries that are more corrupt. According to a recent study by Martimort and Straub (2009), quite the opposite is happening in Latin America. Consumer dissatisfaction with privatization efforts over the last two decades has increased, and especially so in countries that are more corrupt or where corruption has increased over time (see figure below the jump).

The heavy hand of regulation and the hidden cost of information

In his presidential address to the American Economic Association, Avinash Dixit (2009) notes that laws and regulations are necessary for security of property rights, enforcement of contracts and overcoming collective action problems – something that the private sector cannot function without. However, laws and regulations are unlikely to have much beneficial effect if private agents are simply not aware of them. How easy is it for firms to obtain information on laws and regulations? What are the sorts of factors that determine this level of ease?
 
These are important questions that have received virtually no attention in the literature. One exception is Amin (2008). This study uses data for 50 countries from the World Business Environment Survey (WBES, 1999, World Bank). The survey asked managers to respond on a 1 (fully disagree) to 6 (fully agree) scale to the following statement: “In general, information on the laws and regulations affecting my firm is easy to obtain.”

Mass privatization and mortality

This January the British medical journal the Lancet caused a kerfuffle with an article that claimed that privatization in post-communist countries was responsible for massive numbers of deaths. The authors of Mass Privatisation and the Post-communist Mortality Crisis argued that privatization resulted in massive layoffs, which in turn resulted in a staggering increase in mortality rates, particularly in Russia. Could it possibly be true that privatization is that bad for the health? The Economist was quick to rebut the argument, pointing out both that correlation is not causation and that countries such as Poland that implemented shock therapy did not experience the rise in mortality that Russia did.

A new paper from John Earle, a Professor of Economics at the Central European University and a Senior Economist at the Upjohn Institute, extends the rebuttal much further. Earle points out that a very basic link in the chain of reasoning of the Lancet authors is missing - namely, mass privatization did not lead to substantial job loss. In fact, the effects on employment were typically neutral or positive (click on Figure 1 below). For the full argument, check out Mass Privatization and Mortality: Is Job Loss the Link? It's quick but well worth the read.

Privatizing health care in Georgia

Big changes are underway in Georgia's health sector. The central government is taking steps to privatize both publicly owned hospitals and health insurance. As it stands, the public health care system inherited from the Soviet era is bloated - only about 30 percent of its hospital beds are being used, and many of the 250 hospitals need renovation. An article in Transitions Online cites the Minister of Labor, Health, and Social Affairs on the current state of things:

It is absolutely impossible for [a] state like Georgia to retain...254 publicy owned hospitals...Therefore, private medical insurance and [a] private hospital network [are] something that we think is the only way out of the situation.

China vs. India - a battle of the brains

In this brave new world of knowledge-driven economies, it is a battle of the brains. And in perhaps the biggest battle of them all—China versus India—a winner is emerging. If you guessed India, I’m sorry, you get the consolation prize. China is far outstripping India in the race to expand tertiary enrollment. Data collected by the UNESCO Institute for Statistics indicate that in 2006, China achieved a gross enrollment ratio of 22 percent, compared to only 12 percent in India. Granted, raw numbers don’t take into account variations in the quality of education. Nevertheless, India is clearly a laggard at 12 percent—and perhaps even less than that, according to data from the Program for Research on Private Higher Education.

What could explain India’s poor marks? One part of the explanation is India’s ambivalent relationship with the private sector as a provider of higher education. While private higher education has grown rapidly in India, both in terms of number of institutions and enrollments, many barriers still remain. According to the Program for Research on Higher Education, there is

Privatization in 2006 - the year of Chinese IPOs

Our privatization database – listing transactions of at least $1 million from 2000 to 2006 - has been updated again.  In 2006, 48 developing countries carried out 249 privatizations for a total value of $105 billion – a figure comparable to the record year 1997.

The graph below depicts the value of privatization transactions in developing countries between 1990 and 2006. The figure excludes the two IPOs of the Industrial and Commercial Bank of China and the Bank of China, which combined accounted for $35 billion - one-third of all proceeds in 2006:

Russia and Turkey followed China into the second and third place, while Poland bucked the general trend toward privatization that year.

Our interactive map has the full picture.

Big bang or gradualism - which way to reform?

Oleh Havrylyshyn, former deputy minister of finance of Ukraine, looks back at the transition experience of post-communist countries from centrally planned to the market economy. The author contrasts the two opposite reform approaches: big bang, also known as the "shock therapy," with gradualism.

The study finds that the main motivation behind pursuing gradualism – the fear of a rise in inequality – was unsupported. And though the early and rapid reformers did not avoid an increase in poverty altogether, they suffered less of it and more than fully recovered by 2000.

Based on the initial speed and scope of reforms, Georgia was classified as a gradualist but for the last two years managed to become the top-reformer in the Doing Business report.

Lastly, a word from Mr. Havrylyshyn:

Statements about the need for transparency, a level playing field for SMEs and better rule of law, have more effect when they come from a CEO of a leading multinational, rather than when they come from World Bank or IMF officials

Privatization in Africa

Privatizing your largest bank to foreigners certainly invites scrutiny if not criticism especially in Sub-Saharan Africa. A recent study asseses the sale of government-owned Uganda Commercial Bank to the South African Stanbic and suggests that the privatization has been relatively successful.

The portfolio of the privatized bank, which was cleaned prior to sale, remains fairly strong and profitability and credit growth are now on par with other Ugandan banks. Though market segmentation still is a concern, since Stanbic faces little or no direct competition in many remote areas, early results suggest that access to credit has improved for some hard-to-serve groups.

Who's going to lend to rural Chinese?

Seven hundred and fifty million Chinese live in rural areas and most have a limited access to finance. The Enterprise Surveys found that in 2003 nearly 30 percent of firms named access to and cost of financing a "major or severe" obstacle. To address the situation, banking regulators in China began to loosen the restrictions on establishing of small rural financial institutions.

A new Wharton article analyzes the difficulties that for profit microfinance programs encounter. According to World Bank's Jun Wang:

There are still many people who hold the view that rural and microfinance cannot be commercially sustainable. They believe that farmers are a vulnerable group of society, they have limited means of production and opportunities, and deserve government support. Most of these people demand subsidized interest rates, which is problematic.