Discuss privatization as a tool in encouraging economic recovery in a country

Privatization has been a key element of structural reform in many developing and transition economies during the last decade. Governments undertaking privatization have pursued a variety of objectives: achieving gains in economic efficiency, given the extensive prevalence of poor economic performance of public enterprises in many countries and limited success with their reform; and improving the fiscal position, particularly in cases where governments have been unwilling or unable to continue to finance deficits in the public enterprise sector. In addition, liquidity-constrained governments facing fiscal pressures have sometimes privatized with a view to financing fiscal deficits with the proceeds. Other objectives have included the development of domestic capital markets.

These efforts have been reviewed in a large literature on the microeconomic aspects of privatization that has emphasized the potential efficiency gains. However, there has been less work, particularly of an empirical nature, done on the fiscal and macroeconomic impact of privatization. Among the international financial institutions, the World Bank has had the lead role in advising on the design and implementation of the reform of public enterprises, including divestiture. Privatization, however, has important fiscal and macroeconomic implications and is therefore also of interest to the International Monetary Fund (IMF). Indeed, privatization has become an important component of programs in a large number of countries.

This paper reviews fiscal and macroeconomic issues in the privatization of nonfinancial public enterprises in developing and transition economies. Successive sections of the paper consider the following issues: proceeds from privatization and the factors determining the amount accruing to the budget; uses of the proceeds; empirical evidence on the impact of privatization on the budget and macroeconomic aggregates; and the privatization component of IMF-supported programs. The empirical evidence draws on a series of case study countries selected to be representative of a range of privatization experience in developing and transition economies and to reflect geographical diversity.

Privatization Proceeds

Proceeds from privatization have been substantial in a number of developing and transition economies. Gross receipts that can be transferred to the budget are affected by actions prior to sale, the sales process, and the postprivatization regime. Amounts accruing to the budget are found to be less than the sales proceeds as a result of extrabudgetary management and the wide divergence between gross and net receipts. Among the major conclusions concerning privatization proceeds are the following:

First, off-budget placement of privatization proceeds can lead to limited control and lack of transparency in their use. Extrabudgetary funds should be regulated, with accounts publicly reported, audited, and subject to parliamentary oversight.

Second, privatization transactions should be transparently reported on a gross basis. Costs for restructuring, recapitalization, or writing off public enterprise debt should be recorded as spending financed by the gross proceeds of sale.

Third, privatization is an exchange of assets; the receipts are lumpy, one-off, and uncertain. Thus, privatization proceeds should be treated as a financing item in the fiscal accounts.

Uses of Privatization Proceeds

An evaluation of the potential uses of privatization receipts should reflect the implications for government net worth and their macroeconomic impact.

Insofar as government net worth is concerned, receipts from privatization do not of themselves indicate that the government is better off. Privatization has longer-term implications in terms of revenues foregone and/or expenditures that will not be made in the future, and government decisions on the use of proceeds should reflect these intertemporal effects. Government net worth will rise to the extent that private sector ownership leads to an increase in efficiency and the government shares in this gain.

The macroeconomic effects of privatization depend, in part, on whether receipts are from domestic or foreign sources, the degree of capital mobility, and the exchange regime. Broadly, the effects of an increase in the deficit financed by privatization receipts would be similar to those resulting from a debt-financed fiscal expansion. Use of proceeds to reduce external debt provides for an automatic sterilization of what may be substantial capital inflows associated with privatization. Reduction of domestic debt may impact domestic liquidity.

Assessment of governments' stated intentions with respect to the use of privatization receipts needs to allow for the fungibility of resources. Uses commonly considered are

• Higher expenditure. Privatization receipts are temporary and often uncertain, thus it is not advisable to rely on them for current spending. Targeted use to help cushion the short-term social impact of privatization can be appropriate. Use of the proceeds to finance additional capital spending need not reduce government net worth, though it often raises concerns as to the quality of the projects.
• Reduction in net debt. This may be achieved by retiring debt (or settling arrears), or building up assets, with the choice determined by debt management considerations. Advantages include maintenance of government net worth and possibly favorable signaling effects that could impact the cost and availability of debt.
• Earmarking of privatization receipts. Doing so for particular expenditures complicates fiscal management and makes it difficult to reallocate spending in response to changes in circumstances and priorities. As such it should be discouraged.
• Relaxing the fiscal constraint. Privatization proceeds might serve a limited role in providing a temporary cushion for countries pursuing aggressive adjustment and reform programs.

Privatization has a contemporaneous impact on the budget and budgetary effects over time. Econometric results suggest that, for the case study countries, privatization receipts are saved rather than spent. This result applies for receipts channeled through the budget, which does not support arguments that extrabudgetary treatment is necessarily required for prudent management. Most of the countries covered had an IMF program in place, and consequent limitations on the deficit may have substantially influenced this finding.

Piecemeal evidence suggests that, over time, the fiscal situation tends to benefit from privatization. In particular, both the firm level and more aggregate data support positive impacts on revenue; transfers decline markedly following periods of privatization; and broader indicators of consolidated public enterprise accounts for some countries indicate a large decline in deficits, and probably also in quasi-fiscal operations.

Data on public enterprise operations and on the financial flows between enterprises and the government (including quasi-fiscal flows) are often inadequate. There is a need for improvements in this area in many countries.

Macroeconomic Impact of Privatization

Both the microeconomic and case study data are supportive of the positive effects of privatization over time on growth and employment. These results hold for the full sample and the transition countries, though they are less pronounced for the latter.

Growth
The microeconomic evidence indicates that private firms are operationally more efficient than those held by the state, particularly in competitive industries. A strong correlation is also found for the case study countries between privatization and growth. However, and consistent with the growth literature, privatization is likely serving as a proxy in the regressions for one or more missing variables that may broadly be characterized as a favorable regime change.

Labor Markets
Public enterprises often seek to maintain employment, and benefit from soft budget constraints. Consequently, there is concern that privatization may lead to increased unemployment. Although empirical evidence suggests that aggregate unemployment tends to decrease following privatization, particular groups of workers may still be adversely affected. This lends importance to measures that mitigate its social impact.

Issues for IMF-Supported Programs

The World Bank takes the lead in privatization, but the IMF has cooperated closely with it in this area. Drawing on the Bank's experience and recommendations, a majority of IMF-supported programs in recent years have included some form of conditionality on privatization.

Monitoring of privatization in IMF-supported programs has emphasized conditionality on process and targets. Consistent with the recent emphasis in the World Bank, there is scope for IMF conditionality to give more weight to privatization procedures where these have important fiscal and macroeconomic impact. Similarly, programs should, in some cases, give greater importance to the establishment of an appropriate regulatory environment within which privatized firms operate.

The design of financial programs should include as broad a definition of privatization receipts as possible in the fiscal targets and quantitative performance criteria, and consider the macroeconomic effects in assessing use. Adjusters should address the uncertainty attached to the amount of receipts; in general, higher-than-anticipated receipts should be saved.

How does privatization help the economy?

Why privatization is important for a developing country?

How does privatization help stimulate gains in economic?

What are the three advantages of privatization?