DRD DISCUSSION PAPER Report No. DRD292 PUBLIC ENTERPRISE IN DEVELOPING COUNTRIES: ISSUES OF PRIVATIZATION by Bela Balassa ~-------------------M-a-y--19_8_7------~-----·_______j Development Research Department Economics and Research Staff World Bank The World Bank does not accept responsibility for the views expressed herein which are those of the author(s) and should not be attributed to the Wot·ld Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentatinn of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or~o£ its authorities, or concerning the delimitations of its boundaries, or national affiliation. PUBLIC ENTERPRISE !N DEVELOPING COUNTRIES: ISSUES OF PRIVATIZATION Bela Balassa Abstract This paper examines the reasons for the shift towards the privatization of public enterprises in developing countries and the conditions under which privatization will bring the desired results. It is suggested that privatization may be regarded as a response to perceived differences in efficiency between private and public enterprises which is given urgency by the difficult financial situation of public enterprises in many developing countries. At the same time, for privatization to be successful; it is necessary to establish competitive conditions in the industry concerned. Finally, in cases where political obstacles stand in the way of privatization, consid~ration may be given to leasing or management contracts, to closing down firms where conditions are without repair, and to improving the operation of public enterprises. PUBLIC ENTERPRISE IN DEV~LOPING COUNTRIES: ISSUES OF PRIVATIZATION Bela Balassa Introduction There has been a sea change in attitudes towards public enterprise around the world in recent years. In Western Europe, the United Kingdom and, since April 1986, France have set out to privatize public enterprises on a large scale. In the case of France, this represents not only a reversal of the nationalizations undertaken by the previous socialist government in 1981, but companies nationalized in 1945 are also being privatized. At the same time, there is little indication that the Labor party in Britain or the Socialist party in France would undo the denationalizations that are being carried out, if they were returned to power. Furthermore, in European countries with socialist-oriented governments, such as Austria, Finland, and Spain, several public enterprises are being privatized or their privatization is envisaged. Attitudes have been changing in the developing countries as well. While many of these countries, whether their government professed itself to be socialist or not, had considered public enterprise as the mainstay of economic development, there has been an increasing - 2 - disillusionment with public enterprise in recent years and proposals have been made for privatization in various areas. This paper will attempt to provide an explanation for the change in attitudes towards public enterprise in the developing countries, draw the lessons of developing country experience with public enterprises and with privatization, and indicate possible future changes. The discussion will be limited to manufacturing industries, excluding natural resource products which are often considered the preserve of the state; public utilities which as natural monopolies are owned or regulated by the state throughout the world; and services on which there are limited data. Section I of the paper will provide information on the relative importance of ~ublic enterprises in the manufacturing sector of the developing countries. Section II will consider possible reasons for the trend towards privatization, with Section III concentrating on efficiency differences between public and private enterprises. In turn, Section III will review the record of the developing countries with privatization and Section IV will examine prospects for the future. I Public Enterprises in the Manufacturing Sector of the Developing Countries Table 1 contains data on the relative shares of public enterprises in the manufacturing sector of the developing countries. l/ Apart from 1/ For purposes of comparisont the table also includes data for the industrial countries, whenever available. - 3 - Ghana, where only gross output figures are available, the production data refer to value added and are, on the whole, internationally comparable. 1/ However, for a number of countries, there are investment but not production data. Investment data generally overstate the share of public enterprises, which tend to be in capital-intensive industries. Thus, in 1982, public enterprises accounted for 42 percent of the gross domestic product and for 66 percent of gross fixed investment in eight developing countries, on the average (Ayub and Hegstad, 1986, p. 77)~ :1 In the 1970s, the share of public enterprises in the martufacturing sector of the industrial countries was the highest in Austria (23 percent), followed by Italy (19 percent), Portugal (12 percent), and France (11 percent). The French ratio reached 33 percent following the nationalizations of 1981 7 but it has been declining since as a result of denationalizations undertaken by the new government. At the other end of the spectrum, the ratio was practically nil in Belgium, 1 percent in Greece, 4 percent in Australia, and 5 percent in the United Kingdom in the late 1970s. J/ Among developing countries, the share of public enterprises in the manufacturing sector exceeds 90 percent in Iraq and Syria; it was above this level in Egypt in the mid-1970s but declined to 80 percent by 1979. 1/ In several cases, mining is included with manufacturing. But, in the countries in question mining is generally of little importance and hence it can be disregarded in the discussion. 2/ The data include mining and manufacturing. 3/ This explains that, apart from British Telecom, the British denationalizations have related largely to public utilities and transportation. - 4 - TABLE 1: RELATIVE SHARES OF PUBLIC ENTERPRISES IN THE MANUFACTURING SECTOR Year Relative Share (percent) INDUSTRIAL COUNTRIES Australia GDP 1978-79 4.0 Austria GOP 1970-75 23.0 2.1 Belgium GDI 1978-79 0.4 France GDI 1971 11.4 ~ Greece GDP 1979 1.3 Ireland GDI 1974-77 9.4 Italy GDI 1978 18.6 .!1 Portugal GDP 1976 12.0 United Kingdom GDI 1978-81 5.3 SUB-SAHARAN AFRICA Ethiopia GDP 1979-80 60.9 Ghana GDP 1970 32.9 Ivory Coast GDP 1979 25.2 ~/ Kenya GDP 1970-73 13.1 Senegal GDP 1974 19.0 Sierra Leone GDP 1979 14.2 Tanzania GDP i974-77 37 .. 9 NORTH AFRICA AND MIDDLE EAST Egypt GDI 1979 80.4 2.,1 Iraq GDI 1975 96.7 Morocco GDI 1974-76 26.2 Syria GDI 1975 95.9 Tunisia GDP 1982 31.4 Turkey GDP 1979 30.1 Yemen Arab Rep. GDI 1975-76 59.5 ASIA Bangladesh GDP 1981-82 46 .I Burma GOP 1980 56.2 India GDP 1978 15.7 Korea GDP 1974-77 14.9 Nepal GDP 1974-75 4.4 Pakistan GDP 1974-75 7.8 Singapore GDP 1972 14.2 Sri Lanka GDP 1974 33.2 Taiwan GDP 1985 12.0 Thailand GDP 1970-73 5.2 LATIN AMI;;RICA Bolivia GDP 1973-75 5.9 Venezuela GDP 1985 16.2 Sources: Short (1984) and World Bank data files. Note: 2._/ including mining. - 5 - The share of public enterprises in the manufacturing sector is in the 50-60 percent range in Ethiopia and Burma. All these countries, together with Tanzania, where the share of public enterprises rose from 15 percent in 1966-68 to 38 percent in 1974- 77, profess themselves to be socialist. In turn, the share of public enterprises in the manufacturing sector is 33 percent in Ghana, 31 percent in Tunisia, and 30 percent in Turkey, which are considered mixed economies. While India has also been influenced by socialist ideas, the share of public enterprises in its manufacturing sector (16 percent) is not much higher than in Korea {15 percent) and in Taiwan {12 percent). But, the direction of change has been different, with the share of public enterprises rising from 13 percent in 1970-73 to 16 percent in 1978 in India and declining from 56 percent in 1952 to 12 percent in 1985 in Taiwan. 11 The share of public enterprises in the manufacturing sector does not reach 10 percent in Nepal, Sri Lanka, and Thailand. It was below this level also in Pakistan in the mid-1970s, when a number of textile mills were nationalized under Bhutto'L socialist-leaning government, some of which have since been reprivatized. In turn, the 46 percent share of public enterprises in the manufacturing sector of Bangladesh has been substantially reduced as a result of the denationalizations undertaken since that time. In socialist developing countries, the tendency has been for public enterprises to dominate the manufacturing sector. In other 1/ During the period under consideration, no change occurred in Korea. - 6 - developing countries, tobacco and, often, sugar, alcoholic beverages, and· cement, are in public ownership. Such is frequently the case also for petroleum refining, pharmaceuticals, fertilizer, and iron and steel, in countries where these industries exist. Furthermore, there are government printing presses in many developing countries and in a number of cases the public sector includes textile factories. The existing situation reflects past decisions that have responded to a variety of considerations. In some industries, such as tobacco, sugar, and alcoholic beverages, public enterprises have been used to indirectly tax consumption. Industries such as steel are often in the public sector because they are considered to be of strategic importance for economic development. There are again others, such as petroleum refining, fertilizer, and cement, where high capital requirements have led to the establishment of public enterprises. Elsewhere, the creation of public enterprises has been rationalized by reference to the alleged lack of private entrepreneurs. Finally, for social reasons, developing country governments have taken over private firms in difficulties in a variety of industries. II Reasons for Privatization Various reasons have been put forward to explain changes in attitudes towards privatization in recent years. It has been suggested that ideology, and changes thereof, has played an important role, in particular in France and the United Kingdom. Also, budgetary - 7 - considerations have often been cited as reasons for privatization. Finally, it has been noted that private enterprises tend to be more efficient than their public counterparts. While the relevance of ideology cannot be denied in the case of France and the United Kingdom 1 objective factors have importantly entered decision-making in these cases. :1 Furthermore, as noted in the introduction, there is little expectation that re-nationalization would be undertaken in the two countries ir. the event of a change in government and, in Western Europe, privatization is carried out by socialist-oriented governments as well. In developing countries also, privatization by-and- large cuts across the political spectrum, including for example Egypt and Tanzania, although it is not envisaged at this time in some Middle Eastern and African socialist countries. As to budgetary considerations, in the 1974-77 period, for which data are available, public enterprises in developing countries had an overall deficit averaging 5.4 percent of their gross dom~stic product. 2/ This result reflects the fact that the small current account surpluses of these enterprises, averaging 0.6 percent of GDP before depreciation and government transfers, financed only a fraction of their investments that accounted for the deficit on the capital account of public enterprises equal to 6.0 percent of the developing countries' GDP, on the average. In 1/ In the case of France, expectations for increased efficiency and reduced bureaucratic interference have been given as reasons for privatization (c£. Balassa, 1987). Unless otherwise noted, the data derive from Short, 1984, Tables 5 to 8. While the country coverage of the tables varies somewhat, the data are by- and-large comparable. - 8 - fact, the current account surplus of public enterprises in the developing countries did not even cover depreciation, averaging 1.1 percent of their GOP. Yet, the data overstate the current account surplus of the public enterprises as they do not allow for the credit preferences many of them receive. Also, the data include mineral-rich countries, such as Chile, Gambia, Guyana, Venezuela, and Zambia, where public enterprise revenues comprise substantial royalties from the sale of petroleum, copper, bauxite, and other minerals. Budgetary subsidies and borrowing from the government financed, on the average, slightly over one-half of the overall deficit of public enterprises in the developing countries in the 1974-77 period, when these enterprises accounted for three-fourths of the public sector deficit. The rest of the financing was provided in more-or-less equal proportions by foreign and domestic borrowing, the latter from banks and in capital markets. Foreign borrowing assumed particular importance after 1973, contributing substantially to the rising external indebtedness of the developing countries. Thus, in the three largest Latin American countries, Argentina, Brazil, and Mexico, public enterprises hold over one-half of the country's external debt (Balassa et al, 1986, Table 4.4). It has also been reported that public enterprises contracted one-third of developing country borrowing on capital markets in 1976-78 (World Bank, 1980). Furthermore, public enterprises account for a large proportion of domestic bank credit. It has been noted that, for countries for which data are available, the average share of public enterprise credit in total - 9 - domestic credit rose by 20 percentage points between the early 1970s and the end of the 1970s to a level of almost 30 percent (Short, 1984, p. 176). Public enterprises in developing countries, then, simultaneously increased their foreign and domestic borrowing during the 1970s. These r~sults reflect the rising financial requirements of these enterprises, associated with their growing deficits (Short, 1984; Balassa et al, 1986, cb. 4). With the drying up of foreign loans following the debt crisis of 1982, these deficits have come to be financed increasingly from domestic sources, thereby raising the spectre of "crowding out" for the private sector. Budgetary and, more genernlly, financial considerations have thus contributed to the change in attitudes towards public enterprises in the developing countries. But, privatization will not reduce the financial burden that public enterprises represent, unless their performance can be improved. In fact, there are cases, such as Tunisia, where private firms are not willing to take over public enterprises unless the government undertakes their rationalization beforehand. III The Relative Efficiency of Public and Private Enterprises Budget&ry and financial issues, then, lead to the question of the relative efficiency of public and private enterprises. Efficiency comparisons should ideally be made in cases where public and private enterprises carry out the same economic activity. There are few such - 10 - comparisons for the industrial countries, and they generally relate to public utilities and service industries. A recent study, which has taken particular care in selecting among em~irical investigations those which compare identical activities and use appropriate indicators of efficiency, has found seventeen cases where private enterprises were more efficient than public enterprises, six where the opposite was the case, and five where no difference could be discerned (Yarrow, 1986). 21 The twenty-eight cases investigated included only one manufacturing industry, steel, where the private sector has been shown to be more efficient than the public sector. The virtual lack of efficiency comparisons for manufacturing industries in the industrial countries is indicative of the fact that in these countries public and private enterprise can be found side-by-side mostly in public utilities and service industries. In developing countries, comparisons in the service sector have been made for 33 development finance companies (DFC). The study concludes that "the private DFCs are markedly more vigorous and efficient than state-owned institutions in mobilizing domestic resources" (Gordon, 1983, p. 38) and generally have a much higher level of profitability (Ibid, p. 32). At the same time, for selected developing countries, information is available on manufacturing enterprises in the public sector. In the case of Brazil, it has been reported that the rate of return on equity in public enterprises was one-half that in private };/ Within the last group there was one case where pubLic enterprise may be slightly favored. - 11 - enterprises in 1974 and in 1978. Also, in Israel, before-tax profits averaged 1.6 percent on sales in public enterprises, compared with 11.6 percent in private enterprises, in 1976-78 (Ayub and Hegstad, 1986, p. 15). Finally, in India, public enterprises in the manufacturing sector earned a rate of return of just over 2 percent, while private firms earned a rate of return of over 9 percent, in 1976 (Choksi, 1979, pp. 23-24). Yet, the profit figures overstate the efficiency of public enterprises that pay very low, and even nil, interest on public loans in the three countries. Also, no adjustment has been made for differences between market and shadow prices. Such adjustments have been made in the case of public enterprises in 26 Egyptian manufacturing industries, for which financial and economic rates of return have been calculated for fiscal year 1980/81. The results show considerable differences between the two sets of calculations, reflecting the importance of price distortions in Egypt. They also indicate that, on balance, differences between market and shadow prices have raised financial over economic rates of return in Egyptian public enterprises. Thus, while only one-half of public industries had a financial rate of return of less than 10 p~rcent, one-half of them had a negative rate of economic return (Shirley, 1983, p. 33). Although comparisons with private firms are not available, this result puts the Egyptian public enterprises in the manufacturing sector in an unfavorable light. Comparisons of various performance indicators for public and private firms have been made for Turkey. The .results show that, in 1979, labor productivity was 30 percent higher in private than in public enterprises, even though the latter had a capital-labor ratio 50 percent - 12 - higher (Ibid, p. 16). Another study showed that, in 1976, public enterprises utilized 1 percent more labor and 44 percent more capital per unit of output than private enterprises in the Turkish manufacturing sector (Krueger and Tuncer, 1980, p. 43). These results are confirmed by estimates of economic rates of return for 123 Turkish manufacturing firms in 1981. In manufacturing, taken as a whole, the economic rate of return averaged -0.7 percent in public enterprises and 6.2 percent in private enterprises. Only in two sectors (iron and steel products and electrical machinery) out of fourteen was the economic rate of return higher in the public than in the private sector; rates of return were equal for textiles. At the same time, public enterprises were favored by the system of incentives applied. Thus, the effective rate of subsidy, indicating the combined effects of import protection, tax, and credit performances, averaged 31 percent in the public sector and 49 percent in the private sector. The incentive measures applied, then, benefited the largely inefficient public enterprises at the expense of private enterprises (Yagci, 1984, pp. 86 and 97). Firm-by-firm comparisons of efficiency levels for Brazil, India, Indonesia, and Tanzania also show the superiority of private over public enterprises. In the case of the Brazilian plastics and steel industries, the level of technical efficiency was shown to be lower in public than in private firms (Tyler, 1979). In India, it was found that productivity in the fertilizer industry was lower in the public than in the private sector, and the differences were explained only in part by higher input costs due to the government imposing the use of high cost domestically-produced - 13 - feedstock on public enterprises and by outdated technology stemming from the lack of renewal of old equipment (Gupta, 1982). In the Indonesian manufacturing sector, production costs in public enterprises were shown to be generally higher than in private enterprises {Funkhouser and MacAvoy (1979). In particular, "by almost any indicator, the economic performance of the state mills has been inferior to that of private mills'' in weaving (Hill, 1982, p. 2025). Finally, a study of more than 300 firms in ten Tanzanian industries has found that 23 out of 32 public enterprises used both more capital and more labor than privately- owned firms in the same industry (Perkins, 1983). A variety of factors account for the apparent poor performance of public enterprises in the manufacturing sector of the developing countries, some of which have been referred to already in regard to particular cases. A comparative study lists "(i) inadequate planning and poor fea~ibility studies resulting in ill-conceived investments; (ii) lack of skilled managers and administrators; (iii) centralized decision making; (iv) state intervention in the day-to-day operation of the firm; (v) unclear multiple objectives; and (vi) political patronage" (Choksi, 1978, P• iv). One may add overmanning, the payment of excessively hi.'6h wages and/or social benefits, slowness in decision-making, and the lack of the threat of bankruptcy. All these factors are related to two basic conditions: the absence of clear-cut objectives for managers and state intervention in firm decision making. Profits are never the sole, and are often a subsidiary, objective of public enterprises in the developing countries. This means that there is little incentive to reduce costs and to improve technology. The - 14 - situation is aggravated by the lack of the threat of bankruptcy, which provides the ultimate penalty for poor performance in private enterprise. Public enterprises are also called upon to serve social goals, such as the regionalization o£ industry and increased employment, or political objectives, such as favoring the members of a particular race and party and augmenting military power. At the same time, the relative importance of economic, social, and political objectives is far from heing unambiguous and it may show changes even in the lifetime of the same administration and, in particular, following changes in government. The overmanning often observed in the public enterprises of developing countries may also be the result of demands by the supervising authorities to hire -- or not to fire -- labor. The lack of managerial independence further leads to slowness in decision making and to conflicts in sequential decisions. Finally, the dependence of managers on the government in power will induce them to pursue short-term objectives at the expense of long-term targets. IV The Status of Privatization in Developing Countries It may be suggested, then, that the observed shortcomings of public enterprises, resulting in their relatively low efficiency, have importantly motivated the movement towards privatization. But why the - 15 - sudden change in attitudes? Has information not been available for a sufficiently long period on the performance of public ~nterprises? :1 It may be claimed that evidence on the relative inefficiency of public enterprises has accumulated over time, increasing its weight and hence its effect on decision makers. Also, the increasing losses of public economic enterprises, which occurred parallel to the growing budgetary stringency associated with the debt crisis, have made governments recognize the cost of public enterprises to the budget and to the national economy. But, the principal reason may lie in changes in development strategies. Privatization should be seen as part and parcel of the $hift in development strategies initiated in a number of countries, involving greater outward orientation. This shift, necessitating improvements in efficiency, has led to proposals for privatization as private enterprise is considered to be better able to respond to the stick and carrot of competition, which is seen as a condition of improved efficiency. This is the case, in particular, in regard to foreign markets where private enterprises are well-placed to take the risks and reap the rewards l'>f success in exporting. In fact, it has been shown that, in the 1970-81 period, export growth was negatively correlated with the share of public enterprises in the gross domestic product (GDP) and in gross In this connection, reference may be made to a statement by Adam Smith in The Wealth of Nations, according to which "In every great monarchy in Europe the sale of the crown lands would produce a very large sum of money, which, if applied to the payment of the public debts, would deliver from mortgage a much greater revenue than any which those lands have ever afforded to the crown •••• When the crown lands had become private property, they would, in the course of a few years, become well improved and well cultivated." (cited in Yarrow, 1986, P• 324). - 16 - domestic investment (GDI) of developing countries. The regression coefficient, estimated in a cross-section investigation of 21 countries in the first case and 38 countries in the second, is statistically significant at the 2 percent and the 1 percent level, respectively (Nunnenkamp, 1986, p. 190). In the same study, a negative correlation has been obtained between the share of public enterprise in GDP and in GDI, on the one hand, and the growth of GDP and that of GDI, on the other, although the results are not significant statistically. Statistically significant results have been obtained, however, in a multiple regression analysis of 73 developing countries, which included the GDP growth rate as dependent variable and per capita incomes, population, the domestic savings ratio, foreign aid, and the index of state intervention as explanatory variables. The index of state intervention has been defined as a combination of the extent of state regulations in industry and the extent of nationalization. The regression coefficient of this variable has been consistently negative $nd highly significant, under the various specifications used in the study, for both the 1960-70 and the 1970-80 periods (Singh, 1985, p. 223). One explanation for the observed negative relationship between state intervention and econ~mic growth is the higher efficiency of private as against public investment. In fact, a study of 27 developing countries has shown the existence of a positive correlation between the share of private investment in the total and the rate of growth of GDP in the 1971- 79 period (Blejer and Khan, 1984, p. 27). - 17 - Table 2: Trade-Weighted Averages of Standard Deviations of ~xch4nge Rates in Bilateral Relationships, 1970-86 Nominal Exchange Ratea Real Exchange Rates Actual Trade-Weighted Actual Trade-Weighted Rate Rate Rate Rate Benin 5.535 5.579 Burkina Fae.J n.a. n.a. 2.996 3.850 8.75 8.26 Cameroon 3.524 3.900· 4.75 5.06 Central Africa 3.046 3.926 4.22 Congo 3.85 4.198 4.822 6.07 5.81 Cote d' Ivoire 4.583 5.008 7.38 6.86 Gabon 6.145 8.642 8.39 7.97 Mali 2.005 2.730 n.ae n.a. Niger 3.917 6.091 8.41 8.16 Senegal 3.219 4.378 7.50 6.81 Chad 3.728 4.437 n.a. n.a. Togo 4.644 4.774 7 .. 14 7.04 Egypt 23.661 6.650 24.88 7.12 El Salvador 28.699 7.705 8.01 Ethiopia 7.19 8.623 7.187 10.11 9.87 Guatemala 7.423 8.709 Haiti 7.54 8.06 3.720 4.967 6.76 6.56 Honduras 4.948 6.246 Iraq 5.19 5.37 12.367 9.871 n.a. n.a. Liberia 8.613 6.078 7.63 6.75 Nicaragua 55.249 8.426 n.a. Oman n.a. 11.674 6.528 n.a ... - n.a. Panama 6.100 7.610 5.88 6.98 Paraguay 18.743 22.487 15.96 22.25 Per 53.016 9.922 14.41 19.36 Syria 10.906 6.829 n.a. n.a. Trinidad & Tobago 13.106 3.706 7.27 5e68 Venezuela 15.606 5.411 13.66 Vietnam 4.85 349.725 6.172 n.a. n.a. Yemen, Arab Republic 11.291 6.182 n.a. n.a. Yemen, P.D. 7.734 6.324 n.a. n.a. Source: World Bank data base. - 18 - The next question concerns the privatization programs of developing countries and the extent to which these plans have been implemented. Table 2 provides information on planned sales to private interests and on sales actually accomplished, as well as on closings and liquidations and on leases and management contracts with private interests. The table excludes the sale of 133 enterprises in Chile during the 1970s, representing more than one-fourth of the net worth of the 250 largest Chilean private firms (Shirley, 1983, pp. 57-58); the privatization I of jute and textile mills, representing some 40 percent of capacity and about 1000 smaller businesses in 1982 in Bangladesh; and the re- privatization of some 2000 rice, flour, and cotton mills in Pakistan following the nationalizations of the 1970s (Young, 1986, pp. 25-27). The table shows that limited progress has been made so far in implementing privatization programs in the developing countries. The opposition of ve~ted interests, the poor financial situation of the enterprises to be privatized, the political obstacles to their rationalization and the limited availability of private capital~ have all contributed to the delays that have been encountered. In fact, a considerable number of actions have involved the closing-down of inefficient public enterprises rather than their sale and, more often than not, the sales have entailed reprivatization rather than the divestiture of firms that were originally established as public enterprises. Finally, as shown in Table 2, there have been relatively few instances of leasing or management contracts. - 19 - IV Prospects for the Future Just as in recent years, the closing-down option will have to be invoked in the future in cases where the conditions of a public enterprise are beyond repair. At the same time, the political obstacles to closing down large firms may be surmounted t}lrough their division into smaller units, some of which will be viable and others not. As to privatization, it should be emphasized that selling some of the shares of a public enterprise while retaining control in the public sector, as in the case of Petrobas in Brazil, does not constitute privatization. Rather, such sales reduce the availability of finance for the private sector, thereby contributing to "crowding-out." Privatization should be defined as involving the transfer of control. It may not mean selling all shares to private interests, 1n particular in countries where the availabili t·y of domestic capital is limited. It has been reported, for example, that in Zambia 50:50 joint ventures are invariably managed by the private partner (Berg and Shirley, 1986, p. 1). At the same time, one would have to create the appropriate conditions for privatization. This would necessitate, first of all, establishing clear and unambiguous procedural rules and applying these rules in practice. The rules should provide for the valuation of the enterprises to be privatized by an independent body, which may use auctioning or other methods appropriate for the conditions of the country - 20 - concerned. This will permit both to avoid underpricing (as it happened in Chile after 1974) and to avoid putting an unreasonable value on assets of questionable productivity (there may be need, in fact, to set a notional price as it was done in one case in Canada). It may also be desirable for the state to undertake the rationalization of the enterprise prior to privatization, so as to eliminate its excessive debt and to reduce overmanning. It may not be expected that firms whose debt exceed the value of assets would be taken over by private interests. Reductions in the labor force should also be effected before privatization, unless agreem~nt is reached with the labor unions on a timetable for subsequent reductions in manning levels. Domestic financial limitations may hinder privatization in developing countries, in particular in low-income countries. At the same time, combining privatization with democratization may bring fruit in e.g. selling state-owned farms to peasants and selling public trading companies, engaged in the marketing of agricultural produce and inputs, to producers -- just as to council houses have been sold to their occupants in Britain. These cases have been noted in regard to Sub-Saharan Africa, where possibilities exist also in privatizing local industry and fishing 1/ notwithstanding the stringency of domestic financial limitations. 1/ It has been reported that, after collectively purchased motor boats had been sold to fishermen, the share of boats in operating conditions rose from 15 percent to 85 percent, with corresponding increases in output (Berg, 1986, p. 18). - 21 - Furthermore, the example of France indicates that privatization may be used to revitalize the stock market. 1 1 It is also the intention of Pakistani policy makers to use privatization as a means to strengthen the stock market. And, the sale of bonds secured by revenues from the sale of the Bosphorus Bridge and the Keban Dam are said to have contributed to the revitalization of the bond market in Turkey. In indebted countries, debt-equity conversions offer potential- ities for privatization, involving the country's own nationals who have funds abroad as well as foreigners. More generally, the domestic financing of privatization may be complemented by foreign financing. Apart from well-established cases of national interest, there is no reason to discriminate against foreign capital in the process of privatization. Consideration may nevertheless be given to leasing or management contracts as alternatives to privatization, with the contracts awarded through auctions, an option that has long been proposed (Demsetz, 1968). It has been used more recently in socialist countries, in particular Hungary, where ideological considerations limit the sale of public assets. At the same time, for privatization to succeed, certain poli~y conditions should be met. In particular, there is need for policy reform in developing countries where the system of incentives is biased against exports and in favor of import substitution. While reform efforts have contributed to the process of privatization in these countries, the success 1/ The success of the present French government to do so has disproved the contention of the supporters of the socialist government that the French stock market would not be abl~ to absorb the shares offered in the course of privatizing large enterprises (Balassa, 1987). - 22 - of privatization is conditioned on the full implementation of these reforms .. There is further need to strengthen and, where it is lacking, to establish competition in order to derive the benefits of privatization. Without competition, profit maximizatidn by the newly-established private firms may not serve the national interest. l/ In fact, it has been shown that the superiority of private enterprises over public enterprises is the most evident in competitive industries (Yarrow, 1986). For similar reasons, in the absence of privatization, establishing competitive conditions for public enterprises would lead to improvements in efficiency. Such a direction is being taken by the Hungarian policy makers. But this can be successfully done only if the management of public enterprises is made independent of the government and it is given appropriate incentives to maximize profits. The independence of managers can be ensured if they are made responsible to a board of directors, in which the.government representatives are in a minority. At the same time, linking the remuneration of management to the firm's profits and establishing the possibility of bankruptcy would provide the carrot and the stick of competition, provided that provisions are simultaneously made for free entry and/or the breaking up of large firms and for import liberalization. Also, the existing privileges of public enterprises in As suggested in the case of the United Kingdom (Kay and Thompson, 1986, p. 25), efficiency may conceivably deteriorate rather than improve as a result. - 23 - matters of credit and taxation should be eliminated, putting them on an equal footing with private firms. The question remains, however, if one can establish truly competitive conditions for public enterprises while maintaining public ownership.. This question has been much debated in Hungary and while there are some examples of highly efficient public enterprises in developing countries, e.g. in Brazil, a knowledgeable observer of the African scene has expressed scepticism as to the prospects for industrial development via public enterprise. l/ Conclusions This paper has noted the significant role public enterprises play in the manufacturing sector of the developing countries. These ente~prises have often been considered the mainstay of economic development and have assumed particular importance in industries that are seen as being of strategic importance for industrialization as well as in highly capital- intensive industries. Over time, public enterprises have com,a to constitute an increasing financial burden for the developing countries, however. Also, 1/ ''To an African Government contemplating the creation of a substantial public sector as a means of promoting industrialization the advice of this writer would have to be: don't do it; there are better ways of stimulating industrial growth. A large industrial public sector ~ill contribute little to dynamic industrial growth, will tend to become a drain on the public finances, will require a net inflow of resources to cover its capital requirements and will discourage the growth of private industry" (Killick, 1983, p. 87). - 24 - with the drying up of foreign loans, their deficits have been increasingly financed from domestic sources, thereby raising the spectre of ''crowding out" the private sector. The poor financial performance of public enterprises to a large extent reflects their relative inefficiency vis-a-vis private enterprises, which is documented by the experience of a number of developing countries. Privatization, then~ may be regarded as a response to perceived differences in efficiency between private and public enterprises. And, while it is given urgency by the difficult financial situation of public enterprises, it is part and parcel of the shift in development strategies initiated in a number of developing countries, involving greater outward orientation, which requires imprc>ved efficiency. At the same time, for privatization to be successful, it is necessary to establish the conditions of competition. One would further need to overcome the obstacles to privatization in the form of the opposition of vested interests, t:he poor financial situation of the enterprises to be privatized, the political obstacles to rationalization, and the limitations of domestic private capital. It has been suggested that, in the absence of privatization, consideration be given to leasing or management contracts, to closing· ]own firms where the conditions are without repair, and to improving the operation of public enterprises. Effecting such improvements, in turn, would require complete independence and improved incentives for manageJ."s while exposing them to domestic and foreign competition. The question remains, however, if this can be accomplished while maintaining public ownership-. .'\ \ - 25 - References Ayub, Mahmood Ali and Sven Ole£ Hegstad, "Public Industrial Enterprises. Determin4nts of Preformance,'' Industry and Finance Series Volume 17, Washington, D.c.,.world Bank, July 1986. Balassa, Bela uFrench Economic Policy Since March 1986," The Tocqueville Re~iew, 1987 and, in French translation, Commentaire, Et~, 1987. Balassa, Bela, Gerardo M. Bueno; Pedro-Pablo Kuczynski, and Mario Henrique Simonsen, Toward Renewed Economic Growth in Latin America, Washington, DoCo, Institute for International Economics, 1986. Berg, Elliot, "Private Sector Potential in Africa," Journal of Economic Growth, Third Quarter 1986, pp. 17-23. Berg, Elliot and Mary M. Shirley, "Divestiture in Developing Countries" Washington, D.C., 1986 (unpublished manuscript). Blejer, Mario I. and Mohsin S. Khan, "Private Investment in Developing Countries,•r Finance and Development June 1984, pp. 26-29. Choksi, Armeane M., "State Intervention in the Industrialization of Developing Countries. Selected Issues," World Bank Staff Working Paper .No. 341, Washington, D.c. July 1979. Demsetz, Harold, ''Why Regulate Utilities?" Journal of Law and Economics, April 1968, pp. 55-65. Funkhouser, R. and MacAvoy Paul W., "A Sample of Observations on Comparative Prices in Public and Private Enterprise," Journal of Public Economics, 1979, pp. 353-68. Gordon, David L., "Development Finance Companies, State and Privately Owned," World Bank Staff Working Paper No. 578, Washington, D.c., July 1983. Gupta, t.f., "Productivity ,Performance of the Public and the Private Sectors in India: A Case Study of the Fertilizer Industry," Indian Economic Review, 1982. Hemming, Richard and Ali M. Mansoor, "Privatization and Public Enterprises" IMF Working Paper No. WP/87/9. Washington, D.c., International Monetary Fund, February 25, 1987 (unpublished manuscript). Hill, Hal, "State Enterprises in a Competitive Industry: An Indonesian Case Study," World Development, November 1982, pp. 1015-23. Interamerican Development Bank, External Debt and Economic Development in Latin America: Background and Prospects, 1984. - 26 - Kay, J.A. and D. J. Thompson, ''Privatization: A Policy in Search of a Rationale," Economic Journal, March 1986, pp. 18-32. Killick, Tony, "The Role of the Public Sector in the Industrialization of African Developing Countries," Industry and Development No. 7, New York, United Nations, 1983, pp. 57-88. Krueger, Anne~ 0. and Baran Tuncer, HEstimating Total Factor Productivity Growth in a Developing.Country,•• World Bank Staff Working Paper No. 422, Washington, D.C., October 1980. Nunnenkamp, Peter, "State Enterprise in Developing Countries," Intereconomics, July-August 1986, pp. 186-97. Perkins, F.S., "Technology Choice, Industrialization, and Development Experiences in Tanzania," Journal of Developing Studies, January 1983, PP• 213-47. Shirley, Mary M., "Managing State-Owned Enterprises," World Bank Staff Working Paper No. 577, Washington, D.C., July 1983. Short, R. P., "The Role of Public Enterprise: An International Statistical Comparison,'t in Robert H. Floyd, Clive s. Gray, and R. P. Short, eds~ Public Enterprise in Mixed Economies, Washington, D.C., International Monetary Fund, 1984, PP• 110-196. Singh, Ram D., nstate Intervention, Foreign Economic Aid, Savings and Growth in LDCs: Some Recent Evidence," Kyklos, 1985{2), pp. 216-32. Tyler, William G., ''Technical Efficiency in Production in a Devleoping Country: An Empirical Examination of the Brazilian Plastics and Steel Industries," Oxford Economic Papers, November 1979, pp. 477-85. World Bank, Borrowing in International Capital Markets, Washington, D.c., January 1980. Yagci, Fahrettin, "Protection and Incentives in Turkish Manufacturing. An Evaluation of Policies and their Impact in 1981, '' World Bank Staff Working Paper No. 660, Washington, D.C., July 1984. Yarrow, George, "Privatization in Theory and Practice,'* Economic Policy, April 1986, pp~ 323-70. Young, Peter, nPrivatization in LDCs: A Solution that Works," Journal of Economic Growth, Third Quarter 1986, pp. 24-30. BBD:BR-136:5.22.87 Some Recent DRD Discuss.ion Papers 275. Abstracts of Development Research Department Publications: April 1986 - April 1987. 276. Korea's Macroeconomic Prospects and Major Policy Issues for the Next Decade, by V. Corbo and s.w. Nam. 277.. The Pricing of Manufactured Goods During Trade Liberalization: Evidence from Chile, Israel, and Korea, by V. Corbo and P.D. McNelis. 278. Fiscal Policy and Development Strategy in Southern Asia, by G.F. Papanek. 279. Evolution of the Tunisian Labor Market, by C. Morrisson. 280. Labour Allocation Across Labour Markets Under Different Informational Schemes and the Costs and Benefits of Signalling, by 0. Stark and E. Katz. 281. Mobility, Skill and Information, by 0. Stark and E. Katz. 282. Labour Mobility and Intrafamilial Income Transfers: Theory and Evidence from Botswana, by 0. Stark and R. Lucas. 283. Labour Migration, Income Inequality and Remittances: A Case Study of Mexico, by 0. Stark, J.E. Taylor and S. Yitzhaki. 284. Female Labour Mobility, Skill Acquisition and Choice of Labour Markets: Theory and Evidence from the Philippines, by 0. Stark and J. Lauby. 285. Market Structure, Jobs, and Productivity: Observations from Jamaica, by P.B. Doeringer. 286. Coordination of Taxes on Capital Income in Developing Countries, by P.B. Musgrave. 287. The Effects of Labor Regulation Upon Industrial Employment in India, by P.R. Fallon. 288. Factor Substitution in Production in Industrialized and Less Developed Countries, by D. Demekas and R. Klinov. 289. On the Effect of Subsidies to Basic Commodities on Inequality in Egypt, by S. Yitzhaki. 290. Implementing a Computable General Equilibrium Model on GAMS - The Cameroon Model, by T. Condon, H. Dahl, and S. Devarajan. 291. Effects of Exchange Rate Changes in Developing Countries, by B. Balassa.