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Privatizations

By Fotis Fitsilis*

Talks about privatization had a constant presence in the last decades in the public

debate and it is easy to understand why this issue has generated intense political

controversy. Privatization is the transfer of ownership of state property to private

companies or individuals, partly or wholly. The state property can be a public

company or a real estate.

Here we will present the benefits of privatization, some problems that are related to

it, as well as its general principles. Finally, we will examine two examples of

countries that have successfully implemented large-scale privatizations, Germany

and Slovakia.

In Greece the debate on privatization was intensified after the signing of theMemorandum of Cooperation in 2010 between the Greek Government and the so

called Troika, which consists of the European Commission (EC), the International

Monetary Fund (IMF), and the European Central Bank (ECB). Back then it was agreed

that a percentage of the profits from privatization would be used to reduce public

debt. There are various estimations of the amount of money that could be drawn

from privatization actions. Both Government and Opposition presented privatization

plans in the order of 50 billion Euros, but without presenting technical details of the

project. Almost 2 years later, little progress has been made.

Nevertheless, there are certain categories of public companies or public owned land

that is crucial to remain under state control. These could be companies, borderlands

or certain islands sensitive for the national security.

Benefits of privatization

If designed properly, privatization can lead to substantial increase in productivity and

competitiveness. It is important to mention that benefits are not limited to the

immediate financial compensation following the awarding of a privatization contract

to the highest bidder. Often investors proceed with additional investments in orderto modernize production facilities. But the most significant benefit comes from the

increased efficiency of the states economy as a whole, when unproductive public

companies turn into competitive businesses that operate according to the rules of

market economy.

This is why one reads in the literature that the direct economic benefits of

privatization are just one third of the total long-term benefits. The remaining two-

thirds come from the multiplier effect that privatization causes to the national

economy. Beyond political considerations, one way to assess specific privatization

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cases on a technical level is a so-called cost-benefit analysis that compares the total

expected benefit from a privatization against the cost of its implementation. In order

for such an analysis to be complete, both the social dimension and the social

dividend resulting from privatization has to be captured.

Negative consequences and obstacles

Careful planning is essential, especially during the phase of creating the privatization

body (a committee or a special purpose company) and its staffing. Ignorance of the

rules of the domestic and foreign markets and lack of transparency will most

certainly lead to questioning these choices in a political and social level, thus

resulting in long delays.

The management of the privatization body will be required to provide specialized

solutions to a variety of problems, the most important being the following:a) Unclear legal status,

b) Ownership issues,

c) Reactions from the unions,

d) Accusations for mismanagement.

Proper design of the body, its operating rules and solutions to the above-mentioned

problems will largely determine the success of the privatization program in Greece.

In Greece the respective body is called the Hellenic Republic Asset Development

Fund. Despite its foundation in 2011 and the recent change in its management, no

real progress has been demonstrated yet.

General principles of privatization

In my opinion, the four most important principles of a privatization program are:

First. Partial or total involvement of private equity

The change of ownership alone is not a panacea. It must be accompanied by an

extended restructuring of the organization, along with a complete rearrangement of

its strategy and objectives. Even for companies where the majority of the shares

remains to the state, there is a potential for increased competitiveness with private

participation in the shareholder scheme.

Second. Timing

Timing is one of the most critical factors for success when privatizing an

organization. In times of political instability, a lot of investors are reluctant to invest

and, even if they do, the price they are willing to pay is far lower than the market

value due to the actual investment risk.

Third. Independence and control of the privatization body

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The political independence of the privatization body is vital for its regular operation.

Its operating framework will have to be approved by the National Parliament, in

order to allow for a democratic legitimacy of his actions. At the same time, the body

must inform in detail both the Government and the Parliament, about its

achievements in the privatization procedure and its future plans. This information iscrucial because of the usually large volume of legislative acts and regulations that

have to be rapidly promoted by the Government. Ultimately, the transactions of the

privatization body have to be closely monitored and controlled by chartered

accountants.

Fourth. Transparency

Transparency in the operation of the privatization body is of paramount importance

for a smooth privatization procedure. Without strict conditions of transparency, the

management of sensitive and high-risk privatization projects will hardly reach high

levels of performance and each decision will be disputed. Citizens should be able to

know at any time the state of the privatization program.

Case studies

When it comes to privatization Greece does not have to reinvent the wheel. In the

following, we present examples of two countries that have implemented large

privatization programs, Germany and Slovakia. Although none of them is similar to

Greece, however an analysis of the privatization procedures could prove useful and

offer important conclusions.

a. GermanyThe agency that undertook the privatization of an entire former state (East

Germany) was founded in 1990 and named Treuhandanstalt, which roughly

translates as "Foundation Trust". The Foundation was governed by a five member

Board of Directors, whose actions were controlled by a management council. It is of

particular interest that the management of the institution was granted with certain

level of legal immunity, in order to proceed with the work of privatization.The Foundation was dissolved in 1994 and the privatization program continued

through a series of specialized bodies, some of which still operate today. The

Foundation tried to privatize 14,600 businesses with over 4 million employees and

24 million acres of land. Until 1994 around 8000 companies changed hands, but

more than 2.5 million workers lost their jobs. This led to massive protests and social

unrest and the assassination of the first president of the Foundation, Detlev Karsten

Rohwedder. The immediate profits from this series of privatizations amounted to 60

billion Deutsch Marks (approx. 31 billion Euros), while losses were in the order of

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300 billion Deutsch Marks (approx. 154 billion Euros)! This is why both the German

Government and the Board of Directors of the Foundation were accused of waste of

assets and mismanagement. Overall, 1800 cases were disclosed regarding financial

scandals associated with the buying and selling of state assets.

However, the German Council of Economic Experts, often referred to as the FiveSages of Economy, an independent evaluator of the economic development in

Germany, commented in 1994 that the Treuhandanstalt had a decisive role in

shaping a new business landscape in the new German states, without the need for

continuing financial assistance and support from the central Government.

b. SlovakiaPrivatizations in Slovakia were undertaken by the National Property Fund (NPF),

which was founded in 1991 and dissolved in late 2005. The senior bodies of NPFwere the Board of Directors (9 members), the Executive Council (11 members) and

the Supervisory Board (7 members).

The privatization process was divided into two segments. In the segment of small-

scale privatization, small businesses (industries, hotels, etc.) were sold in auctions.

Domestic entrepreneurs had primarily access to this procedure. If there was no

domestic investor, a second round with the participation of foreign investors was

initiated. Large-scale privatization included the majority of state owned companies

and real estate. Both auctions and coupon privatization were used, the latter to

promote citizen participation in state assets.

It is worth noting that, in order to restore the confidence of international markets in

the Slovak economy, the government called a well known international non-

governmental organization, Transparency International, to monitor the auction of

mobile-phone licenses. The process took lots of publicity and helped to promote a

positive image of Slovakia in the world. The results from the Slovak privatization

program are indeed impressive. While in 1990 99% of the Czechoslovak economy

was state-owned, 20 years later and after the division of the state into Slovakia and

the Czech Republic, over 90% of the state property in Slovakia is privatized and 95%

of its (Gross National Product) GDP is generated by the private sector. Minor

exceptions can be found in a few banks and in some areas of transport and

communications.

The massive privatization program in Slovakia also led to social unrest and, like in

Germany, significant financial scandals were brought in connection with it. This firm

policy for twenty years seems to bear fruit for this small country with a population of

5,4 million. In 2010 and 2011 the growth of the GDP was in the range of 3-4%.

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A model privatization process

A further analysis of these examples divides the process of privatization into five

stages:

Stage A. Selection of public companies and state owned real estate assets (in short

assets) to be privatized and performance of cost-benefit analysis for each case.

Stage B. Classification and ranking of the assets and preparation of the bidding

process.

Stage C. Collection of offers and pre-assessment. Short-listing of investors.

Stage D. Folder submission with feasibility studies for the proposed investment.

Stage E. Bid evaluation and contract signing.

Summary

Regardless of the volume of privatization and the specific process that will be

chosen, it is necessary to understand that the main benefit from privatization is not

to be found in the price that the highest bidder will pay for the transfer. The added

value of privatization comes from the competitive operation of the company and its

future profitability, which generates revenues for the state in the form of taxes and

new jobs.

Nevertheless, one must be realistic. Even if the potential for raising significant funds

exists, few countries have managed to privatize with maximum efficiency even a

small part of state property. To focus on the Greek economy, privatization must becarried out as part of a broader restructuring that includes drastic decrease in

government spending along with measures to develop the private sector.

SOURCES

- Rudolf Autner, The national property fund and privatization in Slovakia-

lessons learned, 2006,http://pasos.org/237/the-national-property-fund-and-

privatization-in-slovakia-lessons-learned/

-Ivan Miklo, Privatization in Slovakia during 1991-1995,

http://www.internet.sk/mesa10/PRIVAT/GLOB95.HTM

- Christian Wolf and Michael G. Pollitt, The Welfare Implications of Oil

Privatization: A Cost-Benefit Analysis of Norway's Statoil, March 2009,

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1260280

- Hellenic Republic Asset Development Fund,http://www.hradf.com/gr

http://pasos.org/237/the-national-property-fund-and-privatization-in-slovakia-lessons-learned/http://pasos.org/237/the-national-property-fund-and-privatization-in-slovakia-lessons-learned/http://pasos.org/237/the-national-property-fund-and-privatization-in-slovakia-lessons-learned/http://pasos.org/237/the-national-property-fund-and-privatization-in-slovakia-lessons-learned/http://www.internet.sk/mesa10/PRIVAT/GLOB95.HTMhttp://www.internet.sk/mesa10/PRIVAT/GLOB95.HTMhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1260280http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1260280http://www.hradf.com/grhttp://www.hradf.com/grhttp://www.hradf.com/grhttp://www.hradf.com/grhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1260280http://www.internet.sk/mesa10/PRIVAT/GLOB95.HTMhttp://pasos.org/237/the-national-property-fund-and-privatization-in-slovakia-lessons-learned/http://pasos.org/237/the-national-property-fund-and-privatization-in-slovakia-lessons-learned/

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*Fotis Fitsilis is an electrical engineer (PhD) and an economist. He is the Head of the

Department for Scientific Monitoring and Reporting in the Hellenic Parliament. This

is an updated English version of an article that was posted in two parts, on 3 and 17

of July 2011, in the Neos Agon newspaper of Karditsa, Greece.