Privatization

… a core term in Governance and Institutions and Atlas100

Definition

The OECD (reference below) defines privatization (or privatisation) as any material transaction by which the state’s ultimate ownership of corporate entities is reduced.

The OECD notes that:

“The definition of “privatisation” differs among the relevant authorities of OECD countries. Some agencies include only transactions effected subject to privatisation legislation – hence for instance disregarding asset disposals by partly privatised state-owned enterprises (SOEs). Others consider as privatisation not only any asset disposals but also transfer of individual activities from the public to the private domain.

“This report does not intend to propose a common definition of privatisation. However, for the purpose of reproducing information submitted by member countries a relatively broad definition is applied throughout the text: As privatisation may be considered any material transaction by which the state’s ultimate ownership of corporate entities is reduced. This definition includes direct divestment by the state, divestment of corporate assets by government-controlled investment vehicles as well as the dilution of state positions in SOEs by secondary share offerings to the non-state shareholders. It may also include divestment of subsidiaries by SOEs, though this is more of a gray area: if SOEs for example shed subsidiaries in consequence of government decisions then the resultant transactions would normally be considered as privatisation. However, if partly state-owned enterprises decide to divest based on commercial considerations then it makes little sense to speak of privatisation – lest any merger and acquisition of the said enterprises should be considered as “privatisation” and “nationalisation”. (The following section includes data from the Privatisation Barometer which, as a general rule, includes divestment by partly owned SOEs.)

“By the same definition the transfer of certain commercial activities from SOEs to private operators (e.g. through concessions, delegated management contracts, leasing or other forms of public-private partnership) is normally not considered as privatisation. Nor is the dilution of government control over incorporated entities through means other than share transfers (e.g. share class unifications; changes to the articles of association; cancellation of golden shares). In sum, the word privatisation is used to refer to a transfer of assets to the private sector rather than a transfer of activities. This distinction is particularly pertinent as an increasing share of privatisations takes place in public utilities and infrastructure, sectors which also have a high proportion of public-private partnerships that in some respects may be close substitutes to asset selloffs.

OECD advice on if and when to privatize

The OECD report advises (page 29):

“Countries contemplating the privatisation of certain government activities face an important choice at the beginning of the process, between hiving these activities off the public balance sheets by selling them precipitously (typically through trade sales or management buy-outs), or to continue operating them as corporate entities through a period of sequenced, or partial, privatisation. In the first case, the scope for government intervention in the functioning of the privatised entity prior to sell-off is limited. The best course of action is for the government to limit pre-privatisation restructuring to such issues where it holds a demonstrated comparative advantage and for the rest to rely on the price mechanism to identify the private buyer best suited to undertake necessary changes after privatisation. Conversely, if the government chooses to operate these assets in a corporate fashion (for example, charging near market prices for services) prior to privatisation then it is well advised to restructure and “corporatize” them in accordance with the best practices laid down in the SOE Guidelines.

“The work of corporatizing and privatising government assets may in most cases be best performed by one agency operating with a necessary degree of autonomy within the central administration. This function can be filled by a privatisation agency or by elements of the state-ownership (or co-ordination) unit that the SOE Guidelines recommend as part of the good corporate governance of SOEs. However, where governments have few SOEs to privatise the benefits of such an agency may not be sufficient to justify the costs.

“The consensus view is that SOEs shall be considered for either privatisation or at least full corporatisation at the latest when they become subject to market competition. Many countries go beyond that, setting privatisation in a context of regulatory reform in which a transfer of ownership is contemplated if the introduction of competition is at all feasible. This is arguably a good practice. A full evaluation of the costs and benefits of privatisation should include the counterfactual scenarios of an alternative regulatory environment.

“If full corporatisation of an SOE is achieved – including a fully competitive environment and a separation of ownership and regulatory functions – then the economic arguments for keeping it or selling it off may be equally balanced. However, the owning government should observe the highest standards of transparency and accountability, including its reasons for retaining ownership, to avoid misperceptions by competitors and the general public. Governments need to continually assess the pros and cons of privatising the SOE. This involves weighing the revenues to the public purse and the macroeconomic efficiency gains from privatisation against the net losses of public utility provided by the SOE in public as opposed to private ownership. The political cost of privatisation should, as a general rule, not be considered.

“Transparency and consistency in the methods used to assess the pros and cons of privatisation are important, and can help bestow public trust and credibility on the process. One way of obtaining this is to rely on a battery of increasing standardised evaluation tools, including cost-benefit analysis and regulatory impact assessments.”

Topic, subject and Atlas course

Modernizing Government in Governance and Institutions and Atlas100.

Sources

OECD (2009), Privatisation in the 21st Century – Recent Experiences of OECD Countries, at https://www.oecd.org/daf/ca/corporategovernanceofstate-ownedenterprises/48476423.pdf, accessed 21 November 2016. 

Page created by: Ian Clark, last modified on 21 November 2016.