Privatization is the first step…

26/01/2024by PRIME Institute PRIME Institute No Comments

Privatization is the first step...

By Dr Khalil Ahmad

In Czechoslovakia, they resolved that if privatisation needed to be done, it had to be done. They considered it as the first step towards transforming the economic system.

According to Dr Vaclav Klaus, once a finance minister, prime minister, and president of the Czech Republic, privatisation at a vast scale was done and it proved to be the first decisive step. It was like crossing the Rubicon. No doubt, the political costs were unavoidable but it had to be done and needed to be done as quickly as possible.

There were other aspects that assumed a number of things to be part and parcel of privatisation. The people in Czechoslovakia and other countries also (like Pakistan) believed that in a market economy as compared to the command economy or centrally planned economy every firm and economic activity had to succeed and they attached an undisputed efficiency with every private firm.

Whereas as is evident that is not true even in a major, stable, developed economy. And of course, Dr Klaus says it is much less true in an economy in transition with a dramatically changing economic environment, in competition with much stronger partners from the rest of the world, and without sufficient experience.

As is said, “There are no free lunches,” Dr Vaclav Klaus reminds, likewise, there are no ‘free’ economic transitions. The ‘economic transition’ is a very costly process. It’s an investment and usually, like any investment, has costs and benefits and the business people know that usually when you make an investment, you pay the costs first and you may get the benefits with a considerable delay.

Hence, according to Dr Klaus, the transition from communism to a free society was an investment in certain respects, and the costs were really enormous.

So not only while transitioning from a command economy to a market economy has its costs, in converting a mixed economy into a free enterprise economy has its price also.

Dr Klaus makes a mention of the size of the costs his country had to go through. According to his estimates, in his country they were lower than in other countries. In the first three years of transition, they lost one third of their industrial output – one third.

As happens usually, if we take all of the business people, two would succeed and one would collapse. They lost one quarter of their agriculture output – one quarter – and they lost one fifth of their GDP - and it was lower than in most of the countries in transition.

No doubt, in Czechoslovakia too, transition and privatisation were connected with many business failures and the one who was blamed was the government, of course, not the individuals owning and managing those firms. Dr Klaus tells, it became fashionable to argue that the failures were caused by unsuccessful privatisation and an insufficient legislative and institutional framework.

Dr Klaus admits, both privatisation and the formation of new legislation of market accompanying institutions was as imperfect as any human activity. But the main problem, in his opinion, was that the citizens were not prepared to accept or to live with the phenomenon of a business failure, both at micro and macro level.

As far as foreign help in the process of transition is concerned, Dr Klaus tells that sometime back he was asked to give a speech together with German economists to compare the transition and transformation of Germany in the 1950s and the Czech Republic in the 1990s.

He flashes back, it was a very interesting exercise. One of the differences was really the fact that there was huge foreign help to Germany. We didn’t get it, we have really got nothing in the last ten years, and we didn’t ask for it. The role of the rest of the world in this respect was really zero.

Regarding foreign help, Dr Klaus is very blunt: I think that the typical foreign help was sending would-be advisors and consultants. It became one of the most profitable businesses in the 1990s – to become a consultant and advisor in the transforming societies.

The recommendations of these advisors and consultants weren’t useful and not very good. We know about the troubles that were experienced in South East Asia in the second half of the 1990s. Dr Klaus says, it has become an accepted truth that the policies of the International Monetary Fund (IMF) were a tragic mistake for all what happened in countries like Indonesia, Malaysia and elsewhere.

And, he goes on: I remember I made a well-known statement that was repeated many times, and Milton Friedman called it ‘Klaus Law.’ I was forced some eight or nine years ago in the World Bank in Washington to accept, when I was still the Minister for Finance, a foreign assistance loan, a technical assistance loan. I said we are not interested in a loan for inviting consultants and advisors.

If you are ready to give us a loan to build something, some infrastructure project we can discuss it, but a technical assistance loan? I am not interested.

Lesson for Pakistan: Wiping out the presence of the government from the domain of business, that is, privatization, has its costs and the costs will have to bear, because there is no perfectly infallible method is available to privatize a state-owned-enterprise. That amounts to saying that in altering an economic system, mind the privatization as the first step and be ready to bear the costs of that Change.

[Note: This article is based on a lengthy interview of Dr Vaclav Klaus.]

There Ain’t No Such Thing as a Perfect Privatization

25/01/2024by PRIME Institute PRIME Institute No Comments

There Ain't No Such Thing as a Perfect Privatization

The Story of privatization in the Czech Republic has many lessons Pakistan should learn from.

Dr. Khalil Ahmad | 25, January, 2024

Dr Vaclav Klaus, once a finance minister, prime of minister and president of the Republic, quite innocently made a statement, which became well known. He said, “No, I am not ready to pay hard money for soft advice.”
And Milton Friedman called it the ‘Klaus Law,’ which Dr Klaus liked very much!
On such an unexpected response form Dr Klaus, the likes of International Monetary Fund (IMF) were absolutely shocked because that was exactly what they wanted to organise – soft advice for hard cash - technical assistance, sending experts, entertained in the best hotels in Prague and spending most of their time in the lobby bars of those hotels discussing transformation.
As to the objections on the mechanism of privatisation from its own protagonists, Dr Klaus speaks from the point of view of a government (but sure a limited government): We were confronted with an enormous naivety with regard to the formation of legislation, its enforcement and the relationship between formal legislation and informal rules, etc.
And we have been especially criticised for our inability to create perfect legislation. I have to argue that there is no perfect legislation. You have parliaments just for the fact that you need to make changes to and add new legislation to improve it – to fill some of the gaps and holes in the legislation – it’s a permanent evolutionary process in any country in the world.
He further states that the formation of legislation is and must be slow. It can’t be just a quick process. I must say that what I consider to be very important is that legislation is the outcome of the process of evolution; it is not of anyone’s dictate (and if it is a dictate, it plays havoc as has been the case in Pakistan. KA).
As you know very well, legislation is not the outcome of abstract rationalism. Legislation is the result of a very complicated political process, a very very human political process. You don’t create legislation by picking the five best lawyers from the best universities and asking them to “Please be so kind as to give us legislation.” It is discussed. Every sentence is discussed, in your and our parliament.
And, Dr Klaus admits: I’m sure you know very well that legislation is influenced not only by political or ideological arguments, but by vested interests, by lobbying, by what we economists call ‘rent-seeking’ activities. So there is nothing quite like a body of legislation, which you can simply transfer from one country to another and decide that this is true. There is just one example of such a transfer of legislation in modern history, and you probably know what I have in mind – the reunification of Germany.
It was even the identical language. Even to translate the legislation, Dr Klaus tells, is difficult. And it was the same language, so it was easy just to announce that the next morning the old legislation is no longer valid and the new legislation is valid.
And Dr Klaus hastily adds: I always say that our critics probably assume that we are still a totalitarian state, where the appropriate legislation can be simply introduced. But we know it is a very complicated political process.
This is how Dr Klaus sees the whole process of transition including privatisation. But, sure, if we need free markets and do not need over-regulation or a paternalistic welfare state, we will have to go for the three liberalizations, that is, price liberalization, business liberalization, trade liberalization, knowing well that no single liberalisation can bear fruit.
In the context of privatisation in Pakistan, following points are of utmost importance:
1. Changing the economic system (in Pakistan also) is not an easy task as it involves conflicts of interests, that is, it threatens vested interests. Hence, it needs a principled stand and a will to bring it about. It must be taken as a matter of policy.
2. Privatization is part of an overall economic change, a first step and a very important one. But it will be of no use in the absence of price, trade and business liberalizations.
3. As in other cases, in doing privatisation also, a government may makeor makes mistakes unintentional as well as deliberate.
4. If privatisation is to be done, do privatise all of the business enterprises, and let there be a competition. Keeping some selected enterprises with the state with a privileged status will hurt the competition.
5. The cost of transition, or say privatisation, must be kept in mind.
6. The privatised units may or may not succeed; as un-protected private sector, in sharp contrast to the protected public sector, faces competition, and, as happens with such businesses, may meet failures.
7. Like all other legislations, privatisation legislation may be wrong, manipulated, manoeuvred, vested, rent-seeking, etc, and its implementation and execution partial or flawed or skewed, but what is needed: it must be discussed, exposed, criticized and improved.
Finally, (and so far no one has been making this point) it must be demanded that as privatisation is lessening the size and burden of the government; in turn, burden of taxes on people must also be lightened. This will spur both growth and development.
[Note: This article is based on a lengthy interview of Dr. Vaclav Klaus]

New Privatisation Policy Framework | Working Paper

17/01/2024by PRIME Institute PRIME Institute No Comments

NEW PRIVATISATION POLICY FRAMEWORK

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1. Introduction

The Policy Research Institute of Market Economy (PRIME), as part of the project titled “Privatisation Acceleration Initiative” has prepared this working paper to contribute to the on-going debate and policy initiatives to support, and accelerate, privatization of commercial State-Owned Enterprises (SOEs). As the government has no policy framework for privatization at the moment, we realize that a discussion and consensus on privatization policy is essential. This paper contains a brief overview of the challenges and a list of recommendations which are based on consultation with the stakeholders. We hope that this can lead to useful deliberations and policy evolution. The scope of this working paper is to develop a framework which can be applied to commercial SOEs and outsourcing of public services to private contractors. We hope that it will make the process of privatization transparent, free it from ad-hocism, minimize the potential of misappropriation and corruption attached with it, shorten the process, improve its sustainability prospects, and take cognizance of labour market sensitivities.

2. Background

The issue of privatization of the SOEs is reflective of the complexity, ambivalence and indecisiveness of the public policy in Pakistan. These three traits are embedded in the process of privatization, on the one hand, and on the other, they demonstrate the inability and incompetence of the state institutions and agencies set up from time to time in order to privatize, as the first step, the commercial SOEs, and in particular, but not limited to loss-making SOEs.

A historical review of the various attempts at privatization of the SOEs reveals a number of issues impeding the process of privatization and it is these impediments that have left us with an economic legacy consisting of a heavier footprint of the state (more than 200 SOEs including 87 commercial SOEs1, and 67% state footprint2 in Pakistan’s economy), that includes from commercial SOEs to non-commercial SOEs.

As the state unavoidably needs to shed its burden of the commercial SOEs (whose assets today value more than 40% of GDP), and as it will no doubt relieve the citizenry also from the ever-increasing tax-burden utilized to sustain most of the SOEs, it is imperative to facilitate and accelerate the process of privatization and at the same time to make it transparent, free from bureaucratic and legal disincentives and regulatory hurdles.

And, as the political and economic stakes are extremely high, privatizing the SOEs successfully requires that the concerns of all the stakeholders and issues related with individual SOEs be addressed in a satisfactory manner.

3. Consultation Exercise

PRIME conducted the “Workshop on Privatisation and SOE Policies of the Federal Government” on the Thursday 6th of December 2023, at the Best Western Premier in Islamabad. The workshop had participants and representation from the Competition Commission of Pakistan (CCP), the Petroleum Division (Energy Ministry), an SOE, Zarai Taraqiati Bank Limited (formerly Agricultural Development Bank of Pakistan), a regulator National Electric Power Regulatory Authority, a think tank, Center for Economic Research in Pakistan, and a multilateral lender Asian Development Bank (ADB).

The session was chaired by the Privatisation Minister Fawad Hasan Fawad, and was conducted by the Executive Director PRIME Ali Salman and Programme Director Syed Ali Ehsan. Political Economist and PRIME Distinguished Fellow Dr Khalil Ahmad facilitated the discussions. The first segment of the workshop contained a presentation by Lahore University of Management Sciences (LUMS) Fellow at PRIME Hassan Abbas, with his focus on facts related to privatisation.

Next was an interactive session with participants exchanging their diagnoses on repeated failures to privatise State-Owned Enterprises (SOEs). This was followed by a discussion session on amendments to the privatisation policy and the SOE Policy. The discussion was held under Chatham House Rules. The Workshop was concluded with comments by the Privatisation Minister followed by a networking exchange over Hi-Tea.

4. Identification of Problems

The first interactive discussion revolved around the identification of recurring systemic patterns hindering past privatisation attempts by various governments.

4.1 Problems Stemming from Human Resource Complexities

A significant number of pressures emanate from the labor force related complexities. These were traced to opposition by unions, over extended job contracts which no new owner would plausibly try to accept.

4.2 Political Resistance by employee unions

The participants raised the matter of employee unions blocking privatisation attempts through political resistance and legal measures. Employee unions in many commercial SOEs have direct affiliation with political parties. As large, organized voter segment, employee unions can exert significant pressure on political representatives to oppose privatisation

4.3 Legal Resistance by Unions and Special Interests

Another mechanism that has blocked privatisation efforts has been the invocation of courts by special interests. Unions as well as ex-servicemen communities, and even Public Interest Litigation lawyers are able to obtain legal stay orders at different levels of a privatisation process to completely paralyze the process.

4.4 Unsuitable Human Resource and Rigid Ecosystem

Private investors seeking to turnaround SOEs are unable to relocate, dismiss or terminate the employment contracts of unsuitable HR due to internal organizational rules, or legal protections contained within past legal precedent established by the judicial courts.

Many SOEs contain specialized positions which would otherwise not exist in the private sector. Mostly, these employees cannot be utilized under a new management plan 3 brought in by the private investor. At the same time, the courts have generally protected the positions and financial compensation of such employees, adding a layer of management complexity, and an additional cost burden without value addition.

4.5 Conflicting Interests of Management

Amongst the identified issues were uncertainties caused by conflicting legislation. New laws conflict with older laws, creating ambiguity in what should be well-established processes. This coupled with a broad culture of judicial activism creates a negative environment for privatisation of PSEs. Significantly, G2G transactions are not dealt with clearly under the law.

4.6 Legislative and Judicial Uncertainties

Amongst the identified issues were uncertainties caused by conflicting legislation. New laws conflict with older laws, creating ambiguity in what should be a well-established process. This coupled with a broad culture of judicial activism creates a negative environment for privatisation of SOEs. Significantly, G2G (Government-to-Government) transactions are not dealt with clearly under the law.

5. Recommendations

After the identification of problems, the participants engaged in a discussion around remedies to eliminating failure in privatisation attempts. These were shared as follows:

5.1 No court other than a specialized Privatisation Appellate Tribunal should be allowed to adjudicate civil or criminal cases related to any privatisation transaction. In the past, even government entities have gone into litigations against the federal government.

5.2 Major modifications must be made in the Privatisation Commission ordinance as well as the regulations to modernize the privatisation framework, and to incorporate international best practices.

5.3 Contradictory and conflicting legislation/statutes which create procedural uncertainties must be reviewed and synchronized to eliminate procedural ambiguities in the privatisation process.

5.4 Political parties should clarify their position on the privatisation of SOEs, and specify their plans to a certain degree, so that political uncertainty around the issue can be mitigated.

5.5 A System of reward and punishment be adopted for the bureaucracy overseeing the privatisation process, and regular performance appraisal of the management overseeing the privatisation must be arranged periodically to ensure process continuity, and management effectiveness. Line Ministries managing SOEs must have answerable/accountable bureaucracies.

5.6 Parliamentary Committees in the National Assembly and Senate overseeing privatisation matters and SOE performance issues must play a more active roleand provide more effective oversight and ownership to keep stakeholders accountable to privatisation goals.

5.7 Bundling of SOE verticals may be done after discussions with investor groups. If investors feel that they would draw greater benefit from purchasing a bundle of verticals together, and if Privatisation Commission deems greater value in terms of incoming receipts, then the organizational management can organize assets accordingly.

5.8 Use Special Purpose Entities (SPEs) as an off-balance sheet tool to park the liabilities of Commercial SOEs, whose compromised balance sheet may be the single biggest hinderance in their privatisation. An SPE holding company can be created to manage all these liabilities arising privatisation in one place. An SPE may not come into existence legally until a deal has been reached and finalized.

5.9 Commercial SOEs should be exempted from the conventional rules of the Public Procurement Regulatory Authority (PPRA) to improve their responsiveness to market forces responsiveness and operational environmental threats. Instead PPRA may work on a separate framework for procurement compliance for Commercial SOEs.

5.10 The Central Monitoring Unit of the Finance Division should be given time bound objectives regarding the management of SOEs and those Commercial SOEs which are on the active privatisation list.

5.11 A periodical report on the financial performance of state-owned enterprises comparing them with their private sector counterparts should be prepared and published.

5.12 All SOEs should maintain an accurate Asset & Liability Register (Balance Sheet) and such statements need to be verified by credible and approved external auditors.

5.13 Financial review of SOEs should report any losses which the government might have parked or re-assigned for accounting purpose under any other name or entity.

5.14 A public service campaign to build a favourable public opinion for privatisation should be designed and implemented. It should be backed by research and case studies.

5.15 Training should be conducted by the Privatisation Commission for the benefit of any new organizational management team undertaking privatisation. This training should be compulsory for any management team as soon as their SOE has been added to the active privatisation list.

5.16 A conflict-of-interest policy needs to be introduced and implemented in the board meetings to ensure that those who are present at the board meeting do not have a commercial interest in the transactions. Disclosure rules may be reexamined and incorporated into organizational rules to minimize the possibility of board members’ interests conflicting with transparency and efficacy of the privatisation process

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