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close this bookPrivate Sector Development in Low-Income Countries - Development in Practice (WB, 1996, 188 p.)
close this folderChapter 3-Reforming public enterprise farther performing and faster
View the document(introduction...)
View the documentPublic enterprises are not performing well
View the documentTurning to the private sector—slowly
View the documentThe way forward—farther and faster

The way forward—farther and faster

A striking fact emerging from reform experience in the past few years is that public enterprise reform and divestiture should not be "either-or" pursuits. Countries undertaking serious commercialization efforts also tend to have serious privatization programs. This is as true outside low-income countries (Chile, Mexico, and New Zealand) as in them (Benin and Mauritania). The distinction is not between privatizers and nonprivatizers—it is between reformers and nonreformers.

Combining this insight with the pressing financial weight of so many public enterprises yields the idea that past public enterprise reform strategies and tactics in lowincome countries have been too timid. What is needed now is to go forward much farther and much faster on five related fronts:

· Sell the public enterprises producing tradables or operating in competitive and potentially competitive markets—particularly banks and the large commercial firms previously classed as strategic.

· Liquidate (but only after attempts to sell have failed) persistent lossmakers in industry and commerce.

· Involve the private sector in the management, the financing, and as much as possible the ownership of infrastructure firms, especially the largest ones with the greatest economic weight.

· Commercialize the remaining public infrastructure enterprises.

· Strengthen legal systems and regulatory policies and institutions to set good policy, enhance competition, maintain transparency, provide investors with a stable and predictable environment, and protect the public interest.

The essential point is that only by going beyond the divestiture of small and medium-size public enterprises in manufacturing and services—and by privatizing large commercial firms and changing fundamentally the performance of public infrastructure enterprises—will low-income countries generate the savings and resources, and open the space for private economic activity, needed to break out of the economic stagnation afflicting so many of them.

That the heart of the financial problem lies in the largest firms is exemplified by Bangladesh, where just five public firms—the power corporation, the railways, the steel corporation, the Jute Corporation, and the Jute Mills Corporation—accounted in 1993 for more than 80 percent of the public sector's gross losses. In Nigeria the ten largest public enterprises account for more than 70 percent of the stock of outstanding government loans to the sector, and in Tanzania, for about 55 percent of total public enterprise debt. In Kenya between 1990 and 1992, direct and indirect subsidies to five large public enterprises averaged 2.7 percent of GDP each year. In short, in too many lowincome countries the losses of a few large public enterprises impede if not paralyze most other government action. By addressing the problems of the largest firms low-income countries will free the space needed for private entry—and generate the resources required for avoiding reversal on the macroeconomic policy front and for creating and expanding social services.

The objective for low-income countries is to emulate the successes of such Latin American reformers as Argentina. Large-scale and rapid privatization of both management and assets generated revenues for the state. It reduced the government's foreign and domestic debt. It contributed to the decline of interest rates. It helped attract new private investment. And it led directly to increased government spending on health and education. Moreover, privatized infrastructure firms in Latin America have generally provided more and better services contributing to people's well-being and enticing more investors.

The problem is that Angola is not Argentina, Chad is not Chile, Malawi is not Mexico—low-income countries are not middle-income countries, and the policies and programs that worked well in a middle-income setting do not necessarily produce the same results at the same speed. The special problems of low-income countries mean that governments, donors, and private investors have to be more careful and more innovative than elsewhere. This point is legitimate. But recent experience demonstrates that even governments and economies in great difficulty can be fumed around quickly. Less than a decade ago, the chances for fundamental reform in Argentina, Mauritius, and Mexico were regarded as slight, but their improvements of fortune were both large and swift. It is also clear that the privatization of medium-size, and even larger, enterprises producing tradables could be speeded up appreciably in many lowincome countries—with four "ifs":

· If barriers to purchase by noncitizens or by citizens of a supposedly "wrong" ethnic group were reduced or eliminated.

· If governments set more reasonable floor prices for the firms being divested and accepted that some past investments in public enterprises are now worthless and should be liquidated.

· If there were heavier reliance on the private sector in the privatization process (to handle preparation and implementation) to minimize bureaucratic reluctance or outright resistance to privatization.

· If the concept of strategic enterprises were redefined or discarded.

But many low-income governments have been reluctant to open their privatization markets to foreign investors or to citizens of immigrant stock (for example, Asians in East and Central Africa)—and sometimes to citizens of a particular region or of a supposedly "advanced" or "favored" ethnic group.

In many low-income countries, governments set floor prices for their public enterprises based on accounting values that bear little relation to the market value of the business. And they resist or delay the termination of persistent lossmakers. Nigeria, for instance, withdrew 26 industrial enterprises from its 1989 privatization program because "they were in such poor shape that no one would invest in them except perhaps to strip them of their assets." Certainly, the liquidation of 26 firms would have been painful for Nigeria, as it is the world over. To be taken into account, however, are not only the political costs of a liquidation, or the acceptance of a low price, but the financial and opportunity costs of continuing inaction. What has it cost Nigeria to keep open, for five more years, 26 enterprises in evidently deplorable condition? To what better uses could those resources have been applied?

Liquidation—unsavory but essential

The economics of bankruptcy are impeccable. But the prevailing attitude toward the liquidation of persistently loss-making companies is nearly always and everywhere purely negative, to the point where closures and liquidation are generally regarded as more difficult and time consuming and less palatable than privatization. In Guinea, 28 industrial public enterprises were privatized as part of an IDA program in the mid-1980s. Most of them promptly failed, and in a few years only five of the divested 28 were still in operation.

Many interpreted this heavy failure rate as a disastrous outcome. But was it? The firms had been loss-makers for some time, and they had survived only because of protection, tax exemptions, and other subsidies. The government had not been able to muster the will to restructure successfully or to close these uneconomic ventures. But once they were in private hands, and it was clear that a change of ownership was not sufficient let them survive in the marketplace, the firms were allowed to go under—to "exit." If the firms had not been sold, they would—as public enterprises—probably still be alive today, racking up losses, receiving subsidies, and draining the Guinean economy. So, privatization allowed the government to step away from persistent losers. While it would have been politically preferable for the privatized firms to have survived and flourished, at least the drain of public resources was stopped.

Liquidation of chronic loss-makers has to be seen not as the death hut as the rebirth of previous!!' nonperforming assets

The survival of only 5 of 28 divested firms raises the fear that privatization might lead to deindustrialization in low-income countries. But no country, and surely no low-income country, can afford to subsidize losers perpetually. Liquidation of chronic loss-makers has to be seen not as the death but as the potential rebirth of previously nonperforming assets—since those still of value are auctioned off and put to alternative and, it is hoped, better use. The reduced drain on government could lead to better policies, to improved social services, to a better climate for investment and business, and eventually to better growth.

Moreover, the technological and organizational revolution now under way is based not on large, capital-intensive industrial firms (of the type so often in difficulty in public sectors in low-income countries) but on small and medium-size firms—labor intensive in nature, with quick start-up times and agile responses to rapidly shifting markets and technologies. In a number of sectors in low-income countries private firms have led the way—in Bangladesh (garments), India (software), Kenya (cut flowers), and Mauritius (garments and electronics). The widespread application of this approach can produce more plants, jobs, and exports than the overcapitalized, protected, and inefficient large public enterprises that will inevitably leave the ranks of the public sector.

Privatizing privatization

Many low-income countries have problems in organizing and administering the privatization process. A prime source of delays has been institutional deficiencies, as inexperienced and unmotivated civil servants either have difficulty or take a great deal of time to carry out preparatory measures. A good way to overcome this problem is by using the private sector to handle most of the implementation (but not the policy) steps. This has been done with great success in settings as varied as Mexico, Morocco, and Russia—and is now being applied in Ghana. This approach has the additional payoff of promoting local consulting and analytical capacity, as foreign consultants and investment banks normally rely heavily on local counterparts. Again, the need to move to the divestiture of the largest firms is highlighted, because while it might be difficult to attract large foreign services for the privatization of very small companies, the sale or leasing of large manufacturing or infrastructure enterprises will definitely attract the larger, more experienced foreign firms.

New methods of sale

What is very important for low-income countries is that privatization mechanisms now exist that simultaneously address two critical problems. The first is putting the assets in the hands of more competent, properly motivated managers. The second is giving an ownership stake to the local population to show them that privatization is not just for the benefit of the foreign investor or the local elite. These mechanisms combine the sale of a controlling stake to an experienced, core investor—who brings in capital, managerial talent, access to markets, and new technology—with devices that spread shares widely among the local population.

The mechanisms work in low-income countries. In Sri Lanka, more than 30 industrial and manufacturing public enterprises, some of significant size, have been sold by the negotiated sale of a majority stake to a core, qualified investor, foreign or domestic—and the donation of 10 percent of shares to the workers—followed by sequenced sales of remaining shares on the local stock exchange, with incentives for small and first-time purchasers.

Where local stock exchanges are nonexistent or weaker than in Sri Lanka, interim institutions—such as the Zambian Privatization Trust Fund (box 3.4 )- speed the transfer of a majority stake, remove the remaining shares from direct government control, and start developing the equity market. And one low-income country in transition, Mongolia, pioneered the use of vouchers, which gave citizens purchasing power and allowed them to participate in the mass privatization of the public enterprise sector.

Despite consideration in a few preliminary studies (in Ghana and Tanzania), a voucher scheme has yet to be applied in other low-income countries. A primary impediment is the lack of a complete registry of the citizenry. Bolivia, with the help of IDA, is launching an ambitious capitalization program that will put half the equity of its six largest public enterprises into private hands, with the remaining half going to a group of private pension funds owned by the citizens of the country (box 3.5). Bolivian authorities are finding registration to be a problem, but efforts are under way to overcome it. More devices of this nature will spring up soon in other low-income countries, with IDA support.


Created as part of an IDA-supported reform program, the Zambian Privatization Trust Fund holds for future sale to small Zambian investors blocks of shares in companies in which 51 percent or more of the equity has been sold to core investors. If fund managers consider the minority shares offered to them by the government an unsound investment, they are free to reject them. Once the shares have been transferred to the fund, the government is no longer allowed to vote them but still collects dividends and proceeds from share sales.

The fund's main purpose is to develop the equity market and stimulate share purchase by local investors. It issues shares through public offerings and financial intermediaries, offering deep discounts and establishing ownership limits to avoid large concentrations. Small investors receive encouragement to retain their shares.

The members of the fund's board of trustees are drawn from the banking sector, the Zambia Chamber of Commerce, the Law Association of Zambia, and private persons and entities. The fund will be managed by the private professional management company that wins a competition for the contract. The selection process will be supervised by the board of trustees. The contract is structured so that fund management has an incentive to dispose of—not hold or manage—the portfolio. If all shares have not been sold at the end of five years the fund will be converted into a unit trust and offered to Zambian investors. If there are few takers, remaining shares could be distributed free to Zambian citizens.

Larger industrial public enterprises

Using such methods can speed the sale of small and medium-size industrial firms, but what about the larger industrial public enterprise firms, many formerly classed as strategic—steel mills, fertilizer companies, cement plants? As the limits on the managerial and financial capacity of the state have become more evident, the concept of strategic enterprise has narrowed and in many instances vanished, Many of these large firms can also be moved and should be moved to the sales block—if there is reasonable assurance that competitive forces can be brought to bear on them.

But governments in low-income countries have resisted the sale of such firms. They argue that their operation in monopolistic markets means that privatization would merely transform a publicly owned, constrained monopoly into a privately owned, unconstrained monopoly. Efficiency might rise, but people's well-being would decline. Moreover, even when the principle of divestiture of large firms is accepted, it is often accompanied by plans to restructure the entity before sale, ostensibly to increase the purchase price.


With IDA assistance, Bolivia is transferring into private hands half the ownership and all the management of the six largest public enterprises in the country—the railway, the airline, electricity generation and distribution, telecommunications, the hydrocarbons company, and the mining smelters. New international partners will invest in the companies rather than buy assets and in this way can acquire up to halt the equity in each firm. While this will generate capital for investment-starved firms, the government will receive no revenues from the transactions and could incur substantial short-term costs. Core investors will sign management contracts containing an option to purchase additional shares when the contract expires. The other half of the equity will be held by five to ten newly created private pension funds serving all 3.2 million adult Bolivians. Proceeds from these managed funds will pay shareholders retirement and disability benefits.

IDA is supporting this program through adjustment and technical assistance operations designed to strengthen the Ministry of Capitalization, establish a regulatory framework for the privatized utilities, and begin capitalizing the Bolivian national telecommunications and airline companies.

The power of the first argument is declining. Adjustment programs in lowincome countries over the past decade have set macroeconomic frameworks in order and liberalized the trade and fiscal regimes. These reforms increase the competitiveness and contestability of markets, making it more likely that privatized firms will face competition.

Many low-income countries, especially those in transition, are deeply attracted to the idea that industrial public enterprises, particularly the largest, could and should be restructured before sale. Restructuring is a broad term. When it consists of defensive or passive measures, such as labor-shedding before privatization (box 3.6), or changes in management and organization, or even settling some of an enterprise's debt, it is acceptable—even though some governments have left all these tasks to the new private owners. What is unacceptable is making new physical investments to boost value before the change of ownership.

New physical investments seldom add enough value to recover their cost. Most often, governments would have been financially better off selling at a lower price. Moreover, physical restructuring in a large firm is inevitably a long process. A growing body of evidence indicates that delaying privatization leads to further deterioration of the assets, decreased revenue for the state, and probably decreased welfare and efficiency for the economy.

The financial and economic costs of not privatizing can thus be very high. So even the large-scale public enterprises producing tradables should be sold—once it is clear that competition is present or imminent-and there should be no physical restructuring or new investments before sale.

Divestiture of utilities

What about utilities, the natural monopoly infrastructure service providers? Until recently, these have not been on the divestiture agenda in most low-income countries. But that is now changing. In telecommunications and electricity generation, technology has changed and introduced competition into areas and markets formerly closed. Organizational changes to enhance competition—such as vertical or horizontal unbundling of formerly integrated networks- open the door to increased private participation in many infrastructure firms.

In low-income countries, the privatization of a few utilities, or the heavy involvement of the private sector, would have a large impact on the budget. If experience elsewhere is a guide, it would increase the quantity and quality of service. It would stimulate local shareholding and capital markets—and signal the domestic and foreign private sector about the seriousness of government's intents. And it could slow or stop the hemorrhaging of resources and increase domestic savings. Even in the least developed settings where the asset value of major utilities is sometimes low, the franchise value remains substantial.


India. Because a fear of labor retrenchment was holding back reform of India's huge public enterprise sector, IDA introduced a Social Safety Net Sector Adjustment Program in 1992. The National Renewal Fund, established to help workers affected by adjustment, includes an Employment Generation Fund (EGF) and a National Renewal Grant Fund (NRGF). The EGF finances the delivery of labor counseling, retraining, and redeployment services and area regeneration schemes that create jobs and use newly acquired skills.

Five agencies (including two private entities) are now in charge of EGF programs. Located in cities where major industrial restructuring is taking place, these agencies have conducted surveys of retrenched workers, regional labor markets, and training institutes—information that helped India devise detailed actions now being implemented.

The NRGF finances severance payments to retrenched workers. By March 1994, it had compensated roughly 66,000 retrenched workers from 67 public enterprises-less than the 80,000 targeted in NRGF's Business Plan for fiscal 1992 because industrial restructuring has been slow. These achievements are commendable, however, given that labor retrenchment in India was, until recently, entirely taboo.

Bangladesh. In Bangladesh, labor retrenchment has also been a contentious issue. New owners of privatized enterprises had been required to retain workers for at least one year after privatization. With these restrictions now removed, efforts are being made to retrench as much surplus labor as possible before privatization—usually through voluntary departure schemes based on generous severance benefits.

Telecommunications is a likely priority candidate—for several reasons. In a large number of low-income countries the demand for phone services is unfilled. Government can no longer meet investment needs. Overstaffing is less of a problem in this sector than in others, and the likelihood is good that expansion, and perhaps even increased employment, will follow sale. Considerable knowhow on telecommunications divestiture has been built up in the past five years in the business community and in the governments of lowincome countries. Above all, international investors continue to be interested in acquiring stakes in telecommunications firms in emerging markets. Sales of such firms in Argentina, Chile. Mexico, and Venezuela have produced a stream of positive benefits and account for about half the capitalization of the stock exchanges in those countries. Low-income countries are starting to follow this trend, with partial sales of telecommunications already completed in Pakistan and under way in Bolivia, Burundi, Sri Lanka, and Tanzania.

Severance benefits for all public sector employees were substantially increased in July 1989. A public enterprise employee with 30 years of service, for example, could be entitled to five years' pay. Training and jobsearch services also are being provided. The response has been encouraging. In public jute mills, about 18,000 workers applied for voluntary separation during fiscal 1991 - 93.

The recently approved, IDA supported Jute Sector Adjustment Project will develop training and selfemployment schemes to be administered by nongovernmental organizations (NGOs) and existing government training mechanisms. A reputable NGO will be contracted to act as principal coordinator for delivering training services and to establish a Jute Training Resource Center, with training facilities to be located in areas with a concentration of jute mills. Employees will have the choice of participating in several months of skills training or taking a self-employment course and receiving guaranteed loans to partially finance the set-up of businesses.

Cape Verde. An IDA project sponsoring technical assistance for privatization in Cape Verde helps match retrenched labor with demand in the private sector. The project helps former employees set up their own businesses, subsidizes the costs of retraining retrenched public employees incurred by their new employers (up to 40 percent of the employee's salary for six months), and financially supports the organization of private training workshops and evening courses. So far, the project has financed the retraining costs of 150 retrenched employees, who were subsequently hired by private companies. Progress has therefore been slow, but the program works. Once it is properly advertised, it should expand its operations.

There are two issues for increasing private participation in utilities in lowincome countries. First, how will countries regulate portions of privatized (or partly privatized) infrastructure that cannot be subjected to competitive forces in the marketplace? Institutional and legal deficiencies make regulation onerous. Second, how can private investors be assured that government will maintain policy and pricing frameworks for them to earn a reasonable return on their investment? Investors want stable and predictable business environments, something in short supply in many low-income countries.

The two questions are related, and so are the answers. First, with changing technology the experience from privatization efforts around the world is that many fields of infrastructure can be subjected to some form of competition. So, the scope and need for direct government regulation have been reduced. Second, in recent years there have been promising experiments with tailoring market structure and regulatory choices to institutional capabilities. But there still is much to learn. One option, as yet untested, may be to contract out some regulatory functions. Building credibility in pricing and policy frameworks is likely to take time. Various approaches may be possible in the transition to enhance credibility of the government's commitment. An innovative approach may be recourse to foreign arbitration for dispute settlement. For example, the private operator of the Jamaica telecommunications company can appeal contract disputes to a U.K. court—but this approach may not be easily replicated. Multilateral institutions like the World Bank Group can also provide guarantees against the failure of governments to live up to their policy frameworks.

Privatizing management—and beyond

The economic and business uncertainty in many countries means that buyers will be hesitant and governments will be judged incapable of creating and maintaining a proper regulatory framework. And some governments will remain adamant that outright sale would pose intolerable political problems. In these cases, consideration can go to privatizing management without fully or immediately privatizing ownership. This solution is most appropriate for infrastructure firms operating in monopolistic markets. Methods to privatize management include management contracts, leases, concessions, and franchises.

A recent Bank study shows that in two-thirds of 20 cases reviewed, management contracts improved performance (World Bank 1995). But their use has been concentrated in a few sectors (hotels, agroindustries), and they place great demands on governments in devising, implementing, and monitoring the contracts—and leases and concessions, even more so. Nonetheless, the privatization of management retains its attraction in low-income settings—particularly in infrastructure enterprises, where the need for improved performance is overwhelming—since both government sensitivities and investor wariness are especially high. Between 1988 and 1994, IDA supported 23 operations to privatize management, most of them in the past few years. Sectors and countries included airlines (Cameroon and Chad), telecommunications (Guinea), power (Cote d'Ivoire, Guinea, Mali, Rwanda, and Sierra Leone), railways (Burkina Faso, Cameroon, India, and Tanzania), and solid waste management (Benin, Burkina Faso, Ghana, and Tanzania). For an example from the power sector, see box 3.7. The mechanism is not limited to infrastructure firms. In Guyana, a management contract dramatically improved the performance of a major bauxite mining operation.

The beneficial impact of privatizing management is greatly enhanced when the management provider takes an equity stake—or at least takes direct collection risk. A variation on this theme is the lease with an option to buy an ownership stake—partial or majority. In several World Bank infrastructure projects under preparation (telecommunications in Jordan, water in Trinidad and Tobago), private providers assume responsibility not simply for management but also for a percentage of needed investments during the period of the contract. The contractors have the option of becoming owners of the entity at the expiration of the contract. If they choose to exercise the option, the price of the investments is converted to equity, and World Bank guarantees provide assurance that the government will maintain its commitments. The familiarization period allows the government to examine the benefits of improved performance—and the investor to test governrnent policies and price schedules. This approach can also be used for large-scale industry and for banks, both in great need of reform in almost all low-income countries.

These management and ownership approaches could and should be applied much more widely in low-income countries (for an example from a low-income country in transition, see box 3.8). In these operations, as in Cote d'Ivoire, IDA can provide more than finance for the rehabilitation of infrastructure. It also can provide technical assistance to improve government operations. Comfort levels of private managers and investors can be raised by the traditional mechanism of lending the government, increasingly in support of or in conjunction with private investors.

The path for donors

Donors have to tread a narrow path between helping a government undertake painful reform and providing a government with the means to avoid or delay reform. A 1994 study of privatization in Sub-Saharan Africa argued that aid flows often "delayed rather than promoted" public enterprise reform and privatization (Berg 1994). The report was particularly critical of recapitalizations of stateowned financial institutions that then continued the soft budget for public enterprises, removing incentives for their reform or sale. It is regrettably clear that many governments postpone fundamental reform, especially about an issue as sensitive as privatization, until a crisis or near-crisis stage is reached—that is, until their backs are against the wall.


Before private participation. In the 1970s and 1980s, Energie Electrique de Cd'lvoire (EECI) built the most extensive power grid in West Africa. Total capacity reached 850 megawatts. But its hydropower plants were poorly designed, its thermal units were not well maintained, and the power system never performed close to full capacity. Moreover, as economic decline set in in the mid-1 980s, EECI was hit by budget cuts, bringing weaknesses in financial management to the fore. By 1990, the company was carrying large arrears on accounts receivable and debt in excess of one year's revenue. Losses were more than one-third of revenues.

The lease. In 1990 the government decided to lease the sector's assets to a private firm, Compagnie Ivoirienne d'Electricite (CIE), with 51 percent of the equity (CFAF 10 billion) held by a joint venture of the French utility companies, SAUR and EdF International. The rest of the equity was held by the government until it could be sold to local investors and company employees. At the outset, average power prices were reduced by 10 percent to CFAF 44 per kWh ($0.16)—still high by international standards and a major contributing factor to the country's high factor costs. Following the 50 percent devaluation of the CFA franc in January 1994, prices were adjusted to CFAF 53 per kWh ($0.09)—close to the average price in OECD countries and the long-run marginal cost of power in Cd'lvoire.

Efficiency gains. Observers calculate that while the cost of the concession was high, it was more than offset by efficiency gains. Since the introduction of the lease, system power losses have fallen from more than 20 percent to about 17 percent, and average outage time from 50 to 18 hours per system failure. And collections have risen to 98 percent of billings. In addition, the number of employees has dropped from 9.5 per 1,000 customers to 6.9, and revenues have risen from less than CFAF 90 billion to CFAF 112 billion. In 1991, CIE posted its first profit of CFAF 1.2 billion, and profits have since grown steadily.

The government has already sold half its 49 percent share to 4,000 small investors through a public offering on the Abidjan bourse.

Winners. All stakeholders have benefited from private participation in the sector. Shareholders have received dividends of 10 percent each year. The government can now focus on sectoral policy and regulation. It no longer provides cash injections and other subsidies, and it receives all revenues (net of lease fees and the cost of fuel and energy purchases), plus corporate taxes and dividends. Current tariffs are high enough to ensure the sector's financial equilibrium, with self-financing ratios of about 25 percent.

Employees have also fared well, receiving a 5 percent stake in the company under advantageous terms, a 2 percent wage increase in 1994, and generous benefits by local standards. More than half the employees have also received on-the job training. Compulsory layoffs have been avoided with staff reductions limited to natural attrition and firings limited to cases of malfeasance. Consumers also are better off. Tariffs have fallen in real terms, and in the wake of the devaluation, lifeline rates for lowincome families were introduced.

The future. Capitalizing on the recent discovery of oil and natural gas, the government negotiated an independent power project with private investors. Construction of the gas fired 100 megawatts unit is near completion, with negotiations for an additional 65 megawatts of capacity already under way. While much remains to be done to secure a competitive and efficient power sector, early experience with private participation has produced substantial benefits and convinced the government to redouble efforts to encourage more private investment.

Donors thus have to be selective in their assistance, expending greater effort in assessing whether country conditions—and commitment—are suitable for carrying out the policies and projects recommended. Donors must recognize that there are few technical solutions to what are basically political problems and that the commitment to cut off credits to nonviable public enterprises, to establish biting fiscal controls, and to impose macroeconomic stabile must come from within. Donor coordination in this fashion was particularly effective in Zambia.

For tradable goods, -the first lesson for donors is to create no new public enterprises and to expand no old public enterprises—a lesson largely learned. Almost no donor today lends or offers grants to create a purely public enterprise, at least one designed to produce a tradable good. Some low-income countries are still creating public enterprises, but without donor aid and usually contrary to donor advice. Better use of the public expenditure review exercise is required to consolidate this viewpoint of what constitutes priority actions.


The government of the Kyrgyz Republic has demonstrated its eagerness to privatize most state enterprises rapidly. State ownership will nonetheless remain significant for a period of time, including utilities excluded from the privatization program; shares retained by the State Property Fund (SPF) in partly privatized enterprises, pending their disposal through cash and voucher auctions; and shares in enterprises included in the next two years' privatization program but not yet privatized.

The SPF is responsible for managing the state's ownership interest in the last two categories of enterprises. But it has not effectively exercised its responsibility—in part because of the institution's lack of expertise, coupled with its legitimate focus on implementation of the privatization program, and in part because of the lack of appropriate information, reporting, and control instruments. As a result, the SPF gave up its portfolio management responsibility in some key sectors to line ministries or to state holding companies (thus recreating the old dependence of enterprises on the state). In other sectors, the SPF's supervision has been little more than formal, and the accountability of managers to shareholders, including the state, has been minimal or nonexistent.

To overcome these problems, the SPF is appointing independent private financial and management experts to act as fiduciaries on its behalf, as owner. The experts will be selected in a transparent manner on the basis of their expertise and experience in management. They will be appointed on a one-year renewable contract and compensated according to their performance, including payment in enterprise shares held by the SPF. The SPF intends to implement this approach in 1995 in about 20 enterprises distributed across various sectors in which the state still holds 50 percent or more of the equity. If the experiment succeeds, it will be extended widely.

This approach has several important merits. First, by privatizing the corporate governance function, it promotes the use of market mechanisms and is thus consistent with the current reform philosophy of the government. Second, it places responsibility for governance in the hands of skilled resources. Indeed, while the enterprises' managers and the line ministries have considerable engineering and technical skills, they generally lack entrepreneurial, financial, and market management expertise and orientation. Third, it avoids the creation in the SPF (or elsewhere in the government) of a large civil service— to deal with a mostly temporary issue, the full and rapid privatization of all but a limited number of enterprises.

The second lesson: the legitimate donor operations for industrial public enterprises are those that assist in the reform and privatization processes. These involve "passive" restructuring—preparing the firm for sale, dealing with excess labor, cleaning up the balance sheet, determining environmental liabilities, and assisting in the attraction of stable, competent private managers, lessors, and purchasers.

For public enterprises in infrastructure, the situation is much more complex and the recommended actions more nuanced. The objective is clear: to create an environment in which infrastructure firms can attract private financing, management, and ownership, while protecting social welfare. But given typical country and market conditions, donors are likely first to have to assist in removing major distortions in pricing, correcting regulatory deficiencies, and enhancing competition in and contestability of markets. And while these reforms are being constructed, direct long-term financing of infrastructure fines, by the donors, may be justified—if the country has endorsed a sound policy approach, and agrees with the goal of moving to greater private sector involvement.

In more advanced countries, donors should examine the prospects for immediate involvement of the private sector as manager or financier of the infrastructure firm in question. And it is even possible that partial or full private ownership of the enterprise might be the optimal course of action. Even when the latter actions are preferred, donors retain a substantial role: as facilitators of the process, as providers of technical assistance, as lenders for investment and financing (though more and more rarely), and as guarantors of private loans and equity investments.

Donors must also redouble their efforts to help governments remove subsidies (box 3.9), retrench labor (box 3.10), rationalize tariff regimes, create good regulatory systems, and unbundle integrated firms and networks into smaller, more manageable, more accountable units. In particular, donors must help governments bring public enterprise finances out of the dark and shed light on the complete flow of funds between government and public enterprises— to reveal the real gains and losses of the sector and the cost of inaction, in terms of forgone job opportunities. For example, a 1994 audit of public enterprise performance in Uganda showed that in the 1990s direct and indirect subsidies to public enterprises have averaged $180 million a year, five times the spending on health. The return flow from the enterprises to the government has been very small. The sum transferred is equal to about $6,000 per state enterprise employee per year, over and above the wage and salaries bill. Alarmed by these numbers, the country's leaders immediately stepped up the pace and scope of reform.


The professed rationale for subsidized provision of goods and services by public enterprises is to help the poor. In practice, the benefits of such subsidies rarely reach the poor. Indeed, the poor often bear the burden of financing the subsidies. All too often, the poor either consume very little of the goods or services being subsidized, or intermediaries reap much of the premium created by subsidies.

A recent survey of electricity consumption in the urban areas of several low-income countries shows that the poorest income groups have little access to electricity. In Lusaka, Zambia, only 28 percent of households in the poorest income quintile had access to electricity compared with 70 percent for the richest quintile. In Praia, Cape Verde, while 82 percent of the richest quintile enjoyed access, less than half of the poorest quintile did. Even where the poor have access, they consume far less electricity than do the rich. In Manila, Philippines, nine of ten households in the poorest quintile had access to electricity, but their per capita consumption was only 77 Kwh/month— 17 percent of the consumption of the richest quintile. The benefits to the poor from subsidizing electricity are marginal. They would be better off if subsidies were reduced and the resulting increase in investable funds used to expand access.

In Mauritania, richer households have access to subsidized piped water provided by the public water authority. The poor get their supplies from itinerant water-sellers, who obtain water from public enterprises at subsidized rates, and then charge poor customers several times those rates. In Tanzania, it has been estimated that the poorest fifth of the population receives only about 10 percent of government subsidies for water, whereas the richest fifth receives about 40 percent.

In manufacturing as well, subsidies usually do not benefit the poor. In Bangladesh, the publicly owned sugar and cotton spinning mills had poor financial results for many years. Subsidized provision of the goods produced was a major cause of this. The poor did not benefit because sugar is consumed mainly by richer urban households and poor households rely on sugar substitutes. Yarn was indeed consumed by poor weavers, but the price they paid was substantially higher than the factory prices. The difference went to marketing intermediaries, who took advantage of excess demand to jack up retail prices. The publicly owned jute industry frequently tried to subsidize jute farmers by buying raw jute at much-above market prices, incurring huge losses in the process. Farmers did not necessarily get the higher prices. Benefits were reaped instead by dishonest enterprise staff colluding with marketing intermediaries.

Only when armed with such information can decisionmakers and the public assess the real costs of performance and the opportunities forgone. And only then can public enterprise managers be judged. Otherwise, poor performance will continue to be attributed to the costs of meeting noncommercial goals and strategic objectives.

To repeat, none of this will be easy. Scant human resource bases and weak institutional systems—common problems in low-income countries, and ones that are not capable of overnight resolution—will impede the adoption of the proposed approach. And one must not underestimate the political obstacles to fundamental reform of public enterprises. Fears of increased unemployment, foreign ownership, concentrated wealth, and lost patronage and perks—all constitute powerful barriers to change. Many thus conclude that gradualism is the more realistic strategy, and that optimal donor efforts are those devoted to education, training, and institution-building—actions that, it is hoped, lay the base for progressive change in the longer term.

While not disputing the severity of the impediments, three concluding observations that question the gradualist perspective are in order:


The fear of adding to unemployment is one of the biggest obstacles to privatization of any sort. Four encouraging observations: First, and critical, private investment in most low-income countries creates more jobs than public investment. Governments in these settings would do better to concentrate on job creation through private initiative rather than job preservation in less efficient areas. Second, the incidence of increased unemployment as a direct result of privatization is lower than anticipated. Some countries have started their privatization programs with companies that were in good condition and not overstaffed (in Morocco, for example) or where the new owners immediately invested and actually hired new workers (telecommunications in several countries). In other countries (Bangladesh, Malaysia, Tunisia, Venezuela. and elsewhere) policymakers have issued instructions to selling agents and buyers that no layoffs would be allowed for a certain period after sale. Third, where layoffs have been sizable, they almost always have been "sweetened" by generous severance packages, with terms greatly exceeding the existing labor laws (in Argentina and Pakistan, for example).Fourth, labor can be persuaded that the privatization process is beneficial by means other than cash payments. Many countries give shares, or sell them at a low price, to workers. In Russia, workers and managers in enterprises obtained at least 25 percent and often 51 percent of the shares before voucher auctions. In Egypt, one firm being privatized solved the problem of excess labor by offering parcels of farmland to those who departed voluntarily. The demand far outstripped the supply

First, regarding public enterprise reform, gradualism is exactly what has been tried, and found wanting, in the vast majority of lowincome countries over the past 15 years. A recommendation for gradualism is, in many low-income countries, an acknowledgment that the losses and the missed opportunities will continue indefinitely. One must aspire to action of a more immediate impact than can be expected from training or educational programs.

Second, the proposed strategy—moving farther and faster with private involvement in public enterprises, and concentrating efforts on the largest firms—is actually quite sparing of institutions and administrators in low-income countries, as it reduces demands on government to monitor and manage productive activities and stimulates the growth of the indigenous private sector.

Third, the political sensitivities are many and real, but reforms in industrial and middle-income countries have generated great public support by calling attention to the high costs and low quality of public enterprise goods and services. Some bold leaders in lowincome countries have embarked on this path—and more can be expected to follow.