Privatization and Deregulation in ASEAN and the EC: Making Markets More Effective 9789814376983

Citation preview

PRIVATIZATION AND DEREGULATION IN

ASEAN;:~EC Making Markets More Effective

The European Institute of Public Administration (EIPA), Maastricht, Netherlands, was founded in 1981. It is an autonomous European institution whose statutory members are the governments of the twelve member states and the Commission of the European Community. The Institute's work focuses on key areas of the European process and public management and on important European policy issues. It aims at their continuing improvement to the benefit of European co-operation and integration. Despite its traditional name, the Institute combines the modern approach of think-tank and public executive development.

The Institute of Southeast Asian Studies was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the multifaceted problems of stability and security, economic development, and political and social change. The Institute is governed by a twenty-two-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic and administrative officer. The ASEAN Economic Research Unit is an integral part of the Institute, coming under the overall supervision of the Director who is also the Chairman of its Management Committee. The Unit was formed in 1979 in response to the need to deepen understanding of economic change and political developments in ASEAN. The day-to-day operations of the Unit are the responsibility of the Co-ordinator. A Regional Advisory Board, consisting of a senior economist from each of the ASEAN countries, guides the work of the Unit.

PRIVATIZATION AND DEREGULATION IN

Making Markets More Effective Edited by

Jacques Pelkmans Norbert Wagner

.... lnstitut Europeen d'Administration Publique

""

"" ~ European Institute

of Public Administration

I5ER5 ASEAN Economic Research Unit Institute of Southeast Asian Studies Singapore

Published by Institute of Southeast Asian Studies Heng Mui Keng Terrace Pasir Panjang Singapore 0511 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies and the European Institute of Public Administration. © 1990 Institute of Southeast Asian Studies

The responsibility for facts and opinions expressed in this publication rests exclusively with the contributors and their interpretations do not necessarily reflect the views or the policy of the Institutes or their supporters.

Cataloguing in Publication Data

Privatization and deregulation in ASEAN and the EC : making markets more effective I editors, Jacques Pelkmans and Norbert Wagner. This volume comprises the proceedings of a symposium on "Privatization: Lessons from Europe and ASEAN", organized jointly by the European Institute of Public Administration and the Institute of Southeast Asian Studies, and held in Singapore from 16 to 18 February 1989. 1. Privatization -- ASEAN countries -- Congresses. 2. Privatization -- European Economic Community countries -Congresses. 3. Government business enterprises -- ASEAN countries -- Congresses. 4. Government business enterprises -- European Economic Community countries -- Congresses. I. Pelkmans, Jacques. II. Wagner, Norbert. III. Symposium on "Privatization: Lessons from Europe and ASEAN" (1989 : Singapore) IV. European Institute of Public Administration. V. Institute of Southeast Asian Studies (Singapore) 1990 sls90-110012 HD4295.8 A4P96 ISBN 981-3035-65-X ISSN 0129-1920 Printed in Singapore by Loi Printing Pte Ltd.

Contents

List of Tables List of Figures Preface Acknowledgements List of Contributors

viii X

xi XV

xvii

PART I: INTRODUCTION I

The Economics of Privatization and Deregulation: Lessons from ASEAN and the EC Jacques Pelkmans and Norbert Wagner

PART II: PUBLIC UTILITIES II

III

IV

29

Privatization of Public Utilities in the Philippines: General Direction and Approach Zinnia F Godinez

31

Privatization of Electricity Supply in Malaysia: Issues and Problems M. Zainudin Saleh

45

Privatization of Utilities in the United Kingdom, with Special Reference to Electricity Supply Frederick Bonner

60

PART III: TELECOMMUNICATIONS V

3

The Liberalization and Privatization of Telecommunications: The Malaysian Experience Toh Kin Woon

69 71

Contents

VI

VI

Privatization of Telecommunications Services in Singapore Toh Mun Heng and Linda Low

82

VII

Privatization of Telecommunications Services in Europe Godefroy Dang Nguyen

94

PART IV: TRANSPORT VIII

Privatization and "Publicization": Aspects of Change in Singapore's Public Transport System Ian Thynne

109 Ill

IX

Privatization of the Bangkok Metropolitan Bus Service Kraiyudht Dhiratayakinant

120

X

Privatization of Port Klang: A Case Study Ismail Md. Salleh

130

XI

Privatization of Railways in Japan Yukihide Okano

144

PART V: CAPITAL MARKET

157

XII

Stock Markets and Privatization: Issues in ASEAN Ahmad D. Habir

159

XIII

Reform and Privatization of State Enterprises in Thailand: The Role of the Financial Market Pairoj Vongvipanond

XIV

Recent Deregulation of the Banking Sector in Indonesia Anwar Nasution

PART VI: INDUSTRIAL RELATIONS XV

The Labour Perspective of Privatization in Malaysia A. Ragunathan

XVI

Towards Worker Ownership of Public Utility Firms through Privatization: The Case of the Pangasinan Transportation Company Leonor M Briones and Aileen R. Zosa

173 184

201 203

214

Contents

vii

XVII Privatization and the European Trade Union Movement Giuseppe Fajertag

228

PART VII: PRIVATIZATION AND PUBLIC FIRMS

239

XVIII Privatization and the Performance of Public Firms M R. Bishop and J A. Kay

241

The Editors

260

List of Tables

Major Recipients of Government Support to State-Owned Enterprises

34

Summary of the Privatization Completed for State-Owned Enterprises

36

Major Non-Financial State-Owned Enterprises Monitored by the GCMCC

37

II.4

Major Subsidiaries of Manila Gas Corporation

38

III.l

Major Generating Plants in Operation, 1986

48

111.2

Total Supply, Consumption and Revenue

49

III.3

Cost of Electricity Supply (1975-86)

50

III.4

Total Energy Consumption and Number of Consumers

51

VII. I

Statute of Telecommunications Operators in Europe (European Community)

103

X.1

Total Cargo Handled at Port Klang, 1964-87

131

X.2

Performance of Container Terminal

133

X.3

Performance Indicatiors

140

Xl.1

Passengers Carried, 1987

149

Xl.2

Revenue, Expenses and Profit (March 1988)

150

XI.3

Assets and Liabilities (March 1988)

152

11.1

11.2 II.3

List of Tables

ix

XI.4

Planned Disposition of Employees

154

XII.1

How the Markets Rate

163

XII.2

Financial Assets: Who Controls What

164

XIII.1 Salient Features of Financial Institutions in Thailand (atend1988)

175

XIII.2 Ratio of Domestic Savings and Financial Savings to GDP

176

XIII.3 Market Capitalization/GOP

176

XIII.4 Highlight of Statistics on SET

177

XIV.1 The Structure and Growth of the Organized Financial Sector, 1982-86

186

XIV.2 Geographic Dispersion of Branches of Commercial Banks and RDBs in 1988

189

XVI.l PANTRANCO's Financial Status, 1986-88

219

XVII.1 Employment Changes in Selected Public Enterprises in the European Community, 1982-85

231

List of Figures

X. I

Privatization of Port Klang Container Terminal

137

XLI

Financial Performance of the JNR

145

XI.2

The Restructuring of the JNR and the Allocation and Disposition of Long-term Debts

146

Preface

The Association of Southeast Asian Nations (ASEAN) and the European Community (EC) have gradually extended their co-operation since the first high-level political meetings of the two groups began more than ten years ago. One element of this extension consists in the so-called human resources development co-operation programme, especially directed at high officials working..in the public sector. Sponsored by the Community, the programme offers a framework of co-operation to facilitate the mutual exchange of experiences and ideas with respect to public policies, their execution, administration and management. It includes intensive training where and when it is mutually agreed to be appropriate, or seminars and conferences, where the value-added is expected to be in the reflection and the testing out of ideas. The public policy issues may be at the member-state level within both groups, or at the group level, that is, related to economic co-operation or integration. The present ASEAN-EC co-operation agreement assigns the implementation of the human resources development co-operation programme to the European Institute of Public Administration. In line with this, a symposium on "Privatization: Lessons from Europe and ASEAN" was organized jointly by the European Institute of Public Administration (EIPA) and the Institute of Southeast Asian Studies (ISEAS) and held in Singapore from 16 to 18 February 1989. This volume comprises the proceedings of the symposium. In preparing this joint effort ISEAS and EIPA had in mind the objective of added value right from the start. They had expected no added value from yet another conference and publication on privatization as several such conferences had been held in ASEAN and a great many in Europe as well. Moreover, ISEAS had attempted to deepen the comparison among ASEAN countries by opting for an ambitious research project, the first results of which are already available (Ng and Wagner 1989). After widespread consultations in the region, it was concluded that most value-added could be expected from an approach concentrated on specific sectors. The selection criterion for the sectors was "market failure", that is, markets

xii

Preface

which when left entirely on their own fail to function "properly". Economic analysis, both theoretical and empirical, is, however, less straightforward. The key issue is competition, or potential competition, and the means to bring it about as well as to maintain it in the public interest - that is, the performance of the economy at large. Here, our target group, the civil servants dealing with privatization, will be interested in the state of the art of thinking in economic analysis, about experiences in Europe, in the debates in the respective EC and ASEAN countries and in the lessons from failures, drawbacks and successes that can be drawn from a comparison of specific, difficult sectors in the various countries. Of course, in comparing Europe and ASEAN, one has to be conscious of the major internal differences within the two groups. To wit, the experience of Singapore clearly cannot automatically be imitated, as both the level of development and the role and strength of the private sector differ greatly among the ASEAN countries. In ASEAN circles, however, it is perhaps not fully realized that, to a large extent, the same applies to the EC. The United Kingdom is not Greece, and Luxembourg is not Spain. Yet, despite this fact, the Community is the most interesting laboratory for comparing many different experiences. This is particularly appropriate since a privatization wave is sweeping all of the European Community, not just the United Kingdom. Different combinations of deregulation and privatization are debated or implemented in the various member states, and one might learn at least as much from the study of alternative modes of privatization and deregulation throughout the EC as from the mere focus on the vanguard role in the United Kingdom. The EC is also interesting for a different reason. Since about 1983 the EC has regained enough political backing to reiterate its strict policies on containing public aid to industry, whether private or public enterprise. In addition, the Community has set ambitious targets for completing the reorganization of its internal market by 1992, including a radical opening up of public procurement policies precisely in the sectors discussed in these conference proceedings. Furthermore, the 1992 momentum has engendered decisions or debates on telecommunications, utilities, land and air transport, questioning the fragmentation of the EC market for these services. The intertwining of all this privatization and deregulation at member-state level will make for a fascinating set of experiences, even beyond what the conference and these proceedings could hope to address. The conference on "Privatization: Lessons from Europe and ASEAN" was made possible through the financial support of the European Community, which we gratefully acknowledge. We would also like to thank the writers who contributed to this volume and thus to a fruitful dialogue between ASEAN and the EC. Our gratitude is also due to Mrs Rita Beuter of EIP A and Ms. Anne Yeo of ISEAS for their

Preface

xiii

assistance in the preparations for the conference and in the publication of these proceedings. It is our hope that this volume will deliver the added value it set out to generate and contribute to "Making Markets More Effective", both in ASEAN and in Europe.

Maastricht and Singapore February 1990

Jacques Pelkmans

European Institute of Public Administration Norbert Wagner

Institute of Southeast Asian Studies

Acknowledgements

This research was prepared under the auspices of the international project on "Privatization and Deregulation in ASEAN and the EC", launched by the Institute of Southeast Asian Studies (ISEAS) and the European Institute of Public Administration (EIPA), with financial support from the European Communities and the Konrad Adenauer Foundation. We are particularly grateful for the co-ordination and assistance rendered by Mrs Rita Beuter, Ms Nicolette Brouwers and Ms Anne Yeo in the preparation of this manuscript. Special thanks are also due to the ISEAS Publications Unit for their invaluable editorial assistance.

List of Contributors*

Matthew R. Bishop Privatization and Deregulation Economist Centre for Business Strategy London Business School London, United Kingdom Frederick E. Bonner Member of the Monopoly and Mergers Commission 'JOYA' West Sussex, United Kingdom Leonor M. Briones Associate Professor of Public Administration College of Public Administration University of the Philippines Quezon City, Philippines Godefroy Dang Nguyen Professor, Head of Economics Department Ecole Nationale Superieure de Telecommunication de Bretagne Brest, France

Kraiyudt Dhiratayakinant Professor of Economics Faculty of Economics Chulalongkorn University Bangkok, Thailand Giuseppe Fajertag Ftesearch Officer European Trade Union Institute Brussels, Belgium Zinnia F. Godinez Chief of Public Affairs Philippine Institute for Development Studies Manila, Philippines Ahmad D. Habir Faculty Member Institut Pengembangan Manajemen Indonesia Indonesian Institute for Management Development Jakarta, Indonesia Ismail Md. Salleh Lecturer Institute of Strategic and International Studies Kuala Lumpur, Malaysia

*The affiliations of the contributors mentioned above are during the time of the symposium in February 1989.

XV111

John A. Kay Professor Centre for Business Strategy London Business School London, United Kingdom Linda Low Senior Lecturer Department of Economics and Statistics National University of Singapore Singapore Anwar Nasution Lecturer in Economics Faculty of Economics University of Indonesia Jakarta, Indonesia Yukihide Okano Professor Faculty of Economics University of Tokyo Tokyo, Japan Jacques Pelkmans Professor European Institute of Public Administration Maastricht, The Netherlands A. Ragunathan President Congress of Unions of Employees in the Public and Civil Services Kuala Lumpur, Malaysia

List ofContributors

Ian Thynne Senior Lecturer Faculty of Law National University of Singapore Singapore Toh Kin Woon Associate Professor Faculty of Economics Universiti Kebangsaan Malaysia Kuala Lumpur, Malaysia Toh Mun Heng Lecturer Department of Economics and Statistics National University of Singapore Singapore Pairoj Vongvipanond Professor, Dean Faculty of Economics Chulalongkom University Bangkok, Thailand Norbert Wagner Advisor and Visiting Fellow Institute of Southeast Asian Studies Singapore M. Zainudin Saleh Lecturer in Economics Faculty of Economics Universiti Kebangsaan Malaysia Kuala Lumpur, Malaysia Aileen R. Zosa Ph. D. candidate University of the Philippines Quezon City, Philippines

Part I Introduction

I. Towards More Effective Markets in ASEAN and the EC An Introductory Survey of Developments and Arguments

JACQUES PELKMANS AND NORBERT WAGNER

Introduction

In many countries throughout the world there is, after decades of government intervention into the economy, a renewed emphasis on markets, private initiative, and competition. Privatization and deregulation are essential elements of this change. Governments world-wide increasingly adopt policies of transferring state enterprises to the private sector and of deregulating major parts of their economies. Privatization and deregulation are now in vogue not only in the United States and the United Kingdom where it started in the mid and late 1970s, but also in continental Europe, Japan, New Zealand, and Southeast Asia. In view of the recent developments in the countries of Central and Eastern Europe and the opening up of their economic and political systems, these countries may soon be carrying out one of the most comprehensive and expansive privatization and deregulation exercises so far. The growing emphasis given world-wide to privatization and deregulation may also be seen in the light of the increasing significance being given throughout the world to values such as individual freedom and liberty. Moreover, especially in Eastern Europe the shift away from public ownership and planning as well as heavy regulation and interference by the government in the economy is a manifestation and a corollary of the spreading of democracy, as privatization and deregulation open up new spheres for individual decision-making. Interventionist policies, restrictive regulation, and state involvement in economic activities failed to accomplish low unemployment, low inflation and high economic growth when external shocks were felt in the 1970s and 1980s. On the contrary, it can be argued that interventionism and state involvement hampered structural adjustment and, thus, made the unavoidable changes even more painful in the long run. The focus of privatization is the divestment of public enterprises in favour of private investors and, consequently, the transfer of ownership and

4

Jacques Pelkmans and Norbert Wagner

decision-making from the public to the private sector. The idea is to reduce the role of the state and to enlarge the scope of market forces. Deregulation is concerned with the proper functioning of markets, irrespective of ownership. Markets can be regulated in order to overcome "market failure", that is, instances when markets would function suboptimally if let entirely free, or in order to satisfy certain preferences of the society expressed via the political system. Such social benefits have a cost, however. In altering the incentive structure for pricing, output, and innovation, the cost of regulation may sometimes exceed the benefits, or alternatively, the mode of the chosen regulation may be unnecessarily costly for the market failure or objective at issue. Regulatory reform, comprising both deregulation and (better) regulatory alternatives, is a consequence of a serious reassessment of the existing regulation. Depending on the nature of the market, it may alter or liberalize price controls, market entry, supervision both domestically and internationally as well as redefine the role of competition policies for such deregulated markets. Deregulation may contribute to the reduction or abolition of state intervention into the factor, services and/or product markets, in particular with regard to price controls. Moreover, measures to liberalize the economy, to promote increased competition and to ease market entry may be required. Hence, the "marketization" of the economy and "making markets more effective" reflect the thrust of a new policy to strengthen competition and to improve efficiency. Privatization and deregulation are central elements of this policy.

Privatization and Deregulation in ASEAN

Privatization and deregulation have also attracted increasing attention in Southeast Asia, especially among the member countries of the Association of Southeast Asian Nations (ASEAN) in recent years. Since the mid-eighties almost all the ASEAN countries have, at varying degrees, studied the necessity and possibilities of privatization and deregulation. Some of these countries are already carrying out privatization and deregulation attempts, while others are more hesitant (cf. ADB 1985; Ng and Wagner 1989; Gouri and others 1989). Even non-market economies such as those of Vietnam and Burma are considering, if not to privatize, at least to deregulate parts of their economies. Privatization and deregulation are complex concepts which may embrace many different policies and measures. In the ASEAN countries, where not only the socio-economic objectives, but also the extent of the involvement of public enterprises in economic activities differ considerably, there are varying views on the degree to which privatization and deregulation are desirable or feasible. These views range from an emphasis on a continued role for public enterprises but with improved efficiency to the

Towards More Effective Markets in ASEAN and the EC

5

belief that total privatization is the panacea to cure the ills of an economy constricted by many inefficient public enterprises. Whatever the pros and cons of privatization and deregulation in the ASEAN region, interest in the process has grown considerably and the governments of the ASEAN countries are increasingly committed to privatization and to reduced interference in the economy. The Rationale for Privatization in ASEAN This spreading endeavour for privatization and deregulation in Southeast Asia and particularly in ASEAN is part of a world-wide evolution re-emphasizing market forces and aiming at the reduction of government interference in the economy. As in many other parts of the world, in ASEAN there is a growing perception that governments have distorted market forces. Hence, government failure, not market failure is being blamed for unsatisfactory economic results and, in some cases, slackening economies (as, for instance, during the recession in 1985). More specifically to the region and in addition to the general motivations, privatization and deregulation gathered further momentum from the heavy losses incurred by public enterprises and the tremendous budgetary burden these losses implied, together with the external imbalance and the mounting foreign debt of many of the ASEAN countries. In most ASEAN countries public enterprises are run with inadequate attention to profitability and efficiency. They receive privileges from the government, and in tum are used for blatantly political purposes. These and other factors contributed to the huge deficits sustained by public enterprises and the burgeoning external debt of many ASEAN countries. Thus, for instance, in the Philippines, budgetary support to government corporations reached 12,280 million pesos in 1981 and accounted for more than that year's budget deficit. In 1986, state aid rose to its highest level (31 ,202 million pesos), equivalent to about one-quarter of the national budget and more than 110 per cent of the budget deficit. Similarly, public enterprises pose a serious drain on Malaysia's resources and aggravate its debt problems. The (non-financial) public enterprises, for instance, accounted for more than one-third of the total outstanding foreign debt of the public sector in 1987, and for more than 30 per cent of total debt repayments. The situation is not as critical in Thailand. The losses of the state enterprises amounted to 2,434 million baht (almost US$100 million). Moreover, investments in the public sector increasingly relied upon financing through foreign borrowing, whereas the share of investments financed from internal savings dropped. Consequently, the total outstanding foreign debt of all state enterprises rose substantially in recent years and reached US$6.53 billion in 1987, more than half of Thailand's public sector foreign debt (US$12.3 billion) and more than 40 per cent of its total outstanding foreign debt at the end of 1987.

6

Jacques Pelkmans and Norbert Wagner

In Singapore, where public enterprises are apparently well run, the endeavour to privatize public enterprises is due to other reasons. Managers of public enterprises tend to be over cautious and risk averse and not very imaginative and innovative. The 1985/86 recession highlighted the many shortcomings of public enterprises, such as their inflexibility and progressive complexity resulting from their increasing size. With easy access to credit coupled with the fear of admitting mistakes, civil-servant managers may be found to be slow in facing up to reality, and in introducing necessary adjustments, and cutting losses when conditions become adverse or change. Progress ofPrivatization in ASEAN Despite the growing conviction that government interference in the economy needs to be reduced, the process of privatization and deregulation in ASEAN is only in its infancy. Consequently, there is still ample room for these countries to become even more market-oriented. Among the ASEAN countries, Singapore seems to be the most systematic in its effort to privatize. In 1987 the Public Sector Divestment Committee formulated a programme for the divestment of governmentlinked companies (GLCs) and made recommendations for the implementation of the programme. The Committee considered 634 GLCs and 7 out of a total of 39 statutory boards. Given that the seven statutory boards considered are more complicated to privatize because they are monopolies, governed by legislation, and charged with tasks of a social and economic nature, the Committee recommended that the exclusively profit-oriented GLCs (with some exceptions) be privatized first. Within this group, priority was to be given to companies earmarked for listing in the stock market. Between November 1985 and January 1990, four fully governmentowned companies were privatized; among the partly government-owned companies, seventeen were fully privatized while fourteen were partially privatized. Steps have also been taken to partially deregulate some statutory boards. The management of Housing and Development Board (HOB) flats has been transferred to town councils, while the Port of Singapore Authority (PSA) is leasing out some of its services to the private sector, and Singapore Telecom allows the direct sale of some telecommunication equipment and permits maintenance to be carried out by private contractors (see the paper on the privatization of Singapore Telecom by Low and Toh). The government has decided in principle to privatize Singapore Telecom. A final decision will be taken when studies on how the proposal is to be implemented are completed in two to three years. If approved, a public offering will be made in 1992 or 1993. However, the unusual nature of the privatization exercise in Singapore is that, while the public holding companies are encouraged to actively divest partially or totally the companies under their control, the government is at the same time looking at new areas for investment, holding "golden shares"

Towards More Effective Markets in ASEAN and the EC

7

in some companies or even a majority in others. This practice is called "rolling privatization", where the overall control of the government over the economy is not reduced. The result may be a mere change of company portfolios and activities. Like that of Singapore, the privatization programme of the Philippines is systematic and ambitious. In total, 296 public sector enterprises and 399 so-called non-performing assets of the Development Bank of the Philippines and of the Philippine National Bank have been considered. The primary aims of this privatization effort are to reduce the budgetary burden of the public enterprises on the government and to generate as much funds as possible through the sale of these assets. With some exceptions imposed by the constitution of the Philippines, foreign investors are allowed to participate. More than one-third of the public enterprises under consideration have been approved for sale so far, one-fifth will be abolished, some will be retained and others are still under consideration. The main emphasis of privatization in the Philippines is, however, on the divestment of non-performing assets. Their total realizable sales value is estimated at 22 per cent of book value, or US$1 billion. Between January 1987 and June 1988 non-performing assets amounting to more than US$200 million were divested, with a recovery rate of almost 40 per cent. Malaysia's privatization record is rather limited. The government claims the privatization of 71 projects. Major companies (partially or fully) privatized in recent years comprise the national airline, Malaysian Airline System (MAS), the national shipping carrier, Malaysian International Shipping Company (MISC), the construction of the North-South Highway, and cargo handling at Port Klang (see the paper on the privatization of Port Klang by Ismail Salleh). Only recently, the future privatization policy has been laid down in a Privatization Master Plan. The predominant mode of privatization in Malaysia has been the partial divestment of equity of government-owned enterprises. The privatization of MAS and MISC are the most important examples. Partial divestment implies that the government is still the major shareholder of the respective companies and consequently continues to exert control over them. Another example of privatization is the private company, Syarikat Telekom Malaysia Berhad (STMB), which has been set up to run Malaysia's telecommunications services, but is still fully owned by the government (see the paper on the liberalization and privatization of telecommunications in Malaysia by Toh). The question arises, therefore, whether the Malaysian Government is really committed to privatization as a means to reduce government control of the economy or is the government merely divesting in order to raise revenue? In Thailand, efforts at privatization were launched in 1986 because of the increasing inability of state-owned enterprises to finance their own investments and their increasing reliance upon external debt-financing. However, the progress of privatization in Thailand has been very slow. At

8

Jacques Pelkmans and Norbert Wagner

present there are 67 state enterprises. Among the companies privatized in recent years are the Paper Mill Organization, the Alum Organization, and the Preserved Food Organization, while the North-East Jute Mill and Sugar Mills have been privatized only partially. Major companies that have been earmarked for privatization in the future are Thai Airways International, and the Electricity Generating Authority of Thailand (EGAT). Steps have also been taken to deregulate services formerly provided exclusively by state enterprises. Thus, the Eastern Seaboard Development Committee is planning to allow the private sector to run the port facilities at Laem Chabang. Other examples may be the construction of highways and the Bangkok mass rapid transit system (see the paper by Kraiyudht). Despite the very poor performance of state enterprises and the tremendous budgetary burden they impose on the government there is hardly any attempt to privatize in Indonesia. Yet, it appears that the Indonesian Government is verbally emphasizing the aim of making inefficient state enterprises more competitive. When it comes to the test, however, it opposes any substantial and systematic step towards privatization. Even individual privatization attempts face severe public criticism and are eventually abandoned, as in the case of Indonesia's largest oil-palm plantation, TOR Gamba, in 1985. Even more damaging, the government seems to be prepared to bail out inefficient private companies when their economic survival is in danger, as in the case of the financially troubled steel mill PT Cold Rolling Mill Indonesia in 1990. It is then not surprising that each state-owned enterprise facing financial difficulties looks to the government for assistance, citing similar bad precedents. Whereas the progress of privatization in Indonesia is very limited, there has been more emphasis on deregulation of certain parts of the economy, primarily in foreign trade and the banking sector. In December 1987 the Indonesian Government introduced some steps to reduce intervention in the capital market. In October 1988 a deregulation package on the financial sector was adopted to allow more foreign bank competition (see the paper on the deregulation of the banking sector in Indonesia by Nasution). In November 1988 the government announced another liberalization package in order to dismantle import monopolies in the trade sector, to reduce protection, to simplify import and export procedures, to open the economy more widely to foreign investors, and to boost the non-oil export sector.

Impediments to Privatization in ASEAN Needless to say, the progress of privatization and deregulation is inhibited by various factors. Managers and employees share a common interest in obstructing the sale of a public enterprise to the private sector as they are afraid of losing their jobs and positions, their influence and power, their perks and bonuses. Trade unions, where they exist and are sufficiently

Towards More Effective Markets in ASEAN and the EC

9

independent, usually oppose privatization and deregulation fiercely for the same reasons (see the paper by Ragunathan on Malaysia). The most recent example of this opposition was the four-day strike by six port unions in Thailand in early 1990, resisting plans to privatize the new Laem Chabang deep-sea container port south of Bangkok. And in February 1990 it was announced that the privatization of Thailand's biggest state-owned companies, Thai Airways International and the Electricity Generating Authority of Thailand, would be postponed because the trade unions had threatened to take strike action. Strategic and supply security arguments as well as nationalistic sentiments may prevent a public enterprise from being divested. In some instances, even legal problems pose a stumbling block to the process of privatization. The capital market, too, plays a particularly important role in the process of privatization (see the papers on Indonesia by Habir and Nasution, and on Thailand by Pairoj). The better developed the capital market the easier it is to sell the shares or to find a suitable owner through auctioning and bidding. On the other hand, privatization may also help to develop and strengthen the capital market by attracting new capital and new participants, either from within the country or from abroad. The participation of foreign investors may enhance the possibilities of raising maximum revenue, but may also cause nationalistic sentiments to increase. The most crucial aspect of the privatization process, however, is to what extent it enhances efficiency and thus contributes to the (further) economic development of the countries concerned. In order to achieve this goal two prerequisites must be met. First, government control and interference have to be abolished, and secondly, the privatized companies must be exposed to increased competition. If monopoly power is merely transferred from the public to the private sector, hardly any positive effect on overall efficiency can be expected. This problem is particularly relevant in the case of public utilities, such as electricity and water supply (see the papers on the privatization of public utilities in the Philippines by Godinez and the privatization of electricity supply in Malaysia by Zainuddin Saleh), in the case of telecommunication services (see the papers by Toh on Malaysia, and by Low and Toh on Singapore) and postal services, as well as in the case of public transport and highways (see the paper on Singapore's public transport system by Thynne, the paper on the Bangkok Metropolitan Bus Service by Kraiyudht, and the paper on Port Klang by Ismail Salleh. A short review by Okano on the privatization of the Japanese National Railways has also been included in order to provide some information on one of the most prominent recent examples of privatization in the field of public transport). The danger of a mere substitution of private for public monopoly power, however, is prevalent not only in the case of more or less "natural" monopolies but also when monopolistic power is a result of a small home market or of a regulated market. Moreover, examples from Malaysia and

10

Jacques Pelkmans and Norbert Wagner

the Philippines suggest that privatization, as it is implemented there, may lead to an even higher concentration of wealth in the hands of a few rich families and cronies. In those instances, not only the objective of increased efficiency is violated but also the distribution of income and wealth becomes more unequal as a consequence of privatization.

Privatization and Deregulation in the EC

Privatization and deregulation are complex not only because of the different forms and shades privatization can assume and the great variety in the extent of and approaches to deregulation, but also because they are distinct in sectoral emphasis, so that further complications arise in a comparative perspective. The intricacies of comparative analysis are instructive, however, not only in showing how careful one should be with generalizations based on one country or a regional group of countries, but also in illuminating the richness of the menu of regulatory regimes and the outcomes of very different national and regional experiments. There is a danger that the examples set and the approaches followed in the United States and the United Kingdom will too easily be taken as the standards of experiments. Although the ASEAN countries are of course aware of the differences among themselves as well as those between them and the United States and the United Kingdom, the tendency to employ a framework of reference based on those experiments is widely accepted rather uncritically. The value-added derived from having a comparison with the EC stems from its great variety of experiments, itself based on rather distinct starting points in the respective member states. Additional insights can be had from the unique two-tier regulatory regime the Community has built up and which is in the process of being strengthened. This two-tier regime is not yet developed as far as, for example, the federal/state regimes in the United States or the federal/provincial one in Canada, although there are undoubtedly important similarities (see Pelkmans and Vanheukelen 1988). But the constraints placed on the national regimes by EC Treaty rules and secondary economic regulation profoundly influence the forms and effective exercise of domestic public ownership as well as economic regulation. Even more interesting is the dynamic interaction between the two levels of economic regulation since the mid-l980s, having led to a sweeping supply-side programme at EC level - "Europe 1992" - alongside an almost equally radical transformation of the role of the state in the national economy in the member states. Understanding the "1992" plan in the light of the questions posed in this book requires, first, a grasp of the interaction between the two levels of government (with respect to ownership and economic regulation) and, secondly, an assessment of the driving forces of privatization and deregulation in the EC of the 1980s.

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The EC Impact on National Public Ownership and Regulation Member states of the EC had and still have widely divergent approaches to state intervention, public ownership and economic regulation. The EEC Treaty (Article 222) leaves public ownership as such entirely to the discretion of the member states. It is not clear what economic significance this autonomy has. Such discretion does not exist, however, in the case of financial intervention by the state (for example, subsidies; indirect taxation) or for economic regulation (for example, services; technical regulations) because EC powers exist. Thus, to the extent that public ownership and other means of intervening in markets, regulating their structures or the behaviour of firms are substitutes to achieve certain economic policy objectives, this substitution is constrained by the EC regime. These constraints eventually take two forms: first, the EC internal market, based on the maintenance of the four economic freedoms (to trade goods; services; for persons and workers to move freely; and for capital to move freely), may render illegal a large array of measures at the national level; and secondly, to the extent that these freedoms are combined with joint regulation (or intervention) by the EC itself, national economic policy interventions will be pre-empted. As a response to these constraints, one might perhaps expect member states to revert more frequently or more intensely to public ownership as a way to maintain a degree of autonomy to reach certain objectives, while duly respecting the constraints of the EC internal market. However, over the years this substitution possibility has declined as well. Let us look a little more closely at this evolution as it is crucial in understanding the interaction between the two levels of government with respect to privatization and deregulation. Whereas countries such as Italy, France, Spain and Greece traditionally had public enterprises in competitive and regulated sectors - goods and services alike - and even in specific distributional activities (for example, tobacco products), countries such as Denmark and the Netherlands had very few public enterprises, which were mostly in or originated from certain services sectors (for example, "public" transport; airlines) or in energy supplies and utilities. The number of public enterprises were somewhat higher in Germany, more so in Belgium and still higher in the United Kingdom, which approached ·the French/Italian situation before the Thatcher period. It is interesting to note that Italy's system of public ownership is organized via gigantic holding companies with a great deal of flexibility, whereas French public ownership oscillated between waves of "nationalization" and privatization, with the former aiming at a presence in many sectors without, however, linking them in holding companies, while the British state sector was shaped- even more so than in France or Italy- by the rescuing oflame ducks, without any strategic view. In this introduction it is not possible to do justice to the range of differences between these three systems, let alone among all EC countries.

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The original EC constraints on national public enterprises were modest. Distribution monopolies (such as tobacco; paper for newspapers; salt) were forced to operate as normal commercial enterprises after two decades of litigation (according to Article 37, EEC Treaty) before the EC Court of Justice. In the beginning, little more was done although it was obvious that the use of public enterprises for national "industrial policy", or perhaps merely as a (subsidized) source of extra jobs or for unprofitable economic activity in weak regions, could contradict the rules and objectives of European integration. In particular, two key articles were only beginning to be enforced towards the end of the 1970s, and in the early 1980s. Article 90 states that public enterprises are not exempted from the internal market and its (strict) rules of competition, except in the case of "entrusted tasks" and even then, only in so far as the task entrusted to the public undertaking would necessitate it. Meanwhile, the EC has moved far beyond the disputes following an EEC Directive in 1980 authorizing investigation powers by the EC Commission on the precise relation between the national state or semi-state organs and the national public enterprises. Three member states lost in court cases over it. The resulting "transparency" obviously reduces the autonomy of the member states, as violations of the Rome Treaty can henceforth be stopped or prevented via the infringement procedures of the Community. Another article which has only recently been enforced concerns the prohibition (with exceptions) of state aid to public enterprises. State aid to or via public enterprises had previously not been questioned for reasons of political sensitivity or could not be tackled because, without investigations into the "transparency", they appeared opaque. The Commission in the past had to deal with de facto social issues which were long considered to be within the realm of domestic politics, no matter what the Treaty said. Clearly, now that both articles have been enforced more rigorously and more systematically, the political attraction of public enterprises has been reduced enormously, especially in competitive markets. The four areas which remained either de jure or de facto out of the reach of the economic freedoms of the internal market until the mid-1980s were public procurement in the goods market where (some) public enterprises were active, the public firms in the energy sector, public transport and the utilities. "Europe 1992" has changed this radically. By liberalizing public procurement even in supplies to the utilities, telecommunications and public transport; by questioning the remaining distortions in the energy markets; by pursuing a sweeping liberalization of all non-local transport modes (except rail, as yet), the scope and economic significance of "entrusted tasks" of a public enterprise - and hence the regulatory and political protection it may expect - are suddenly at the centre of a fierce debate. The chapter on telecommunications by Godefroy Dang Nguyen exemplifies this shift.

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With respect to public ownership, therefore, the EC has gradually limited the effective use of national public enterprises by supervising the state-enterprise linkages and by widening the sectoral scope of the internal market. The latter implies that EC-wide deregulation and liberalization have greatly increased the pressures on states to loosen or give up state control of public enterprises, first in the competitive sectors, and later in the regulated sectors, too. The decision to sell off shares or to transfer the state enterprise to the private sector, however, remains a strictly national matter. Origins of the Pro-market Drive in Europe There were also other pressures to rethink the role and importance of public enterprises, if not the public sector as a whole, in the economy. These pressures were not connected to the EEC Treaty and the supervisory powers of the EC Commission. During the early 1980s it became abundantly clear that the EC economies as a group exhibited considerable rigidities, showed a comparatively dismal capacity to absorb shocks (like the second oil price hike), and experienced serious setbacks in competitiveness in industrial markets especially in third countries, but in some cases even in Europe. In all the EC countries, the public sector was large and expanding for decades. There were mounting pressures to subsidize large lame ducks and to increase protection. France even engaged in a new round of nationalization in the financial services sector as well as in industry (in 1981 ). In a low (or zero) growth and high-unemployment environment, where conservative and protectionist state measures ultimately eliminated the last incentives to invest or to assume major entrepreneurial risks whereas the distribution of the flow of income and the stock of wealth as well as regulation of other aspects of how to generate the income took unquestioned priority over attempts to increase income and wealth, where high marginal rates of direct taxation further reduced incentives, a realization emerged that the Community was suffering from what came to be called "Eurosclerosis". When traditional Keynesian macro-economic recipes proved incapable of generating new jobs, and the wide-spread refusal to "accommodate" price inflation following the second oil shock actually led to a highly restrictive policy stance, causing rapid increases in the jobless rate to alarming two-digit percentages, Europe turned to the micro-economic problem of how markets actually performed, or rather, to what extent markets were allowed to perform under "Eurosclerosis". The ideological and social resistance against "supply side policies" dwindled surprisingly swiftly in almost all EC-Ten countries (Greece being the only laggard) and also caught on in the new EC members, Spain (under a socialist prime minister) and Portugal (which even altered its first post-197 4 constitution for it). State enterprises incurring ever higher losses without any prospect of improvement were quickly spotted as prime targets to improve both micro-economic efficiency and the miserable pictures of

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many state budgets via the cutting of subsidies, and partial or complete selling off or unprecedented closures (for example, shipyards, steel mills, coal mines). Another major plank of the recovery strategy employed was a conscious acceptance of wage restraints so as to restore profitability of firms, without a change in demand and capital/labour ratios. Behind this social acceptance lay the pursuit of the medium-term aim of shifting investment from being labour-saving to expansion oriented. Both aspects of the strategy burdened domestic politics so heavily that adding national deregulation on top of all this - though increasingly viewed as desirable - was initially considered to be too radical. It would fuel resistance especially in regulated sectors which tended to be highly organized for the obvious reason that this was rewarding in a regulated sector. Nevertheless, the EC business sector pressed harder and harder for deregulation and liberalization as a necessary condition to improve global competitiveness. It was here that, once again, the EC came in. Leading politicians of the member states began to realize that they could exploit the implicit deregulatory and liberalizing nature of a more complete "common market" to achieve improvements in the functioning of markets at home, especially in a more competitive environment, without having to rely exclusively on domestic political support. The more ambitious the plans to "complete the internal market" became and the greater the experience of national ministers and especially prime ministers with the resolution of difficult cases at EC level, the more enthusiastic and bolder their support turned out to be for pursuing deregulation and liberalization at the EC level rather than at the national level. It is important to note, however, that this perspective was different from the scenario in the United Kingdom. In the other member states the EC had been used for domestic purposes of deregulation which would otherwise have been difficult, whilst in the United Kingdom the "1992" plan was at first considered a logical extension of its policies at home. The Community: A Laboratory of D(fferent Experiments This fascinating interaction should not cloud the fact that in the EC, differences among the countries are enormous. The ease with which the United Kingdom is regarded, especially outside Europe, as the example, allowing a kind of extrapolation to other EC countries, is not justified. Surely, the practical example set by the Thatcher government has had a healthy demonstration effect. On the other hand, the unique circumstances in each EC member state and the ideological overtones in the British privatization approach have probably prompted strong arguments against a reliance on the Thatcher example in the domestic politics of other EC countries. The EC countries differ in many respects. Per capita income ranges from the very highest in the world (Luxembourg, Denmark, Germany, followed by the Netherlands, Belgium and France) via a middle group (United Kingdom and Italy), to a group of NIC-type countries such as

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Spain, Ireland and Greece, having much lower per capita income, followed by Portugal which ranks considerably lower still. Interventionist traditions also diverge greatly. Shares of the public sector in gross national product (GNP) differ considerably, too, particularly with respect to expenditures on social security and the weight of state enterprises. The state's influence also varies: public ownership could mean no interference at all, not even in appointments (such as Volkswagen in Germany and DSM Chemicals in the Netherlands), whereas at the other end of the spectrum, it could be used as a hidden form of social policy (the railways in Italy, where tickets and discount fares are kept extraordinarily low) or of employment policy (such as the coal mines in the United Kingdom, Germany and Belgium; steel in six EC countries and shipbuilding throughout the EC). In Italy, political nominations are rampant and concern all five coalition parties, whereas in France and Greece they are much more biased towards the controlling socialist parties (when in power). In Belgium, and to a degree in Spain, extreme regional sensitivities explain a number of oddities and inhibitions to nationalization (but also to privatization). In countries with a relatively conflictual tradition of industrial relations (the United Kingdom; but in different ways, Italy and France with strong communist labour unions), public enterprises tended to be greater in numbers and their privatization was expected to be more controversial than in countries with a consensual system of labour relations (Netherlands with its quasi-corporatist tradition; Germany and Denmark with fairly harmonious collective contracting traditions). Iberia has peculiarities of its own. Spain and Portugal, emerging in the mid-1970s from half a century of autocracy and widespread protectionism, both domestically and vis-a-vis third countries, were faced with no less than a transformation of their societies. The attempts in Iberia to privatize and deregulate must be placed against the complex background of a catch-up movement of modernization, a rapid shift of labour from agriculture to industry (and from rural to urban areas), a dismantling of pre-war corporatism in legislation, the teething problems of re-born democracy and a large-scale removal of external protection vis-a-vis EC countries as well as third countries. Therefore, whilst the generalizations at the national level and those about the EC member states' interactions are helpful and provide additional insights in a comparative analysis with ASEAN countries, it should also be appreciated that diversity within the EC is a rich source of learning as well. The Community comprises, in fact, twelve laboratories with different experiments and only partially overlapping experiences. The Economics of Privatization and Deregulation

The experiments in and debates about privatization and deregulation have prompted questions about the economic justification of these two policies.

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When assessing their economic merit, the following questions should be answered: 1.

Why are there public enterprises in the first place?

2.

Why is there (economic) regulation?

3.

Is the general economic welfare, and the efficiency of enterprises, improved by privatization?

4.

Is the general economic welfare improved by deregulation?

5.

And where regulation profoundly influences a firm's conduct, is the efficiency of enterprises improved by deregulation?

The first four questions will be summarily answered in this section, with occasional references to the fifth one as this last is also addressed throughout this book. Why Public Enterprises? In both the EC and ASEAN countries, one observes economic and political objectives behind public ownership of enterprises. To the extent that the objectives are identified as "politicar', privatization is just as much a political exercise. Nevertheless, every country may legitimately ask the question: at what costs should such objectives be pursued? More generally, even if the objectives are given for political reasons, it is advisable to weigh all alternative means of pursuing these objectives and to incorporate in the political cost/benefit analysis the economic and budgetary costs of those alternative instruments. It is interesting to note that the "political" objectives usually have substantial economic content. They may include income redistribution, regional distribution of industrial or service activity, minimum infrastructural provisions, development preferences for national ownerships and/or a minimum size of the activity. Close inspection of these examples shows that public ownership is neither the only nor necessarily the best instrument to achieve such objectives. Conversely, the latter point implies that privatization does not necessarily mean sacrificing those objectives. An economic perspective on public ownership versus privatization - even when the objectives are political - requires the simultaneous consideration of four aspects: economic regulation, the functioning of the market in question, subsidization, and ownership. This brings us to the possible economic objectives of public ownership. The clearest benchmark is to assume that a market for product or service y, which is not regulated, functions properly (that is, it is competitive) and is not distracted by subsidies. In such a market the only

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possible economic argument for public ownership would be that public enterprises are more efficient in achieving the desired supply of goods or the provision of services than private ones. A sizeable pool of literature on this comparison has emerged but one has to be careful to distinguish literature on this "pure" case of competitive markets from those analysing cases with regulations and subsidies. There is ample empirical evidence that public enterprises are frequently less efficient, but there have been cases where there was no observable difference in performance. More importantly, the relative inefficiency can almost always be traced to some kind of "protection" against the full impact of competition by means of a preferential supply position or subsidies (especially loss coverage or some vague, yet effective political "bail-out" guarantee), or alternatively, to specially entrusted tasks to the public firm, entailing higher costs. All these circumstances reduce the comparability of the two classes of companies. Hence, economists are not impressed by the shift in ownership as such. In a properly functioning market, a public enterprise enjoying no protection of whatever kind, having no monopoly and not having been entrusted with special (cost raising) tasks, will be forced to behave like a private one. From an economic point of view, the key issue is whether privatization alone will generate the incentives to behave, permanently, like competitors: cost efficient, innovative and responsive to demand. In general, this depends on the market structure, the scope for anti-competitive conduct, the regulatory environment, other government interventions (such as subsidies or "political" nominations) and not ownership primarily. In other words, unless a market is competitive and undistorted, the shift to privatization will simultaneously require changes in regulations and interventions as well as intra-firm reorganizations. Singling out privatization as the panacea is unhelpful and belongs to political rhetoric. The major economic objectives used to justify public ownership in Europe can be classified into three groups: allocative, redistributive and stabilizing (in the macro-economic sense). The allocative justifications include natural monopoly (where usually both economic regulation and public ownership have been employed), the strategic role of the company or industry (for reasons of security-of-supply, assurance of high and stable quality, or plainly the weight of the sector in the input-output relations of the economy), and the pursuit of a particular industrial policy (perhaps overlapping the previous motive, especially where industrial development aspects have played a role). From a strictly analytical point of view, however, these arguments are neither necessary nor sufficient in economics. Indeed, the gradual recognition that there are alternative and more superior ways of pursuing such objectives as well as a general disenchantment with "industrial policy" compared with market approaches may well explain why privatization is much more accepted in today's Europe.

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The redistributive functions in the mixed economy of the EC have been frequently pursued both at the macro-economic level (via taxes, social charges and benefits) and via "entrusted tasks" assigned to public enterprises, such as railways, regional air transport, telecommunications, mail and utilities. In conceiving their output as public services, the "benefit principle" was applied but frequently with elements of cross-subsidization or with discounts on user charges for the very poor or for "basic needs". Again, different mixtures of public ownership and economic regulation have been utilized, with a few instances of private ownership of utilities subjected to price and supply regulation. Public enterprise has also been justified for purposes of macroeconomic stabilization. This was particularly relevant in the days of the Keynesian "fine-tuning" of the economy. It was believed that stable employment in public enterprises would have anti-cyclical effects in a downswing. Moreover, the rate of interest (for public enterprise borrowing) and public sector borrowing requirements were viewed as instruments to fine-tune the macro-economic performance of the country. Finally, when inflation pressures mounted, price and income controls were suggested to be readily available instruments for setting wages and the price of output of the public sector enterprises. A peculiar case of macro-economic stabilization is that of the energy exporters, the United Kingdom (oil) and the Netherlands (gas), since balance of payments considerations and real appreciation of their currencies are dependent on the world price of oil. Both countries have introduced a mixture of (minority) public ownership with a range of other instruments to extract societal benefits, such as preferential public procurement, special taxes, economic regulation, and conditions to concessions for exploration, distribution and exports. Many of these justifications have played a role in the ASEAN countries too. However, a crucial difference with most EC countries is the perception of public enterprises as a vital instrument of economic development, especially of self-reliance. In the absence of capital markets and basic infrastructure, and given the reluctance or inability of the private sector to invest in those sectors or industries with unusually high commercial and non-commercial risks and to implement investment projects which require large amounts of investment, public enterprise was believed to be the only effective option for a wide range of developmental activities, such as (critical) imports and exports, the provision of basic needs such as public transport and utilities, the construction of infrastructure such as ports and telecommunications network, and so forth. Moreover, there was a general conviction prevailing among development economists, development agencies, and governments of industrial as well as developing countries throughout the fifties, sixties and even early seventies that only governments can undertake the steps necessary to promote and guide the development

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process. Multi-annual development plans, therefore, required instruments to control them as opposed to a mere structure of market-driven incentives. The public good character of many such activities suggested that markets would fail to supply the output in sufficient quantity or quality. The planning of medium-term economic development was justified by the absence or malfunctioning of markets, and a lack of managerial skills, as well as by the targeting of activities generating "external economies", thereby raising the rate of growth of other sectors through the input-output interdependencies in the economy. Of course, the rationale for establishing public enterprises varied among the individual ASEAN countries. In Indonesia there was a strong conviction that natural resources should belong to the state which was vested with the responsibility of fair distribution among its citizens, rather than certain individuals. Moreover, the exploitation of natural resources, especially in the case of petroleum, required huge amounts of capital as well as sophisticated management and technology which were not readily available from the private sector in Indonesia. The emergence of public enterprises in Singapore was to a large extent a result of the government's attempt to provide the necessary infrastructure for its ambitious industrialization programme. As regards the ownership and/or control of many industrial, financial and commercial enterprises, they originated from an active structural policy based on the assumption that local entrepreneurs were lacking the information, external linkages, know-how, financial and management resources, and experience required to compete effectively with multinational enterprises from developed countries. It was perceived to be the role of the government to counter these market failures. For Thailand and Malaysia, the exploitation of natural resources was a crucial factor in the growth of public enterprises, similar to the case of Indonesia mentioned earlier. In addition, ethnic and social factors played a dominant role in the growth of public enterprises as they were entrusted with specific social and distributive tasks of providing employment opportunities and/or raising the share in the capital ownership of a certain social/ethnic group. In the Philippines, the rapid growth of public enterprises after 1972 can to a large extent be attributed to the propensity for selective government intervention based on political patronage. Why Economic Regulation? Regulation and public ownership can serve as imperfect substitutes for one another but may also be complementary. Economic regulation may have political motives, just like public ownership. Nevertheless, there is a presumption that market incentives are considered to be more appropriate than the hierarchical command relationships of public enterprises.

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Of course, in the economic reality of both the ASEAN and EC countries, a very wide spectrum of regulatory strictness can be observed ranging from providing the conditions for effective competition in a market (for example, competition rules; prudential rules in banking) to the other extreme of regulating in detail the price and supply behaviour of a statutory state monopolist. The rapid acceleration in European integration has raised the awareness of the wide variety in economic regulation (also in the same field) among the EC member states. "Europe-1992" is no doubt the greatest supply-side programme ever pursued in non-socialist economies: it is perplexing to notice the range of experiments the EC countries have undergone since World War II- countries that, from an ASEAN perspective, might perhaps be perceived as not too dissimilar. Although an analogous revelation process does not take place among the ASEAN countries, the recently published literature and this book testify to the great variations in economic regulation practised in the respective ASEAN member states as well. In economic theory there are three types of market failure which may justify economic regulation: externalities, market power (or, as in the special case of a natural monopoly, competition), and asymmetric information. A few illustrations will be given here. However, these normative economic results should not be confused with what one might observe in EC or ASEAN practice. Just like the actual use of public enterprises, economic regulation can be exploited by those being regulated for higher rents (regulatory capture), lower pace of work and less innovative pressure (X-inefficiency). Because of asymmetries of information, sector supervisors may not be able to regulate properly even when they attempt to avoid regulatory capture. The problem may have already arisen when the regulatory framework was enacted as the regulation may have been vague or, indeed, far too ambitious. Worse still, regulation may have been introduced to serve interest groups, and not because a market failure has to be corrected. Externalities are market failures in the sense that private and social costs (or benefits) of a particular activity diverge so that observable prices cannot bring about the social optimum. In principle, one could conceive of a market in which A, suffering from a negative externality caused by B, would pay B to take the needed measures to stop the activity or eliminate the externalities it generates. One only needs to imagine the classical case of a polluted river and down-stream brewer to understand that such a market will not easily emerge if only because the contracts could not be properly monitored and enforced. So, one might argue that the market failure here is nothing more than a "missing market" (Kay and Vickers 1988). An example of a positive (network) externality is the effect on the welfare of a subscriber to the telephone network of every additional subscriber to the (same) network. Thus, economic regulation may justifiably impose access

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charges below costs. An example of a negative externality is a run on the banks by depositors. Capital adequacy rules, supervisory provisions and deposit insurance schemes provide the confidence, preventing the negative externality from occurring. A failure to regulate properly would fatally undermine the market. Market power represents a market failure as the efficiency properties of the market equilibrium are not optimal. Firms with market power will raise sales prices significantly above marginal costs which will distort the choices of users and hence lower allocative efficiency. Technical efficiency (or X-efficiency, concerned with cost minimization within the firm) also tends to be negatively affected by the lack of competitive rivalry or threat. Finally, it is frequently argued that innovation or dynamic efficiency will also decrease over time; however, the Schumpeterian strand of thought actually claims that research and development (R&D) expenditures and the degree of uncertainty involved require the availability of (monopolistic) rents before systematic R&D would be undertaken. If there is an emerging consensus about this point it is probably that perfect competition may impinge on innovation but that, in imperfect markets, rivalry would be required for dynamic efficiency to be high. A natural monopoly is defined in terms of technical efficiency: economies of scale are such that, given the size of the market, technical efficiency can only be achieved by single firm production. Hence, competition means raising costs, and is therefore wasteful. Of course, it does assume that, in the absence of domestic competition, other means are available to discipline the monopolist and to provide it with incentives or pressures to innovate and be responsive to demand. Regulation is one means to pursue these objectives. However, problems of asymmetry of information between the regulatory agency and the regulated monopolist and the difficulty of preventing any degree of "regulatory capture" render regulation a rather imperfect instrument. Discipline might be exercised by the threat of entry or the possibility of (a small volume of) alternative supply from abroad. The theory of contestable markets shows that if the costs of entry are not "sunk" (that is, can be recouped upon exit of the sector), the mere threat of entry exercises a forceful discipline. Unfortunately, "sunk" costs do exist and act as an entry barrier. Natural monopolies based purely on the scale of output are almost non-existent. If we are concerned with product markets, free trade will extend the market size to such an extent that some rivalry at world or regional level always remains possible (such as wide-body aircraft). The problem is more serious when network externalities or economies of scope are tied in with scale effects. Network externalities, as defined before, are positive consumption externalities; they represent, as it were, "scale effects" at the demand side. Take a telecommunications network: allowing a competitor to build its own network would only be beneficial if (a)

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X-inefficiencies are present under the monopoly and rivalry would force the actual costs of the incumbent down (which is extremely hard to predict), which, in turn, must mean that the second network must be large enough to reap most economies of scale, which in turn depends on network externalities, which crucially depend on the two networks being interconnected somehow (perhaps imposed by anti-trust authorities or regulation), for subscribers to be attracted to the second network; (b) allocative and dynamic efficiency would be improved, which is highly likely. Thus, if the network externalities would not diminish even when the subscriber connections are already numerous, if the incumbent is very dynamic and responsive to demand for service differentiation and if an international comparison of cost levels would show that the incumbent is at the best-practice level of cost efficiency, there would seem to be no economic justification for deregulation. Economies of scope exist in multi-product firms if the cost of producing product or service y decreases because of the addition of the production of x. Transport networks of suppliers typically tend to benefit from economies of scope. The key issue here is that natural monopolies may only exist on parts of the network (for example, thin routes for buses, train or air) although the entire transport service provision is often regulated. If, at first, price regulation forces cross-subsidization between "thin" routes and profitable trunk routes, the introduction of competition may lead to "cream-skimming". This will force the incumbent to give up crosssubsidization (which improves allocative efficiency) but it may imply that some of the "natural monopolies" become unsustainable. Thus, if there is no obligation to provide several services a day or daily service throughout the week, or a minimum of service throughout the year, one might observe some competition during certain peak hours or peak days or seasons and no services at all during other periods. By bundling thin air transport routes towards a hub and so enlarge the transfer possibilities for every single passenger at that hub, demand per "spoke" can be increased so that many more routes become economically viable, thanks to economies of scope. Thus, "hubbing" in a relatively free market may help to reduce the problem. However, it does not eliminate it so that in some cases regulation might be needed to block entry, or subsidies have to be provided for thin routes in order to guarantee optimal service at a given cost level. Asymmetries of information have become the corner-stone of today's economic theory of regulation. Sellers will usually know much more about safety, durability and other aspects of quality than buyers. In services, the extreme case is professional services where the consumer cannot even judge the service when he actually gets it. Confidence is a prerequisite for the market to function properly; since cheating is highly profitable, regulation to assure quality (or at least, professional education and recognition of the provider) is needed. The opposite is true in insurance where buyers are

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better informed (about the risks for the insurer) than insurance suppliers. The companies have strong incentives to select low-risk individuals as clients whereas the high-risk individuals have the greatest incentives to buy insurance. Since risk-minimizing behaviour cannot be enforced except rarely (one such exception is that motorists should wear certified helmets) and certain risks are independent of behaviour anyway, the insurance market may fail as either the supply of types of insurance services will be highly selective or many people would not obtain policies. With respect to product quality, regulation via brand images, guarantees and warranties, standards and certification marks and liability will all mitigate the problem. Regulation may, nevertheless, be justified for ethical reasons (such as for dangerous or hazardous goods) or for public cost/benefit reasons (that is, the opportunity costs to society of injuries and victims). In underdeveloped economies, the special problem of inadequate price information may occur as a result of underdeveloped communication systems. This will lead to allocative inefficiencies and may also invite local and regional collusion.

Is Privatization Welfare-improving?

The discussion about the original justifications of public enterprises indicates that there is an enormous scope for privatization but that the welfare effects critically depend on elements other than ownership. In properly functioning product or services markets (for example, hotels) ownership may be private or public without any observable difference in performance as long as no protective devices favour the public enterprise. Nevertheless, because the market for corporate ownership cannot function in the case of public enterprises, management might still retain a margin of "slack" which would invite a take-over under private ownership. One presumes, therefore, that privatization even in such markets is welfareimproving. However, in the past many EC and ASEAN countries actually employed protective devices for public enterprises in competitive markets. In such a case, privatization is likely to improve welfare even more in the long run, but there is a likelihood of short-run labour adjustment costs. Fear of adjustment is a major obstacle to privatization and frequently labour unrest has to be bought off by means of long-run guarantees on jobs, wage levels, or perks. In other markets, public enterprise and economic regulation are partial substitutes. Again, the key issue is how to achieve a measure of competition sufficient to improve allocative, technical and dynamic efficiency. The United Kingdom, which, in Europe, has gone the furthest in its privatization programme, often has to organize restructuring, de- and re-regulation and privatization together before it can actually proceed.

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One could also employ a broader conception of "welfare", namely, the pursuit of policy objectives of the privatizing government. Six objectives play a role, with more or less weight, depending on the case and the country: improving efficiency; reducing public borrowing; easing public-sector wage bargaining; retreat of the government, and moving the economy towards becoming more "pro-market"; spreading share-ownership and developing capital markets; redistribution of income or wealth. Our comments will remain brief given the nature of this introductory chapter. The efficiency objective for the enterprise has to be measured against the (entrusted) tasks of the previously public and, henceforth, private enterprise. In practice, it can be surmized that privatization in markets with at least some competitive pressure will lead to great gains in X-efficiency (that is, cost minimization). Such gains also amount to social gains. Public borrowing and wage bargaining in the public sector have dubious effects on welfare in the long run. The reduction in borrowing is a short-term political device, which may have a signalling function; however, what counts in economic terms is the present value of a stream of future revenues from the enterprise. If the enterprise is loss-making in the first place, and this is not attributable to "entrusted tasks", the firm will be sold at a low (or negative) price when there is no prospect that allocative and technical efficiency can improve sufficiently. Wage bargaining can be "led" by strikes in public enterprises but there is no a priori reason to presume a long-term welfare gain after privatization. Retreat of the government and moving the economy towards becoming more pro-market is the broader aim of "supply-side policies". It is based on the idea that incentives work better if they are individualized or directed at small organizations reaping the benefit of their own effort and initiative. It can be summed up in the slogan "competition and private enterprise where possible, regulation and public ownership where necessary". Of course, such sloganized approaches are not fit for analytical treatment. The analyses of the OECD, recommending cautious but sustained supply-side policies for more than a decade and monitoring them closely, suggest that they do tend to raise welfare in complex ways. Whether and to what extent privatization is a necessary element of such policies depends on the initial situation. In more than half the EC countries and most of the ASEAN countries the answer would appear to be confirmative. Spreading share ownership is a political objective. It is hard to assess whether a culture of widespread share ownership has an impact on the performance of the economy or the functioning of the capital market.

Towards More Effective Markets in ASEAN and the EC

25

Perhaps the case for promoting the local capital markets in ASEAN can partly be based on this objective. Redistributive objectives have been discussed above. In democracies, the so-called social welfare function of a society is determined by the (political) process of revelation of voters' preferences and the adoption of them in a government programme, subject to budget constraints. The theoretical approach shows that, in principle, it is possible to analyse the effect of privatization on redistribution as one of the elements of that social welfare function. In practice, however, no categorical statements are justified. It is none the less worthwhile to consider whether a given redistributive objective cannot be achieved by macro-economic means (taxes and social charges and benefits) or by targeted subsidies rather than by distortive practices of public controlled enterprises. The problem is one of comparing one second or third-best situation with another and may therefore be ambiguous. In ASEAN, the special problem exists of who is the buyer of public enterprises. With underdeveloped capital markets, wealthy families or a few holdings may buy up such enterprises, thereby making even more unequal the distribution of wealth and the power derived from it. It follows then that the economic case for privatization is largely based on two considerations: 1.

a re-assessment of the original (economic) justifications for public ownership; frequently, they were mistaken or of temporary validity (for example, early development in ASEAN; post-war recovery in Europe) and the political climate to accept privatization makes structural adjustment possible;

2.

an empirical assessment of the cases at hand, comparing current economic performance of the firm(s), in the light of possible "entrusted tasks" and the regulatory environment, with the expected performance of the privatized firm, in the light of the tasks entrusted to it (if any) and the regulatory environment determining competitive pressure (which may have to be altered when privatization is pursued.)

One ought to recognize that in certain EC and most ASEAN countries the actual performance of public enterprises was frequently (though not always) dreadful. Thus, the combination of the two considerations may well justify a selective privatization programme as a kind of shock therapy. However, in such circumstances, a broad societal consensus is needed in order to avoid the worst of all worlds: political oscillation between successive governments privatizing and re-nationalizing parts of industry and services (for example, France between 1976 and 1985).

26

Jacques Pelkmans and Norbert Wagner

Is Deregulation Welfare-improving? Deregulation is welfare-improving if there was no economic justification for regulating the market in the first place, if the regulation was disproportionate to the objectives pursued, and hence unnecessarily burdensome, or if a combination of deregulation and re-regulation is more effective in overcoming the market failure at issue. Even if regulation can be justified economically, the cost-benefit analysis is complex, as will be shown below. It is, therefore, impossible to generalize about the benefits of deregulation. A simple textbook case may be used as a starting point. Let us assume constant (marginal and average) costs, for simplicity, and monopolistic supply, given the nature of the sectors at issue. In theory, "efficient" regulation would set the market price precisely at the level of marginal (and, in this case, average) costs which would prevail without X-inefficiency. However, it is impossible to know this cost level because in these special sectors there may be few or no experiments introducing rivalry to push down cost levels for major suppliers by squeezing out X-inefficiency. In case this level is known, the social benefits to (price) regulation amount to the deadweight loss that would result in the absence of regulation (as the monopolist would price up at lower volumes of supply, an excess profit is transferred from consumers to the monopolist, but a triangle of deadweight loss of resources would be wasted). Lacking the needed information, the price regulation will fix a price above (X-efficient) cost levels; this cost discretion will immediately be "used" in the form of resources by the monopolist so that observable marginal (and average) costs will be equal to the set price level. Inefficient resource use may consist of lower work pace, the conceding of wage demands above productivity, extra emoluments for higher staff, excessive standards, etc. On top of this high cost level, a monopolist or a well-organized sector of oligopolies may invest resources into rent-seeking activities, which may well result in a price level allowing excess profits even above the X-inefficient cost levels. The government might be tempted to go along with these demands if it can tax away or otherwise "reserve" a substantial part of this excess profit. Together this would yield the following cost benefit analysis: the benefits of such a price regulation would be reduced by:

the cost of X-inefficiency (which can be substantial); the cost of rent-seeking activities; the cost of introducing and monitoring the regulation(s). The problem with such simple textbook cases is their interpretation for policy application. One might surmize that the benefits of deregulation would amount to the removal of the three costs mentioned, but that does not automatically follow. By assumption, the supply was monopolized and deregulation would only lead to such benefits if the monopolist were

Towards More Effective Markets in ASEAN and the EC

27

prevented from engaging in profit-maximizing behaviour. This can only be expected in "contestable" markets. If the market is not contestable, one probably ends up with a combination of monopoly profits and, over time, X-inefficiency. Contestability might sometimes be achieved by free trade, but precisely the sectors at issue in this book, the discipline of (services) imports, may not be easy to accomplish. So, a key question for the identification of (positive) welfare effects is whether a part of the "monopoly" can be made contestable, even if a "core" part of the activity cannot. In any event, the simple textbook case should be extended in several ways before policy judgments can begin to be cast. First, regulation is complex and can rarely be translated into price levels of a good or a service. Relative prices (and, hence, cross-subsidization) may be at issue; access to networks, standard setting, service or product innovation may be hindered by administrative or other discouragements. Secondly, regulation in sectors where networks play a role (and this is true for several sectors discussed in this book) is usually combined with a degree of direct or indirect control of investment in the network, the regional spread of the network, its quality and standards and the level of technology used. Over time, this "installed base" of the state monopolist does not only represent "sunk costs", which already lower contestability, but the mere existence of the network may make it very difficult to build up an equally attractive network even if an entrant is willing to invest "sunk costs". When the bus company National Express was privatized in the United Kingdom, the location of well-known bus terminals in the centres of cities turned out to be decisive in confirming its dominant position. The same is true for trains, and in different degrees for telecommunications and probably air transport. Thirdly, the textbook example is an exercise in static welfare economics and remains silent about dynamic questions. Competition has price and non-price characteristics and both may be influenced by innovation. Under rivalry such innovations would be quickly introduced and may, in tum, help fuel demand, and hence economic growth. Examples in practice are the throttling regulation of financial services in Spain and Italy- now being dismantled- and the restrictive policies of European post, telegraph and telephone systems (PTTs) until the 1980s. The implicit costs of rigid regulations also increase rapidly in sectors where technological progress is continuous. Fourthly, it is worthwhile to consider deregulation in a broader perspective rather than in sectorial isolation. An economy in which deregulation is applied to many sectors at the same time will result in flexibility, a wider spectrum of services and downward pressure on most costs and thus possibly increase competitiveness and growth. It may also help to reduce the rigidities in the labour markets although this effect is perhaps stronger in the United States than in areas such as ASEAN and the EC.

28

Jacques Pelkmans and Norbert Wagner

Fifthly, detailed analyses will differ from sector to sector and will require a substantial degree of understanding of the specifics of the products and services in that sector. All these elements ignore the case mentioned earlier, namely, that deregulation would be welfare-improving if there was no economic justification for market regulation in the first place. An example would be the common agricultural policy of the EC, where price regulation has reduced the proper functioning of the internal agricultural market, at tremendous costs for the EC and the rest of the world, without really achieving the key objective of the policy-makers, that is, a reasonable standard of living for the small farmer. Quite apart from the original intentions of a policy, if the actual implementation of market regulation is plainly political, a measured degree of deregulation is obviously highly advantageous for the society as a whole. Such regulatory instances are likely to exist in both ASEAN and the EC in several sectors, in perhaps less conspicuous forms. REFERENCES Asian Development Bank (ADB). Privatization: Policies, Methods and Procedures. Manila, 1985. Geeta Gouri, T. L. Sankar, Y. Venugopal Reddy, and Khalid Shams. Privatisation: The Asia-Pacific Experience. A Regional Synthesis. Kuala Lumpur: Hyderabad, 1989. Kay, John, and John Vickers. "Regulatory Reform in Britain". Economic Policy, no. 7 (October 1988), pp. 285-352. Ng Chee Yuen and Norbert Wagner. "Privatization and Deregulation in ASEAN. An Overview". ASEAN Economic Bulletin 5, no. 3 (March 1989): 209-23. Pelkmans, Jacques. "Les fonctions des entreprises du secteur public" [The functions of public sector enterprises]. In Les entreprises du secteur public dans les pays de Ia Communaute europeenne, edited by Gerard Timsit. Bruxelles, 1987. Pelkmans, Jacques and Marc Vanheukelen. "The Internal Markets of North America. Fragmentation and Integration in the US and Canada". Cost of non-Europe project, Basic Findings, vol. 16. EC Document Series. Brussels/Luxembourg: Office for official publications of the EC, 1988. Pera, Alberto. "Deregulation and Privatisation in an Economy-wide Context". OECD Economic Studies, no. 12 (Spring 1989), pp. 159-204.

Part II Public Utilities

II. Privatization of Public Utilities in the Philippines General Direction and Approach

ZINNIA F GODINEZ* Much discussion and heated debate have centred on the progress of the privatization programme in the Philippines since its formal launching in December 1986. Once the large number of state-owned enterprises (SOEs) as well as non-performing assets (NPAs) turned over by the two biggest government financial institutions (the Development Bank of the Philippines and the Philippine National Bank) was revealed to the general public almost immediately after the assumption of the Aquino administration, the fate of the SOEs had been hanging in the balance. More so, after some studies showed that government assistance to SOEs in recent years had eaten up roughly a quarter of the national budget, and had in fact reached 26.2 per cent in 1986. 1 The two agencies assigned the task of handling the Privatization Programme are the Committee on Privatization (COP) and the Asset Privatization Trust (APT). There are twelve (12) disposition entities which have been tapped to assist in the privatization of the SOEs; as of end December 1988, about 23 SOEs out of the total of 296 have been privatized (16 fully and 7 partially). On the other hand, the APT, which handles the (re-)privatization of the NPAs and a few SOEs has been able to dispose of 147 (102 fully, 45 partially) out of 399 accounts. Of specific interest in this paper are some aspects in the general direction and approach used in the privatization of SOEs operating public utilities in the Philippines, with particular reference to the Manila Gas Corporation (MGC), the Metro Manila Transit Corporation (MMTC) and the Manila Electric Company (MERALCO). The Public Utilities Sector in the Philippines There is a dearth of organized data and studies which look into the nature and characteristics of the public utilities sector in the Philippines. The little *The author gratefully acknowledges the comments and suggestions of Dr. Florian A. Alburo.

32

Zinnia F. Godinez

that has been written has been amorphous, although there has been some work done on sub-sectors 2 (such as energy and electricity, transportation and communication). Generally, the sector has been described as capitaland technology-intensive, high-risk and requiring extended gestation periods. Partly because of the huge amount of investment outlay required, the sector invites very little interest from small- or medium-scale firms, particularly for power-generating activities. Almost invariably, the utilities sector, especially in those cases where natural monopoly exists, is dominated by one or two large firms, perhaps with the exception of the transport sector. For example, since 1903, the Manila Electric Company as a privately-owned company, has held the exclusive franchise to distribute electricity to residential, commercial, and industrial customers in Metro Manila and the provinces of Rizal, Bulacan, Cavite and parts of Quezon and Laguna. Outside these areas, electricity is supplied by electric cooperatives, while a few areas still do not have access to readily-available electricity on a 24-hour basis. The same is true for the country's biggest privately-owned telephone company, the Philippine Long Distance Telephone Company (PLOT). The franchise granted to PLOT in 1928, together with the acquisition of the assets, properties and the entire operations in the South of the then existing Philippine Telephone and Telegraph Company, enabled PLDT to become the country's largest telephone operator, with an estimated 93.8 per cent of the total telephone connections in the country as of 1985. Other telephone companies were also set up by private groups such as the Republic Telephone Company (RETELCO), and a few others serving some parts of Metro Manila and the nearby provinces. The Reorganization Law of 194 7, which created the Bureau of Telecommunications, also established shortly thereafter the Government Telephone System to supplement telephone service in government offices. However, in 1979, a government policy allowed only one operator to service an area, and for the Metro Manila area, PLDT was the obvious choice. Later, RETELCO was absorbed by the PLDT, while the Bureau of Telecommunications continued to operate its telephone service only in a few areas in the Southern Tagalog region. 3 Related telecommunications services, such as toll facilities (for example, satellite and communication cables), are handled by the Philippine Communications Satellite (PHILCOMSAT) which holds the franchise, and the Domestic Communications Satellite (DOMSAT), both government entities. There are a few international common carriers such as ITT-Globe Mackay and Capital Wireless (CAPWIRE), but international telephone services are still handled by PLDT. On the other hand, telegraph and telex services are provided by several private operators. All communicationsrelated activities fall under the general supervision and control of the Department of Transportation and Communications and the National Telecommunications Commission (NTC).

Privatization ofPublic Utilities in the Philippines: General Direction and Approach

33

In the provision of water supply, the government-owned Metropolitan Waterworks and Sewerage System (MWSS) is the major entity. Apart from the MWSS, however, there are other public agencies involved in the management of water supply and the development of water resources. These include the Local Water Utilities Administration (LWUA), which is primarily a lending institution geared towards developing not only water supply but also waste-water disposal systems; Rural Waterworks Development Corporation (RWDC), and the Department of Public Works and Highways (DPWH).

Government Participation in the Public Utilities Sector In the Philippines, as in most developing countries, the growth and development of the utilities sector has been closely associated with infrastructure building, and has hinged largely on the degree of government support, particularly in financing and project implementation. As of 1987, 31.1 per cent of total disbursements from the approved P 26.2 billion infrastructure programme 4 for that year was allocated to the energy sector, followed by the water resources sector, and thirdly, the transport and communications sector. It has to be pointed out that while the infrastructure programme may be biased towards public utilities, the major part of the programme is handled by public infrastructure corporations (for example, through government-guaranteed loans) and not regular government line departments. Studies by Amatong (1985) and Manasan ( 1986) have indicated the major SOEs which have contributed to the fiscal burden from 1975 to 1984. As Table 11.1 shows, other than the two government financial institutions cited earlier (that is, the Philippine National Bank and the Development Bank of the Philippines), the government has substantially supported the development of the public utilities sector, particularly in the areas of energy and power generation, though generally not in the form of direct contributions to specific utility firms. Topping the list is the National Power Corporation (NPC) in which total government exposure is estimated at P 15.804 billion for the period covered. It will be recalled that the original mandate of the state-owned NPC was limited to the development of the country's hydropower potentials, and it was only in 1971 that the NPC Charter was revised in order to expand its power generation base to include oil, coal, geothermal, nuclear and other energy sources. A year later, in 1972, Presidential Decree No. 40 authorized the NPC to install additional generation and transmission facilities in the country's major islands, with the ultimate intention of it becoming the sole owner and operator of a single integrated power network for the entire country. The list also includes the National Irrigation Administration (NIA); the National Development Company (NDC) which is the holding company for Manila Gas Corporation and its subsidiaries, as well as the National

w

TABLEII.l Major Recipients of Government Support to State-Owned Enterprises (In million pesos)

Corporation

Total Govt. Contribution* 1975-84

+>

Percentage of Total Govt. Budget 1980 1985

1. National Power Corporation 2. Development Bank of the Philippines

15,803.94 13,757.53

5.0 1.0

3. National Irrigation Administration

4,157.35

1.0

4.

6,692.87

1.6

5. National Electrification Administration 6. National Housing Authority

2,003.58 2,018.62

0.8

7. Philippine National Oil Company 8. Philippine National Bank

2,508.32 1,998.16 1,470.00

National Development Company

9. Metropolitan Waterworks and Sewerage System 10. Human Settlements Development Corporation

0.6 0.9 0.3 1.6

0.3 9.9 1.7 0.4 0.4 0.2 0.1 2.0 0.5

1,146.80

* Includes current contribution, equity contribution and net lending.

bl ;:;

SouRcE: Amatong (1985) and Manasan (1986).

E;'

;:;

~

~ [:l

Privatization of Public Utilities in the Philippines: General Direction and Approach

35

Shipping Corporation of the Philippines; and the National Electrification Administration, the entity responsible for the implementation of the Rural Electrification Programme through the creation of electricity co-operatives in the countryside. The Philippine National Oil Company and the Metropolitan Waterworks and Sewerage System are also among the major firms listed. In certain cases, the government has actively participated in the organization and management and/or funding of the enterprise, as in the case of the transport sector (that is, Metro Manila Transit Corporation, Philippine National Railways and the Metrorail), and the direct provision of water facilities (that is, MWSS) though still not on a nation-wide basis.

The Privatization of Public Utilities: Some Test Cases

The excessive burden imposed by public corporations in both developed and developing countries is a general observation and has been documented in several studies (for example, Manasan 1986), as has also been the case for the success stories in privatization. For the Philippine government under the new administration, the over-zealous public support for public corporations in the utilities sector and its draining effect on the fiscal position of the national government presented only two options: either these firms should be privatized (to the extent of government equity ownership), or the services offered by these firms would have to be priced to recover full costs, either through tariff rate adjustments or operational cost-cutting measures, whenever appropriate. Of the 133 SOEs slated for privatization as of October 1988, at least 7 public utility firms were included. Moreover, as indicated in Table 11.2, three subsidiaries of the NDC, mostly shipping firms, had already been either fully or partially privatized. There were fourteen major non-financial SOEs whose operations were closely being monitored by the Government Corporate Monitoring and Coordinating Committee (GCMCC), as indicated in Table II.3. Several of these SOEs had been listed for privatization; however, because of the huge amount of government subsidy that had gone into these firms, and continue to do so (though not in the same magnitude) their operations are deemed of special interest to finance and budgetary authorities. Most of these firms are either directly providing public utility services or are supportive of public utilities. For example, those of the former include the Metro Manila Transit Corporation, the Light Rail Transit Authority (LRT or the Metrorail), Philippine National Railways (PNR), and the Metropolitan Waterworks and Sewerage System (MWSS). Examples of the latter include the Local Water Utilities Administration (LWUA) and the National Electrification Administration (NEA).

36

Zinnia F. Godinez

TABLE 11.2 Summary of the Privatization Completed for State-Owned Enterprises*

Corporation A.

Fully privatized 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

B.

PTA NDC NDC GSIS DBP GSIS NDC NDC PNB PNOC NDC NDC PMS

Argao Resort Development Corporation Asia Industries, Inc. Beta Electric Corporation Commercial Bank of Manila DBP Service Corporation Hotel Enterprises of the Philippines Mindanao Textile Corporation National Marine Corporation Pilipinas Bank PNOC Petroleum Carriers Corporation Tacoma Bay Shipping Company Usiphil, Inc. Veterans Manpower and Protective Services, Inc.

Partly Privatized 1. 2. 3. 4. 5. 6. 7.

Disposition Entity

Disposition Entity

Apo Production Unit, Inc. International Corporate Bank National Shipping Corporation of the Philippines National Stevedoring and Lighterage Company Negros Occidental Copperfield Mines, Inc. The Energy Corporation Wood Waste Utilization and Development Corp.

APT NDC NDC NDC NDC NDC PMS

Total No. of Enterprises Privatized (Fully and Partly): 20 *As approved by the Committee on Privatization, with completion of sale for those partly privatized pending final settlement of legal claims. SOURCE:

Reform Program for Public Corporations, Philippines, October 1988.

In order to understand some of the dimensions that need to be looked at in arriving at privatization decisions and approaches, it is useful at this point to examine illustrative cases of SOEs in the public utilities sector. Manila Gas Corporation The Manila Gas Corporation was established in 1912 by Republic Act No. 2039. It was later amended by Republic Act No. 2278 and registered

Privatization ofPublic Utilities in the Philippines: General Direction and Approach

37

TABLE 11.3 Major Non-Financial State-Owned Enterprises Monitored by the GCMCC

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

Philippine Ports Authority National Food Authority Export Processing Zone Authority Metro Manila Transit Corporation Light Railway Transit Authority Local Water Utilities Administration National Electrification Administration National Housing Authority Philippine National Railways National Power Corporation Philippine National Oil Company Metropolitan Waterworks and Sewerage System National Irrigation Administration National Development Company

SouRCE: Philippine Development Report, 1988 (Manila: National Economic and Development Authority, 1988).

accordingly with the Securities and Exchange Commission. MGC holds the franchise to manufacture, distribute and sell piped gas for residential, commercial, and industrial uses throughout Metro Manila. In addition, MGC also operates a gas reforming plant and a liquified petroleum gas (LPG) bottling plant. As of 1985, 60 per cent of MGC was held by the National Development Company while the remaining 40 per cent was held by Philips Electronics and Pharmaceuticals of New York. MGC is slated for full privatization. However, it appears that although NDC's interest in MGC (which has risen to 78 per cent of the total shares) can be met by the settling of financial claims by MGC, the remaining 22 per cent can only be bidded out once the ownership issue has been resolved. As it stands now, the 22 per cent ownership is under sequestration by the Presidential Commission on Good Government (PCGG). It would also appear that the resolution of the 22 per cent minority ownership in the utility firm can affect the sale of NDC's interest in MGC. Once these issues have been resolved, the process of public bidding to interested parties, potentially oil companies and/or foreign gas companies who have tie-ups with local firms, can proceed. In recent years, MGC has not been a financially viable company and, in fact, it reported a net loss of P 6.204 million in 1985 despite a hefty P 176.850 million in gross revenues for the same year. Apart from the losses incurred from its operations, the four subsidiaries of MGC, which

38

Zinnia F. Godinez

TABLE 11.4 Major Subsidiaries of Manila Gas Corporation

Corporation 1. 2. 3. 4.

Inter-Island Gas Pagkakaisa Gas Liquid Gas Borromeo Corporation

Equity Invested by MGC

Percentage of Holdings ofMGC

P4.3 m 2.0 m 2.0 m 0.98 m

100% 100% 100% 100%

represents its major long-term investments, have also been losing propositions. These companies are held exclusively by MGC, and it was estimated that in 1985 the amount of equity invested by MGC in these firms totalled almost 'P10.0 million (US$476,190). Table 11.4 lists these subsidiaries and related information. In the case of MGC, the decision to privatize is straightforward and need not be subject to much discussion after all technical issues have been clarified. Relative to the general principle of allowing the private sector to operate in activities it can "do better", the degree of externalities and the political stakes involved appear insignificant.

Metro Manila Transit Corporation The Metro Manila Transit Corporation is owned by the national government (77 per cent) and the Development Bank of the Philippines (23 per cent). Established in June 1974 by Presidential Decree No. 492, the MMTC was formed primarily to: . . . integrate public transportation operations in Metropolitan Manila into one corporate entity such that the operators, with franchises to operate within the area, would transfer their assets involved in the transport business in exchange for equity participation in the corporation. 5

This objective was prompted by the concern in the mid-1970s for fuel efficiency in transportation through a more direct role by government in the management and operation of the urban transport system. It was deemed that private operators could not satisfy sufficiently the requirements of the riding public owing to their financial positions as they would be unable to maintain, replace or add to the existing fleet of buses plying Metro Manila routes. However, by 1980, it became apparent that the financial position of private operators had improved; hence, the implementation of a public bus monopoly was not pushed. The integration of numerous private operators into fewer but larger (more viable) firms led the MMTC to revise its strategy to that of "complementing" private industry, at the same time serving as a

Privatization ofPublic Utilities in the Philippines: General Direction and Approach

39

tool for the government to meet certain (vague) social objectives (such as to undertake developmental projects by pioneering new technology and/or services/routes). In its first ten years of operation, MMTC generated profits only in 1982. Prior to 1982, operating revenues could not even cover direct (variable) costs, not to mention indirect (fixed) expenses. In 1984, it was estimated that the governmnent poured in P7.0 million (US$333,333) in equity contributions alone. The government can privatize MMTC by either selling its units to the private sector, which is finding it difficult to purchase new units given the current restrictive import quotas for capital equipment and related purchases; or selling MMTC as a going concern. At this time, there is still no indicative method for privatizing MMTC, but the most attractive mode that can be taken by the government would be public bidding. Timing is of the essence in the privatization of MMTC, as in the privatization of most utility firms. Recent reports from the GCMCC indicate that the general performance of public utility firms, which form part of the fourteen SOBs being monitored by the GCMCC, have so far been encouraging, with dividends and interest payments to the national government totalling Pl.545 billion in 1987. On an aggregate basis, the internal cash generation of the fourteen SOBs posted positive gains amounting toP6.1 billion (US$290.48 million) in 1987, compared toP0.30 billion (US$14.29 million) in 1986. Thus, if this trend continues, MMTC would not have much difficulty in attracting private buyers into the firm. On its own, MMTC had adopted cost-cutting measures which proved invaluable during 1986. Because of these measures, MMTC was able to offset the decline in operating revenues and resulted in positive profits. For the transportation sector in general, the Department of Transportation and Communication (DOTC) has implemented the privatization of certain services such as port cargo handling, initially with the Manila International Container Terminal. Moreover, a policy of deregulation is now a long-term goal in the maritime industry as well as in air transport, with the rejection of the one-airline policy. On the other hand, for strategic reasons, the Philippine National Railways will not be privatized despite losses during the past ten years, even with continuous government subsidy, since its commuter rail services are conceived as "public goods" that cater to the transport needs of a "disadvantaged group". Extending the natural monopoly argument further, the Light Rail Transit (Metrorail) will also not be privatized, despite earlier plans by the DOTC to completely privatize the entire Metrorail system. In this case, however, the reason is not the heavy dependence of Metrorail on the national government for yearly financial assistance, since Metrorail posted profits in its first three years of operation (1981-84 ). One of the major considerations in assessing Metro rail's performance is the direct participation of the private sector (that is, the

40

Zinnia F. Godinez

Meralco Transit Organization, Inc.) in the management and operation of the Metrorail, which is covered by an existing agreement between the Light Rail Transit Authority (LRTA) and the Meralco Transit Organization, Inc. since 1981. This may, in effect, constitute the furthest extent that the Metrorail will reach in the privatization process. As it is, the Metrorail stands out in the entire urban transport system as a highly efficient, reliable and economic mode of transportation. It thus appears that the privatization of MMTC depends on whether there are identified social objectives which the government would want to achieve, the capacity of the private sector to absorb its assets, and other related considerations. The Manila Electric Company Until 1962, the Manila Electric Company (MERALCO) was an Americanowned firm. It was then purchased by a group of Filipino investors led by Eugenio Lopez, Sr. under the banner of Meralco Securities Corporation (MSC), now named First Philippine Holdings Corporation (FPHC). Subsequently, in 1977, FPHC sold MERALCO to Meralco Foundation, Inc. (MFI), a non-stock, non-profit organization. Purportedly, MFI was established with the primary purpose of broadening the ownership base of MERALCO in accordance with the government's policy during the 1970s to promote widespread ownership of Philippine industry. The transaction was effected through a leverage buy-out, with the MERALCO shares held by MFI expected to be sold to MERALCO consumers over a period of time, while a minority interest would be retained by the government. Operationally, from 1977 to 1979, MERALCO sold a substantial part of its electric generating facilities to the National Power Corporation in compliance with Presidential Decree No. 40. 6 MERALCO thus purchases power from NPC and limits itself to the distribution of electricity, while NPC took over and expanded MERALCO's power generation facilities. The purchase of the MERALCO shares by MFI from FPHC was financed by a loan from the Development Bank of the Philippines (DBP). Consequently, the DBP held on to the shares as pledge to MFI's loan. Early in 1986, negotiations for the direct debt buy-out of Meralco Foundation Inc., and the First Philippine Holdings Corporation started. This signalled the start of MERALCO's privatization. Initially, the main concern was only to "sell" the debt of MFI, as carried in the books of the Development Bank of the Philippines. In the succeeding stages of the negotiations, an emerging consideration became apparent; not only was the value of the compensation due to the government important, but the method of dispersal was equally relevant. In line with the government's main concern with dispersing the ownership of MERALCO shares to "as many people as possible", an intricate "mass privatization plan" was prepared. 7 This was subsequent to

Privatization ofPublic Utilities in the Philippines: General Direction and Approach

41

the lifting of the sequestration order (which was imposed on two separate occasions) by the Presidential Commission on Good Government (PCGG). The privatization scheme agreed upon was for the sale of 46.45 per cent of all outstanding MERALCO shares to the syndicate led by the Bank of the Philippine Islands, and J.P. Morgan Guaranty Trust Company of New York, upon an expressed understanding that the members of the syndicate would divest their shares in the next four or five years so that not one individual or corporation would be owning more than 10 per cent of MERALCO. In order to give credence to the dispersal concern, the syndicate would offer to each MERALCO resident consumer a maximum of 100 shares, to be sold in lots of ten. The consumer may opt to purchase a minimum of one lot, or ten shares. Simultaneously, the syndicate would offer up to seven million shares to the exchanges, at a rate slightly higher than that offered to resident consumers. The number of shares would be divided equally between the two exchanges and also among its brokers. The offer to both resident consumers and the exchanges would be valid for only thirty days. Assuming that the question on the fair amount of compensation that the national government should get from the syndicate is settled (after the controversy that followed the approval of the transaction on whether the syndicate should be asked to pay around P 200.0 million more than the agreed price of P 690.0 million}, the issue remains whether the syndicate can be expected to abide by the expressed understanding on the stock dispersal programme since there are no enforcing provisions or penalties for the syndicate if they should decide to dispose of the shares beyond the prescribed period, despite the "20-40-20-20" per cent formula listed in the syndicate's shares resale plan. It has also been argued that, indeed, the whole transaction may simply facilitate the transfer of monopoly power from the public to the private sector. Given that a substantial portion of the shares (that is, 34.8 per cent) are pledged to a few private institutions 8 in support of the loans obtained by Meralco Foundation, Inc. from these institutions, there is the fear that a foreclosure on the shares by any of these institutions could effect the transfer of ownership and control of MERALCO to a few private parties. It may thus be necessary to first tighten the provision on the syndicate's stock dispersal programme to make it imperative for them to divest the shares at the soonest possible time, ideally within the agreed five-year period. Secondly, the mechanisms for dispersal, as revised, could be detailed by the syndicate subject to a review by the government through the COP or the APT.

Concluding Remarks

The privatization of public utilities in the Philippines is not expected to proceed smoothly given the complexities that underlie the transfer of these

42

Zinnia F. Godinez

firms to the private sector, as illustrated in the three cases discussed. As has been observed by many, the firms or assets that have been assigned to the Asset Privatization Trust have been more speedily disposed of relative to most SOEs, whose privatization plans are managed by their parent agencies. 9 Thus, given their mandate, the APT proceeds with the disposal of assets in an indifferent manner since there are no (inherent) interest groups. Neither is the APT concerned with protecting or expanding "turf", given its limited lifespan of five years from 1987. In the case of holding companies (such as the National Development Company) the argument for privatizing subsidiaries may not be as convincing, if by so doing, the interest of the whole organization is perceived to be negatively affected. Thus, in general, holding companies may not push for immediate privatization of their subsidiaries, given their narrower interest. Nevertheless, much of the promise lies in the fact that there is sincere intention on the part of the national government to privatize "with a difference" -by ensuring that public utilities do not turn into private monopolies once they are divested from public hands. What becomes apparent is that privatization decisions regarding public utility firms need to take into account some important considerations. Foremost among these is whether the utility firm is a natural monopoly (such as power generation), in which case there is a very strong argument for governmental presence. Another consideration for governmental involvement is the traditional role of providing "public goods", as in the case of the Philippine National Railways (PNR). In recent years, the PNR has expanded its activities to include bus operations, real estate and equipment rentals, and running a hospital. These activities obviously do not answer the PNR's objectives and should be readily divested to the private sector. The third factor that also impinges on the decision to privatize a utility firm is whether the government would naturally want to influence market rates and service standards in an industry operating within a specific geographical area. This appears to be the main consideration for the setting up of the Metro Manila Transit Corporation in 1974. It is now for policy-makers to decide whether the government should continue to play this role, given the active interest of the private sector in the land transportation industry in Metro Manila. The three public utilities that have been examined have all been listed for privatization. However, their time frames differ. For instance, there appears to be very little quarrel with the divestment of MGC and MMTC at the soonest possible time. MERALCO is the unique case among the three firms discussed. It is not only the dominant public utility firm in the energy sector (and the sole distributor of electricity in the Metro Manila area and nearby environs), but it is also one of the biggest public utilities. The dispersal plan of the syndicate must, therefore, be carefully monitored to ensure compliance

Privatization ofPublic Utilities in the Philippines: General Direction and Approach

43

based on what has been agreed upon between the national government and the syndicate. To the extent that Meralco Foundation, Inc. may lose its shares to its creditors, the financial health of MFI should be closely watched; if there is a grave concern on the part of the national government to deter the trend towards private monopoly, it may find it necessary to provide some form of assistance in the short-term to enable MFI to remove the encumbrance on the shares by its creditors. As to the approach with which privatization should proceed, MERALCO's stock dispersal programme is perhaps one of the major breakthroughs in equity "deliberations". Not only does it dilute effective control of a strategic firm by a few, but it also allows consumers to become part-owners. This in itself is a welcome development. If consumers respond favourably to the offer of the syndicate to purchase MERALCO shares, the initiative to enhance MERALCO's profitability will be heightened from below. Another consideration to the privatization of utility firms, particularly for those that are unprofitable, is whether privatization ought to proceed only after profitability has been established or regained, as the case may be. It would appear that in the case of MGC and MMTC, the decision is to sell off as soon as possible, even without clear indications of profitability. On the other hand, MERALCO has proven itself profitable in the two years, 1986-87, with increases in both net income and working capital over the period. This would enhance the attractiveness of MERALCO shares when they are floated in the stock market. In conclusion, the direction of and approach to privatization in the Philippines seem to rely on well-defined criteria and public philosophy. However, some fine-tuning is called for, especially for some public utilities, as has been shown in this paper.

NOTES I.

Zinnia F. Godinez, "Privatization and Deregulation in the Philippines: An Option Package Worth Pursuing?" ASEAN Economic Bulletin 5, no. 3 (Institute of Southeast Asian Studies, March 1989): 259-89.

2.

See Clodualdo R. Francisco, Demand for Electricity in the Philippines: Jmplicationsfor Alternative Electricity Pricing Policies (Philippine Institute for Development Studies [PIDS], 1988). Sec also Leander Alejo, A Study of Energy-Economy in the Philippines, Monograph Series No. I (PIDS, 1983).

3.

See National Statistics Office (NSO), Philippine Yearbook 1987, pp. 884-94.

4.

Philippine Development Report, 1987 (Manila: National Economic and Development Authority, 1987), pp. 260-69.

44

Zinnia F Godinez

5.

See Department of Transportation and Communication, Manila, "Inter-Agency Study of Urban Public Road Transportation Regulation", January 1988, p. 131.

6.

Presidential Decree No. 40 ·has been amended by Executive Order No. 215 (dated I 0 July 1987) allowing private corporations, co-operatives, or similar associations to construct and operate electric generating plants with the intention to sell their production to the national power grid. While the Executive Order terminated NPC's monopoly in the generation of power, the responsibility for the bulk transmission of power and the setting up of transmission lines remain with NPC.

7.

As amended, the Articles oflncorporation and By-Laws ofMERALCO " ... restricts the ownership of its common stock by any corporation and its wholly- or majority-owned subsidiaries, or by any person or persons related to each other within the third degree of consanguinity or affinity, to not more than I 0 percent of the outstanding voting common stock of MERALCO ... ".

8.

The institutions include Philippine Commercial and International Bank (PCIB), Meralco Pension Fund, and the Philippine Commercial Capital, Inc.

9.

The large government corporations have been tasked as disposition entities for their subsidiaries. The approval for the privatization of these subsidiaries require the review and approval of the Committee on Privatization (COP). Even the state-owned enterprises assigned to the Asset Privatization Trust for disposition will need to undergo COP's review.

REFERENCES Amatong, Juanita. "Explicit Budgetary Contributions of National Government to Government Corporations." Manila: Philippine Institute for Development Studies (PIDS) Report, 1985. Manasan, Rosario, and Corazon Buenaventura. A Macroeconomic Overview of Public Enterprise in the Philippines, 1975-1984. Staff Paper Series No: 86-03. Manila: Philippine Institute for Development Studies, 1986.

III. Privatization of Electricity Supply in Malaysia Issues and Problems

M ZAINUDIN SALEH Introduction In most developing countries during the past decade or so, a number of public enterprises have incurred financial losses, become net capital users and failed to accomplish the economic, social and political objectives for which they were created. 1 Furthermore, the quality of their services has been poor and inefficient. The world recession, which started in the late seventies, falling commodity prices in the early eighties, rising foreign debt service and mounting fiscal deficits have forced the Malaysian Government to examine critically its development policy, including the introduction of new strategies, one of which is privatization. By selling public enterprises to the private sector, it is hoped that they will become less politicized, more efficient and be able to provide higher quality products and services. Corporate tax revenue will increase and thus boost the financial income of the Treasury. The purpose of this paper is to analyse the justifiability and suitability of the privatization of the National Electricity Board (NEB), a long established government monopoly. It has always been said that privatization of a natural monopoly would be harmful to the public, as such an exercise would not create competition. This is because the NEB, being a natural monopoly, hardly has any competitors in the market. Furthermore, the NEB has always been making profit; thus, the question here is: can privatization make NEB more efficient and more profitable than if it is retained as a public company? As a company providing an essential service, would it be able to provide the service at a reasonable price after the privatization? Privatization, in its general and most obvious form, is the transfer of ownership and control of an existing enterprise, activity or service from the public sector to the private sector. It thus reduces the role of the government, while increasing the role of the private sector in an activity or in the ownership of assets. In Malaysia, this transfer of ownership and

46

M Zainudin Saleh

control might be in the form of divestiture- that is, only part of the equity is transferred to the private sector. Other forms are contracting out, or government withdrawal from the provision of certain goods or services monopolized by it, leaving them wholly or partly to the private sector. The government could also sell or lease a part of its services to the private sector, while retaining some services under public ownership, control and management. In some instances, privatization in the sense of ownership transfer may not be necessary or feasible. What is needed then may be some deregulation, that is, the removal of statutory restrictions on competition.

History of the National Electricity Board

Electricity first made its appearance in Malaysia in 1895, when an electric generator was installed for the Railways Department in Kuala Lumpur. Electricity was first supplied to the public in Penang in 1904. The residents of Kuala Lumpur received their electricity in 1905 when a small hydroelectric station was built in Ulu Gombak, about 20 kilometres away. Since then, the demand for electricity has expanded rapidly. On 1 January 1927, the Government Electricity Department, which was a section of the Public Works Department, became an independent Federal Electricity Department controlling electricity supply in the Federated Malay States. By the end of the 1940s, there was an incentive to reconsider several recommendations made before World War II in order to monitor effectively the development of electricity supply to meet the increasing demand. It was decided that a proper development of electricity required: 2 1.

the interconnection of large electricity undertakings;

2.

the development of more hydroelectric power stations in locations away from local centres.

To monitor such a development strategy, a central body would be necessary to build and operate an integrated electricity scheme. Following several examples elsewhere in the world, it was decided that the business of generating and distributing electricity should be handled by a public corporation. Therefore, on 1 September 1949 the National Electricity Board (known as the Central Electricity Board at that time until 1965) was established to replace the Electricity Department. The NEB had the following functions: 3 1.

To promote the generation of electrical energy for the economic development of Malaya (currently known as Peninsular Malaysia);

2.

To secure the supply of such energy at a reasonable price;

Privatization ofElectricity Supply in Malaysia: Issues and Problems

47

3.

To advise the minister responsible for electricity on all matters relating to its generation and use;

4.

To manage and operate electrical installations transferred to, acquired, or established by it;

5.

To make regulations for the generation and use of the energy.

6.

To construct and operate supply lines and stations to generate and sell energy; and

7.

To acquire electrical plant and property.

The Sarawak Electricity Supply Corporation (SESCO) and the Sabah Electricity Board (SEB) are charged with similar responsibilities in the states of Sarawak and Sabah respectively. As the country developed and the people's living standard increased, more electricity was demanded especially from industrial, business and domestic consumers. Future supply development was then split into two main objectives: 1.

To increase the number of local diesel generating power plants m small towns; and

2.

To increase and consequently interconnect the two major bulk supply schemes in Selangor and Perak.

Energy development plans were based on a ten-year forecast while the construction programmes were based on a five-year plan. To meet the increasing demand, the Board worked out a five-year plan which included the following major projects: Completion of Connaught Bridge Power Station; Construction of a 30-megawatt steam station near Melaka; Doubling the capacity of the existing diesel stations; Obtaining unrestricted supply from Singapore for Southern Johor; and Extending the transmission grid from Melaka to Muar. In the mid-eighties, there were at least 19 major generating plants in operation, with total generating capacity of 4490 MW (see Table III.l ). At the end of 1986, there were 9 thermal, 29 hydro, 6 gas turbine, 29 diesel (excluding 12-hour-supply rural stations) and one combined-cycle stations with a total generating capacity of 4710 MW. In 1986, a total of 13,515 GWh and 24 GWh units of electricity were generated by the non-rural and rural stations respectively.

M Zainudin Saleh

48

Table 111.1 Major Generating Plants in Operation, 1986

Plant Gelugor Malim Nawar Mel aka Port Klang Perai Sultan Ismail Tuanku Jaafar Sultan Iskandar Bersia Chenderoh Kenering Kenyir Sultan Idris II (Woh) Sultan Yussuf (Jor) Temenggor Paka Connaught Bridge Lundang Telok Gua SOURCE:

Generating Capacity (MW)

Type

40 40 30 600 450 90 600 240

Thermal Thermal Thermal Thermal Thermal Thermal Thermal Thermal Hydro Hydro Hydro Hydro Hydro Hydro Hydro Combined-cycle Gas Turbine Diesel Diesel

72

40 120 400 150 100 348 900 180 50 40

National Electricity Board, Statistical Bulletin, 1986.

Electricity Supply In Malaysia, there are mainly five types of electricity generation stations, that is, thermal, hydro, turbine gas, diesel and combined-cycle. The turbine gas and combined-cycle stations were introduced in 1979 and 1985 respectively. The main supply of electricity comes from thermal-generators (50.4 per cent in 1986) with hydro being the second (26.9 per cent). The thermal generators use oil as fuel. The oil crisis during the late 1970s gave rise to financial problems to the National Electricity Board. For example, in 1980 the NEB made a loss amounting to M$7.8 million, and there were pressures to diversify power generation plants. In Malaysia, the most viable alternative is hydroelectricity. Over the years, especially in the eighties, the share of electricity generated by thermal stations decreased while that of hydro-stations increased. The total cost of electricity supply consists of operating and capital costs (expenditures). The former include expenses on administration, such

49

Privatization ofElectricity Supply in Malaysia: Issues and Problems

TABLEIII.2 Total Supply, Consumption and Revenue

o/o Increase Units Generated/ in Units Year* Purchased Gen./Pur. 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

4652.7 5356.9 6257.8 6991.5 7650.5 8466.1 9099.5 9816.9 10731.5 11705.1 12730.4 13544.2

13.31 15.14 16.82 11.72 9.43 10.66 7.48 7.88 9.32 9.07 8.76 6.39

Units Sold (GWh) 3982.30 4543.58 5297.15 5934.17 6540.64 7265.51 7802.79 8367.94 9047.23 9893.55 10780.29 11420.80

% o/o Increase Increase in Units m Revenue (M$million) Revenue Sold 13.71 14.09 16.59 12.03 10.22 11.08 7.39 7.24 8.12 9.35 8.96 5.94

352.62 487.86 566.11 643.36 821.62 1091.38 1577.99 1839.67 2008.93 2195.63 2399.38 2312.82

30.16 38.36 16.04 13.65 27.71 32.83 44.59 16.50 9.20 9.29 9.28 -3.61

*Financial year ending 31 August. SOURCE: National Electricity Board, Statistical Bulletin, 1986.

as emoluments and allowances, and maintenance, such as equipment maintenance, fuel and the purchase of electricity by the Board. The capital costs include expenses on electricity generation, transmission and distribution as well as the cost of expansion projects, particularly major ones. Table III.3 shows the increasing trend in the cost of electricity supply. The cost of fuel is the main component of the operating cost. Currently, and for several years hence, the Board will depend on oil as the main source of power. This will be a financial burden to the Board as the last decade has witnessed a rapid increase in the price of oil. Table III.3 also shows that capital costs have been increasing, except in 1982. The major sources of growth in capital costs include those incurred in expanding and carrying out major projects, distribution and transmission. Electricity Demand

The demand for electricity has increased rapidly, especially in the seventies, hand in hand with the economic development of the nation. The growth of industrial, commercial and residential areas and the rising standard of living have provided the impetus for the increasing demand for electricity. Most of the electricity consumption comes from the industrial and commercial sectors. For example, out of the total electricity consumption in 1986, 40 per cent was by the industrial sector, 34 per cent by the

50

M Zainudin Saleh

TABLEIII.3 Cost of Electricity Supply (1975-86) (M$ million)

.

Year

Operating Cost

Index

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

313,793 376,281 461,450 502,472 698,814 1,062,952 1,425,210 1,597,530 1,505,405 1,444,659 1,789,471 1,649,257

290 348 427 464 646 983 1,317 1,477 1,391 1,335 1,653 1,524

. Total Cost

Capital Cost Index 133,575 281,099 322,843 420,321 569,258 633,406 815,016 783,226 1,263,184 1,352,947 1,292,696 1,049,082

185 389 447 582 788 877 1' 128 1,084 1,749 1,873 1,790 1,452

447,368 657,380 784,293 922,793 1,268,072 1,696,358 2,240,226 2,380,756 2,609,589 2,797,606 3,082,167 2,698,339

.

Index

248 364 435 511 703 940 1,242 1,320 1,446 1,550 1,708 1,495

* Indices are computed by taking 1970 as the base year. SouRcE: National Electricity Board, Annual Reports, 197 5-86.

commercial sector, 22 per cent for domestic use, 3 per cent by the mining sector, and the rest was for public lighting. However, in terms of the number of electricity consumers the majority are from households or residential areas. For example, in 1986, 87 per cent comprised domestic (residential) consumers, 13 per cent was commercial, below 1 per cent was industrial, and the rest was for mining and public lighting. During the seventies and eighties, the population grew at a rate of about 2.3 per cent per annum. As electricity is one of the basic needs, rapid population growth causes rapid increase in electricity consumption, particularly by households. In line with the government's effort to expand the industrial and commercial sectors through various development policies, energy consumption by both sectors has also increased over the years. The industrial sector is the largest energy user and its level of consumption is increasing over time. Most of the energy is consumed in the central region of the peninsula, where most of the industrial activities can be found. At the end of the seventies, the demand for electricity from the commercial sector constituted about 30 per cent of the total electricity consumption. By 1986 this share had risen to 34 per cent. Although the number of consumers from the commercial sector increased over the years, their percentage contribution decreased. For example, at the end of the seventies, the number of consumers in the commercial sector constituted about 15-16 per cent of the total. However, in 1986 the figure was 13

51

Privatization ofElectricity Supply in Malaysia: Issues and Problems

TABLEIII.4 Total Energy Consumption and Number of Consumers

Year

Domestic

Commercial

Public Industrial Mining Lighting

Total

Energy Consumption (GWh) 986.7 1979.1 1979 1147.9 2151.3 1980 1301.6 2333.1 1981 2517.6 1457.0 1982 1804.1 2876.7 1983 2000.2 3165.5 1984 2249.2 3590.7 1985 2480.3 3891.0 1986

3221.1 3606.8 3814.5 4033.1 3793.0 4170.4 4419.3 4608.1

294.7 294.4 284.8 285.3 487.9 462.9 420.2 329.1

59.0 65.1 68.8 74.9 85.4 94.4 100.9 112.3

6540.6 7265.5 7802.8 8367.9 9047.2 9893.5 10780.3 11420.8

Number of Consumers 948,228 174,315 1979 1980 1,062,679 191,059 204,175 1981 1' 180,866 1982 1,316,127 216,351 1983 1,548,599 250,649 1984 1,687,594 270,033 1985 1,832,406 284,165 1986 1,983,252 297,137

3199 2830 2993 2962 4175 4041 4274 4778

66 59 61 58 538 485 434 271

1827 1850 2033 2149 2820 3009 3397 3936

1,127,635 1,258,477 1,390,128 1,537,647 1,806,781 1,965,162 2,124,676 2,289,374

SouRCE: National Electricity Board, Statistical Bulletin, various years.

per cent. This shows that most of the increase in energy consumption came from the expansion of currently existing business entities or their operations. With respect to energy consumption in the mining sector, a large part of it is consumed by the tin mining industry. Since the end of the seventies, owing to unfavourable prices in the world market and the depletion of the existing reserves, the tin mining industry has been slowing down. The deteriorating industry has meant a decreasing demand for electricity in the mining sector. Conditions for the Success of Privatization In 1987, Bumiputra Merchant Bankers Berhad was appointed to carry out a study on the prospects of privatizing the National Electricity Board. The study was completed at the end of August the same year. Then in October, the Minister of Energy, Telecom and Posts announced that the Cabinet was considering to privatize the NEB. Since then, it is claimed that the Board

52

M Zainudin Saleh

has been examining the report and making necessary preparations for privatization. The success of privatization in the sense of raising the efficiency and effectiveness in the production and delivery of services depends on several conditions. 4 Firstly, the political leadership must be committed to the programme. In other countries in the past, privatization had worked best when governments were strongly committed to new changes or policies. Secondly, the privatization exercise should not reduce competition among suppliers. Hence, the replacement of a government monopoly (in the case of electricity, a natural monopoly) by a private monopoly may not increase the public welfare if there are no other suppliers. In the case of electricity, this can be a difficult problem since there are very few private electricity companies in Malaysia. To avoid unhealthy competition attributable to a lack of suppliers, regulations need to be reviewed. Over-regulation of the industry may discourage private initiative. For example, the unduly low ceilings on the price may depress the incentive for production. Thirdly, consumers should be able to link the benefits they receive from the service to the cost they pay for it. This will ensure satisfaction on the part of consumers. In the electricity company, and many other public utility services, this can be achieved by replacing the traditional accounting method with the marginal cost pricing policy. Fourthly, the privatized company should be less susceptible to fraud and bribery. Necessary regulations and "check-and-balance" procedures should be enforced. For example, any regulation passed should be subject to criticism from trade unions, opposition and social interest groups. Fifthly, equity or more equal distribution is an important consideration in the delivery of public services. Broadly speaking, the benefits of privatization can accrue to shareholders who receive dividends, to consumers who receive a more efficient service, and to the public at large, through a reduction in the public sector deficit and through increase in corporate tax collection. From the social point of view, privatization will not be successful if the ability of the public to pay, determined by the prevailing level and distribution of income, becomes the sole guide for the delivery of services, since this will ensure that only the financially eligible groups of consumers get better service. On the part of shareholders, if the sale of shares is not conducted in the open market, the benefit of privatization will likely be reaped solely by local elites, expatriate groups, or multinational corporations.

Possible Options and Modes of Privatization of the NEB

The privatization of the NEB can take two forms: either the entire NEB is privatized or only certain activities are privatized. Under the second, there may be two choices:

Privatization ofElectricity Supply in Malaysia: Issues and Problems

53

1.

By privatizing the generation activity. In Malaysia there are two major types of electricity generation: thermal and hydro. Even though the variable cost of electricity generation by hydropower is lower, it needs a tremendous amount of capital as it involves the construction of dams and other relevant infrastructures.

2.

By privatizing the transmission and distribution services according to area or sector. The cost of distribution will depend on the geographical nature, the types and the number of consumers.

Considering that the NEB was established as a government company and that its service can be broken down into several stages, such as generation, transmission and distribution, there are possibly three modes of privatization open to the NEB: 1.

Private placement. The government could give away the whole or part (such as either the generation or distribution activity) of the NEB to local or foreign companies or to certain individuals. The first question arising here is what are the criteria for the selection of the institution or individual? Should the decision be made based on merit or political connections or both? The merit criterion may include the record of management, the size of paid-up capital, the record of success, and so forth. Should a local institution be chosen, it may be connected to the ruling political party or monarchy. If this happens, it is not in line with the spirit of free auction or tender. If it is given to a foreign company it may cause the problem of outflow of capital in the forms of dividends and profits to parent companies abroad.

2.

Public floatation of shares. In Malaysia, this is usually done at a fixed predetermined price. The shares then could be listed and traded on the Kuala Lumpur Stock Exchange. By public floatation of the NEB's shares its ownership will not fall into the single hand of a local or foreign company, or a joint-venture or an individual, but the public. However, the common practice in Malaysia, as has been done for Malaysian Airlines System (MAS), Malaysian International Shipping Corporation (MISC) and Syarikat Telekom, is that a large portion of the shares is still owned by the government.

3.

Deregulation. Due to the complex nature of electricity supply and distribution, the transfer of ownership may not be necessary. What is needed is probably some deregulation, that is, removal of statutory restrictions so that sufficient competition could emerge. By deregulating the industry, competition among private firms could be encouraged and new entrants into the established monopoly could be

54

M. Zainudin Saleh

permitted. Therefore, the deregulation should be able to make it less politicized and more corporatized as well as encourage new suppliers from the private sector.

Issues of Privatization of the NEB Pricing Policy and Efficiency In most developing countries, including Malaysia, electricity is considered a basic necessity and, therefore, its supply is a social obligation of the government. Hence, the role of the government is not only to ensure that the supply capacity is adequate to meet demand but also that it should be priced such that the welfare of the people (particularly the poor) is not jeopardized. The pricing policy generally adopted by most electricity authorities is based on the concept of average cost where cost (that is, capacity cost, energy cost and administrative cost) is spread over the number of units consumed. This is because average cost decreases as the consumption or production increases. The principle of average cost pricing is aimed at achieving financial objectives vis-a-vis revenue requirement. However, it does not guarantee an efficient resource allocation and, furthermore, consumers do not know the true costs of resources used in providing the services, that is, the incremental cost (marginal cost) of expanding an additional kilowatt or kilowatt-hour. A more efficient method of pricing is the marginal cost pricing principle (MCPP). This principle basically says that from the allocation and welfare point of view, the price of a product should be equal to the incremental cost of meeting the additional unit of output, that is, the next kilowatt-hour. The MCPP is derived from the Pareto optimality concept of welfare economics by which an efficient use of available resources (and the attainment of the highest level of consumer satisfaction) is achieved when the price of the output is equal to the marginal cost. By this principle, the consumers will be aware of the cost of resources used in supplying the electricity and will make their consumption decision based on relative prices which should closely reflect the cost of resources used in producing the service. 5 The unique feature of electricity is that its demand fluctuates through time, that is, daily and seasonally, and that it cannot be stored economically and demand has to be met with instantaneous supply. Therefore, the Board has to provide adequate capacity to meet peak period demands, knowing fully well that this capacity will only be partially utilized during off-peak periods. Therefore, from the viewpoint of the Board, it is cheaper to produce electricity during off-peak periods compared to peak periods. This is simply because peak period generation forces the additional use of the least efficient plants (higher operating cost) in order to meet the peak period

Privatization ofElectricity Supply in Malaysia: Issues and Problems

55

demand, while during off-peak periods the demand could be met by using only the most efficient plants. Hence, the application of the MCPP would mean that prices during off-peak periods are considerably lower than at other times and higher during the peak periods. In attempting to relate marginal cost to the price of electricity, it is better to classify marginal cost into short-run marginal cost (SRMC) and long-run marginal cost (LRMC). In the context of electricity generation, SRMC refers to variable cost comprising, principally, fuel and small elements of operating expenses. SRMC is determined without taking into account capital investment and capital charges because these are considered as fixed cost, which hardly varies in the short-run. The SRMC of electricity generation (comprising largely fuel cost) is influenced by the operating system (type) of the generating plant and the combined effect of total load growth with the introduction of new generating plants. On the other hand, LRMC refers to capital investment, that is, the capital charges (expenses) incurred for expanding the generating system to meet the increasing demand. In the electricity industry, it is a projection of capacity costs over a considerable period of time, usually ten years and does not take into account capital investments existing at the beginning of the period for which the LRMCs are assessed. 6 This includes the plan to build new generating plants and expand the existing plants. Hence, from the nature of the SRMC and LRMC it can be postulated that the application of the marginal cost pricing principle would mean that off-peak electricity price should be based on the SRMC, while the price for the peak period should be based on both SRMC and LRMC. The present increasing-block tariffs for domestic consumption and flat rates (for low and medium voltage commercial as well as industrial use) as practised by the NEB will not tell consumers that peak-hour consumption is expensive, and therefore will not provide sufficient incentive to reduce peak-period consumption or increase off-peak consumption. Rural Electrification In order to raise the standard of living of the rural people, the government places great emphasis on the extension of essential utility services to the rural population, and electricity has featured prominently in this. The availability of rural electrification or its absence reflects the social inequalities between individuals, groups or villages. Rural electrification is thus an indication of one's income, wealth or social status in the rural areas. Therefore, the rural electrification programme constitutes an important component of the basic infrastructural facilities under the various national development plans. In 1977, the Rural Electrification Department was established with the following primary roles: 7

56

M Zainudin Saleh

1.

to provide the leadership in directing all available resources towards achieving the rural electrification objectives;

2.

to take the initiative in solving the perpetual problems besetting the successful implementation of the rural electrification programme; and

3.

to invent ways and means to encourage greater utilization of electricity to raise the real income of the rural population.

Even the criteria used in selecting villages for rural electrification are the responsibility of the Ministry of Energy, Telecom and Post and the NEB is only the implementing agency. This is because, being a private company after it is privatized, it may no longer be interested in providing electricity to villages, particularly in remote areas, since the cost might outweigh the benefits. Under government management, even if it is not economically profitable, it is politically necessary as the lack of electricity in the remote areas would lead to social discontent and injustice. Furthermore, it may distort the government's effort to reduce poverty and raise productivity among the rural population. How far this problem can be avoided will depend on the privatization exercise. If too much administrative power is given to the private company, so that the government would have insignificant control over the enterprise, the rural electrification programme may not be successful in lifting the living standard of the rural population.

Privatization and the Management It has always been said that an adequate number of managers is required for the successful management of a privatized enterprise. However, in Malaysia, efficient managers are lacking. The Prime Minister himself once said: Management is not one of Malaysia's strong points. In the first instance, we do not have enough managers. Of the ones we have, a good number are unfortunately mediocre. Some we have seen are downright dishonest. If privatisation is going to remedy the ills of nationalisation, then we must have good managers. 8

However, the government has argued that the supply of efficient managers can be enhanced through privatization, competition and the adoption of the profit-maximizing principle. If a privatized enterprise exposed to competition is to be successful the management must make sure that it makes profits and avoid the risk of being taken over by other enterprises. This requires that they manage efficiently. However, in most cases of privatization in Malaysia, the same group of managers, or at least most of the managers from the public enterprise will be on the Board of Directors or management group after it is privatized. This is because the appointment of the managers or members of the Board of Directors is always influenced by politics and seniority in the government service, and

Privatization ofElectricity Supply in Malaysia: Issues and Problems

57

is not solely based on the merits or capability of the managers. If the appointment of the management group is made open to the public or to the "national manager market" the management of the privatized enterprise might be geared towards better performance.

Privatization and Labour Welfare The privatization of public enterprise has always been opposed by trade unions. They feel that workers' employment and thus their income as well as other fringe benefits and their existing status will be affected if privatization takes place. As profit maximization is the primary concern of any private enterprise, it is inevitable that there would be attempts to reduce cost and to charge higher rates for services to consumers. One of the cost-cutting measures may include trimming the work-force. Furthermore, if the rates are raised, the interest of poor consumers, mostly workers, will be affected. The trade unions in the public enterprises usually have high bargaining power and they are aware of their access to political circles and government administration activities. They enjoy a relatively higher status than trade unions in the private sector. Therefore, any changes, such as a privatization exercise, will inevitably affect their present role and status. 9 There is also a possibility that the existing trade union may no longer be allowed to represent employees in the newly privatized enterprise. In an attempt to minimize the fears of the trade union, the government has agreed that: 10 1.

there should be no retrenchment of employees for a stipulated period after privatization.

2.

those employees involved in the privatized service should not lose any benefits they had enjoyed in the government service. They can, however, choose a private sector scheme which would entitle them to share ownership, bonuses and other benefits not normally given to government employees. In this case, they will not be entitled to the government scheme.

It would seem that the privatization of the NEB, if it is carried out, is not to fulfil the objective of increased efficiency and competition or to accelerate growth, but rather to reduce the size of the government sector and the government financial burden, as well as to achieve the objectives of the New Economic Policy (NEP). However, the reduction of the public sector and the government financial burden is being questioned by some economists as the privatization experience in Malaysia thus far has shown that the involvement of the government in the economy has been reduced only marginally. 11 Furthermore, the privatization of a natural monopoly normally does not create competition due to the complex nature of production

M. Zainudin Saleh

58

and the marketing strategy. The generation, transmission and distribution of electricity need a tremendous amount of capital and a good management group. Competition may not be suitable for a company which has both economic and social objectives. These two objectives are always contradictory to each other.

Conclusions

The rising foreign debts, mounting fiscal deficits and the existence of loss-making public enterprises have forced the government to examine its development policy. One of the remedies is through privatization, including the supply of electricity. It is hoped that by privatizing the NEB, the supply of electricity to the people would be more efficient. Even though the actual privatization has not taken place yet, it may not be out of place to make some recommendations and evaluations. For the privatization of electricity supply to be successful the government and particularly the management must really be committed to the effort. Social considerations such as how far the welfare of the poor (especially the rural population) should be sacrificed for efficiency should be given special attention. If too much emphasis is put on free competition, and thus efficiency, the privatized NEB, driven by its profit maximization objective, may raise tariffs and may not be so willing to provide electricity to the rural areas. This will hurt the poor and prevent a fairer distribution of welfare. On the part of the newly privatized NEB, there should be "check and balance" procedures - that is, any regulation, particularly the ones that affect the public, should be open to public criticism. Criticisms from trade unions, and opposition and social interest groups should help to minimize any malpractices, fraud and bribery which might exist. Furthermore, criticism from trade unions may help to avoid jeopardizing the welfare of employees after privatization.

NOTES I.

James E. Austin, eta!. (1986), pp. 51-60.

2.

National Electricity Board of the States of Malaya ( 1984), p. 10.

3.

Ibid., p. 14.

4.

Samuel Paul (1985).

5.

Razali Ismail (1983), pp. 34-38.

6.

Ibid.

Privatization ofElectricity Supply in Malaysia: Issues and Problems 7.

Ariaratnam Kumurasamy (1983).

8.

Malaysian Business (Kuala Lumpur), l August 1988, p. 14.

9.

Phiphat Thaiarry (1987).

59

l 0.

Opening Speech delivered by the Prime Minister of Malaysia, Dato Seri Dr Mahathir Mohamad at the Conference on Privatisation in Malaysia: Opportunities and Implications, Kuala Lumpur, 14 July 1988.

11.

For example, Toh Kin Woon (1988). Most of the privatized corporations are either wholly or substantially owned by the government, political parties belonging to the ruling coalition, or the monarchy.

REFERENCES Austin, James E., Lawrence H. Wortzcl, and John F. Coburn. "Privatising State-Owned Enterprises: Hopes and Realities". Columbia Journal of World Business 21, no. 3 (Fall 1986): 51-60. Ecnomic Planning Unit, Prime Minister's Department. Guidelines on Privatisation. Kuala Lumpur, 1985. Kay, J.A., and D.J. Thompson. "Privatisation: A Policy in Search of a Rationale". The Economic Journal 96 (March 1986): 18-32. Kumurasamy, Ariaratnam. "Rural Electrification as an Indicator of Socio-economic Development- A General Perspective". Power !0, no. 1 (June 1983): 12-18. National Electricity Board of the States of Malaya. 35 Years Together. Kuala Lumpur, 1984. Paul, Samuel. "Privatisation and the Public Sector". Finance and Development 22, no. 4 (December 1985): 42-45. Radin Soenamo Al-Haji and Zainal Aznam Yusof. "Privatisation in Developing Countries: The Experience of Malaysia". Paper presented at the Conference on Privatisation: Policies, Methods and Procedures, held in Manila, 31 January-! February 1985. Razali Ismail. "Electricity Pricing and Its Impact on Energy/Power Demand and Resource Use". Power 6, no. 2 (December 1978): 32-36. - - . "Electricity Pricing Policy". Power 10, no. l (June 1983): 34-38. Thaiarry, Phiphat. Privatisation-Its Impact on Labour Relations. Public Enterprise Institute, Chulalongkorn University, 1987. Toh Kin Woon. "Privatisation in Malaysia: Restructuring or Efficiency?" Asean Economic Bulletin 5, no. 3 (March 1988): 242-58.

IV. Privatization of Utilities in the United Kingdom, with Special Reference to Electricity Supply FREDERICK BONNER This paper is primarily concerned with the privatization of the electricity supply industry in the United Kingdom but brief reference is also made to the privatization of the water industry, which will come first. In the public utility field, gas supply and telecommunications have already been privatized. Prior to nationalization, in the years following World War II public utilities tended to be owned by regulated companies and municipalities because of their monopolistic nature. The present government, however, has decided to "roll back" the public sector and has transferred or is transferring utilities to the private sector by selling shares to institutions and to the public. However, since the monopoly position remainstransmission and distribution of electricity, for example, are natural monopolies 1 - this has not been accompanied by deregulation except in the case of the generation of electricity where there can be competition. Directors General have been appointed to regulate the gas, electricity, water and telecommunications industries. Privatization as such did not open the way to competition in electricity generation although this was possible under the Energy Act 1983. It did not take place essentially because the nationalized generators owned the main transmission system and controlled access to it. One may well ask why there should be privatization at all in such circumstances? Why not leave the industries in question in the public sector? On this, a number of points can be made: 1.

The U.K. concept of a "public corporation" which can operate at "arms length" has not been a success.

2.

Privatization promotes wider shareholding.

3.

It also encourages more employee participation.

Privatization of Utilities in the UK, with Special Reference to Electricity Supply

61

4.

From a financial point of view it is probably true to say that, certainly in the years prior to privatization, there was more motivation in the raising of funds for the Exchequer than there was for promoting more competition. The proceeds of the sale have proved extremely helpful to the Chancellor in relation to the public sector borrowing requirement or towards public sector debt repayments.

5.

Privatization introduces the discipline of the capital market instead of a straight drawing of funds from the government.

Regulation Having made these comments it is important to say something about regulation. As several authors at the London Business School have pointed out, regulation can be looked at in the sense of controlling the structure of an industry as well as the controlling of its conduct. 2 The former is certainly easier but in the early privatization exercises in the United Kingdom, little regard was given to structure. British Telecom and British Gas, for example, were more or less privatized lock, stock and barrel. There is little point really in converting a public monopoly into a private one unless structural changes are also made. Thus, very little competition was introduced when British Telecom and British Gas were privatized because there was no major structural change. The regulation of conduct has proved more difficult because the regulator obviously does not have the full information which must be available to the industry. Mercury is the only real competitor of British Telecom but the latter can basically overcharge Mercury for access to the local telephone network because it alone has the detailed costs. The British Gas position is somewhat similar. It is not surprising, therefore, that when it comes to the electricity supply industry - already a federal industry - the government has decided to change the structure as well as to introduce a change in the conduct of the industry. This naturally makes the situation more complex. For the water authorities also, there will be a structural change in that when these are privatized their environmental functions will be taken over by a National Rivers Authority. Quite apart from monopoly powers, other regulations may well be needed, for example, to protect the environment. Without them, the water authorities, for example, might be less inclined to bother about environmental damage. The same can be said for electricity. Moreover, there are usually copious provisions included in the licence which each privatized company has to obtain from the government in order to operate.

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Frederick Bonner

Electricity Supply Proposals

Having dealt with the generalities, one can now turn to the proposals for the privatization of the U.K. electricity supply industry. This is a radical change and legislation is expected to be passed by the end of July 1989. The key elements in the privatization exercise 3 are: 1.

splitting the Central Electricity Generating Board (CEGB) into three- a National Grid Company and two generators, National Power owning 70 per cent of the generating capacity including nuclear power, and Power Gen owning the balance of 30 per cent.

2.

the introduction of competition into generation.

3.

the National Grid Company to be jointly owned by the twelve distribution companies;

4.

the twelve Area Boards will become the twelve companies;

5.

the obligation to supply is transferred from the generating side of the industry to the distributors;

6.

the Electricity Council which is the present central body coordinating the policies of the industry will be abolished, as will the Electricity Consumers Council;

7.

there will be a contract-based system of supply of electricity between the generators and the distributors with the grid becoming the common carrier;

8.

the order of merit (under which power stations are operated according to their avoidable costs of production) will be price, rather than cost-based.

9.

the introduction of arrangements whereby the consumer can recover compensation if he is not provided with a satisfactory service.

With regard to protection of the electricity consumer, the government is proposing to abolish the Electricity Consumers Council and the Area Consultative Councils and in their place there will be established, under the Director General of Electricity Supply, consumer committees covering the areas of the public distribution companies. Moreover, there will be a shift from production to consumer orientation which will necessitate a change in "cui ture". The arrangements for Scotland are a little different in the sense that the two Scottish Boards are already vertically organized concerns and will be

Privatization of Utilities in the UK, with Special Reference to Electricity Supply

63

privatized as such. There is a provision, however, that all the nuclear capacity in the South of Scotland Board's area will effectively be jointly owned by the successor to that Board and the successor to the North of Scotland Hydro-Electric Board. 4

Problems The process of privatization will not be without problems. It is useful to review some of the issues which may arise.

Impact on Costs to Society 1.

Fragmentation is likely to lead, as in the United States, to a "salami" approach to new investment - smaller power stations, which will mean a loss of economies of scale, and a demand for more sites.

2.

Smaller power stations will probably have lower initial costs per kilowatt but higher running costs, compared with a major base load power station. This can mean a departure from an optimal system which is a mixture of base load, mid-merit and peaking plant (base load is the lowest-cost plant at one end of the spectrum and peaking plant, the highest-cost plant at the other end).

3.

The ending of an integrated generation and transmission system which has enabled the United Kingdom to cope with major disturbances on the system, coal strikes and natural occurrences, such as the gale of October 1987.

4.

A possible reduction in the security of supply if companies have more regard for the profit motive rather than consumer interests.

5.

The operation of an order of merit for a generating plant is made more complex by the decision to operate on the basis of prices quoted by the generators to distributors under contracts which will be entered into between them.

6.

The likelihood that there will be less research and development by the privatized companies in order to cut costs and inflate profits.

7.

There will be an increase in administration costs with the fragmentation of the industry. Each company is likely to have to set up its own specialist services in place of those previously discharged on a national basis, although some services will certainly be maintained in a central services company.

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Frederick Bonner

Of major concern will be the future of nuclear power. The government's aim of privatization is not consistent with its aim to further develop nuclear power. It has been suggested that nuclear power should remain in the public sector but this is not really possible because it would appear illogical. The government has, therefore, decided that: 1.

nuclear generation should remain the responsibility of National Power;

2.

the distributors would be required by statute to have available contracts for a given percentage of non-fossil (mainly nuclear) capacity;

3.

the fact that nuclear power now looks less economical than fossil fuel power, due in the main to the lower cost of coal and oil and the higher returns that are now likely to be sought under privatization, means that the additional burden in equity should fall upon all consumers. To that end all kilowatt hours supplied will be charged on the basis of fossil fuel generation whilst the generator, National Power, will receive its actual costs for nuclear generation. Any difference will then be levied on the supply companies which will then pass it on to the final consumer.

4.

Over and above that, the government has undertaken, in the Electricity Bill, to contribute up to £2.5 billion towards the cost of reprocessing nuclear fuel, the treatment, storage and disposal of radioactive waste and the de-commissioning of any licensed nuclear installation.

Price Regulation It may be helpful to say something about the control of prices for utilities

in the United Kingdom. Directors General have been appointed or will be appointed for the industries in question. They will have a major responsibility for the regulation of prices except where there is competition, such as what has been proposed for electricity generation. One major item of consideration was whether the United Kingdom should follow the U.S. approach to regulation or whether there should be a different one. In the United States, taking electricity as an example, regulation takes the form of fixing a rate of return on capital employed and the need to establish that the latter involves assets which are "used and useful" and where the "prudence" test is also employed. 5 This approach, however, has a number of disadvantages:

Privatization of Utilities in the UK, with Special Reference to Electricity Supply

65

1.

what should be the rate of return;

2.

how does one determine whether capital investment has been "prudent" or not;

3.

allowing a rate of return in the rate calculation does not provide sufficient motivation for management;

4.

the regulatory process can be very slow with the result that it becomes known as "regulatory lag".

The U.K. Government has given a great deal of thought to this and concluded that the price increase of RPI-X should be basically adopted, where RPI is the increase in the retail price index over a given period of time and X is the percentage improvement in efficiency, which should be capable of achievement by the industry in question. To be effective, however, it is essential for the regulator to have adequate information. At the same time: a)

over a long period one cannot ignore the return being achieved on capital employed, as otherwise an organization may well go out of business;

b)

when an industry is very much influenced by external factors it may be necessary to add a Y factor, for example, where primary fuel prices increase, say in the case of gas or electricity;

c)

the formula cannot be continued without some periodical review, if only to look at the X factor. The question arises as to when such review should take place;

d)

should one work on the basis of an actual or an estimated X, that is, in arrears or in advance?

e)

should X be identical for all of the units within a particular industry?

f)

should the price increase be related to average prices or, say, to a "basket" of services.

Price regulation in the electricity supply industry will generally follow the lines above, except that because of competition, the generators will not be subject to economic regulation. The Secretary of State, however, will examine the initial contracts between the generators and the distributors. The distributors will have to buy electricity on the most favourable terms.

66

Frederick Bonner

This is especially so as the Y factor in the price formula will be related to average generating costs of the industry as a whole. Cross subsidies will not be allowed.

Regulation and Approvals

There are detailed provisions regarding the obtaining of consents for new power stations and transmission lines. Statutory undertakings will have compulsory purchase powers and there will also have to be a supply code, but present environmental regulation will probably be continued. Consumer protection will be introduced against the failure to obtain specific standards of performance and there will be regulation relating to supply and safety. Each electricity company will have to obtain a licence. There will effectively be four different varieties: 1.

Public Electricity Supply Licence, which will be required by distributors;

2.

Transmission Licence, which will be required by the National Grid Company;

3.

Electricity Generator's Licence for those involved in generation;

4.

Licences to supply premises (called "second-tier licences") for those who supply customers direct.

These licences will be given for an initial duration of 35 years (with 10 years notice of termination being required). Distributors will be enabled to own some generating plant themselves up to a given limit so that they do not effectively operate a vertical monopoly.

The Water Industry

By way of analogy, one can also note that the privatization of the ten water authorities in Great Britain is by no means easy. Many have doubted the logic of transferring the water industry to private ownership, although a number of privately owned statutory water undertakers already exist and have been the subject of take-over bids by a number of French companies. The water authorities have also embarked on this activity but with the government making clear that they will not provide public funds for this purpose. There has been no suggestion of introducing more competition into the industry because it is basically a natural monopoly. A Director-General of

Privatization of Utilities in the UK, with Special Reference to Electricity Supply

67

water supply has been appointed to monitor prices and the quality of water supply. There was debate over whether a National Rivers Authority should take over certain functions from the privatized companies. The Authority would effectively be responsible for controlling the extraction of water from rivers, monitoring water quality, supervising flood protection, conserving fish stocks, and overseeing the recreational uses of lakes and rivers. Finally, the establishment of a National Rivers Authority was adopted. A major problem is how revenues of the privatized companies will be collected, following the abolition of domestic rates (local taxation). The rateable values (which are based on hypothetical rents) have been the basis for levying water charges, as well as for local authorities to levy their own rates. Water metering seems to be a logical alternative but it is expensive although it clearly has some advantages. Some thought is now being given to a standard licence fee for all unmeasured customers- equivalent to 100 per cent of the standing charge. The water authorities have vast land holdings and there is a public fear that in order to raise funds, some will be sold off, thereby reducing recreational land and damaging the countryside. Again, legislation is being contemplated.

Conclusions

The foregoing demonstrates the complexity of the privatization of the public utilities currently under consideration. Electricity is probably the most complex and it shows that unless there can be competition, as in generation, there cannot be any deregulation of the natural monopoly. A complex regulatory system has to be introduced as a proxy for competition in order to control the use of monopoly powers. It is also clear that while there may be some change in structure there will also need to be control of conduct, which is less easy. It remains to be seen how successful regulation will be in practice. Again, the success of the privatization process depends very much on the marketability of the industry. Any open-ended commitment on nuclear power will deter likely investors. Profit will certainly have to be increased above the present level, which is already affecting electricity prices. Not unexpectedly, the government is effectively transferring to the Director-General of Electricity Supply many of the functions which they had with regard to the nationalized industries, although some have been retained. The complex system of generator/ distributor contracts (rather than the grid acting as a market maker, it will be the common carrier) will involve additional administrative functions and, indeed, the whole regulatory regime could be a deterrent to new entrants on the generation side. Moreover, there will be a "golden share" and a limit of 15 per cent of ownership for any one shareholder to act as a deterrent to would-be predators and prevent take-overs among the new

Frederick Bonner

68

companies. On the other hand, these provisions will tend to make the companies bid-proof, thus taking them out of the "market for corporate control". This removes some of the pressure for efficiency. One wonders whether the government has been wise in attempting such a radical change in more or less one move in a relatively short time. Other countries have been much more cautious in making changes and perhaps it would have been a better approach if one or two organisations in the industry had been privatized in the first instance so that one could see how privatization worked before making a leap forward! Electricity supply is far too important an industry to have it go wrong.

NOTES 1.

Vickers and Yarrow, Privatisation and the Natural Monopolies. (London: Public Policy Centre, 1985).

2.

Bishop and Kay, Does Privatisation Work (London Business School, 1988), particularly ch. 4.

3.

"Privatising Electricity", Cm 322 (HMSO London, February 1988).

4.

"Privatisation of the Scottish Electricity Supply Industry", Cm 327 (HMSO London, March 1988).

5.

James C. Bonbright, Principles of Public Utility Rates (New York: Columbia University Press, 1961 ).

Part III Telecommunications

V. The Liberalization and Privatization of Telecommunications The Malaysian Experience

TOH KIN WOON Introduction

The objectives of this paper are fivefold. The first is to describe the process and proposed mode of privatization of telecommunications services in Malaysia. The second is to discuss the problems encountered in this privatization exercise. The third is to examine the mode adopted to regulate both the quality and the prices of telecommunications services. The fourth is to describe the liberalization of these services while the final objective is to discuss some issues related to this privatization exercise in Malaysia. There is no denying that telecommunications services are fast gaining importance as an input into the other economic sectors, such as banking, finance, retailing and transportation. The manner in which the telecommunications industry grows and develops leaves, therefore, a significant impact upon the other sectors. In fact, the successful development of many sectors, in particular banking and finance, depends heavily upon telecommunications becoming a technologically modern and efficient sector. It is imperative, therefore, that every effort be made to improve its performance and efficiency if growth of the economy is not to be impaired. Realizing this, the Malaysian authorities embarked upon the first phase of privatizing telecommunications some years back. It is hoped that, ultimately, when the transfer of ownership to private hands has been completed, the discipline of the capital market will be brought to bear upon the privatized telecommunications agency. This, together with its commercialization and its exposure to more competition that comes with the liberalization of the industry, will hopefully bring about the desired improvement in the quality and quantity of services, lower prices and technological advance. The newly privatized agency will then be better able to respond to market conditions with the reduction in bureaucratic rigidities and inflexibility while substantial amounts of revenue can also be raised through privatization. Furthermore, it is hoped that privatization will help relieve the administrative and financial burden of the government and contribute

72

TohKin Woon

towards meeting the objectives of Malaysia's New Economic Policy (NEP) (Malaysia 1985, p. 1).

Mode of Privatizing Telecommunications in Malaysia The privatization of the Department of Telecommunications (DOT) in Malaysia involves two stages. The first, the corporatization phase, has been completed. This involved the incorporation of the department into a public company registered under the 1965 Companies' Act. It was effected on 1 January 1987 with the establishment of Syarikat Telekom Malaysia Berhad (STM), the successor public company, with a share capital of M$500 million. A Telecommunications Services (Successor Company) Act 1985 (Act 322) was passed through Parliament to enable the government to transfer the assets and liabilities of the previous DOT to STM. Since 1 January 1987, STM has taken over responsibility for the provision of telecommunications services and network. STM conducts its activities and exercises its responsibilities under a twenty-year licence issued by the Minister charged with the responsibility for telecommunications. The terms and conditions of the licence stipulate the obligations that STM must undertake. These include the provision of rural telecommunications services and the offer of employment to all employees previously employed by the DOT for a period of five years on terms and conditions no less favourable than those they enjoyed while serving as employees of the government. Upon its corporatization, STM invited some top-level private-sector management personnel to sit on its Board of Directors as well as hold senior managerial positions in a bid to infuse the corporate culture into this erstwhile government entity. While the first stage has been completed, the second is still in its planning stage. This stage involves the sale of a portion of the equity of STM, which is currently wholly owned by the government, to the public via a public floatation. A listing of these shares in the Kuala Lumpur Stock Exchange (KLSE) will also be sought. It is as yet uncertain when this public floatation exercise will be launched as there are still several problems to be resolved.

Problems Faced 1.

One of the most difficult problems is that pertaining to land. Titles have not been obtained for much of the land, including those on which major exchanges are located. In Malaysia, land is a state matter. Much of the land on which the telecommunications facilities are located was alienated to the DOT by the various state governments for the specific

The Liberalization and Privatization of Telecommunications

73

purpose of providing telecommunications services by a federal government agency. Now that the services are run by a private company, there is the legal problem of whether this private company can continue to occupy state land alienated to a federal government agency. This problem has been overcome in part by the passage through Parliament in 1988 of an amendment to the Federal Constitution that enables state governments to sell land to STM at commercial rates. But this administrative process is likely to be lengthy. In some instances, the DOT had paid for land originally alienated by the state to the Federal Government. Since the titles are still not in STM's name, further payments may be required to secure such land. 2.

Before a public listing for the shares can be sought, there is the need to maintain proper accounts. Prior to incorporation as a public limited company, the accounts of the DOT were not properly kept. The accounting procedures were weak while management information was lacking. One of the major tasks that STM has to perform is the reconciliation between assets recorded in the books and the actual assets, while there is also the need to revalue all the assets and liabilities according to commercial accounting criteria. The need to perform this time-consuming exercise led to a delay in the preparation of the statement of accounts for 198 7, the first year of operation of the STM as a private concern.

3.

The third factor that may hinder STM's progress towards eventual public floatation is the condition imposed by Malaysia's Capital Issues Committee (CIC) that a company seeking a listing of its shares on the KLSE must have a proven track record of continuous profits for a minimum period of three years. In its first year of operation, STM incurred a loss of M$96.63 million for the year ended 31 December 1987, after making a provision for extraordinary items of M$1 01.54 million (STM made a pre-tax profit of M$4. 91 million for the year before such a provision). These extraordinary items comprised understatements of various provisions, including provisions for pensions and gratuities, stock obsolescence and doubtful debts. It was also found that the net assets transferred from the DOT to the STM were overvalued. The fact that STM has been forced to shoulder the burden of providing for these extraordinary items will slow down the progress towards eventual divestment.

4.

The fourth factor that may hold back the public floatation exercise is the need to allow for a time period between incorporation and floatation to enable employees to adjust to the discipline of the private sector. Reservations and doubts have been expressed whether those

74

TohKin Woon

previously employed in the civil service environment could provide the much hoped for efficiency and innovativeness normally associated with a private sector organization. Although experiences in other countries do not totally confirm these fears, it is still felt that a transition period of, say between 2 and 3 years from incorporation, is required to progressively infuse private sector work ethics into STM's work-force. The fact that STM provides an output where the quality of customer service is important makes it imperative that this exercise be carried out. Regulation of Telecommunications in Malaysia

The eventual transfer of ownership from the government to the private sector, whether wholly (which is unlikely) or partially, does not alter the fact that the telecommunications industry continues to remain a monopoly (unless alongside privatization, the entire industry or parts of it are exposed to competition). The substitution of private for a public monopoly is a poor swap and immediately calls for a need to regulate the industry , especially with regard to standards and the prices of output. Unless this is done, there is the real danger that the newly privatized company may exploit its monopolistic position to the detriment of the consumers. In the United States of America, the telecommunications industry is regulated by the Federal Communications Commission (FCC), with the Office of Telecommunications (OFTEL) being the equivalent regulatory agency in the United Kingdom . In the United States, the FCC adopts the rate-of-return method to regulate the prices of output of the industry. Under this method, the FCC fixes the maximum prices that the industry can charge to ensure that it makes no more than a "fair" rate of return on its capital (The Economist, 30 July 1988, p. 67). If it makes more or less than this, prices are lowered or raised. This has two defects: 1.

There is little incentive to improve efficiency. If by reducing costs, the industry makes bigger profits, these will be clawed back in lower pnces.

2.

It may encourage over-investment. The industry has an incentive to expand its capital base (on which the rate of return is allowed) to increase its absolute profits.

In the United Kingdom, OFTEL uses a second method of regulation called "Retail Price Index (RPI) minus X". This allows prices to increase by no more than the annual rise in a country's retail price index less X percentage points, where X is determined by efficiency improvements expected from the industry. This formula does provide some encouragement for efficiency improvement since the extra profits that arise from the difference between

The Liberalization and Privatization of Telecommunications

75

the expected and actual productivity increase can be kept by British Telecoms (BT) (The Economist, 30 July 1988, p. 67). Still, the formula has two flaws: I.

It applies only to average prices. BT can reduce some prices to fend off competition and increase them where it has a monopoly.

2.

OFTEL depends on BT for information on its potential for efficiency improvements. BT has every reason to mislead in order to obtain generous price increases (The Economist, 30 July 1988, p. 67).

In Malaysia, neither of the two methods of price regulation are adopted. Instead, the mode of regulation may be said to be founded on so-called pragmatism. Tariff increases for services produced by STM can be entertained but only after the necessary approval has been obtained from the Minister in charge of telecommunications. The latter will be advised by the regulatory agency called Kawalselia set up by the DOT. The latter has been stripped of its operational role, which is now played by STM after the latter's incorporation, but retains its role as a regulator. In deciding whether to advise the Minister to approve, to amend or to reject the request from STM for a tariff increase, Kawalselia is not guided, as mentioned earlier, by any fixed formula. It is guided only by a section in the Telecommunications (Amendment) Act 1985 (Act 628) which describes the functions of Kawalselia, which are, among others, to promote the interests of consumers, purchasers and other users of telecommunications services or operators with respect to prices and the quality of services; to regulate any aspect of telecommunications and the running of telecommunications services network and the establishment of standards and their enforcement. The official position is that such a provision is, for the moment, sufficient to protect the interests of consumers since the Minister is, after all, accountable to Parliament and has to answer for any unwarranted price increase. Moreover, the fact that STM operates under a licence means that the government retains the prerogative of reviewing its monopoly position. But in the absence of any formula, the decision whether to grant or reject STM's request for a tariff increase will clearly be arbitrary. Such a situation does not provide any incentive for improvement in efficiency either. It is true that the threat that the licence can be withdrawn from STM may provide some protection against unjustified price increases but such a threat appears in theory only, especially when STM has already been given a twenty-year licence to operate.

The Liberalization of the Telecommunications Industry

While the national and international telecommunications network in Malaysia have been retained under the ownership and control of a

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monopoly, other aspects of the industry have been liberalized somewhat. Customers can own and maintain their own terminal equipment, whether telephone, telex or data terminals, provided that such terminal equipment has been type-approved, or they can choose to use terminals supplied by the DOT. Approvals are granted by the DOT which, therefore, has an advantage over other suppliers since customers will prefer to acquire terminal equipment direct from the DOT, fully confident that these must be of the approved type. The DOT can also delay or withhold the approval of equipment supplied by others in order to have a monopoly of the terminal equipment market. Similarly, the maintenance ofPABX can also be carried out by private firms. In the supply of telecommunications equipment, some competition has been introduced. There are several companies producing and supplying pagers, telephones, telex and telefax machines. STM on its part acquires some of these terminal equipment (for example, telephones) for onward rental to consumers through competitive bidding by several telephone manufacturers. For several years, some projects have been contracted out to private telecommunications companies, some on a turnkey basis. The biggest of these was the laying of M$2.4 billion worth of cables, the contract for which was equally shared among the four major telecommunications contractors, Uniphone, Binafon, Electroscon and Sericom. Interestingly, almost all of the four are owned by ex-senior employees of the Department of Telecommunications, Malaysia.

Evaluation of the Privatization of the Department of Telecommunications

Malaysia's experience in privatization in general, and that of the telecommunications industry in particular, has not been long. Since it takes time for privatization exercises to bear fruit, it may be too early to assess and evaluate the performance of government-owned entities following privatization. Still, it is useful to review the privatization of the telecommunications industry in order to draw out certain conclusions with regard to: 1.

the extent to which the specific privatization objectives of the telecommunications sector and the more general objectives outlined in the Government Guidelines on Privatization have been achieved;

2.

the performance of STM; and

3.

the specific constraints which have restricted the achievement of the full benefits of privatization.

Increasing Efficiency Let us begin by looking at the extent to which the objective of improving economic efficiency has been or is likely to be achieved. There are three

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aspects to the degree to which the industry has been opened up to competition, the extent to which management has improved, and finally the quality of telecommunications output. 1.

Theoreticians have stressed that privatization, in the sense of the transfer of ownership from the public to the private sector, will not by itself bring about the much-hoped for improvement in efficiency. But privatization accompanied by steps to expose the industry to competition will (Kay and Thompson 1986, p. 22), for competition in the product market encourages firms to supply goods desired by consumers at a price which reflects the cost of production, while private ownership would subject the firms to the discipline of the capital market, such as the need to avert the threat of take-overs from others for corporate control and queries from shareholders should the profit performance of the company be unsatisfactory. In Malaysia, the ownership of the telecommunications industry has not as yet been transferred to private hands (although there are plans for partial divestment by 1990) while liberalization of the industry has been carried out only to a limited extent. Essentially, the STM has a monopoly over basic telecommunications services, of which voice communication is the dominant product. Even where licences or contracts have been given out to private sector firms for the provision of non-basic value-added services (VAS) and the supply of terminal and customer equipment, not much competition has been generated in most instances. What is happening is the fragmentation of some segments of the industry, each of which is in turn monopolized by different groups. For example, urban public pay-phone services are currently monopolized by Uniphone. This is not to say that no progress at all has been achieved in this regard. Licences have, for instance, been issued to several companies to operate paging companies and to manufacture and market terminal equipment.

2.

Although the telecommunications industry has not as yet been opened up to much competition, the incorporation of STM has at least placed the latter within a more commercial milieu. For a start, the industry is now freed, although not completely, from governmental bureaucratic rigidities. As a result, the personnel recruitment process is now more liberal and the management system more adaptable and flexible. Various professionals from the private sector have been recruited and this has led to the infusion of a measure of commercial culture into STM. Various foreign consultants have also been employed to improve management operations. But a major management problem confronted by STM is that it currently still faces a shortage of professional accountants, systems analysts and marketing personnel to help modernize its management system.

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As mentioned earlier, STM has not been totally freed from civil service rigidities. It is still required to seek Treasury approval for tenders exceeding M$15 million and to submit five-year development plans to the Economic Planning Unit for consideration. As stipulated in its licence, STM cannot abandon commercially non-viable projects in view of the government's commitment to carrying out its social obligations. This has led to a considerable amount of crosssubsidization for rural telephone subscribers by their urban counterparts in the basic voice communicatio n service, since the tariff for this service is calculated on the basis of the cost-plus pricing principle, that is, average cost plus a profit mark-up. 3.

There is no denying that as a result of the commercializa tion process, the quality of both product and customer services of STM has improved. For example, the detailed billing system has reduced errors, counter service has improved while the response to applications for telephone installations is now quicker. The backlog of those waiting for telephones has been reduced from about 200,000 to 50,000. Meanwhile, plans are afoot to further improve customer service. There is a suggestion that rebates be given to customers for the period their telephone lines are out-of-order. This provides an incentive to STM to step-up repair work, for failure to do so could result in much foregone earnings.

Reducing the Financial Burden on the Government 1. It is still too early to assess the extent to which the privatization of the telecommunica tions industry has led to a reduction in the fiscal burden on the government. But as STM improves upon its turnover and profitability, the government's revenue receipts from STM should grow via corporate tax (although STM has been granted exemption from paying income tax for a period of three years), licence fees equivalent to 0.5 per cent of turnover, dividends as a shareholder, assessment fees, and charges for postal services. It is also immediately relieved of the need to provide housing subsidies, salaries, pensions and medical benefits to former employees of DOT. The government has, of course, foregone its revenue from the DOT after the latter's incorporation as a private company. The net fiscal benefit can, therefore, only be ascertained after comparing both costs (including foregone revenue) and revenue. 2.

As STM is now responsible for its own funding and the raising of its loans without any government support, this has eliminated the government's necessity to borrow on behalf of the DOT. This should help to reduce the public sector borrowing requirement and, therefore, public sector debt.

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Apart from the various sources of revenue mentioned earlier, there is a very big potential source of revenue, which has not yet materialized. This will come from the sale of part of the equity, now entirely owned by the government, to the public via a public floatation. But, as in earlier exercises, there will always be the possibility of considerable under-pricing of shares. This arises from the desire on the part of the government to disperse the ownership of shares to as wide a spectrum of the population as possible. But under-pricing can lead to substantial loss of revenue for the government. It will also bring about a transfer of wealth to those who will successfully obtain the shares from those who will not, since most public issues have been oversubscribed, and since the very definition of under-pricing implies a gap between the subscription price and the price the shares will fetch on the KLSE. To overcome this problem, the authorities ought to sell the shares in various tranches, charging each successive tranche what the traffic can bear.

The Impact on the Capital Market The public floatation and subsequent listing of STM's shares are likely to add further depth to the KLSE. But there are several issues to consider in this exercise. One, that of possible under-pricing, has already been mentioned. The other is a possible conflict among the different objectives of public divestment. To reduce under-pricing, shares can be sold at a premium but the amount depends on the profitability of STM, which in turn is determined by its market structure. Generally, the more competitive the industry is, the less the premium and, therefore, the less the possibility of maximizing net proceeds from the sale of the shares of STM. There is clearly a conflict between protection against monopolistic exploitation of consumers and the promotion and maintenance of effective competition in the telecommunications industry on the one hand and revenue maximization from the sale of equity on the other (Vickers and Yarrow 1986, p. 229). Then there is the question of the absorptive capacity of the local capital market and the timing of the issue. The authorities have to consider the absorptive capacity in order to determine the amount of the issue (the portion of the equity that the government itself wants to retain is the other) while timing, such as the state of the local bourse (besides technical factors such as yield, net asset backing and the price/earnings ratio), is important in determining the price of the issue. Labour One of the major constraints faced by STM is the requirement that the latter must employ all previous employees of DOT, numbering amount 29,000, on terms and conditions no less favourable than those they were previously used to, for a period of five years. This has been adhered to but not without

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problems. Going strictly by commercial criteria, only employees who are efficient and productive should be hired while unproductive personnel will have to be fired. But, as it is, STM has to retain all, regardless of their productivity. This has given rise to a burgeoning of financial costs. To contain the rise in wage costs, STM has reduced both overtime payments and travelling allowances. The National Union of Telecom Employees (NUTE), which represents employees in the telecommunications industry, is obviously not happy with this move on the part of STM. In early 1988, it was on the verge of issuing strike ballots to demand the payment of two months' bonus. But the long-term fear of the union is that many of their members may lose their jobs after the five-year moratorium on retrenchment is over. This fear has, however, been allayed by the management of STM which reaffirms that STM's policy is not to reduce staff but to expand business. Government Debtors Another constraint faced by STM, which unless overcome can affect adversely its revenue, is the difficulty it faces in collecting debts from the various government departments. The pre-privatization culture remains as most government departments still perceive telecommunications services to be a basic right to be provided free of charge. Interrupting services as a means of collecting debts would only elicit retaliation from these departments, which include the police, transport department, and other similar bodies. In addition to collection problems, STM may also encounter difficulty in revising its rates for maintenance services that it provides to some government departments. Conclusion It is important to stress that privatization alone will not improve efficiency unless accompanied by efforts to liberalize and deregulate. It is only the

interaction between privatization and competition that produces the much-hoped for productivity increase, improved range and quality of services to satisfy consumer needs, and technological advance. It has often been argued that telecommunications, like many other public utilities, is a natural monopoly and that there are solid reasons for bringing it under the ownership of a single corporation, particularly in countries with a small domestic market. Given the strategic importance of telecommunications services, this sole ownership is normally vested in a government agency. Following from its structure as a natural monopoly, competition, it is argued, will lead to the duplication of capacity, which can be wasteful. But this is not wholly true, for the technical nature of telecommunications is such that not the entire industry is naturally monopolistic. Of the three major elements making up the telecommunications industry, namely, the supply of equipment, the running of networks and the supply of services, the evidence is that a natural monopoly is more likely to exist in

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telecommunications network facilities, that is, switching and transmission (Vickers and Yarrow 1986, pp. 223-24). Hence, only the running of networks, especially local networks, need be brought under sole ownership but the rest can be exposed to competition. The market structure of the telecommunications industry is also never static. This is because technology is constantly advancing, and it is highly possible that technological change may transform a natural monopoly into an industry in which cost conditions permit effective competition (and vice versa) (Vickers and Yarrow 1986, pp. 222-23). In the case of Malaysia, a good part of the industry is naturally monopolistic, especially given the limited size of the domestic market. It is thus not easy to generate competition. Already, there is considerable excess capacity as reflected in only half of the telephone lines being utilized and the high stock levels. Be that as it may, efforts to open the industry to competition must continuously be made. Privatization should not merely lead to the establishment of private, in place of public, monopolies. Where it is unavoidable, however, as in some types of services, there is a case for regulation to prevent the exploitation of consumers through the exercise of monopoly power. Such regulation should be guided by a formula in order to minimize the use of discretionary powers on the part of the regulatory agency. Regulation is also necessary to ensure that the social obligation of providing rural telecommunications services is carried out even though this may require STM to compromise on its commercial objective. REFERENCES Kay, J.A. and D.J. Thompson. "Privatisation: A Policy in Search of a Rationale". Economic Journal 96, no. 381 (March 1986). Malaysia, Economic Planning Unit. Guidelines on Privatisation. Kuala Lumpur: Prime Minister's Department, 1985.

The Economist, 30 July 1988. Vickers. John and George Yarrow. "Telecommunications: Liberalisation and the Privatisation of British Telecom". In Privatisation and Deregulation - the UK experience, edited by Kay, Mayer and Thompson. London: Oxford University Press, 1986 ..

VI. Privatization of Telecomunications Services in Singapore TOH MUN HENG and LINDA LOW Introduction Privatization in general, and of telecommunication services in particular, appears to be a world-wide phenomenon (Snow 1985a; Snow 1988; and Hills 1986). In Singapore, the Economic Committee (Singapore Ministry of Trade and Industry 1986) has selected the Telecommunication Authority of Singapore (TAS), or more recently renamed Singapore Telecom, as one of the statutory boards which may be privatized. 1 The main objective of this paper is to study the economic feasibility and implications of this proposition. The proposed privatization of Singapore Telecom differs from that of other telecommunications authorities in two respects. Even after the Report of the Public Sector Divestment Committee (PSDC) (Singapore, Ministry of Finance 1987), Singapore Telecom, like other statutory boards, is still in the stage of engaging consultants to look into its feasibility rather than how it is to proceed. 2 Secondly, unlike the financial and inefficiency problems which prompt privatization in other countries, Singapore Telecom has grown from strength to strength as a statutory board. A broad definition of "privatization" covers a range of alternative means of exposing the public sector to competitive market forces (Shackleton 1984). At one end of the scale, liberalization introduces more competition in a traditionally monopolized industry by relaxing some of the legislative controls, such as restricted entry, which preserve the statutory monopolies. Liberalization occurs if new ventures, either from the private sector, or jointly with the public sector, form to take over the provision of some services under a contract, or if private capital is invited on a project basis. It may lead to higher efficiency, greater innovation, and consumer choice. It could also lead to "cream-skimming" (Snow 1985a) as private enterprises are more likely to engage only in profitable activities, leaving the unprofitable ones to the former public monopoly which usually cross-subsidizes them. Liberalization may precede any attempts to privatize and may be looked upon as a precondition to privatization.

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Deregulation, which also involves entry into activities previously restricted to public sector enterprises, is a form of privatization which is only applicable after a public enterprise has been privatized. It refers to the further transfer of control from the government to the private sector to make a regulated private company less regulated. A narrower or shorthand definition for "privatization" is the transfer of ownership from the public to the private sector (Kay and Silberston 1984). A company which is formed under a companies act and has at least 50 per cent of its shares subsequently sold to private shareholders is said to have been privatized (Beesley and Littlechild 1983). This is also called divestiture or denationalization. The next section gives a profile of the Singapore telecommunications sector, its response to technology and development, and its economic impact. This sets the arguments for and against its privatization, the issues and the effects in the following section. The last section concludes with some policy suggestions.

Development and Economic Impact of Singapore Telecom

The original statutory authority was the Singapore Telephone Board (STB), formed in 1953. A two-stage metamorphosis occurred: first, the merger of the STB in 1974 with the Telecommunications Department to form the Telecommunication Authority of Singapore (TAS), and then in 1982 with the Postal Services Department. Before these mergers, both the Telecommunications Department and the Postal Services Department were major revenue earners in the Ministry of Communications. Hiving them to a statutory board enabled a switch from a cost-centred to a more profitcentred corporate strategy and greater administrative and financial autonomy. Apart from this financial reason, the advent of electronic mail, starting with facsimile transmission, which at that time involved machines located in post offices rather than in offices or homes, for the delivery of a message which could be a postal or a telecommunications function, required either a joint venture or a merger to synergize efforts. Singapore, thus, appears to have moved backwards to the traditional postal, telephone and telegraph (PTT) framework. 3 Over the decades, Singapore Telecom has undergone three phases of growth. To keep pace with economic progress, Singapore Telecom has since 1974 strived to meet the shortage in telephone lines with massive investments in infrastructure. In the second phase from 1979, value-added services and electronic mail were emphasized and the merger of postal services was part and parcel of this phase. Since 1987, there has been increased outward orientation as the national network has diversified to become more internationalized in line with developments in the industrial and services sectors. A joint marketing effort is taken together with the

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Economic Development Board (EDB) and the National Computer Board (NCB). Both Singapore Telecom and the NCB complement the EDB's bid to woo foreign investment by providing reliable telecommunications services and forging the information technology image for Singapore. Like most statutory boards, Singapore Telecom is self-financing, with positive net revenue earned after deducting operating expenditure from operating revenue. As a rough rule of thumb, the rate of return as measured by the operating return on average net fixed assets was about 22 per cent in 1983/84. In 1984/85 when there was a recession which led to numerous cost-cutting measures to enable Singapore to regain its international competitiveness, the rate fell to 18 per cent, and to 15 per cent in 1985/86. These were still very respectable rates of return, at more than twice the prime lending rate prevailing in those years. It was at about 18 per cent in 1987/88. The deliberate policy of the government to have the public sector, including the statutory boards, to reduce surpluses which are contractionary in impact, thus resulted in smaller surpluses for Singapore Telecom. While profitability is not a yardstick of efficiency, Singapore Telecom is indeed the best performing statutory board by the size of its accumulated reserves. In the financial year 1988, it was the top among eleven statutory boards in contributing S$1 01 million, or 2 7 per cent of the total amount transferred under the newly enacted Statutory Corporations (Contribution to Consolidated Fund) Act 1989 (Straits Times, 5 June 1989). As a basic infrastructural service, telecommunications appears adequately provided by Singapore Telecom. It has diversified into the export of consultancy services under its new subsidiary, Singapore Telecom International (STI), formed in 1988. The STI has done jobs for Taiwan, Saudi Arabia and Columbia. In line with its aim of becoming an international business hub, Singapore has nurtured information technology (Toh and Low 1990) to enhance its locational and other comparative advantages as a service economy. Telecommunications per se cannot be an enclave sector, and integration and linkages with various services to develop a full service economy via telecommunications become vital (Toh and Low 1989).

Issues of Privatization

The many forms in which privatization can take, as discussed earlier, reflect the policy objectives of privatization. They range from methods which transfer ownership, with or without transferring control, to those not involving the transfer of ownership as in leasing and contracting out. Privatization may also be complete, partial or selective. The ultimate objective is for more competition although the socio-political policy implications may dictate the forms privatization may take.

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The PSDC appears to have opted for the narrow concept of privatization while Singapore Telecom has undertaken liberalization measures since 198 7. Before discussing both views, another conceptual issue to note is whether Singapore Telecom can be considered to have a natural monopoly. This is a unique issue in Singapore, given its small domestic base, as it may be difficult for more than one enterprise to operate profitably. The arguments for state-run monopolies vested in statutory boards to provide basic services, as in port services, utilities, telecommunications, broadcasting and many others, are also beyond economics. Besides the public good and externality arguments, security and assurance in supply, avoidance of wasteful competition in terms of scarce resources, especially of land, equity and even profitability, may be further arguments for state-run monopolies. These monopolies, like Singapore Telecom, Public Utilities Board and Port of Singapore Authority, have earned substantial profits. In the financial year 1988, the trio contributed S$1 01.0 million, S$99.2 million and S$52.6 million respectively to state coffers under the Statutory Corporations (Contributions to Consolidated Fund) Act 1989. 4 It is also the typical interventionistic style of the government to establish public enterprises wherever and whenever private initiatives are deemed lacking. However, the question cannot be meaningfully examined, given the lack of information on the Singapore Telecom's pricing principles, which seem to be based on cost recovery. 5 Prices are set to ensure that net revenue covers operating expenditure and the development and improvement of infrastructure. One may deduce that efficiency is attained in spite of the monopoly status as Singapore Telecom's charges are among the most competitive in the world. 6 A hypothesis is that a slack pricing policing is also practised whereby Singapore Telecom does not necessarily charge the cheapest rates but what the market can bear, so long as they are among the most competitive. In this respect, Singapore Telecom behaves as a price follower and enjoys a surplus which may be reduced in a contingency, such as in a recession. Cross subsidization between any two services is not practised. However, among departments, some practice of "transfer pricing" appears acceptable as one department, say for international telephone, may pay another, for national telephone, an imputed cost. It is also difficult to prove empirically whether the principles of a contestable market structure are at work. A contestable market is one in which a monopoly takes note of potential competition. Singapore Telecom, being a prime infrastructural industry for the island economy, has a need to offer efficient and reliable supportive services to be in tune with the national development strategy based on attracting foreign investment. Hence, it has to maintain internationally competitive prices under a perfect competition pricing mechanism.

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A related issue on pricing is the flat rate tariff structure which does not offer any quantity discounts to heavy user groups, as envisaged under a monopoly practising price discrimination or a multi-part tariff structure. Subsidization occurs between large and small users and the end result is a smaller deadweight loss than if there was no price discrimination. For internationally leased circuits, for instance, a flat rate is charged, assuming a 24-hour usage, and there is no option for time-sharing of the same leased circuits either. For international telephones, the three-tier rate structure has promoted social calls after peak hours and fuller utilization of otherwise idle facilities. Liberalization may even promote competition further by widening consumer choices and overcoming rigid tariff rates. Another conceptual question which affects the privatization of Singapore Telecom is whether the integration of postal services in 1982 was a retrogressive step. In contrast, British Telecom hived off postal services in 1981 before its privatization in 1984. For all intents and purposes, postal services would be least, if not wholly, not privatizable. If private courier companies were allowed to handle all ordinary mail, issues of creamskimming, equity and reliability may arise. These problems do not emerge as long as the PTT functions remain under one statutory roof. Two core issues on privatization may be posed. One concerns how privatizable Singapore Telecom is, or what privatization principles are valid. In the Singapore context, there can hardly be a situation of telecommunications being completely in private hands even if the latter were as regulated as the American Telephone and Telegraph Company (AT & T). With so much infrastructural costs and efforts sunk in by Singapore Telecom, the thinking appears to be that a bit of both deregulation and privatization is desirable, but more of ownership than control, to make telecommunications services more competitive. The second core issue is how to privatize Singapore Telecom, that is, the mechanisms or methods to be used. Thus far, the privatization of public enterprises, such as Singapore Airlines (SIA), has been through public offering of shares. It is likely that the same method will be used for Singapore Telecom, given that one of the stated objectives of the PSDC is to stimulate the stock market which lacks breadth and scope. One limitation of this method of privatization is that the government may not be perceived to be giving up control as ownership becomes "democratized" through many members of the public being given allotted shares. The government needs only to retain majority share in order to have the control. A cosmetic kind of privatization results without much change in the management and directorship of the company. This in itself may be intentional so as to cause minimum disruption to companies which had been doing well before privatization. Surrounding these two core issues are a number of peripheral ones, such as that concerning the degree of foreign participation in the

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telecommunications industry. Given the small size of the local investing public, the absorptive capacity may be quite limited unless members of the Central Provident Fund (CPF) are allowed to tap CPF savings. 7 For Singapore Telecom, which has an international clientele, some foreign ownership may be both unavoidable and desirable. The PSDC has recommended a limit of no less than 20 per cent for foreign participation, as presently applicable to the banks. Ideally, some local firms should take over certain privatized activities. However, given the competitiveness of multinational corporations (MNCs) with their global networks in telecommunications, the probability of foreign domination is high unless the government ensures some local share and participation. Otherwise, a transfer of wealth from one group to another, be they the consumers or producers, both local and foreign, may take place (Hills 1986, p. 31 ).

Implications of Privatization

The impact of new technologies is supposed to be conducive to more competition, especially in services and equipment. In this respect, Singapore Telecom has practised a rather liberal policy with the twin objectives of promoting an open market environment to ensure the best value for customer's money and to provide private suppliers with more market opportunities. Since the last quarter of 1987, users have been allowed to maintain their Private Automatic Branch Exchanges (PABX), Key Telephone System (KTS), and Multi Line System (MLS) equipment. At the same time, a provision for spares in the maintenance contracts was covered. The changes stimulated systems installations which rose by 19 per cent during 1987/88, compared to 10 per cent the previous year. Customers can own their extension telephones connected to their P ABXs and users of radio pagers can buy their own equipment instead of renting them from Singapore Telecom. Similarly, facsimile machines are sold rather than leased. In June 1987, further liberalization enabled users to buy existing extension telephones. From August 1987, extension telephone sockets and telephone wiring could be installed by private contractors as well as Singapore Telecom. The point to note is that privatization to promote greater efficiency and technological advance seems to have less validity in Singapore, given Singapore Telecom's efforts in these directions. The profit-seeking culture has permeated the policy-makers in the public sector, although no stipulated rates of return have been imposed on the management of statutory boards. As such, productive agencies, in particular Singapore Telecom, guided by such a culture are no less profit-centred or efficient than if they are privatedly managed, under a market-determined rate structure. The fact that there is no stipulated rate of return has enabled Singapore Telecom to avoid the adverse effect known as the Averch-Johnson (A-J) effect (Littlechild 1979,

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pp. 190-93). The A-J effect explains the behaviour of a monopoly firm seeking to maximize profits but which is subject to a regulatory constraint on its rate of return. The firm does not equate factor substitution to the ratio of factor costs and, consequently, operates inefficiently in the sense that social cost is not minimized at the rate of output it selects. It has the incentive to expand its capital base in economically inefficient ways in order to increase its gross profits. Such an A-J effect is absent in Singapore Telecom as far as can be observed. On the contrary, several developments have been initiated. Singapore is in the forefront of the latest telecommunications and postal services. These include the Intelsat Business Service (IBS), or high speed international digital leased circuits, Diginet, Home Country Direct Service for some tourists and business travellers, and other value-added Phone-Plus facilities. In infrastructure, a new international telephone exchange, coupled with an Integrated Services Digital Network (ISDN), enhances international business communications. There is a balance in the use of cable and satellite transmission media in Singapore. Through a network of international submarine cables, which also acts as telecommunications "highways", Singapore is linked to countries in Asia, Southeast Asia, Australia, the Middle East, Africa and Europe. An interactive videotex system called Teleview allows access to computer-based information and performs transactional services. The fully-owned subsidiary, STI, has extended consultancy services to export the expertise of Singapore Telecom abroad. All told, Singapore Telecom seems to be at the cutting edge of new technologies and the information age even before privatization. Given such high costs sunk into infrastructure, prospective competitors face huge up-front cash outlays and, hence, high exit costs unless alternative uses can be found for the investment in infrastructure. In Singapore's case, either Singapore Telecom retains such infrastructural investments or they can be properly costed for sale to private operators. The latter option is neither easy nor feasible. Satellite technology, microwaves and optic fibres may have made these costs less onerous, and telecommunications and cable broadcasting can provide alternative uses for the same network. Nonetheless, given the scale of investment, which does not commensurate with the size of the domestic market, competition in local networks is less likely than on long distance transmission where up-front costs are also lower. The traditional arguments for privatization are, thus, either weak or already obviated in the case of Singapore Telecom. It may be better to observe how telecommunications in other countries are being privatized, their rationales, methods and impact. In other words, through learning from the experiences and difficulties in these "proxy" markets, Singapore Telecom can be more insightful in evaluating and improving its services. Among the models which may offer examples of what services can be successfully privatized, the American model appears rather confusing

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compared to that of the Japanese where the distinction between two types of services is clearer. One is where the corporation owns the infrastructure and applies for a licence from the government to operate. The other is where the infrastructure is rented or leased, and the firm can practise "cream-skimming". The British model features regulated privatization (Beesley and Littlechild 1983). But in Singapore, the end results of higher efficiency and benefits for the customers may be reaped without actual privatization. Instead of a single scale to judge and assess regulation, the criterion of public use of private interest may be more useful for Singapore (McCraw 1984). The political forces towards privatization are no less in Singapore than in West Germany and France where liberalization and decentralization respectively are favoured. While privatization may on the surface appear unnecessary, a case for more competition is still relevant. It is important for Singapore to continue to remain at the forefront of the state-of-the-art technology in telecommunications services as part of its own development strategy, which emphasizes a service economy based on information technoloy, as well as being a leader in the region. Singapore cannot afford to lose out in the information revolution and it must maintain its comparative advantage by being the first and best in Southeast Asia in telecommunications services and infrastructure (Jussawalla 1983). As more intensive liberalization takes place, an apparent division in activities is discerned. On balance, it is strongly suggested that Singapore Telecom should retain its control and ownership in providing the infrastructure needed for efficient transmission, in services and in communications software. Apart from the high investment in existing infrastructure, the social cost embodied in new ones preclude private investment. Other hardware and equipment and the maintenance of certain services can be liberalized or privatized. However, even in these areas, Singapore Telecom must retain some check and control over private operators to ensure a high standard of service and technology. Similarly, in international trade, a government regulatory agency is desired to provide some watchdog functions. It may thus have to re-regulate these private enterprises to upkeep the spirit and Jetter of the powers as vested under the TAS Act of 1982. This is not in violation ofthe empirical evidence found in the Pacific Rim countries that deregulation tends to follow as economic development proceeds (Snow 1985b). The principles of free markets and competition are cardinal ones in Singapore. However, the uniqueness of a small, open and vulnerable economy must be underscored to support the slightly more interventionistic tendency of the government. Conclusion and Policy Suggestions

Technological advances have intensified competitiOn, which has also become globalized. Virtual monopolies, such as the AT & T and BT and the

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dual monopolies of Nippon Telegraph and Telephone Public Corporation (NTT) and Kokusai Denshin Denwa Co (KDD), have faced more ostensible competition (Dyson and Humphreys 1986; Evans, ed., 1983; and Faulhaber 1987). In general, deregulation and privatization do not constitute mechanisms of industrial policy. But as part of a process of gaining comparative advantage in the information technology sector, deregulation in these countries becomes a primary mechanism of their industrial policies. The American trend is away from the concept of telecommunications services with rights of public access to deregulation and privatization of both terrestial and space communications, to more specialized and differentiated services for business. In Europe, the responses to technological changes and new markets have been quite different. The greatest divergence appears to be between Britain, which follows a U.S.-style market-driven strategy, and France which has made it clear that it wants to retain governmental dominance in at least the public network, with peripheral concessions to competition and liberalization in other areas. The disparity epitomizes the argument that technology and markets do not alone condition specific political or institutional arrangements. Pragmatic, ideological, economic or political factors are just as important. Thus, a new political economy of deregulation that attempts to incorporate normative concerns by taking into account the political environment has evolved (Olson 1982; and Noll and Owen 1983). The decision to privatize is not straightforward and clear in Singapore, which seems to have moved a step backward as its four statutory boards deemed most privatizable have engaged consultants to look into the feasibility of privatization rather than how best to go about doing it. The traditional arguments for privatization found with other telecommunications authorities do not appear relevant in Singapore. Some of these include the provision of a wider range of products and services to widen consumer choice, increase employment, attract foreign investment, greater cost effective pricing, more market-oriented research and development, and response to new technologies. Singapore Telecom appears to have done sufficiently well on all these scores and has undertaken liberalization policies since 1987. However, this does not preclude wider and more competition. A more specific arrangement, as in granting a contract to private firms to provide highly labour-intensive services may be suggested. These include the laying of underground cables and pipelines and the installation and maintenance of telecommunications equipment located at the subscribers' premises. This would enable Singapore Telecom to concentrate on more capital- and technology-intensive higher value-added activities. At the same time, the private sector can also take over some specialized services within their technological competence, such as Teleview and Telepac. ~uch a strategy would allow Singapore Telecom to be more technology-dnven and scale

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newer technological heights and be more customer-oriented. These suggestions are well within the TAS Act of 1982. The Second Schedule of this Act has provisions which, for instance, allow Singapore Telecom to engage, in conjunction with other corporations, in the production, manufacture or sale of equipment either in Singapore or elsewhere. The only valid argument for the privatizatio n of some functions of Singapore Telecom remains that of stimulating the stock market which lacks both depth and scope. The Singapore stock market is small and it is historically very much tied up with the Malaysian market which has plantation and other commodity shares to offer. Well-timed floatation of stocks of viable government enterprises will, thus, meet with both the broadening of the stock market and the scaling down of the public sector. In conclusion, the proposed privatizatio n of Singapore Telecom should follow a global trend or be just the fashionable thing to do. Both merely not internationa l and domestic as well as technological factors together determine the appropriate market structure for telecommun ications in Singapore. It must also be latched on, be complemen tary and supplement ary to its overall development strategy, as well as to that of the region inasmuch as telecommunications go beyond Singapore's territorial confines.

NOTES I.

The Economic Committee recommended that "Telecoms should continue to provide the basic telecommunica tion infrastructure. However, wherever possible, we should privatize the provision of telecommunica tion services" (Ministry of Trade and Industry 1986, p.l78). The new corporate name, with effect from January 1989, is Singapore Telecom and this is used throughout the paper even when earlier periods are referred to, so as to avoid confusion. It was restructured in April 1989 to be more customer-orien ted and to adopt a globalization strategy; see Business Times, 22 February 1989.

2.

Besides Singapore Telecom, the other three statutory boards undertaking feasibility studies arc the Public Utilities Board (PUB), the Port of Singapore Authority (PSA) and the Civil Aviation Authority of Singapore (CAAS, formerly known as the Department of Civil Aviation).

3.

Under theTAS Act (1982), Singapore Telecom is empowered to provide, operate and maintain information communicatio n services, defined as "any service enabling communicatio n between person and person, thing and thing, or person and thing by means of telecommunica tions or for the transmission of postal articles by means of post". Broadcasting under the Singapore Broadcasting Corporation (SBC) is excluded from theTAS Act and is also excluded in this paper due to length constraints. Though the SBC is also identified by the PSDC, it is considered least privatizable.

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4.

Following the recession in 1985, the Economic Committee, which had representations from both the public and private sectors, recommended that public sector surpluses be cut. A one-time transfer of S$1 billion was made from the self-financing statutory boards. This transfer of surplus became more formalized through the 1989 Act with the amount to be creamed off equivalent to 20 per cent of the boards' surpluses, compared to the corporate tax rate of 33 per cent.

5.

From an interview with a senior officer in Singapore Telecom in January 1989.

6.

Since 1979, there have been nine rate reductions, giving savings of S$2.4 billion to consumers. These reductions have resulted in Singapore's International Direct Dialled (IDD) leased circuit and telex rates being the lowest in the world, as reported in Telecoms Annual Report 1987/88, p. 9.

7.

The CPF is a self-financing social security scheme with contributions from both the employers and employees. The government has liberalized the use of CPF savings and members can withdraw their CPF balances for approved housing and commercial properties, stocks and shares, local tertiary education and Medisave purposes.

REFERENCES Beesley, M., and S. Littlechild. "Privatisation: Principles, Problems and Priorities". Llyods Bank Review, July 1983. Dyson, K., and P. Humphreys. The Politics of the Communications Revolution in Western Europe. London: Frank Cass, 1986. Evans, D. S., ed. Breaking Up Bell: Essays on Industrial Organisation and Regulation. New York: Elsevier Science Publishing Co. Inc., 1983. Faulhaber, G. R. Telecommunications in Turmoil: Technology and Public Policy. Cambridge, Massachussetts: Ballinger Publishing Co., 1987. Hills, J. Deregulating Telecoms: Competition and Control in the United States, Japan and Britain. London: Frances Pinter, 1986. Jussawalla, M. "The Economics of Telecommunications Infrastructure for Third World Countries". In Proceedings from the Tenth Annual Telecommunications Policy Research Conference, edited by H. G. Oscar, Jr, P. Espinoza, and J. A. Ordover. Norwood, NJ: Ablex, 1983. Kay, J., and A. Silberston, "The New Industrial Policy: Privatisation and Competition". Midlands Bank Review, Spring 1984. Littlechild, S. C. Elements of Telecommunications Economics. London: The Institution of Electrical Engineers, 1979.

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McCraw, T. K. Prophets of Regulation. Cambridge, MA: Harvard University Press, 1984. Noll, R. G., and B. M. Owen. The Political Economy ()f Deregulation: Interest Groups in the Regulatory Process. Washington DC: American Enterprise Institute, 1983. Olson, M. The Rise and Decline ofNations: Economic Growth, Stagflation and Social Rigidities. New Haven, CT: Yale University Press, 1982. Oscar, H. G. Jr, P. Espinoza, and J. A. Ordover, eds. Proceedings from the Tenth Annual Telecommunications Policy Research Conference. Norwood, NJ: Ablex, 1983. Shackleton, J. R. "Privatisation: The Case Examined". National Westminster Bank Rn·iew, May 1984. Singapore, Ministry of Trade and Industry. Report of the Economic Committee. 1986. Singapore, Ministry of Finance. Report of the Public Sector Divestment Committee. 1987. Snow, M. "Regulation to Reregulation: The Telecommunications Sector and Industrialisation, With Evidence from the Pacific Rim and Basin". Telecommunications Policy 9, no. 4 (December 1985a). --."Arguments For and Against Competition in International Satellite Facilities: A US Perspective". Journal of Communication 35, no. 5 (Summer 1985b). Snow, M. "Telecommunications Literature: A Critical Review of the Economic, Technological and Public Policy Issues". Telecommunications Policy (June 1988). Toh Mun Heng and Linda Low "The Economic Impact of the Information Sector in Singapore". Economics of Planning 23, no. I ( 1990). --."Trends and Issues in Service Sector Development: Singapore's Options". Asian Economic Journal II, no. I (March 1989).

VII. Privatization of Telecommunications Services in Europe GODEFROY DANG NGUYEN Introduction

The privatization of telecommunications is part of a general movement affecting the telecommunications industry since a decade or so. Sometimes called deregulation, sometimes liberalization, sometimes privatization, this trend aims at loosening the control of the state over a crucial economic activity, telecommunications servicing. The confusion of terminology does not add to a better understanding. In this paper instead and in accordance with the overall setting of this volume, a distinction will be made between privatization, deregulation and liberalization, as it has been convincingly made by Waterson. 1 Examples of each category will be given with their relative weight in the European context. This will be followed by a description of the general economics of state-control loosening, its advantages and its limits. Finally, a general conclusion will be drawn on the specificity of the telecommunications sector and on the applicability of European solutions to different economic contexts. Privatization stricto sensu, that is, the transfer of ownership from the state to private shareholders, has happened in a spectacular way in the United Kingdom only. Some marginal transfers of ownership have also occurred in Italy and Spain, for SIP and Telefonica respectively, but this was made possible because both companies were already private, with majority shares owned by the state. In the U.K. case instead, the public company British Telecom has been made private and its shares sold to the public in one stroke, making this a most impressive move.

Historical Background to the Privatization Debate in Telecommunications

That telecommunications networks have to be run by a public administration is not obvious at the outset. After all, telecommunications services are commercial services, which can be operated by private companies and have been run in this manner in the United States, Canada, and the European

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countries, such as Spain, Hungary, Italy (partly) and Czechoslovakia until 1945. In fact, in Europe, two nationalization periods can be distinguished: Early nationalizations happened in the late nineteenth century and the beginning of the twentieth. It concerned large countries such as France, Germany and the United Kingdom, but also Switzerland (1881 ), Belgium (1893), the Netherlands (from 1881 to the 1930), and Sweden (1918). Late nationalizations happened after World War II in the countries which had been preserved from public monopoly before the war : Spain, Hungary, Italy, Czechoslovakia and Greece. The history of the development of the telephone in the late nineteenth and early twentieth century gives some useful insights into the privatization/ nationalization debate: 1.

Historically, the telephone has been a commercial invention exploited successfully by AT&T in the United States and abroad. But in some countries, this business has had to cope with public intervention. First, public networks have competed with private ones, then nationalization followed, economically motivated by arguments such as natural monopoly.

2.

But public intervention has not been the rule everywhere. In some countries where economic conditions were not so favourable, the state left to a private, often foreign (ITT and Siemens, in particular) company the task of developing a telephone network. Nationalization occurred much later, when the network had reached a reasonable size.

What are the arguments for nationalization? Some of them applied during the early development period when the network had to be built and were used during the first nationalization period. They are investment arguments and can be used as such in the Third World now. Other arguments for nationalization appeared in the debate when the network had reached a sufficient degree of penetration. They relate mainly to public service considerations. Development-related Arguments for Privatization They all relate to infrastructure provision. The most reliable one is the social versus private discount rate debate. It has been argued by economists that the private discount rate of investment, measured by the interest rate on financial markets, does not take into account socially beneficial externalities, which cannot be internalized. Furthermore, because of the :__..-,..,. .... +..... ..-..-+-~"...., Af' -m~rJcptc;;: thP 1PvP1 n.f ~....,t.ar.a.cof-

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a risk premium for the eventuality of the non-solvability of the borrower. By using a lower discount rate, taking into account social and business externalities, and by not being limited by solvability issues, a state company is able to undertake investment which would be considered as unprofitable by a private investor. Therefore, the development of the infrastructure would be faster under public ownership. Is there empirical evidence for this in telecommunications? A full answer to this question would require a careful analysis of a host of data, which is beyond the scope of this paper. Some crude evidence can be supplied, however, which shows that in some cases, the argument might be true. The nationalized Swedish PTT (post, telegraph and telephone) has over seventy years developed the most dense network in the world (60 main lines per 100 inhabitants), ahead of the U.S. network which is in the hands of private firms. The French network also has risen from 5 million connections to 21 million connections from 1972 to 1981 : this performance would probably have been difficult for a private firm to achieve, simply because the debt/output ratio would have been considered as too risky by private lenders. This brings us to another, more subtle investment-related argument, that is, over-investment by public companies in order to avoid taxation. In fact, a private firm would be subjected to general fiscal schemes, such as tax on profits. A public company on the other hand may eschew this, but its net result would have to be near zero, because the state would be tempted to take away money where it can be found. By over-investing, a public company would be preserved from this. A second line of argument concerns the development of telecommunications in less favoured regions. This is also an externality type of argument, which states that the economic take-off would greatly benefit from the setting up of basic infrastructure to attract private investment. Since the telephone is such a basic infrastructure for business, and since private ownership of the telephone network would lead to investment in favoured regions (which are already profitable) instead of the less favoured, nationalization would avoid an imbalance in the development of the country. Once again, some empirical evidence confirms this argument. In Italy, where the telephone industry was given to private, local interests, the development of long-distance, inter-city traffic was completely neglected, and the government had to nationalize this activity in 1923. Some more wealthy regions, such as Piemonte or Lombardia, have had faster telephone development than other regions. Finally, a third line of argument has nothing to do with economics and involves the role of the state as an institution which represents more than the collection of interests of its citizens. The state warrants privacy and, therefore, the secrecy of correspondence. This is the legal foundation of the

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state postal monopoly, which has been naturally extended to the electrical transmission of messages (telegraph and telephone). The need for the defence of the nation and the importance of transmission for such needs would require the state to control, provisionally or permanently, telecommunications infrastructure. In the development phase of the network, this control as well as the guarantee of privacy would compete with commercial objectives. Public Service Arguments In most European countries, the telecommunications networks have achieved a degree of maturity which render obsolete the developmentrelated arguments for nationalization. However, there are still proponents for nationalization, which is the dominant position in Europe, since only the United Kingdom has, up to now, undertaken privatization. The first and major motive for nationalization, together with monopoly, is the cross-subsidy issue. Local traffic charged at less than cost is subsidized by long distance traffic, because it gives to households - the major makers of local calls - some access to telephone usage. The difference is paid by business customers who have to use more long distance traffic and have the financial capacity for this. The cross subsidization of long distance to local traffic has thus a distributive purpose. In a way, cross subsidization would be a very effective and non-bureaucratic method of levying taxes (from the business sector) and to redistribute funds (to the households). This argument has become weaker and weaker, however. Under the pressure of business customers (large customers such as banks may have a telecommunications bill reaching 80 to 100 million ECU a year) and under the threat of bypass, telecommunications operators are rebalancing their tariff structure : local tariffs are being increased while trunk and international tariffs are being lowered.

Privatization, Deregulation and Liberalization

Although stemming from the same concern, that of loosening state control over telecommunications activities, privatization, deregulation and liberalization are by no means synonyms. Privatization means the transfer of public ownership to private ownership. Deregulation leads to diminishing the rules and constraints governing the activity of companies in the sector, both incumbent and new entrants. Liberalization refers to relaxing the restraints on entry by newcomers. 2 Finally, the state could break up the telecommunication monopoly into entities, in order to prevent the abuse of a dominant position when competition is opened. To give an example, British Telecom was partly privatized in 1985; more precisely 51 per cent of BT's ownership has been given to the public. This is partial privatization. In 1981 and 1983, the state-owned shares of

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Cable and Wireless, which was already a public limited company, were sold to the public. Later on, the company set up a competitor to British Telecom, Mercury. In the face of this new competitive environment, however, BT has not been broken up, unlike AT&T in the United States. Still in the United Kingdom, the market for value-added services has been deregulated by the VANS licence of 1986 : under certain conditions, it is no longer necessary to obtain permission from the government to operate a value-added service. Thus, this segment of the telecommunications market has been deregulated. Finally, the Customer Premise Equipment Market has been liberalized, in the sense that a former monopoly of British Telecom, the supply of large PABX (more than 100 lines), has been opened to free competition. The major motive for privatization is generally that a private company is more efficient, compared to a public one. The efficiency loss, called X-inefficiency in economic literature, is considered lower because a corporate owner has a higher self interest in stimulating performance than a top civil servant. A quick review by Waterson of experimental measurements does not support this view, however. His conclusions are that there may be no organizational advantage in private or public ownership. In the case of telecommunications, anecdotal evidence has shown that before AT&T's divestiture, the telephone company in the United States was a private monopoly which was no more efficient than, nor could provide services as cheap as the state telecommunications administration of Sweden, Televerket. Italy's STET (Societa Finanziaria per il Telefono), an incorporated company with majority ownership by the government, was less efficient in the late seventies than France's DGT (Direction Generale des Telecommunications), a public administration. The reason why a private owner has no incentive to perform better than a public one lies in the regulatory process. If the company has the monopoly, its profits will be controlled by a regulatory authority and limited to a ceiling. Therefore, why should the company's shareholders worry about improving its performance since it will not profit the owner but his customer, through price decreases? The provisory conclusion is that privatization per se and alone is by no means a way to achieve efficiency, if internal issues of management only justify the way to privatization. In fact, external relations of a public utility company may justify privatization. In particular, by changing the statute from an administration to an incorporated company, the state may decide to have less opportunities of intervention in the business of the company. An administration will be subject to administrative rules, which may hinder its activity, limit its recruitment (because private companies' salaries are much higher), raise annual contributions to the general budget and set up constraints on its investment capacity, and so forth.

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To evaluate the weight of these arguments is difficult, however. Direct evidence of state interference in the PTTs (post, telegraph and telephone systems), especially the public telecommunications operations sector, is given below. 1.

Tran~fers to the general budget. The German Bundespost in the Federal Republic has, as a public administration, the obligation to transfer 10 per cent of its revenues to the German Federal Budget. France Telecom, the French telecommunications administration, has also the obligation to pay 13 billion francs out of its 85 billion francs in revenue for subsidizing activities not directly linked to its business.

2.

Tariffs control. In most countries where PTTs are administrations, tariffs have been controlled and monitored by the government, sometimes against the interest of the PTTs. In France in 1984, tariffs increased by 20 per cent against the will of the French DGT. In Italy, however, increases in tariffs were blocked for three years while inflation was soaring at 20 per cent a year during the period 1976-79. Therefore, the tariff policy set up by individual governments may be constructed without taking into account the commercial interests of the telecommunications operators.

3.

Investment control. Sometimes, the investment policy of a PTT has been stimulated by the state in order to implement Keynesian macro-economic policies through public investment when demand was falling. This happened in Germany in 1975-76, in the United Kingdom during the same period at a time when British Telecom was still a public company, and in Germany again in 1985-86. In each case, the temporary stimulus to demand had indeed macro-economic effects, while it may have thrown off-balance the investment policy of the PTTs.

4.

Manpower management. Civil servants and employees of public companies have very rigid career profiles. In particular, they cannot benefit from productivity gains made by the PTTs, nor do their commercial talents get a fair return.

The experience shows that all PTTs in Europe, whatever their statute, are very anxious to get rid of this state interference. In brief, they want more autonomy to conduct their business. The experience shows also that this autonomy is seldom given when PTTs remain public administrations. In Europe, however, only the United Kingdom has experienced the real process of privatization: 51 per cent of British Telecom's capital has been floated and sold to the public. Moreover, the government, although still

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owning 49 per cent of BT's capital, has refrained from playing the role of a majority shareholder. The competitor of BT, called Mercury, is owned by Cable and Wireless, which was itself privatized in 1981. On the whole, Europe, unlike the United States and Japan, and despite the United Kingdom, is not, at least in the immediate future, on the way to privatization. The general attitude, instead, is to get the PTTs to become state companies or state-owned or controlled incorporated companies. The second element of the PTTs' evolution is deregulation. Here again, differences can be seen between the United Kingdom and other European countries, although the trend is towards rapid convergence under the auspices of the European Commissions. Deregulation can take four forms: 1.

More transparent and cost-related pricing schemes;

2.

More open standards;

3.

More liberal certification procedures; and

4.

More autonomous regulatory authorities.

1.

More transparent pricing schemes. PTTs have often been accused of setting tariffs arbitrarily, in particular for lines leased to business customers with heavy traffic needs. In the new context of deregulation, rules have been defined to allow for a fair pricing scheme. In the United Kingdom, for example, where British Telecom is still in a quasi monopoly position, a price cap scheme has been devised called the RPI minus x formula. It allows BT to increase its tariff for a basket of services to x per cent under the Retail Price Index scheme. 3

2.

More open standards. Standards are necessary to enable the reciprocal understanding between communicating persons or entities. In telecommunications, the importance of the inter-operability of networks has given rise to public standards set up by a committee of the international organization, ITU (International Telecommunications Union). At the national level, standards are complemented by nationally defined network specifications, which in the past had acted as non-tariff barriers to trade. However, more and more standards have been set up at the European level. A European Telecommunications Standard Institute (ETSI) was established in 1987 by European PTTs to set standards valid all over Europe. The European Commission is also urging PTTs to define standards for access to the network (the so-called Open Network Provision, or ONP). A framework directive of the Commission states that these standards should be defined on conditions of transparency and non-discrimination.

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3.

More liberal certification procedures. The certification given to terminal equipment was traditionally in the hands of PTTs, which were also often the sellers of this equipment. Such confusion of roles was clearly to the disadvantage of manufacturers. In the future, things may change for two reasons. On one hand, certification will be removed from the PTTs in order to separate the network operation from regulation. On the other hand, certification given in one EC country will, according to an EC directive, be automatically endorsed in other EC countries. 4

4.

More autonomy for regulatory authorities. The legal separation of regulation from network operation is under way in most European countries: the United Kingdom, the Netherlands, Spain, Ireland, Denmark, Sweden, and Italy have already achieved it. It will soon be implemented in France and Germany- probably in spring 1989 through a ministerial decree, in the former, and in July 1989 at the latest, through a law-passing process, in the latter.

On the whole, the motives for regulating telecommunications activities in Europe have become less and less urgent, so that this economic activity has been relegated to normal commercial procedures and litigations. Liberalization is the third facet of deregulation in Europe. By allowing a larger entry of new firms in the telecommunications sector, the public authorities hope to trigger off a strong competitive process in selected areas. Liberalization has happened in the terminal market segment : the main telephone set, for example, can be purchased freely in many European countries, while this was a PTT monopoly several years ago. PABX modems, also formerly under PTTs' monopoly in most European countries, are being sold freely. The European Commission has issued a directive asking the European countries to eliminate any restriction in the terminal market segment by the beginning of 1990. Another important segment which is being opened to competition is the market for value-added services (videotex, electronic mail, on-line data base retrieval, network management and so forth). This market is still small compared to the telephone but it is growing very quickly (15-20 per cent a year). Most of the European governments are now prepared to allow the development of value-added services and computer applications on leased lines, or on any telecommunications infrastructure hired from the PTTs. These governments are also prepared to allow PTTs to compete among themselves in these markets. Finally, some European governments have recognized that competition for the provision of mobile telephone infrastructure might be beneficial. They have authorized a second operator of mobile telephone services. These

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countries are the United Kingdom, France, and the Netherlands, while Germany will be doing the same. But PTTs, even when they face some competition, are in a quasi monopoly position. The revenues they draw from their main activity (telephone services) are high and secure, since the price elasticity of demand is low ( - 0.1 to - 0.3 in general). Therefore, private investors might find PTTs a good investment, with secure revenues growing by 5-7 per cent a year. This is why the business community sometimes urges the governments to privatize their PTTs. This also explains why the fears of the trade unions concerning job losses are probably exaggerated: with a business growing at 5-7 per cent a year and a monopoly position, most PTTs have the means to take care of their industrial relations and avoid manpower reduction. Therefore, a more radical solution for promoting competition has to be considered - that is, breaking up the PTTs in order to avoid a situation where there is a dominant firm in the sector. After AT &T's break-up in the United States in 1984, the conservative government in the United Kingdom envisaged such a solution for BT, but discarded it in favour of privatization. The floatation of a fragmented BT would have been less attractive than the complete BT. 5 In Japan, the NTT break-up was envisaged after the Recruit scandal, but nowhere in the industrialized countries has this attitude been imitated. Oddly enough, some network operations have been fragmented for many years in countries such as Italy, Denmark, and Finland where the operation of local networks and trunk networks is in the hands of different companies. However, unlike in the United States, there is still no competition for the operation of trunk routes. Privatization in Europe and Lessons for Other Countries On the whole, the concept of deregulation in Europe is by no means limited to privatization. In fact, privatization does not seem to be widely diffused. Most countries have organized their telecommunications services along a mixed structure, blending public control with either a corporation or a public company statute. Table VII. I summarizes the situation of telecommunications operators in Europe. In the table, three layers of statutes can be seen: the first one includes countries with public administrations (France, Luxembourg, and Germany). The second layer is made up of countries which have had a private structure at the beginning, but have subsequently nationalized this activity partly, through public majority control or ownership (Italy, Spain, Denmark, Belgium, Greece, Portugal). Finally, the third layer consists of countries which have undergone a process of privatization or quasi privatization (the United Kingdom and the Netherlands). This third category is clearly the smallest. The European experience with privatization can be divided into two categories: privatization in the early days of telephony, and late privatization.

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TABLEVII.l Statute of Telecommunications Operators in Europe (European Community)

Germany

Public administration

France UK Italy Spain Netherlands Belgium Ireland Portugal Greece Luxembourg

Public administration Two private companies : British Telecom and Mercury Holding company (STET), with majority control by the state Private company, with minority control by the state (Telefonica) Private company, with 100 per cent control by the state Public corporation Public corporation; privatization in discussion Public corporation Public corporation Public administration

Early Privatization Privatization in the early days of telephony concerned countries such as Spain and Italy. In both countries, the operation of telephone services was in the hands of private companies and subsequently controlled by the state. In both countries, the development of telephone services has not been at the level of the other major countries (France, Germany and the United Kingdom) in which the telephone operator was a public administration. In Spain, the Campania Telefonica Nacional de Espana was established by ITT in 1924 and nationalized in 1946. It has been given a monopoly over the telephone service. Telefonica had around 10 million lines in 1985 (compared to 25 million in Germany and 23 million in France). The government gradually reduced its participation from 4 7 per cent in 1985 to 32.5 per cent in 1987 by placing shares in several major financial centres. But the most impressive consequences have been the partnerships and agreements signed by Telefonica with industrial partners: with AT&T for the building of a plant manufacturing micro-electronic components, with Corning for producing fibre optics, with EDS (Electronic Data Systems), the General Motors subsidiary, and IBM for value-added services. Telefonica recently underwent a crisis which led to the removal of its chief executive, Luis Solanas: very classically in the telecommunications business, an ambitious investment plan (US$4.37 billion for 1989) triggers off and is outpaced by telephone demand; demand for new lines rose by 16 per cent in 19 8 8 and usage increased by 8. 5 per cent. 6 Dissatisfaction grew among users and the public got the impression that global industrial strategies of partnership were undertaken at the expense of installing and maintaining telephone lines. In Italy, three companies (Telespazio, Italcable and SIP) belonging to the STET (Societa Finanziaria peril Telefono) group have the franchise for the operation of most of the telecommunications network: local circuits and

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most of the trunk network by SIP (Societa per l'esercizio telefonico), space communications by Telespazio, and most of the cables in the Mediterranean Sea by Italcable. The STET group also owns Italtel, the major Italian manufacturer of telecommunications equipment , and SGS a component manufacturer, which recently merged its activity with the component division of Thomson, a French group. The STET group is 82 per cent controlled by IRI (lstituto per la Ricostruzione Industriale), the state holding company. STET in turn controls 65 per cent of SIP, 50 per cent of Italcable and 66 per cent of Telespazio. The government through the Ministry of PTT still operates the telex network plus a circuit switched data network called "Rete Fonia-dati". A public administration under the control of the Minister, called ASST (Azienda di Stato per il Servizio Telefonico ), operates the long-distance network for 3 7 districts out of 241, the rest being in the hands of SIP. The structure of telecommunications in Italy is thus mixed: state operation for a small part of the network, and public concessions to a group which is majority controlled by the state, for the largest part of the network. The results of this mixed structure in terms of network development are not particularly brilliant: there were about 16 million subscribers in 1984, and the tariffs for telephone usage in Italy are the most expensive in Europe, particularly for international traffic. Italy is now undergoing a process of rapid change: on one hand IBM and Fiat have signed an agreement to operate a joint venture for value-added services. This venture called Intesa uses the state network, Rete Fonia-dati. Fiat also owns a major transmission equipment manufacturer, Telettra. On the other hand, STET and AT&T are on the verge of signing an agreement around Italtel. Since AT&T already controls 25 per cent of Olivetti, the Italian market is now divided into two blocks: Fiat/IBM on one hand, and STET/ Olivetti/AT&T on the other. To summarize the experience gained with early privatization, Italy and Spain have shown that such experience is perfectly possible in the development phase of the telephone network, but does not bring major results for network development. Instead, the incorporation of telephone companies leads naturally, in the present economic context, to a diversification of the company's interests in value-added services and equipment manufacturing. This diversification is made through joint ventures or a direct participation of large international groups into the capital of the national telephone company. Privatization gives a flexibility to the company's strategy, perhaps at the expense of network growth. Another lesson of early privatization is that the structures are difficult to change in the long run. Once a company has been privatized, renationalization can happen but this leads to confusion more than anything else, as happened in Italy after World War II.

Privatization of Telecommunications Services in Europe

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Recent Privatization As said above, only the United Kingdom has undergone a process of recent privatization. British Telecom was split from the Post Office in 1981 and its shares were floated in 1984. The lessons that can be drawn concern the process of privatization and the strategy of a privatized telephone company. When privatization was announced, the estimation of BT's capitalization was £ 7-8 billion, with 51 per cent of shares being sold. At first, the City got the impression that BT as a "utility" would not give high returns on capital. 7 The privatization bill was also opposed by British manufacturers, on the ground that they would lose their market shares, by the National Farmers Unions, by the Scottish and Weish authorities and by the Post Office Users National Council, all of whi

0'-

l 1

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6

167

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Privatization of Railways in Japan

147

much better than expected. The aim of this paper is to explain why the privatization has been successful.

The Failure of the JNR In its final proposal the JNR Reform Commission pointed out the causes of the failure of the JNR:

1.

The JNR had failed to reshape the railway business to compete with emerging competitors, that is, road and air transport;

2.

There was overmanning, and low productivity due to labourmanagement disputes; and

3.

Bureaucratic and irresponsible management.

The Commission was correct in attributing the failure of the JNR to public ownership, with its centralized and unified nation-wide operation. It can be added that the JNR had enjoyed monopoly in the transport market for a long time until the late 1950s. The bureaucratic management of a public enterprise and the long-time monopoly must have been the two ultimate causes of the failure of the JNR. Ludwig von Mises was admirably correct in pointing out the defects intrinsic to publicly owned enterprises. 2 He emphasized the key difference between private enterprises and publicly owned enterprises - that is, the goal of management. The goal of the management of private enterprises is clearly defined: maximization of profit. Thus, the measure of a successful management is "profit". The goal of a publicly owned enterprise, however, is usually not a single well defined one like profit, but is multiple. The multiple goals are difficult to define clearly. They may include promotion of public welfare, and are sometimes contradictory. 3 The abandonment of unprofitable branch lines in the rural areas in order to make both ends meet is contradictory to the promotion of public welfare of the residents of those areas. As the goals are not clearly defined, the management of publicly owned enterprises has to be guided by the government. As the account of profit or loss is not to be considered the criterion of the management's success or failure, the only means to make the manager responsible to the boss, the treasury, is to limit his discretion by rules and regulations. If he believes that it is expedient to spend more than these instructions allow, he must make an application for a special allotment of money. In this case, the decision rests with his boss, the government, or the municipality. At any rate the manager is not a business executive but a bureaucrat, that is, an officer bound to abide by various instructions. The criterion of good management is not the approval of the customers resulting in an excess of revenue over costs

148

Yukihide Okano

but the strict obedience to a set of bureaucratic rules. The supreme rule of management is subservience to such rules. 4

Thus, political intervention was very much responsible for the failure of the JNR. The construction plan of new lines was determined by the Railway Construction Council. Ten out of twenty-eight members of the Council were Members of Parliament. They were, in fact, decisive in determining the new lines to be constructed. Politicians were always enthusiastic about the construction of new lines because it was a very effective political instrument to win votes. Most of the unprofitable branch lines were constructed through log-rolling among politicians. The JNR had to submit a budget to the Parliament, and the Ministry of Finance examined the budget. An increase in the standard rate of fares of the JNR was also a matter for decision by the Parliament. In the 1960s and afterwards when the government became increasingly concerned about inflation and suppressed price rises with government regulation, the fare increases were often made political issues by the government. Thus, as Ludwig von Mises stated, the managerial discretion of the JNR was strictly limited. Another cause of the failure, in particular, the financial aspect, must be attributed to the long-time monopoly the JNR had enjoyed. The monopoly, together with the rather lenient auditing by the government, caused a high degree of inefficiency in the JNR. The financial surplus was absorbed by the treasury so that the JNR had no incentive to make efforts to minimize costs. Until the early 1960s it was easy for the JNR, which had monopolistic power in the transport market, to make both ends meet even when the costs were high. The purchase prices of inputs, especially those specific to railways, were high. Retired staff of the JNR were employed by the suppliers and part of the monopoly profit was shared between the JNR employees and the suppliers. They were called "the JNR family". As a matter of fact, it was extremely difficult for the Board of Audit to determine the minimum costs of railway services. Excessive costs due to inefficiency could be easily covered by raising fares as long as the JNR was a monopoly. Neither regulation nor auditing could control these excessive costs. The Japanese people were also partly responsible for the JNR failure. They always opposed any fare increases even after the JNR made losses. They demanded that the government should subsidize the JNR. They believed that public enterprises which did not seek profit were "good" and should be subsidized. They did not understand the defects intrinsic to publicly owned enterprises until they recognized that private railways could be much more efficient. The failure of the JNR can typically be represented by the everincreasing current deficits of the 1970s and afterwards (see Figure XI.l). Moreover, interest payments on the deficits added to the losses carried

Privatization of Railways in Japan

149

forward. In the 1980s the JNR could not pay the interest from its current revenue. If the JNR had been a private enterprise it would have gone bankrupt in the 1970s.

The Consequence of Privatization More than twenty-two months have passed since the privatization of the JNR. Though it is hard to assess the effects of the privatization based on the experience of this short period it seems that privatization has been very successful. The results of the first year were as follows:

1.

The number of passengers carried by the six new JR passenger companies increased by 4-8% per cent except one company, JR West, and the passenger/kilometre of all the six companies increased by 1-9% per cent over the previous year (Table XI.l ).

2.

All the companies, including the freight company, were profitable. The current profit (before tax) reached a total of¥ 151,500 million. 5

3.

The total long-time debt for the six passenger companies and the freight company decreased by ¥400,000 million in a year (Table XI.2 TABLEXI.l Passengers Carried, 1987

Planned (million) JR Hokkaido JR East Shinkansen Old Line Total JR Tokai Shinkansen Old Line Total JR West Shinkansen Old Line Total JR Shikoku JR Kyushu SOURCE:

91 48 4,782 4,830 92 283 364 54 1,469 1,523 52 239

Passengers Actual (million)

o/o

Passenger-Km Planned Actual (million) (million)

o/o

96

105

3,720

3,920

105

50 5,062 5,068

104 106 105

11,654 87,831 99,485

12,138 92,353 104,491

104 105 105

102 301 392

I 11 106 108

29,597 8,836 38,433

32,123 9,025 41,148

109 102 107

55 1,451 1,496 55 248

102 99 98 106 104

13,041 32,409 45,450 1,548 7,053

13,153 32,629 45,782 1,674 7,664

101 101 101 108 109

Ministry of Transport, Annual Report.

;:; 0

TABLEXI.2 Revenue, Expenses and Profit (March 1988) (In ¥ hundred million)

Hokkaido Operation Profit & Loss (Business Profit & Loss) Business Revenue 726 Business Expense 1,261 Business Profit & Loss L1535 Miscellaneous Revenue 193 Miscellaneous Expense 195 Misc. Profit & Loss L1 2 Total Business Prof. & Loss L1538 (Incidental Profit & Loss) Incidental Revenue 517 Incidental Expense 1 L1 22 Operation Profit & Loss (Special Profit & Loss) Special Profit 111 Special Loss 56 Profits before Tax 32 Corporate Income Tax 20 Profit 12 SOURCE: Ministry of Transport, Annual Report.

East

Tokai

West

Shikoku

Kyushu

Sub-total

Freight

Total

15,351 8,683 12,469 7,972 2,881 710 63 305 222 58 4 82 2,964 715

7,470 6,768 701 161 154 7 708

306 446 L1140 46 55 L1 9 L1149

1,266 1,547 L1280 32 39 L1 7 L1288

33,802 30,463 3,337 800 723 75 3,412

1,727 1,615 111

Ill

35,529 32,078 3,448 800 723 75 3,523

178 2,376 766

124 232 607

89 717 80

159 0 10

304 1 15

1,371 3,327 1,456

12 64 59

1,383 3,391 1,515

112 157 721 447 274

111 110 608 442 165

83 71 92 72 20

39 38 10 7 2

39 18 36 27 9

495 450 1,499 1,015 482

4 4 59 41 18

499 454 1,558 1,056 500

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TABLEXI.3 Assets and Liabilities (March 1988)

;::;

~

.,;:.;:,

(In ¥ hundred million) East

Hokkaido Assets Liquid Assets Fixed Assets Fund Total Assets Liabilities Liquid Liabilities Fixed Liabilities Total Liabilities

Tokai

West

Shikoku Kyushu

Sub-total

Freight

Total

~

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500 2,849 6,822 10,171

2,556 36,620

1,812 5,225

1,919 12,483

625 3,299 3,877 7,801

7,636 61,559 12,781 81,976

406 1,378

14,402

224 1,083 2,082 3,389

1,785

8,042 62,937 12,781 83,761

-

-

-

39,176

7,037

403 341 745

6,958 28,977 35,936

1,803 3,413 5,217

3,062 9,770 12,832

158 102 261

428 373 801

12,812 42,976 55,792

337 1,086 1,423

13,149 44,062 57,215

Capital 2,000 1,120 1,000 Capital 90 Reserve Fund 2,502 966 535 550 Fund 6,822 12(12) 274(274) 165(165) 20(20) Surplus Fund Capital 9,426 3,240 1,820 1,570 39,176 14,402 Liabilities & Capital 10,171 7,037

35 1,009 2,082 2(2) 3,128 3,389

-

160 4,405 190 2,953 8,515 153 12,781 3,877 482(482) 9(9) 18(18) 6,999 26,183 361 7,801 81,976 1,785

ll;::;

4,595 8,668 12,781 500(500) 26,544 83,761

SouRCE: Ministry of Transport, Annual Report.

V>

152

Yukihide Okano

and X1.3). The performance of the railway companies has improved remarkably. These positive results can be attributed to many factors, such as the prosperous economy and the waiver of excessive debts. However, the most important factor was the removal of bureaucratic management which gave the railway companies the flexibility to make necessary changes.

The Principal-Agent Theory The principal-agent theory can be very useful in explaining the effects of privatization. 6 In the case of the privatization of the JNR, ownership has not changed yet. All the shares of the new railway companies are held by the JNR Settlement Corporation. The principal, the JNR Settlement Corporation, is the sole temporary shareholder representing the government. In the future, when the companies meet the listing requirements the shares will be sold on the open market. Thus, presently the principal, that is, the JNR Settlement Corporation, has no incentive to induce the agents, the JR companies, to act in the principal's interest. But the agents are doing their best to increase their profits not because they may go bankrupt but because they want to clear off their apportioned debts as early as possible. Their efforts to increase profits are in tune with the interests of the principal which also wants to clear the huge debts by selling shares at the highest possible prices. The great difference between publicly owned enterprises and privatized ones is the government regulations they are subjected to. There is a close relationship between ownership and government regulations. When the JNR was privatized, the statutory controls over public enterprises, such as the parliamentary control of fares and the Treasury's examination of the budget, were, of course, abolished. The new JR companies are now subject to the same regulations as existing private railways, although there are some additional regulations imposed on the JR companies. Some of these additional regulations require that the selection and dismissal of the chairman and directors of the board must be approved by the Minister of Transport; that annual business plans must be approved at the beginning of the financial year by the Minister of Transport; and that the JR companies' non-rail businesses must not be detrimental to local small businesses. This regulation was introduced because of political pressure backed by local small businesses. Since parliamentary control was abolished, political interventions have been reduced to a great extent. The relaxation of regulations has enabled the new JR companies to adopt new strategies. It must be noted that the set of business strategies which were actually available to the JNR was a subset of the set of strategies permitted by government regulation. The manager of the JNR was

Privatization ofRailways in Japan

153

constrained by the government or politics from adopting other strategies that did not violate the regulations. Thus, the options were very limited. It is surprising how the change in the principal-agent relationship brought about by privatization has spurred the management of the new JR companies. There are many examples which show how the management has improved. New railway stations have been built in the suburbs of big cities to attract more commuters. Express trains have been used for carrying passengers in the rush hours at a supplementary charge. Subsidiary companies have been set up to engage in other businesses, such as real estate, hotels, snack bars, retail shops and so on. One of them even holds concerts in the station hall once a week. All these have changed the attitude of people towards railways and increased patronage indirectly. At the same time, efforts have been made to reduce costs. One passenger railway company renewed the uniforms of its employees for about half the cost of those provided before privatization. This was due to the open tender system being used. The number of signatures required on the documents of decisions have also been reduced considerably. This means that a smaller number of staff take on more responsibility. There are many other examples. However, the apparent success of privatization is represented by the remarkable financial improvement and the increased patronage of the railways. The recently published annual reports for 1988 showed even better performance. The number of employees has decreased tremendously while the train-kilometres have increased. This implies an improvement in labour productivity. Thus, the new privatized railway companies seem to have made a good start in business. However, two major problems still have to be addressed. The first one is the labour problem. One of the motivations of privatization was to improve industrial relations and to resolve over-manning. There were several trade unions within the JNR and they had struggled for power. These struggles made the industrial relations worse. It is said that one of the reasons that the government decided to split up the JNR into six regional passenger companies and one freight company was to reduce the power of the largest and most militant union, the Kokuro (the JNR Trade Union). When the new companies were formed, the government reduced the number of employees from 276,000 (1 April 1986) to 215,000. Other government sectors and even private enterprises in the manufacturing industry, such as automobile and electronics companies, were asked to employ the redundant employees of the JNR. The government also gave special supplementary retirement allowances to promote early retirement. As many of the employees were pessimistic about the future of the JR companies, the number that chose retirement was more than expected. Thus, the JR companies started with less employees than had been planned by the government. The employees who voluntarily retired numbered more than 39,000, and finally about 21,000 surplus labourers were transferred to

v.

TABLEXI.4 Planned Disposition of Employees

""'

NEWJR ,.----

183,000

t--

NEWJR (ACTUAL)

I I I

215,000

I I

EMPLOYEES EMPLOYEES 1 April1985 ,.-- 1 April1987 307,000

.--

r---

SURPLUS IN NEWJR

1-----J

32,000

276,000

SURPLUS 1...---

93,000

VOLUNTARILY RETIRED 20,000

PLACEMENT REQUIRED

~

41,000

~

g: ~ ;:;

c

rRCE:

Ad Hoc Commission on Administrative Reform, !983. Figures have been readjusted by the author.

Privatization ofRailways in Japan

155

the JNR Settlement Corporation (Table XI.4 shows the planned disposition of employees authorized by the government.) The second problem is debt management. The JNR left debts of ¥ 37 trillion of which ¥25.5 trillion was transferred to the JNR Settlement Corporation. The Corporation has to repay the debts by selling properties transferred to it by the JNR and not used for railway operation, as well as shares of the new companies. Although prices of land have risen, the Corporation would still not be able to repay all the debts. 7 The remainder of the debts must therefore be repaid from tax revenue. However, the government has not yet decided how to raise the necessary tax revenue.

Conclusions

Privatizing the national railway in Japan was probably a risky experiment because most railways in developed countries have been unprofitable. In Japan, the railways in the three islands of Hokkaido, Shikoku and Kyushu are hardly exceptions. In the mainland, however, there is a big market of railway commuters and all private railways that have survived have been profitable. In general, railway operation in Japan is much more favourable than railways in Europe. Since the population is large and the density high and roads are often congested, the railways have a large patronage except in the rural areas. In 1984 the railways in Japan carried more than three times as much as the French railways, and more than five times as much as the British railways in terms of passenger-kilometres. Thus, if the management of the railways is sound, railway operation in Japan could be very profitable. It was certainly the inefficient management intrinsic to public enterprises that had caused the JNR to be unprofitable. Thus, market conditions are very important when privatization considerations are discussed. If the demand for railway transport services is so small that it is difficult for the railway to be profitable, then privatization will not have significant meaning. There are at least two necessary conditions for privatization to be successful. The first one is deregulation. Without deregulation, a privatized enterprise cannot improve its managerial efficiency because operational strategies are limited. The second is market competition. Without competition, a privatized enterprise has no strong incentives to improve managerial efficiency. It should be noted that the existence of competitors makes it easier and faster for the manager to get agreement on decisions within a firm.

NOTES I.

It must be noted that the latter two corporations are not private but public organizations.

Yukihide Okano

156 2.

Ludwig von Mises (1944), chapter 3.

3.

A good example is the Japanese Railways Fare Act which provides that the fare shall be a) just and reasonable, b) remunerative, c) able to contribute to the development of industry, and d) to contribute to stabilizing wages and prices of commodities. Fare increases that would have enabled the JNR to be viable was often regarded as against the third and fourth objectives.

4.

Mises, op. cit, pp. 62-63

5.

Three JR passenger companies, JR Hokkaido, JR Shikoku and JR Kyushu are not viable. The government has endowed each of these three companies with a fund on which interest gained would be just enough to cover the annual deficits. Accordingly, the current profits shown by these companies have included the interest revenue on the funds. This one-time lump-sum grant is superior to subsidizing deficits every year.

6.

See J. Vickers, and G. Yarrow ( 1988).

7.

The long-term liabilities of the JNR Settlement Corporation have increased from 18.1 trillion yen to 20.4 trillion yen (Table Xl.4). The increase is due to the delay in selling land.

REFERENCES Gravelle, H. S. E., and E. Katzs. "Financial Targets and X-efficiency in Public Enterprises". Public Finance 31 (1976): 219-34. JNR Reform Commission. The Options on the Restructuring of JNR -for the development of railway's future. 1985. Leibenstein, H. General X-E.fficiency Theory & Economic Development. Oxford University Press, 1978. Ministry of Transport. Annual Report. 1987, 1988. Mises, Ludwig von. Bureaucracy. Yale University Press, 1944. Okano, Y. "The Japanese National Railways- A Public Enterprise in the Changing Market". In Public Enterprises in Japan, edited by Y. Okano and M. Uekusa, chapter 10. University of Tokyo Press, 1983 (In Japanese). Vickers, J., and G. Yarrow. Privatization -An Economic Analysis. The MIT Press, 1988. Williamson, 0. E. Corporate Control and Business Behavior. Prentice-Hall, Inc., 1970.

PartV Capital Market

XII. Stock Markets and Privatization Issues in ASEAN

AHMAD D. HABIR Introduction

Capital market development and privatization of state-owned enterprises (SOEs) have become key issues for governments that have been burdened by increasing foreign debt and domestic budget deficits. Government dominance of the financial sector in the developing countries and the reliance on debt finance by both government and companies have inhibited the institutional growth of capital markets, relegating them to an insignificant role in total fund raising in the economy. They have also resulted in a vulnerability to downturns in the world economy created by debt servicing problems of governments and the unbalanced capital structures of companies. This puts pressure on governments to relieve their burden by, among other ways, selling their SOEs to the private sector. The shape of these privatization strategies and, indeed, the likelihood of their implementation, are influenced to a great extent by the strength of their capital markets. While the term "privatization" can have a number of interpretations, ranging from efforts to improve the efficiency of SOEs to efforts to sell them, this paper refers to the latter, or more specifically to "the transfer of commercially oriented SOEs, activities or productive assets of the government (for example, those in the fields of agriculture, manufacturing, and public services, such as transport and communications) to total, majority or minority private ownership or to private control". 1 This definition allows for one or any combination of such commonly used methods of privatization as the a) public offering of shares, b) private sale of shares, c) new private investment in an SOE, d) sale of government or SOE assets, e) management/employee buy-out, and f) lease and management contract. However, the focus of this paper will be on the public offering of shares through the stock exchange, the method most commonly associated with privatization, and the issues and problems associated with it, with particular reference to the ASEAN region.

160

Ahmad D. Hahir

Determining the Methods to Use While privatization through the public offering of shares is, as noted above, the method most commonly associated with the transfer of shares, this should not imply that the method is necessarily the most appropriate. It would be useful, therefore, to first look briefly at some important factors that determine the method or combination of methods to use. Policy decisions made should be based on a careful examination of a) the objectives of the government; b) the current organizational form of the SOE in question; c) the financial health and performance of the SOE; d) the ability to mobilize private sector resources; e) socio-political factors; and f) the degree of development of the capital market. 2 Generalizations are difficult to make as conditions differ in each country and, indeed, in different industries and individual companies within the same country. In the end, decisions should be made on a case-by-case basis and could range from not privatizing at all to the other extreme of complete liquidation. The objectives of the government can include: a) relief from both the burdens of subsidies and debt service requirements of the SOEs and that of management and control; b) increased efficiency of the SOEs; c) implementation of policies stated at the time of the creation or the acquisition of the SOEs; d) greater revenue from state assets; e) developing the private sector; f) increased competition by, for example, selling off production units of an SOE separately rather than the whole SOE; and g) developing wider business ownership through public offerings. The privatization process is relatively simple if shares of an SOE are already being traded since the government need only offer additional blocks of shares to the investing public through the stock exchange. On the other hand, an SOE set up as a statutory corporation under an act of parliament, or as a government department, would have to be changed into a corporate body subject to ordinary company laws before shares can be offered to the private sector. The steps being taken to prepare Jabatan Telekom Negara (JTN) for privatization in Malaysia is an example of this process. The profitability of a company is an obvious determinant of how well a privatization process will go. Yet, privatization potential need not be limited only to profitable SOEs. The particular method, the prices of the sale, and to whom it is sold to, can be just as important factors. If the government cannot accept the price of the sale, other methods may be chosen, such as management contracts or, in some cases, liquidation. Public offerings are feasible if the companies involved are seen to be secure long-term investments. In cases where these are underperforming and suffering losses, efforts can be made to turn them around into profitable enterprises before being sold. For example, British Airways, through new operational practices and a reduction in the work-force, was restructured into an attractive investment for the general public. In Sri Lanka, several loss-making textile companies were turned around through management

Stock Markets and Privatization

161

contracts and are being prepared for public offering. 3 Other restructuring measures could include management changes, reorganization, and debt reduction. Private sale could be a more appropriate method than a public offering when a) the profits record is not good enough to support a floatation; b) a discount has to be offered to attract investors; and c) purchasers can provide financial and management strength to assure improved performance. The decision-making process in determining the method to use for privatization is fraught with political and social implications. The intensely political nature of the topic, the role of ideology and the influence of power groups of elites may play a predominant role, as it does in Indonesia, for example. 4 In general, interest groups usually include the general public (taxpayers, customers, voters), the SOEs (management and employees), the government and its various departments, prospective investors, commentators and opponents, both inside and outside the government. Political factors, thus, naturally impinge on decisions to privatize as well as influence or determine the means to be applied. One specific area in which political and social issues tend to arise is in the potential need for retrenchment of the work-force of an enterprise. Another factor could be the government's concern over the concentration of ownership, leading to the adoption of mechanisms to ensure widespread share ownership. An example of a special interest group is private investors who, in the case of SOEs in weak financial condition, may urge the government to write off liabilities, and demand substantial discounts. Such socio-political factors are not necessarily constraints as a range of alternative methods can be found for dealing with them. For example, transforming SOEs into joint stock corporations with a provision for new private equity can be a feasible first step if there is much political opposition to a proposed straight privatization. At a later stage, when opposition is muted, those government-held shares can then be sold. Another way to ameliorate political concerns is to ensure that the advantages of the proposed privatizations are explained in well-devised and large-scale information and publicity campaigns which should be integral parts of any privatization process. Yet another way, already much practised, is the use of a special or "golden" share that can only be held by the government and which entitles it to special rights described in the company charter. The government can then ensure that certain major decisions affecting the operations of the enterprise are consistent with its policies. Finally, political considerations may open the way for privatization through the relatively open method of a public offering in the capital market. A public floatation offers ownership to a large number of investors thus avoiding the potentially politically undesirable sale to much smaller numbers of investors belonging to various interest groups.

162

Ahmad D. Habir

All the above presupposes the presence of a capital market developed enough to organize the sale of large companies. But if share distribution channels do not exist and if the investing public is small, a traditional public offering of shares is usually not feasible. Private sales to local and foreign investors would then be most likely. However, based on experiences in Jamaica, Kenya and two West African countries with no equity markets at all, but where local capital for privatization was raised through other mechanisms involving a broad section of the investing public, the constraints imposed by a weak capital market may not loom as large as was previously thought. 5 Thus, the absence of a strong local capital market should not in itself preclude public offerings or at least private sales targeted to a relatively wide group of investors.

ASEAN Capital Markets and Privatization

Such experiences notwithstanding, it is generally acknowledged that a weak capital market represents a substantial obstacle to any privatization programme. Singapore and Malaysia, which have gone furthest in terms of privatization in the ASEAN region, also have the strongest capital markets. Thailand, the Philippines and Indonesia, which are in various stages of privatization policy formulation, have far weaker capital markets, with the Philippines ahead of Thailand and Indonesia, which is just growing out of its embryonic stage. As Table XII.l indicates, stock-market capitalization as a percentage of gross national product (GNP) at December 1984, taking only locally incorporated companies, was 68 per cent for Singapore and 63 per cent for Malaysia. This compared with 4.3 per cent in Thailand, 2.9 per cent in the Philippines, and an infinitesimal 0.1 per cent in Indonesia. An Asian Development Bank study on capital markets in Asia in 1985 pointed out some reasons for the stunted growth of capital markets in the region. These included a) the tendency of government policy to channel bank loans to favoured sectors, resulting in an over-dependence on debt financing; b) the dominance of government-owned financial institutions which control much of the total assets in their financial sectors (see Table XII.2); c) the predominance of family-owned companies as well as state enterprises; and d) regulations that restrict foreign portfolio investment. 6 In Singapore, where the capital market is the most advanced in the region, one of the major aims of the privatization programme is to broaden and deepen the capital market as part of an effort to make Singapore a leading international financial centre. During the period 1985-87, eight state companies- Singapore Airlines, National Iron & Steel Mills, United Industrial Corporation, Neptune Orient Lines, Resources Development Corporation, Singapore National Printers, Sembawang Shipyard, and Sembawang Maritime - divested part of their equity by selling shares through the stock exchange. 7 Despite such mildly controversial issues as

~ ~

~

TABLEXII.l How The Markets Rate

"'"'-;:,; ~

(December 1984) Indonesia S. Korea Listed companies 24 Shares listed ('000) 57,650 105.1 Market capitalization (US$ million) Annual turnover (million) 1,218 Annual turnover 2.4 (US$ million) Turnover/market 2.3 capitalization(%) Total funds from equities 1.0 (US$ million) Stockmarket capitalization, 0.1 %ofGNP

Malaysia

336 6,326 5,776

281 25,337 28,416

4,350 3,498

1,852 2,341

60.6 537 6.9

8.2

Philippines 154

Thailand

942

308 29,900 38,039

96 290 1,732

13,823 79.9

3,043 3,937

83 421

8.5

783 93.3(63*)

Singapore

10.4 447

2.9

206.0(68*)

~ §"

~·

;:,;

24.3 185 4.3

*Taking only locally incorporated companies SouRcE: Far Eastern Economic Review, 30 January 1986, p. 44.

a, w

164

Ahmad D. Habir

TABLEXII.2 Financial Assets: Who Controls What

(In per cent) Indonesia S. Korea Malaysia Philippines Thailand 1982 1982 1983 1984 1982 Central bank Commercial banks Finance companies Merchant banks Discount houses Provident and pension funds Insurance funds Development finance institutions Savings institutions Other financial intermediaries Total (US$ billion) SOURCE:

41.6 46.8 0.0 0.0 0.0 0.0

10.0 52.9 2.2 1.4 0.0 4.9

10.8 45.5 10.3 3.8 1.4 16.4

18.7 46.9 3.5 0.0 0.0 0.0

19.6 56.0 11.2 0.0 0.0 0.0

3.0 4.6

3.2 15.3

2.9 2.6

3.2 3.3

1.3 3.2

1.4 1.6

5.8 4.2

3.1 3.1

3.4 21.2

6.7 2.0

36.5

109.8

60.4

20.0

37.5

Far Eastern Economic Review, 30 January 1986, p. 45.

underpricing and priority sales to employees of the privatized companies, others will follow as the Public Sector Divestment Committee continues to manage an orderly privatization process that will still leave the Singapore government's activist role in the economy intact. In Malaysia, partial divestment of such companies as Malaysian Airline System (MAS) in 1985 and the national shipping company, Malaysian International Shipping Corporation (MISC) in 1987 through public floatations has also taken place within the context of a government privatization strategy. The divestments were partial so that the government could retain control of the companies and because of the perceived limited absorptive capacity of the capital market. In both public offerings, the shares were oversubscribed. This could have resulted from the evident underpricing of the initial offering, as prices increased sharply in trading in the few days after the public subscription. 8 It could also have meant an underestimation of the absorptive capacity of the Malaysian capital market. Overall, these divestments have helped to develop the Kuala Lumpur Stock Exchange and increase the number of shareholders in the country, while at the same time bringing in revenue to the government albeit at less than optimal levels due to underpricing. 9 In the Philippines, despite the creation of the Committee on Privatization (COP) and its implementing arm, the Asset Privatization Trust

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(APT) in December 1986 and an ambitious privatization programme, implementation has floundered from political inertia. 10 Another major obstacle, however, is the weakness of the capital market to raise funds for any prospective privatization. Public floatation of shares of stock, while being the preferred method for the sale of a government-owned or controlled corporation, is the least used method. That in itself is not suprising since the market is not very active. Only 48 corporations, out of the top 1,000 corporations listed under the Securities and Exchange Commission, were listed on the exchanges in early 1987 while the proportion of shares being traded was only 10 to 30 per cent of outstanding shares. 11 Factors inhibiting the development of the capital market are a) a general lack of confidence by investors; b) the relative attractiveness of debt financing which is easily obtainable, often at concessional rates; c) the tax-deductibility of interest payments to loans compared to dividends which are not; and d) the perception that investment in the stock exchange offers higher risks and lower returns compared to investment in fixed investment instruments offered by banks and by government securities. Nonetheless, there are encouraging signs of a revival as the Philippine economy improves. More specifically for the privatization effort, the governmentowned Philippine National Bank (PNB), Manila's largest bank, sold 30 per cent of its shares to PNB depositors, its underwriters, and stock exchange brokers and was listed on both Manila stock exchanges in June 1989. The PNB floatation, which was oversubscribed within three days, adds a nominal capitalization of P 1.08 billion to the combined annual turnover of the two exchanges of only about P36 billion. 12 In Thailand, the Thai stock market, Securities Exchange of Thailand (SET), is still small with a market capitalization ratio to gross domestic product (GDP) of about 11 per cent in 1988. This was accounted for by only 141 companies listed out of more than 1,000 private large and medium-sized companies in Thailand as potential candidates for listing. In its peak year 1987-88, the SET raised new capital of about 12 billion baht, compared to the 85 billion baht of household savings mobilized by commercial banks in 1987. 13 With the strong economic growth of more than 10 per cent for 1988 and an inflation rate of between 4 and 4.5 per cent, there are indications that the stock market is strengthening with more active trading and the increase of foreign investors in the market. However, it still has a long way to go before being a main source of long-term investment capital. One obstacle is the still limited number of securities, with many issues tending to remain dormant after their sale, owing to long-term holding by investors. Efforts are being made by the SET to attract well-established private firms to apply for listing. At the same time, it is lobbying for sound state enterprises to sell part of their stock in the exchange as well. 14 As an initial step, the SET allows state enterprises to be listed on the exchange without share divestment to the public. Two state

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enterprises, the North-East Jute Mill and Sugar Mills, have been partially divested and the shares traded on the SET. The names of another four major state enterprises, the Electricity Generating Authority of Thailand, Telephone Organisation of Thailand, Petroleum Authority of Thailand, and the Krung Thai Bank, have been submitted by the Finance Ministry to the Cabinet for approval to be listed on the SET. All four are financially viable and will use public funds to finance proposed long-term expansion if the Cabinet approves the listing. The government will continue to be the majority shareholder in the enterprises. 15 In Indonesia, which has the least developed capital market in the region, tax-free and high returns on fixed deposits have for many years made it extremely difficult for the stock exchange to compete. At the same time, a highly regulatory environment imposed on the capital market has discouraged companies from listing and investors from buying. With the October 1988 imposition of a 15 per cent withholding tax on deposits, investing in the stock exchange will begin to look more attractive. Other deregulatory moves which were announced in December 1987 had already relaxed burdensome listing requirements, done away with the 4 per cent restriction of daily stock-price movements, opened an over-the-counter (OTC) market, and allowed foreign investors to hold up to 49 per cent of the shares of companies listed in each bourse. 16 By December 1988, it was clear that the moves had injected more life into the exchange as trading surged to its highest level since it opened in 1977. This encouraged the government to allow the operation of a private stock exchange in Surabaya, the second leading commercial centre in Indonesia. The new Surabaya Stock Exchange, which opened in June 1989, will deal in the 27 stocks and 16 bond issues already listed in the government-run Jakarta Stock Exchange in addition to the new issues of three local companies. On the supply side, the Jakarta Stock Exchange is expecting to list fourteen new companies in 1988. These additions, and the twenty others expected to follow in 1990, may finally herald the emergence of a viable Indonesian capital market. 17 While there is no indication that any state enterprises are to be listed, the government state investment trust company, Danareksa, has begun to give tentative encouragement for state enterprises to go public through the stock exchange as a politically acceptable method of privatizing. 18

Implementation Issues Given a viable stock market, the chances of successfully privatizing state enterprises are greater. Yet, once a decision has been made to privatize through a public offering, there are a number of implementation issues that a government needs to take into account. These include a) the condition of the SOE; b) the targeting of ownership; c) valuation and pricing; d)

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underdeveloped equity markets; e) regulatory requirements; f) marketing, and g) the crowding-out effect. If the SOE is a poor performer, only a restructuring and a turnaround in performance can make a public offering acceptable to investors. Where the enterprise clearly has good earning potential, this would not be an overwhelming obstacle, as the examples of the British and Japanese telecommunications privatizations indicate. The example already cited of the improvement in performance by British Airways is a case in point of an enterprise with no reasonable earnings potential turning around after a restructuring programme. Alternatively, a government could first privatize by directly selling a minority but controlling interest to an investor or investors with enough financial and management leverage to turn the company around. Once the company becomes profitable, the rest of the government-held shares would be offered to the general public. Investor confidence could be boosted by the presence of a capable core group. Whether the objective is to achieve widespread share ownership or to target certain segments of the investing public, specific measures can be introduced to make sure those objectives are achieved. By ensuring control of an enterprise through the retention of a special "golden" share, for example, a government could allow for a wider share ownership than would be the case without one. Other measures could include the restriction of foreign ownership and the encouragement of employee participation in share ownership. Valuation and pncmg are difficult and sensitive issues even in developed markets. Too low a price will result in a windfall for investors and leave the government open to criticism for undervaluing state assets. Too high a price could result in the failure of the sale. In Singapore, for example, the Public Sector Divestment Committee in Singapore has emphasized the importance of satisfactory prices over the temptation to rush the sales of shares; nonetheless, it has not escaped criticism for underpricing share issues. 1 9 Public offerings in weak capital markets will not generate much response unless mechanisms are devised that allow the general investing public to be reached. Not having an effective primary market would then be a major obstacle to privatization. At the same time, the need for an effective secondary market should not be overlooked. The absence of one could discourage investors by rendering shares of privatized SOEs difficult to resell. In Indonesia, for example, only registered shares are traded, which forces sellers to wait until brokers can find buyers who have then to be approved by Bapepam, the capital market authority. Procedures in Thailand, where the usual delay between selling and being paid is around three to six weeks, are even more cumbersome. 20 In less developed capital markets, governments may have to pay special attention to disclosure requirements. Investors should be informed of the

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inherent risks involved and not to expect a government guarantee or the recovery of principal. The lack of rating agencies in developing countries underlines the importance of a securities commission that can independently make judgements on securities offered to the public. In the rush to develop its capital market, a government may be tempted to overlook such aspects and to push for listings that may be more appropriate for venture capital to finance. In the long term, this will be detrimental to the healthy growth of the capital market. Related to the issue just discussed, informing and educating the public can play an important part in the successful subscription of a public offering. In the case of the successful NCB (a state bank) privatization in Jamaica, for example, the government launched an elaborate information campaign about the public share offer, which included the distribution of 200,000 copies (for a country of two million) of a question-and-answer sheet that described in basic terms the nature of shareholding and the stock exchange. 21 Finally, large-scale public offerings can prevent (or "crowd out") the investment of resources in other productive enterprises or activities, especially where the volume of available resources, or the capitalization of the stock market, is not increasing. In such a case, a phased approach to the public offering can be considered. Alternatively, steps can be taken to increase the volume of available resources. In Singapore, for example, plans to activate the bond market coincided with the expected offering of shares from 23 SOEs and four statutory boards over a period of ten years. To ensure adequate funding, regulations governing Central Provident Funds (CPF) were relaxed to allow CPF contributors to invest 40 per cent of their investible funds on trustee stocks (profitable companies certified by the government). 22 Floatation of Malaysian Airline System: A Case Study23 To illustrate many of the points discussed above, it would be useful to look briefly at the implementation process of the public offering of Malaysian Airline System (MAS). MAS was originally a private company, registered in 194 7 as Malayan Airways Limited. In 1963, when Malaysia was formed, the airline became Malaysian Airways. In 1967, the name was changed again to MalaysiaSingapore Airlines to reflect both Singapore's leaving the Malaysian federation in 1965 and the acquisition of majority control by the two governments in 1966. In 1971, the airline was split into the present MAS and SIA (Singapore Airlines). From 1975 to 1985, MAS grew steadily and was profitable in all its thirteen years of operation except for 1981/82 when high oil prices and a world-wide lack of passengers meant losses for most of the world's airlines. In the context of the Malaysian government's privati-

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zation programme, it became a prime candidate based on its financial performance and its status as a commercial company under the Companies Act, thus requiring no restructuring. While the most important overall government objective was to reduce its financial and administrative burden, one of its specific targets was to sell not less than 30 per cent of MAS equity, and in the long run not more than 70 per cent. By March 1985, MAS had met the Malaysian listing authorities' requirement that a company coming to the market should have showed a profit during the previous three years. In 1985 a total of 105 million shares were offered to the market at M$1.80 per share. Of the total, 35 million shares were reserved for bumiputera (indigenous) institutions, 3 million for an "approved institution", 17.5 million for MAS employees, and the remaining 49.5 million shares for the public. The public offering was oversubscribed by more than six times. Total proceeds of M$189 million were raised, two-thirds of which went to the company as new capital and one-third to the government. To retain some powers besides those held by the Ministry of Transport and its regulation of civil aviation, the government adopted, firstly, a limitation on shareholdings by any person or identifiable group of associates to I 0 per cent of the company, and, secondly, the use of a special (or "golden") share, a unique share to be held only by the government. This gives the government veto power over such crucial acts as a change in the limitation on large shareholdings, a major disposal of assets, merger, or take-over. The special shareholder also has the right to appoint six of the twelve directors of the company, including the Chairman and Managing Director. Concerns about the absorptive capacity of the Malaysian capital market were put to rest by the over-subscription of the public portion of the sale. The largest public offering up to that time had been M$64 million and the average size of public issues during the previous three years had been M$17 million. The MAS offering was subsequently followed in 1986 by an even larger public offering for Malaysian International Shipping Corporation. Pricing for the MAS share offering was subject to the approval of the Capital Issues Committee and other authorities, and the question was whether MAS should be placed at the top of the average level of PIE ratios, reflecting its status as the sole national airline, or whether it should be below the average, reflecting the degree of risk involved in the airline business. A gross P/E ratio of 5.9 times, nearer to the upper end of the range, was finally decided. In terms of outcome, the proceeds from the privatization exercise were significant for both the government and MAS. For the investor, the share price has performed satisfactorily, having more than tripled since being listed. The Malaysian capital market itself proved it could absorb very large new issues. It also benefited from the increased volume in the market. Not much has changed in the management of the airline as the government

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retains considerable control over the enterprise. It has also not created more competition as the privileged status of MAS continues to be protected.

Conclusion

The privatization of MAS encapsulates many of the complex issues surrounding privatization through the capital market. These can be divided into two areas: first, the institutional aspects of the capital market and its capacity for implementing and absorbing the large share issues that privatization normally entails; and, secondly, the effect that stock exchange privatization has on the enterprise being privatized. Where the capital market is institutionally developed, there is the capacity to implement privatization, as experiences in Malaysia and Singapore show. It is too early to assess the effect that listing will have on the efficiency of the companies concerned. However, the general conclusion of studies on the effects of privatization in England, where it has been taken the furthest, indicate that privatization is most effective when accompanied by competition. To the extent then that governments in the region either encourage competition or implement effective regulatory solutions in the absence of competition, the full benefits of privatization will not be realized. 24 Where the capital market is not developed, there is a case to be made for policies designed to strengthen it through direct institutional support or, indirectly, through discouraging the use of other less efficient financial channels before privatization can take place. The development of a strong capital market in itself is of great significance as it means shifting some of the burden of financing economic development from the state to the private sector.

Postscript

Since the time of wntmg, there have been a number of significant developments in the ASEAN region relating to stock market and privatization issues. In the Philippines, the Asset Privatization Trust (APT), after facing difficulties in selling off large assets to single buyers, has begun emphasizing a "securitization" plan to sell equity in a company through the stock market. On 31 December 1989, the separation of the Singapore and Kuala Lumpur Stock Exchanges formally took place. In October 1989, the 182 Malaysian companies listed in Singapore was ordered to be delisted in Singapore by the Malaysian Finance Minister, and Singapore responded in kind. The Malaysian move was seen as a bid to make the Kuala Lumpur Stock Exchange (KLSE) a leading regional stock exchange. It will continue to be relied upon heavily by the government in its privatization plans. In the

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long run, the separation will generate the competitiOn which will bring continued efficiency improvements in both exchanges. Much to everybody's surprise, the deregulation of the Indonesian capital market resulted in a dramatic resurgence of the Jakarta Stock Exchange. The number oflisted companies jumped from 24 in mid-1989 to 63 in early March 1990. More are in the pipeline. However, difficulties in managing the rapidly increasing stock turnover volume underlined the need for institutional strengthening as failed trades, settlement delays and late registrations became more common. Nonetheless, for the first time, the government now had a viable option in its continuing state enterprise reform efforts. In November 1989, the Finance Minister announced that 52 state enterprises would be readied for sale through the stock exchange. In May 1990, it was announced that three state-owned cement companies, PT Semen Gresik, PT Semen Padang, and PT Semen Tonasa, would be the first to go public.

NOTES 1.

C. Vuylsteke, Techniques of Privatization of State-Owned Enterprises, Vol. I, World Bank Technical Paper No. 88 (World Bank, 1988), p. 1.

2.

Ibid., p. 60.

3.

Ibid., p. 63.

4.

See Mari Pangcstu and Ahmad D. Habir, "Trends and Prospects in Privatization and Deregulation in Indonesia", ASE-'AN Economic Bulletin 5, no. 3 (March 1989): 224-41.

5.

C. Vuylsteke, op. cit., p. 68.

6.

Far Eastern Economic Review, 30 January 1986, pp. 46-47.

7.

Ng Chee Yuen, "Privatization in Singapore: Divestment with Control", ASE-AN Economic Bulletin 5, no. 3 (March 1989): p. 316.

8.

Toh Kin Woon, "Privatization in Malaysia: Restructuring or Efficiency?", ASEAN Economic Bulletin 5, no. 3 (March 1989): p. 249.

9.

Ibid., p. 256.

10.

Zinnia F. Godinez, "Privatization and Deregulation in the Philippines: An Option Package Worth Pursuing?", ASE-'AN Economic Bulletin 5, no. 3 (March 1989): 259-89.

II.

Ibid., p. 283.

12.

Far Eastern Economic Review, 1 June 1989, p. 68.

13.

Pairoj Vongvipavond, "Privatization: Dimensions of State Enterprises and Financial

Ahmad D. Habir

172

Markets in Thailand", Symposium on Privatization: Lessons from Europe and ASll

;:; ~

~

:!.

SET Index

84.08

No. of Quoted Co.

21

Dividend Yield(%)

10.16

Market PIE Ratio

4.98

Capital Mobilized (million baht)

107.75

Market Capitalization (billion baht)

1978

~·

g.

5.39

257.73 61

106.62 80

134.95 97

386.73

;;;·

141

163

.,~

5.74

9.57

8.15

3.84

8.46

9.52

9.59

12.03

3,997.8 33.09

1,084.36 23.47

4,143.3 49.46

"'

~

879.19

~ ;:;

.,_

26.0

10,880.64

36,848.46

223.65

658.40

SOURCE: Securities Exchange of Thailand.

_, _,

178

Pairoj Vongvipanond

been made more flexible with realistic ceilings, leaving more room for private sector interest rate adjustments, etc. As a consequence, different interest rate strategies have been adopted by banks and other specialized financial institutions. Competition among banks has been high especially during the recession years, as evidenced by the decline in interest rate spreads and profitability, measured by the return on assets and equity during 1982-86. In the economic boom years of 1987-88, this interest spread and profitability indicator increased. In general, according to the Bank of Thailand research findings, interest rate spread and effective spread of the Thai banking system of 3.09 and 2.39 respectively during 1982-88 is still high by international banking standards, though it is not certain whether it is high when compared to those in developing countries. Among the financial industries, the return on assets of the commercial banking industry is the lowest (0.93 average for 1982-88) compared to 1.48 and 11.27 per annum for finance companies and the insurance sector. Commercial banking returns on assets are also much lower than those in non-financial industries, although the former is more stable. In spite of a possible decline in profitability, the banking sector is highly oligopolistic and concentrated. The four largest banks account for more than two-thirds of the total assets. Moreover, during the past two decades entry into the banking sector has been formally closed. With regard to the competition and efficiency in the financial system, structural regulation has inhibited competition in the pursuit of stability and soundness of the institutions. There is not much competition between the banks and the finance companies; the two seem to be complementing each other. There is also little competition between the commercial banks and government specialized institutions as they all cater for different segments of the market. Future financial reform obviously requires more interest rate flexibility as well as enlarging the scope of business of the various financial institutions. Undoubtedly, an efficient capital market and a sound financial system are needed to serve the privatization of state enterprises. State Enterprises Finance: Role of the Government and the Financial Market Thailand's state enterprises (SEs) sector is of a relatively moderate size and is quite manageable. Though the sector asset is large, their investment amounts to only about 10 per cent of the total investment. Of the 63 SEs in 1989, just over a dozen of them in sectors such as power, water supply, energy, public utilities and telecommunications and transport were significant in terms of asset, employment borrowing, profit, investment, and so forth. They accounted for almost 90 per cent of the entire SEs sector. In 1988 the profitable ones made a total of 34.1 billion baht which far exceeded those which made losses amounting to 1. 7 billion baht (utilities, petroleum, Thai International, and the tobacco monopoly were the largest profit-makers). Bangkok Mass Transit Authority (BMTA) and the State

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179

Railway of Thailand (SRT) were the largest SEs that reported losses for the past years. The SEs depend on the government to varying degrees, ranging from the infusion of equity and capital transfer to loans and government guarantees. Unless the SEs are registered as limited liability corporate entities, they are also exempted from income taxes. In return, part of the profit or dividend is paid back to the government. Several interesting patterns have emerged in the relationship between the SEs and both the government and the domestic financial market. First, as a result of heavy investment and inadequate self financing, the SE sector contributed to a large portion of public sector deficit, which was mostly financed through external borrowing with government guarantees during the late 1970s and early 1980s. This external borrowing obviously aggravated the foreign debt service burden in the early eighties at a time of increasing macro-economic instability. In the past and up to recently, the SE sector borrowed little from the domestic capital market. Some state enterprises borrowed from the state-owned Krung Thai Bank but not to a large extent. There are several reasons why domestic bond issues were not fully utilized by the SEs. One is that it is government policy to provide guarantees for SEs' bond issues but it is reluctant to do so because it has itself incurred large deficits by issuing bonds to commercial banks, the government savings bank, and the public. It may not want SE borrowing to crowd out private borrowing. The other reason is that, discounting foreign exchange risk, interest rates in the overseas markets are lower than in the domestic market. Moreover, at a time of falling international reserves in the early eighties, foreign borrowing helped to bring in long-term capital flows and to strengthen the reserve position. Whatever the reasons, the fact remains that the SEs have made little use of the domestic capital market. Secondly, the SEs are required to hold deposits with and to borrow from the state-owned Krung Thai Bank. SE deposits at the KTB account for half of the bank's deposits and lending to theSEs amounts to about 20 per cent of the bank's !endings. Much of this lending is believed to be at below the market rate, which implies a subsidy. Thirdly, the local currency lending of foreign borrowing by the government (which assumes the foreign exchange risk) to the SEs implies an indirect hidden subsidy to the SEs. The upshot of this arrangement is that strong financial discipline is not imposed on the SEs. Such financial management also implies a lack of financial autonomy on the part of the SEs. Better alternatives could lead to more financial responsibility and, perhaps, more pressure for efficiency of the SEs. Utilization of the Domestic Capital Market as a More Efficient Alternative

In an effort to reduce the fiscal deficit and external debt burden the reform and privatization of state enterprises during the Fifth Fiv~-Year Plan

180

Pairoj Vongvipanond

(1982-86) brought about positive changes. A number, though small, of manufacturing and trading enterprises were totally liquidated while some were converted to government-private joint ventures, one of which was the North East Jute Mill which was listed on the stock market. In 1989 the state-owned Krung Thai Bank also divested 10 per cent of its shares to the public and was listed on the Securities Exchange of Thailand. The government has also contained the level of SE investment during the Fifth Plan and required that substantial investment be financed from internal savings rather than by borrowing from domestic or foreign sources. As a consequence, by the inception of the Sixth Plan, borrowing as a proportion of total financing had declined drastically. The first three years of the Sixth Plan, 1987-89, showed a dramatic reversal of overall and sectoral performance. Double digit growth was achieved in 1988 and 1989 and a fiscal surplus emerged. International reserves reached an all-time high. The foreign debt service burden declined drastically. Meanwhile SE investment in electricity, other public utilities, telecommunications and transport was expected to be very large, estimated to be about 290 billion baht between 1989-95. Currently, the infrastructure bottleneck is acute. In spite of improvements in the external financial position, the external debt committee has set an annual ceiling of US$1.2 billion. This foreign public debt ceiling has implications for the financing strategies of the SEs and has set off subsequent debates. There seems to be a consensus that an improvement in the efficiency of state enterprises is needed. But unsettled issues and conflicts seem to prevail when serious implementation is called for with regard to the role of private sector participation. The issues and controversies boil down to the question of how much and how to. The labour union, for instance, has protested against the government's move to contract out port management on the Eastern Seaboard to the private sector. At issue also are the financing strategies of the SEs in new infrastructure projects, such as the Skytrain, and Expressway Project II, which call for private participation, and the share divestment to the public of profitable existing enterprises such as Thai Oil Co., Thai International (Airline), and the Electricity Generating Authority of Thailand (EGAT). These SEs are encouraged and pressured by the Minister of Finance to raise part of their domestic capital requirements through selling shares to the public via the stock market. The primary reasons for doing so seem to be, according to the Finance Ministry, overcoming the public foreign debt ceilings. Little or no attention seems to be paid to long-term efficiency improvement that would accrue from more reliance on domestic capital and from different financial arrangements. As mentioned before, in spite of the fact that there are more than sixty SEs, the gain from privatization and the financial implications of various strategies depend on the big SEs, public utilities, and transport and telecommunications. There is no doubt that most of them would still be

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monopolist despite movements towards some kind of privatization, and in the Thai context most SEs would still be government-owned. Projects, however, can be privatized- for instance, the franchising of the Skytrain and Expressway Stage II for the BOOT (Build, Own, Operate, and Transfer) scheme in which private ownership management and financing are vital. To ensure fairness and to prevent monopolistic practices, the government still has to regulate the pricing, and so forth. Nevertheless, this trend towards increasing the participation of the private sector does have implications for the capacity of the domestic capital market, assuming that the public sector foreign debt ceiling continues to exist. A number of pertinent questions arise: will there be sufficient demand for long-term debt and equity financing on the part of the SEs? What is the likely impact on the capital market? What is the likely impact on the efficiency of the SEs? What other changes in financial management are needed to increase the efficiency of theSEs. As part of the privatization policy, a number of key SEs have been called upon to raise capital by selling part of their equity to the public and have them listed on the security exchange. This would also promote the development of the stock market by increasing the supply of securities. Well-run and managed SEs, such as Thai International (Airline) and EGAT are cases in point. These two SEs have different legal organizational bases. The former is a limited liability company, the stocks or shares of which can be sold to the public without any change in its corporate form. On the other hand, EGAT and other similar SEs were set up by either a parliamentary act or royal decree. For EGAT to sell its shares, a new limited liability subsidiary must be set up, or EGAT must change its legal status. However, these legal problems are not insurmountable. A subsidiary could also be set up by Thai International to be listed on the SET to raise funds for the fleet expansion of Thai International. In the domestic capital market, there are the long-term government and SE bond market and the equity market. As for the development of both primary and secondary markets, the government should employ a number of strategies, namely, realistic interest rates, sales promotion, abolition of the 16 per cent holding by commercial banks and replacement with a liquid asset holding. With good yield, bonds from profitable SEs could be issued without any government guarantee, as was the practice in the past. With all these measures, SE bonds would be highly demanded if an active secondary market is developed. SEs, particularly the larger ones like EGAT, Thai International, PTT, Thai Oil, etc., should be encouraged to issue bonds to tap funds from the domestic capital market which had been neglected in the past. As for the stock market, by the end of 1989 the SET had emerged as a rising star in the Pacific region, according to most foreign fund managers. Given that the 1990s will see Thailand having a sustained growth of 7-9 per cent annually and more institutional reform at SET and the financial sector, the Thai stock market is now placed

182

Pairoj Vongvipanond

in an excellent position to service the listing of prominent SEs (especially partial listing without the loss of government control). More big private companies should be encouraged to be listed. The SET is now also in urgent need of a strong supervisory and regulatory agency in the nature of the SEC. What will be the long-term impact of listing SEs on the stock market, or of share divestiture? Those who are opposed to the listing of SEs in the SET, especially in sectors such as the airline, telecommunications, power and electricity, often cite national security reasons. Experience in other countries, namely, the United Kingdom and Singapore (the case of Singapore Airlines) to name just the few, has shown that this perceived threat to national security is often exaggerated and unfounded. After all, in the Thai case, the share divestitute can only be partial and control can still rest with the government. The cost to the government is nil or negligible. The benefit in the longer term, however, is immense. First, it represents a major change in outlook and image which will have a positive impact on both domestic and international business. While the listing of prominent and successful SEs on the stock market (SET) in itself should not be based on the primary reason of promoting the market or increasing the supply, its consequence and psychological impact on the capital market could be intangibly large. For it represents a departure to a new and open government system subject to exposure of the market - in fact, a privatization of the government outlook. Secondly, share divestiture to the public and the listing of some SEs, such as Thai International or EGAT, would expose more information on the enterprises to the public or private shareholder for scrutiny. This exposure in itself should increase management accountability and the enterprises' operating efficiency (such as overstaffing, privileges, and so forth). Employee and wider public subscription of shares is also an instrument for wider stock ownership. Thirdly, the adoption of a more vigorous strategy by the SEs to tap the domestic capital market through bonds and equity would be a stimulus to capital market development. Last but not least, as the capital market becomes more mature and efficient, it could impose discipline on the management to achieve higher efficiency, as the performance would be indicated in the share prices. Changing the financing strategies of the SEs through share divestiture and listing on the SET are only part of the broader financial environment and framework within which the SEs have to operate. In the pursuit of greater operating efficiency, more rigorous private financial discipline has to be applied on the SEs. Changes in government financial policies towards SEs are also needed, especially the abolishment of government guarantees for large and strong SEs. These SEs should be able to borrow directly on their own instead of the present practice of borrowing from the government. Income and other tax exemptions should also be eliminated. Stronger financial discipline and greater financial autonomy would be consistent with more exposure to capital market discipline in equity financing. These

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183

suggested financial changes should supplement other competitive market pressures through privatization policies to increase efficiency.

REFERENCES Berg, E., and M.M. Shirley. Divestiture in Developing Countries. World Bank Discussion Paper. World Bank 1987. Comptroller Dept, Ministry of Finance. Annual Evaluation of State Enterprises' Performance in 1988. Thailand, 1989. Dhiratayakinant, K. Privatization : An Analysis of Concept & Implementation in Thailand. Thailand Development Research Institute, 1987. Domberger, S., and J. Piggott. "Privatization Policies and Public Enterprises". Economic Record, June 1986. Hataseree, R. "Profitability of the Thai Commercial Banking System". Bank of Thailand Monthly Bulletin (forthcoming) Kay, J. et a!., eds. Privatization and Regulation : The UK Experience. Clarendon Press, 1986. Kriangkrai, P., and S. Krirakul. "Specialised Financial Institutions in Thailand." Bank of Thailand, Monthly Bulletin, July 1988. Krongkaew, M., et al. Thailand Financing Public Sector Development Expenditure. Manila : Asian Development Bank, 1988. Phisit, Phakkasem. Privatization : The Thai Experience. Manila : Asian Development Bank, 1985. Richupan, S. "Comments on World Development Report." Journal of Finance, 1988. Ruangsakul, N. Commercial Banking Development. Thammasart University Press, 1986. Ruangsakul, N., et al. Money and Finance and Management of Economic Policy : Essay in Honour of Ajarn Puey. Chulalongkorn University Press, 1987. Thaiaree, P. Principle of Privatization and Thai State Enterprises. Chulalongkorn University Press, 1988. Vongvipanond, Pairoj. Major Issues in Financial Development :Analysis and Policy. Report Prepared for Asian Development Bank, Manila, 1987. World Bank. Thailand : Managing Resources for Structural Adjustment, 1984.

XIV. Recent Deregulation of the Banking Sector in Indonesia* ANWAR NASUTION Introduction

The aim of this paper is to provide a brief overview of commercial banking in Indonesia, including a historical perspective, and detailing the economic and regulatory environment within which banks operate. Particular attention is given to recent deregulation measures and their economic impact. Deregulation, in the Indonesian context, has two meanings: first, to reduce the rules and constraints governing the activities of the banking institutions. This partly reflects the reorientation of Bank Indonesia, the central bank, from utilizing quantitative controls in favour of a more market-oriented monetary management. The second meaning of deregulation is to relax the barriers of entry into the banking industry. Lessening barriers to market entry is widely known as "liberalization" (Waterson 1988). The government avoids using the word, however, as "liberalization" has negative connotations in Indonesia's political jargon, it being used to refer to "cut-throat" competition that could lead to exploitation of workers by capitalists. The word "deregulation" has thus far not included privatization in the sense of the transfer of public ownership to the private sector. A decline in real economic growth from an annual average of 7.5 per cent in 1973-81 to 3.3 per cent in 1981-88, and an increase in the current account and budget deficits, required Indonesia to adopt a comprehensive stabilization and adjustment programme. The past strategy of financing the twin public sector and current account deficits by foreign borrowing proved to be untenable. The debt service ratio became unacceptably high because of the limited ability of the economy to generate the requisite export and fiscal surpluses. To finance the required investment to reach the 5 per cent targeted annual rate of growth in the Fifth Five-Year Plan, Indonesia supplements its growth cum debt strategy with efforts to expand non-oil exports, to increase *Special thanks are due to Professor David 0. Dapice and Dr Mari Pangestu for comments, suggestions and editorial assistance in the preparation of this paper.

Deregulation of the Banking Sector in Indonesia

185

mobilization of domestic savings, and to promote greater participation of foreign private investment. Mobilization of domestic savings through the banking system, the core of Indonesia's financial sector, has motivated the banking deregulations. The period of ceilings and credit allocation policy during most of the oil boom years ( 197 4-83) encouraged inefficiencies in the already bureaucratic state banks. The credit ceilings were introduced in April 197 4 to control the monetization of the windfall "oil money". However, credit ceiling ruled out competition and this was reinforced by closed market entry. Such repressions of the financial sector discouraged domestic savings mobilization, increased the cost of intermediation and induced misallocation of financial resources. At the same time, the controls nurtured the expansion of the curb markets. To replace quantitative controls with market instruments which could be used as monetary policy tools, the authorities introduced the banking reforms in June 1983. The reforms were followed by a new reserve requirements policy, the introduction of debt instruments, and improvements in the central bank exchange rate swap facility. Deregulation measures on the security market were issued on 24 December 1987 and similar measures relating to the banking industry were further announced on 27 October 1988. Two months later, another deregulation package aimed at the non-bank financial institutions (NBFis) was issued on 20 December. Deregulation reforms the characteristics of the regulatory system in the banking industry to make the industry more prudent and safer for their customers. Major changes in prudential or preventive measures include the relaxation of regulations on market entry, permissible business activities and on interest rate determination, a reduction in the reserve requirement ratio and more stringent rules on capital adequacy requirements, asset diversification (including foreign exchange exposure), and supervision and inspection. The major change in protective measures covers the lender of last resort facilities. Deregulation measures were also aimed at increasing competition both within the banking industry and between the banking and the non-banking financial institutions, and to integrate the domestic financial market with international financial centres. The increase in competition will improve efficiency, encourage domestic savings mobilization, reduce the cost of financial intermediation, and increase the efficiency of allocation of financial resources in the economy. An Overview of the Characteristics of the Banking Industry

Banking as the Core of the Financial System Judging from the amount of assets and the number of offices, the core of the Indonesian financial system is the banking system (Table XIV.l ). The

;;;; 0\

TABLEXIV.l The Structure and Growth of the Organized Financial Sector, 1982-86 Number

1982 Bank Indonesia 1 Deposit Money Banks 115 National FX banks 15 Foreign banks 11 Other commercial banks 61 Development banksa 28 Non-bank intermediariesb 14 Savings banks 3 Insurance companies 83 Leasing companies 34 Other credit institutionsc 5809 All institutions 6059

1986 1 110 15 11 56 28 14 3 100 83 5789 6100

Gross Assets (Rp. tril)

1982 13.7 15.9 12.7 1.2 0.7 1.3 0.8 0.5 0.7 0.1 0.1 31.8

1986 34.5 46.6 36.8 2.7 3.6 3.5 2.1 1.9 3.0 1.4 0.4 89.9

Average Gross Assets (Rp. tril)

1982

1.01366 0.84667 0.10909 0.01148 0.04643 0.05714 0.16667 0.00843 0.00294 0.00002 0.00525

1986

2.88807 2.45333 0.24545 0.06429 0.12500 0.15000 0.63333 0.03000 0.01687 0.00007 0.01474

Including 27 regional development banks Investment and development finance, and general finance companies. c Village, rural paddy, petty traders' and employees' banks, and state pawn shops. Excludes credit extended by foundations and informal sources, for which estimates are unavailable. SouRCE: Bank Indonesia and Indonesian Insurance Council.

Share of Assets(%)

1982 43.1 50.0 39.9 3.8 2.2 4.1 2.5 1.6 2.2 0.3 0.3 100.0

1986 38.4 51.8 40.9 3.0 4.0 3.9 2.3 2.1 3.3 1.6 0.4 100.0

Asset growth (% p. a.)

1982-86 20.3 24.0 23.7 17.6 38.8 21.9 21.3 30.6 33.8 69.5 32.0 23.1

a b

~

;:s

~...

~;: ~ ;:s

Deregulation ofthe Banking Sector in Indonesia

187

dominant size of the banking system and the heavy reliance on intermediation through the banking sector in Indonesia are also due to the lack of other sources of financing such as through the sale of debt and equity instruments. Following the pattern prevailing during colonial times, banks mainly provided loans for facilitating foreign trade and for short-term working capital used in domestic production and commerce. Long-term investment credit has only been available since 1969 at state-owned banks and are financed by government earnings from oil and from foreign aid and borrowings. Consistent with the colonial tradition, bank loans are mainly granted based on the value of collateral rather than on the overall credit worthiness of the borrowers. At the end of 1986, the financial system consisted of a commercial banking system, which was regulated by the central bank (Bank Indonesia), 11 0 deposit money or commercial banks, 14 non-bank financial institutions (NBFis), 3 savings banks, 83 insurance companies, 34 leasing companies and some 5,800 village, paddy and market banks. By ownership, deposit money banks (DMBs) can be divided into seven groups: five state-owned banks; twenty-seven regional development banks (RDBs) owned by provincial governments; ten branches of foreign banks; one joint-venture bank; one co-operative bank; and sixty-six national private banks. TheMonopoly Position of the State Banks Various government regulations in the past have led to the group of state-owned banks occupying a monopsony position in the funds market and a monopoly position in the credit market. The first regulation, issued in 1967, required all of the public sector (including state enterprises) to deposit only with state-owned banks. This constituted a very large captive market for state banks because of the dominant role of the public sector in the economy. Government subsidies to state-owned banks were thus given in the form of providing captive markets. The regulation also provided exclusive access of the state bank group to foreign aid and loans as well as to government oil revenue. Secondly, Bank Indonesia imposed ceilings on foreign borrowings and swaps by banks and NBFis. Because these facilities were allocated based on the size of assets and the past performance of the individual bank, the system preserved the status quo. Thirdly, deposits with the state banks are explicitly and implicitly guaranteed by the government. The guarantees are explicit for both savings and time deposits. As for demand deposits, the general notion is that the government will not allow any of its banks to become bankrupt at the expense of its depositors. Fourthly, since nearly all of the priority credits were handled by the state banks, the past policy of ceilings cum selective credit provided an exclusive access of state banks to liquidity credit financing from the central bank. Fifthly, those exclusive rights and their wider network of branch

188

Anwar Nasution

offices, gave the state banks an important advantage in tapping domestic savmgs. Geographic Dispersion Indonesia has adopted a branch banking system. The geographic dispersion of bank offices in Indonesia is strongly oriented towards the major cities (Table XIV.2). To some extent, the authorities have tried to redress the alleged rural versus urban imbalance in the availability of financial services by encouraging national private banks to establish branches in small towns and the rural sector. The rapid expansion of branch offices of state banks in the 1970s was related to this supply-led policy. The result of this policy has been disappointing since there is no similar response from the rural sector. Service, Management Style and Efficiency ofState Banks Long periods of financial repression have suppressed the initiative of state banks to introduce financial services outside the existing credit and saving schemes. Before the deregulation in 1983, the type of financial services at the state banks as well as their fees and interest rates were uniformly determined by the central bank. On the other hand, since they were not tightly regulated, private banks were free to introduce schemes and to set their own service charges. Selective credit controls also meant that the central bank was deeply involved in the operations of the state-owned banks. Detailed selective credit allocation requires an effective supervising machinery and enforcement that cannot always be left to conventional solutions. As a result, more time and resources were needed by the state banks for co-ordinating meetings and other administrative jobs, at the expense of building business capabilities. Central bank involvement in the day-to-day operations of the state banks implied that the state bankers were also part of the government bureaucracy. They were expected to work under central bank administrative guidance and, consequently, were discouraged from taking initiatives and being innovative. The increase in the cost of administration together with the rapid expansion of their branch offices contributed to an increase in the cost of intermediation of the state banks. Furthermore, the capability of state banks to evaluate the credit worthiness of their customers could not keep up with the expansion of programme credits which exploded during the oil boom period. Adverse selection also contributed to a high credit risk. Moreover, since some of the credits were allocated based not on economic considerations only, some of the state banks' bad debt problems could not be overcome merely by collecting collaterals. Politically, collateral might not be easy to collect if the bankrupt projects belong to state enterprises, political constituents, or other influential people. Collaterals

~

~

~ IS"

TABLEXIV.2 Geographic Dispersion of Branches of Commercial Banks and RDBs in 1988

~· ;::;

Five Largest Other Provincial Other Cities Total Percentage Cities a Capitals and Towns (by Group to Total of Banks)

Jakarta

Group

Absolute %b Absolute %b Absolute

0mb

Absolute 0mb

21 34 35 34 23 7

117 20 23 17 33 24

15 22 21 29 15 8

485 39 47 21 133 245

64 43 44 36 62 85

759 90 107 58 215 289 (3543)

34 21 75

21 100 27

76 21 163

48 100 58

48 0 47

30 0 17

36 0 71

23 0 25

160 21 281

10.7 1.4 18.7

13 243

5 16

19 436

7 29

39 251

14 17

220 812

79 54

278 1499

18.5

Percentage to Total

16.2

10

•Jakarta, Surabaya, Medan, Bandung, Semarang. bPercentage of Total by Group of Banks SouRCE: Bank Indonesia.

29.1

16.7

"'~ ;::;

?;-

Oq

157 31 37 20 49 20

27

;;.

;;·

13 24 26 22 13 3

100 22 28 13

State Banks Bank Bumi Daya Bank Dagang Negara Bank Ekspor lmpor BankBNI Bank Rakyat Indonesia (Unit Desa) Foreign Exchange Private National Banks Foreign Banks Non-Foreign Exchange Private National Banks Regional Development Banks Total (by location)

~

50.6 (6.0) (7.1) (3.9) (14.3) (19.3)

~

§ .... s·

......

;::;

2;::; "'"'~·

54.2

00

-o

190

Anwar Nasution

may be overpriced since borrowers sometimes add the kickbacks and other costs they spend in getting the loans to the true value of their collaterals. A non-transparent and complicated law system and the absence of a well developed capital market have led to the high cost of litigation to recover the principle of loans. Under the past ceiling cum credit policy, state banks' credits were mainly financed by Bank Indonesia's liquidity financing. Large parts of their credit risks were also assumed either by the central bank, or by the government. This reduced the need for credit review, supervision and collection which led to an increase in bad debts at state banks. The high cost of intermediation and high credit risks have thus contributed to high operating costs and spread margins. According to Chant and Pangestu (1987) the gross spread margin for all banks in Indonesia in 1986 was 5.02 per cent. The margin for state banks in that year was 4.65 per cent and for private banks it was 7.83 per cent. The ratios are not much higher than the average of 3.5 per cent for Malaysia and 4.3 per cent for Thailand, both in 1980.

Recent Financial Deregulation

Relaxation ofEntry Barriers To increase competition in the banking industry, the October 1988 banking deregulation removed many of the barriers to entry. After being closed since 1971, new banks are now allowed to be set up and the authorization procedures to open new banks or branches have been simplified. Foreign banks are allowed to set up foreign-owned joint ventures with a maximum share of 8 5 per cent. The existing foreign banks are also allowed to open branches in five other large cities, outside of Jakarta. The cities are: Medan, Bandung, Semarang, Surabaya, and Ujung Pandang. The joint-venture banks can also have branches in Denpasar in addition to the six big cities already mentioned. A year after their operations, at least 50 per cent of the credit of the joint-venture banks and branch offices of foreign banks outside Jakarta has to be earmarked for export credits. This rule reflects the objective of the government to restructure the domestic economy to a more export-oriented one. This constraint, however, can potentially create distortions in their portfolio, particularly since there is no clear-cut definition of export credit. New regulations for applying for foreign exchange licences were rationalized, with more emphasis on prudential measures such as capital adequency requirements, liquidity requirements, and asset diversification rules. The old non-economic considerations under which foreign exchange operations were granted, such as the pribumi ownership requirement,

Deregulation ofthe Banking Sector in Indonesia

191

mergers, and dispersion of branch offices, were removed from the new regulations. Indonesia uses the reciprocity principle as a policy to limit the access of foreign banks into the domestic market rather than as a bargaining chip for the access of domestic banks to foreign markets. On the other hand, there is no restriction on cross-border international banking operations. The long history of economic and political instabilities, exchange controls, monetary purges, successive devaluations and financial repressions have encouraged Indonesian residents to hold deposits at banks based in Singapore or Hong Kong. Residents are also permitted to borrow from foreign-based banks through their representative offices in Jakarta. At the end of 1988, 59 foreign banks maintained representative offices in Jakarta. By June 1989, the Ministry of Finance had granted licences to 28 new domestic private banks, 8 joint-venture banks and 282 BPRs. New licences to deal with foreign exchange transactions have also been given to three private banks. Eleven of the existing BPRs have obtained permits to operate as full commercial banks. Foreign banks have also opened branches outside Jakarta, mainly in Surabaya. Private banks have also undertaken rapid expansion in their branches to compete in the retail markets.

Capital Requirements The value of domestic assets of the financial institutions have been impaired recently owing to, inter alia, the severity of the economic downturn, successive devaluations, and currency realignments. The impaired quality of their assets, and the general increase in risks faced by them, have led the authorities to encourage the financial institutions to increase their capital resources. The 27 October 1988 deregulation increased the amount of paid-up capital of a newly established bank to Rp 10 billion, or roughly US$600,000, at the current exchange rate of Rp1,685 per U.S. dollar. The minimum paid-up capital for secondary banks was set at Rp50 million, or US$30,000. Previously, capital requirements for banks and secondary banks were set according to their location, and individual branch offices were subject to separate capital requirements. Capital adequacy is now consolidated for all branches. To open new branch offices, the applicant should meet the overall consolidated capital adequacy ratio and liquidity requirements, for a period of at least twenty-four consecutive months. In the 1970s, the authorities encouraged the existing national private banks to consolidate and merge in order to strengthen their capital base by offering various tax and credit facilities, the right to open new branches and sub-branches, the right to obtain a foreign exchange licence, and to establish joint venture banks. However, there is no information available to study the impact of the policy to increase the degree of bank concentration on bank safety or on reducing the cost of intermediation.

192

Anwar Nasution

Through the legal lending limits regulation, the authorities are indirectly encouraging the existing banks to build up their capital base. In the new ruling, capital includes reserves for bad debts, subordinated and two-step loans which are basically government-gu aranteed foreign borrowings channelled through the state-owned banks. Reserve Requirement The 27 October 1988 deregulation also reduced the reserve requirement ratio from 15 per cent to 2 per cent of the banks' deposit liabilities, both in rupiah and in foreign exchange. The 13 per cent reduction in bank reserve requirement, however, must be temporarily held in the form of Bank Indonesia Certificates (SBI), which currently bears 17.5 per cent interest per annum. The same reserve requirement ratio is applied for both secondary banks and NBFis. In the past, the maximum gearing ratio of NBFis was 15. The reduction in the reserve requirement ratio is expected to reduce the cost of funds and, hence, the bank spread margin. Provisioning By the 1968 statute, each of the state-owned banks was assigned to specialize in a specific economic sector. In reality, however, they are allowed to compete in nearly all sectors, except in financing the rice and other rural sector programmes, which are reserved for Bank Rakyat Indonesia. The state banks, by being able to diversify their assets and incomes by economic sector would be able to reduce the risk of their asset portfolios. As state banks have been given more freedom to determine the pattern of their credit, they are now expanding operations into sectors and activities previously closed to them. In the past, they used their subsidiaries, such as investment finance corporations and leasing companies, to serve those sectors. The activities include providing working capital loans for trade and distribution activities, and personal and consumer loans. Measures announced in December 1987 and October 1988 had allowed a commercial bank to operate as an investment bank and finance company. The March 1989 ruling, however, prevents a commercial bank from underwriting an emission of securities and reduces the scope of the activities of secondary banks, which had been previously allowed to operate as wholesale village banks. The 27 October 1988 deregulation allows state-owned enterprises to deposit and use the services of the non-governmen t-owned financial institutions and imposes legal lending limits which apply uniformly to all banks and NBFis. Each of the non-bank state enterprises is allowed to deposit a maximum of 50 per cent of its deposits with non-governmentowned financial institutions. The maximum deposit by each of the state enterprises at each private bank is limited to 20 per cent of its deposits.

Deregulation ofthe Banking Sector in Indonesia

193

These regulations removed the exclusive right of state banks to the public sector and, at the same time, liberalized access to credits. Most of the portfolios of the national private banks, particularly those belonging to groups of companies, are heavily concentrated in their own non-bank business firms. Because of the sister-company relations, the quality of their assets are often not superior to those of state banks. The legal lending limits regulation, as introduced in the October 1988 package, is intended to protect the rights of ignorant depositors, to prevent the misuse of funds by insiders, and to democratize access to credit in order to prevent the concentration of financial power. The ruling, which will be effective from October 1990, restricts the aggregate amount of loans and advances to insiders, single borrowers and groups of borrowers. Democratization of access to bank credit alone, however, does not necessarily remove economic distortion and improve distribution of wealth owing to the scarcity of entrepreneurship. Foreign Exchange Exposure In the absence of exchange controls, the private sector is, in theory, free to tap the international money and capital markets. However, their access to the world markets is limited because of their small size by international standards and also the lack of information about their profiles. On the other hand, foreign borrowings of the public sector is centralized in the Ministry of Finance. As the policy is to maximize concessional funding sources, public borrowing from international markets is only used as a last resort. On 25 March 1989 the authorities replaced the ceilings on foreign borrowing by financial institutions with a daily net foreign position amounting to 25 per cent of their capital. Eligible foreign exchange banks and NBFI are allowed to extend loans in foreign exchange. Under the recent deregulation, Bank Indonesia has also removed the ceiling on its swap facility, extended the maturity to three years, and allowed the premium to adjust so that it would equal the interest rate differential. On the other hand, banks and NBFI are not allowed to issue bank guarantees denominated in foreign exchange, and foreign borrowings remain subject to a 20 per cent withholding tax. New regulations on foreign reserves of banks reflect the new government policy of holding foreign exchange reserves. In order to secure continued inflow of concessionary loans from the Inter-Governmental Group on Indonesia (IGGI), in the 1970s the government had "hidden" some of its acquisitions of "oil money" in the form of secondary international reserves held by the state banks (Grenville 1977). With the reduction in oil revenues, the authorities are discouraging capital outflows. The central bank policy to reduce the rate of growth of its domestic credit has forced the banks to monetize their foreign holdings. On top of that, the authorities have also used "moral suasion" to force banks to reduce their

194

Anwar Nasution

foreign reserves. An extreme example of this is the so-called "Sumarlin shock" in June 1987 which instructed the state enterprises to withdraw their deposits from state banks and convert them into Bank Indonesia Certificates (SBI). The elimination of ceilings on foreign borrowings and the new rule on foreign exchange exposure of financial institutions hurt the state banks most. The removal of ceilings eliminates their revenues from economic rent since they were mainly allocated to state banks. A reduction in the accumulation of foreign assets has reduced their profits from the rupiah devaluation and from high interest rate differentials between the international and domestic markets.

The Economic Impact of Deregulation Measures

The Welfare Gain The effect of deregulation measures on national welfare can be analysed by using a static and partial equilibrium supply and demand curve for credit, as shown in Figure XIV.l. SS0 is the supply curve of credit without government intervention. At the same time, the supply curve reflects the amount of savings mobilized by the banks. 000 is the demand for credit. The pre-June 1983 detailed ceiling cum selective credit policy with subsidized interest rates affect both demand and supply curves. Credit ceilings mean that the authorities restrict the amount of credit at a lower level than could have been extended by the banks in a competitive market. Suppose the amount of credit ceiling is KP and the interest rate is regulated at iP, the effective supply curve would now be changed to SABJ. A portion of the supply curve SS 0 (SA) remains sensitive to interest rate up to iP. At that regulated interest rate banks mobilized savings by K 0 • To enable them to extend credit amounting to KP, Bank Indonesia provides the banks liquidity credit equal to K 0 KP, or the difference between the permissible amount of credit and their own mobilized funds. The demand for credit depicts the willingness of the demander to pay the interest rate at various amounts of supply of credit. At the credit ceiling equal to KP, customers are willing to pay the interest rate equal to i 1 • Thus, rectangle iPBCi 1 is economic rent and triangle GEC is the welfare loss. Economic rent is divided between those who have access to credit at the official interest rate (including those who have influence to obtain credit and those who actually qualify for the specified purposes of the credit programmes) and the banks. Since foreign banks are allowed to enter and share the regulated credit market (K 1 KP being their market share), then the total welfare cost to the national economy is equal to triangle GEC and rectangle IBCH, where the latter is the rent going to foreign banks, which they may repatriate to their head offices.

195

Deregulation of the Banking Sector in Indonesia

FIGURE XIV.l Welfare Effects of Financial Deregulation

Interest Rate

D

J

0

Ke

K'e

Savings/Credit

196

Anwar Nasution

Deregulation in the financial sector redistributes income and leads to a welfare gain for the national economy. Economic rent received by rent seekers under the regulation will go to bank customers (both savers and most borrowers). The increase in competition will achieve further welfare gain by triangle GEC. In the competitive market, domestic financial institutions will have strong incentives to reduce interest rates, to introduce new financial products or to improve the quality of their services by advancement in technology, innovation, and management skill. All of these reduce marginal costs and shift the overall supply curve SS0 down to S' S' 0 • This increases the welfare gain further by a part of area SMLS'. The increase in the welfare gain is also attributed to the improvement in the allocative efficiency of financial institutions after the elimination of administrative controls. The elimination of controls over the deposit rates and over the allocation of credits has sharply reduced the role of curb markets which had flourished before deregulation. The elimination of administrative controls and the reduction in operations of the segmented, inefficient and unregulated curb markets has improved the effectiveness of monetary policy.

The Impact on Savings Mobilization and Interest Rates The effect of deregulation on financial savings mobilization can be examined with the aid of Figure XIV.l. The increase in savings from K 0 to Ke is not only stimulated by the increase in the interest rates as returns on financial savings. The expansion in branch networks, the introduction of new financial instruments and other non-market qualities which cater to the preferences and needs of savers, also play an important role in financial savings mobilization. As shown previously, the immediate impact of deregulation is to raise the interest rate from iP to ie (Figure XIV.l ). The reduction in the scope of selective credit reduces the level of the interest rate. Gradually, in the intermediate and long-run, the interest rate in the non-regulated sector moves down to i2 • The long-run decline in interest rate is due to the increase in the efficiency of the financial sector and to closer integration of domestic to international financial markets as deregulation relaxes official barriers to capital inflows. The interest rate differential between domestic and international markets, however, may not be reduced dramatically. The interest rate differential is not only attributable to the currency risk factor, and to the limited access of domestic economic agents to international financial markets. The interest rate differential is also due to the underlying difference between financial instruments in Indonesia and those in the international markets: liquidity, credit risk, tax treatment and other related attributes which reflect structural factors and domestic economic policy. This implies that domestic securities are not tradeable in international

Deregulation ofthe Banking Sector in Indonesia

197

markets. Because of this, deregulation will not reduce the autonomy of the national monetary authority in controlling domestic financial yields and monetary policy.

"Non-Price" Competition The increase in competition in the financial sector has led to "non-price" competition as well. Many banks, including state-owned banks, have improved their systems, introduced new instruments, improved services and even tried to improve their images by changing names and logos. Severer competition occurs in the wholesale and retail markets. The rapid expansion of their branches have enabled private banks to cater to a wider area of operations and classes of customers, including medium and small-scale enterprises and lower-income groups. These classes of customers had been neglected in the past. To lure small savings some private banks introduced small savings schemes in early 1989. To promote the schemes they are combined with lotteries. The schemes have been well received by small savers and savings have increased at the cost of a reduction in the existing lottery sales. The Simpedes scheme of Bank Rakyat Indonesia grew at the rate of 60-70 per cent in 1986-88. In less than three months the four private banks of the BCA group mobilized Rp200 million in small savings after the Tahapan scheme was introduced in May 1989. In addition to the interest return at 15 per cent per annum, each RplO,OOO savings deposit in the Tahapan scheme receives one lottery coupon. Drawing is done every three months to select 351 winners, for a total pay-off of Rp500 million. A comparable savings scheme without the lottery element carries an interest rate of 17.5 per cent per annum. The cost of the jackpots of the Simpedes programme is 0.025 per cent; and of the Tahapan, 0.25 per cent, well below the 1 per cent permissible ceiling as set by the central bank (Tempo, 22 July 1989). As in any gambling business, the schemes require a large number of savers and good administrative capability of the bank. Because of these requirements, only a bank which has a good reputation, a wide network of branches, and a good administrative system can commercially run this savings cum lottery system. As in other lotteries, however, the schemes are regressive because the huge lottery jackpots concentrate pay-outs, and most savers lose their wages. Because they are combined with lottery elements, the schemes also create obsession with short-term speculation and foster a cultural bias away from skill and hard work towards luck and fate as the road to wealth. Conclusions Financial deregulation has successfully introduced competition to the banking sector. The competitive market has forced the banking industry to

198

Anwar Nasution

improve its technology and management skills, and to innovate so as to compete both in price and non-price aspects. The improvements in bank efficiency have encouraged domestic savings mobilization. The introduction of small savings schemes by large private banks in early 1989 has also reduced the existing lottery sales. Financial deregulation has not altered the overall dominant position of the state banking system. This is because of the implicit protection provided for these banks, the rigidities in the non-bank state enterprises, and their wide branch networks. The credit programme and publicly guaranteed credits which are channelled through these banks are excluded from the legal lending limits. The inclusion of reserves for bad debts in the definition of bank capital favours state banks. The transfer of public deposits from the state bank groups is pending deregulation measures on the state enterprises. The stricter preventive and protective measures introduced in the October 1988 deregulation require improvements in Bank Indonesia's ability to enforce them. Accordingly, its accounting, administrative and legal systems need to be improved. At the same time, the supervisory task of the central bank has been expanding because of the relaxation of entry barriers to establish both new banks and branch offices. The new regulations have also shifted the task of supervising the secondary banks from Bank Rakyat Indonesia to the central bank. The rise in interest rates has helped to cut the domestic aggregate demand that is required for the stabilization programme. At the same time, the interest rate policy has supplemented the deregulation measures taken in the licensing system, production, trade, and transportation for an adjustment programme to improve the efficiency of resource allocation in the economy. As has been argued elsewhere (for example, Edwards 1984 and Lal 1987), an improvement in the efficiency of resource allocation is very important to prevent capital flight as the domestic financial market becomes more integrated with the international financial centres. The improvement in the efficiency of the economy requires further removals of domestic distortions in goods and capital markets, the attainment of fiscal order and further liberalization of the balance of trade, as well as deregulation in the capital account of the balance of payments.

REFERENCES Bhagwati, Jagdish N. "Trade in Services and the Multilateral Trade Negotiations". World Bank Economic Review I, no. 4, (September 1987). Chant, John, and Mari Pangestu. "The Analysis of Efficiency of Indonesian Banking". Preliminary draft, Jakarta, April 1987.

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Cho, Yoon Ye. "Some Policy Lessons from the Opening of the Korean Insurance Market". World Bank Economic Review 2 no. 2 (May 1988). Edwards, Sebastian. The Order of Liberalization of the External Sector in Developing Countries. Essays in International Finance 156. New Jersey: Princeton University Press, 1984. Grenville, Stephen. "Commercial Banks and Money Creation". Bulletin of Indonesian Economic Studies (BIES), March 1977. Hanson, James A., and Roberto de Rezende Rocha. High Interest Rates, Spreads, and the Costs of Intermediation- Two studies. Industry and Finance Series, Volume 18. Washington D. C.: The World Bank, 1986. Lal, Deepak. "The Political Economy of Economic Liberalization". World Bank Economic Review I, no.2 (January 1987). Leff, Nathaniel H. "Industrial Organization and Entrepreneurship in the Developing Countries: The Economic Groups". Economic Development and Cultural Change 26, no. 4 (July 1978). Nasution, Anwar. Financial Institutions and Policies in Indonesia. Singapore: Institute of Southeast Asian Studies, 1983. - - . "Instruments of Monetary Policy in Indonesia After the 1983 Banking Deregulation". Paper prepared for a conference on Financial Research in Indonesia, organized by the Ministry of Finance of Indonesia and Harvard Institute for International Development, Lembah Bukit Raya, 24-27 August 1986. - - . "The Structural Adjustment for Sustainable Growth: The Case of Indonesia in the 1980s." Paper prepared for a conference on Structural Adjustment for Sustainable Growth in Asian Countries, Economic Planning Agency of Japan, Japan, 7-8 November 1988. Schaefer, Stephen M. "The Design of Bank Regulations and Supervision: Some Lessons from the Theory of Finance". In Threats to International Financial Stability , edited by R. Portes, and Alexander K. Swoboda. Cambridge, England: Cambridge University Press, 1987. Short, B. K. "Capital Requirements for Commercial Banks: A Survey of Issues". IMF-Staff Papers 25, no. 3 (September 1978). Waston, M., Peter Keller, and Donald Mathieson. International Capital Markets. Occasional Paper No. 31. Washington D. C.: IMF, August 1984. Waterson, I. M. Regulation of the Firm and National Monopoly. Oxford and New York: Basil Blackwell, 1988.

Part VI Industrial Relations

XV. The Labour Perspective of Privatization in Malaysia A. RAGUNATHAN At the outset, it would be of interest to have a bird's eye view of the privatization scenario in Malaysia before focusing on the labour perspective of privatization.

Concept of Privatization

The general aims of privatization are to: 1.

promote competition, improve efficiency and increase the productivity of the service;

2.

accelerate the rate of growth of the economy through private entrepreneurship and investment;

3.

assist in reducing the size and presence of the public sector, with its monopolistic tendencies and bureaucratic support, in the economy; and

4.

contribute towards meeting the objectives of the National Development Plan.

Privatized Enterprises The agencies or parts of agencies which are being or have been privatized include the following:

1.

Malaysian Airline System

2.

Sports Toto (M) Sdn. Bhd.

3.

Container Terminal, Port Klang.

4.

North Klang Straits Bypass.

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5.

Kepong Viaduct.

6.

Malaysian International Shipping Corp.

7.

Airod.

8.

Labuan Water Supply.

9.

Radio Advertisement.

10.

North-South Highway.

11.

Department of Telecommunication.

Other Agencies to be Privatized According to reports, the government is presently studying about 90 projects for privatization and among them the prominent ones are the Printing Service; Medical & Health Service; Malayan Railway; National Electricity Board; Commercial Vehicle Inspection; Postal Services; Malacca Port & Other Ports; Lumut Dockyard; Penang Municipal Council Bus Service; Desaru Tourist Project; and Government Companies. The government is also embarking on a massive master plan study to identify in a more exhaustive manner other projects that can be privatized and to determine the timing of the privatization. This is expected to be completed by 1989. According to the government, there are numerous government companies which can be divested. These companies are involved in all sectors of the economy and they range widely in size, amounting to several million ringgit and comprise both profitable and unprofitable companies. Additionally, there are agencies with certain services or projects, such as garbage collection and disposal of municipalities, quarries of the PWD, and so forth, which can be privatized. It is an acknowledged fact that Malaysia is now going through a wave of privatization. The Fifth Malaysian Plan ( 1986-90) embodies this concept as the government moves to promote greater private-sector participation in the ownership, operation and management of public sector projects and the provision of public services. This new policy is contrary to that of the Second Malaysian Plan ( 1971-7 5) when the New Economic Policy (NEP) was launched. At that time the government sought to participate more directly in the commercial and industrial sectors in order to achieve the twin objectives of the NEP, namely, to eradicate poverty among all Malaysians irrespective of race, and to restructure Malaysian society in order to correct racial economic imbalances. This policy recognized the fact that such a process of transformation had to be achieved within the context of an expanding economy.

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The result was a proliferation of public enterprises wholly owned or controlled by the government, and others jointly owned or controlled by the private sector. As and when the socio-economic objectives were fulfilled, the aim was for the government to hand over the public enterprises to the private sector to give them the flexibility to respond more successfully to the free market economy. It is evident from the guidelines issued by the Economic Planning Unit, Prime Minister's Department, that the government is serious in its efforts on privatization. According to the guidelines, inter-alia, the forms of privatization could include: 1.

Privatization or the transfer of ownership and control from the public to the private sector.

2.

Complete privatization.

3.

Partial privatization.

4.

Selective privatization.

5.

Management and privatization.

6.

Private-sector privatization in activities and the provision of services through "contracting out".

7.

Leasing and privatization.

The Labour Perspective

In order to gauge the impact of privatization on labour, a study of the recently privatized public sector industry, namely, the Telecommunications Department, is summarized below.

Syarikat Telecom Malaysia (STM) The recent privatization of a public service in Malaysia involved the telecommunications services. The employees of the Telecommunications Department were given option papers requiring them to indicate their choice from three options proposed to them. The date of the privatization was 1 January 1987. Under Scheme B, a total of 28,662 employees opted to work for STM, 224 employees opted to retire, 103 employees joined the Telecoms Regulatory Section of the Department, and 40 employees on secondment returned to their respective government departments.

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Options offered to Employees in the Telecommunications Department The government offered three options to the serving employees of the Telecommunications Department: 1.

Opt for Scheme 'A' and accept transfer to STM and continue to remain on the existing terms and conditions of service.

2.

Opt for Scheme 'B' and accept transfer to STM on its terms and conditions of service, or

3.

Opt for retirement from government service under the Pensions Act.

Implications of the New Terms and Conditions ofService The implications of the new terms and conditions of service are set out below.

PENSION

1.

Under the 1986 amendments to the Pensions Act, an officer who opts for Scheme 'A' will only be eligible for his pension and gratuity on attaining the age of 55 years, even if he terminates his service on reaching the optional retirement age. This is a deviation from the conditions on which he was emplaced on the pensionable establishment by the government. However, if he opts for Scheme 'B' he is eligible for his pension and gratuity on attaining his optional retirement age and at the same time he could continue his employment with the STM. Furthermore, officers who have attained the optional retirement age are not eligible to opt for Scheme 'A'. They are only eligibe to apply for Scheme 'B'. It is, therefore, obvious that the 1986 amendment to the Pensions Act is discriminatory and inequitable.

2.

The Pensions Act (Section 17) provides for the payment of disability pension to a public employee who is required to retire as a result of industrial hazards or occupational diseases. However, employees who opt for Scheme 'B' will cease to be governed by this section of the Act. Moreover, the Social Security Act (SOCSO) provides protection against occupational hazards only to employees whose monthly salary is $1,000 or less.

3.

According to the Pensions Act, derivative pension is only payable to the spouse if he or she was married to the pensioner while in service. In other words, if an officer marries after his retirement and then he dies, his wife will not be eligible for any penion after the expiry of 12lf2 years from the date of his retirement.

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As almost all officers are normally expected to marry before they reach their retirement age, the object of the above provision in the Pensions Act is to discourage a person from marrying a pensioner with the hope of enjoying derivative pension. However, it is ironic that the above provision will apply to all unmarried officers of the Telecoms Department who opt for Scheme 'B'. It is indeed an unfair and unjust condition, as most of such officers are still young and they have a long way to go before reaching retirement age. Besides, privatization of the department has been forced on them and they would continue to be in service except that their status as a public employee would cease. 4.

Employees have to serve at least five years before they are entitled to pension benefits, accrued during their service in the public sector. In the event they are dismissed within the five-year period and they are still below the optional retirement age, they stand to lose all their retirement benefits.

SALARIES

I.

The non-executive employees would receive on the average about 12 per cent increase in salary when they join the STM. However, for those who are on the pensions scheme, their take-home pay would be only about 3 per cent higher as 9 per cent would be deducted as contribution to the EPF. However, some of the top executives of STM are given much higher pay increases, resulting in a even bigger gap between the pay of top executives and that of the lower rung than when the STM was a government department.

2.

The STM's time-scales are longer (21 and 26 steps), which means that it would take the workers longer to reach the maximum of the salary scale.

3.

The employees in the Telecommunications Department have not received any salary revision since the last revision in 1980, although the Consumer Price Index (CPI) has increased about 28 per cent for the period 1981-88. The STM salary scales, it is evident, has not taken into consideration the increase in CPl.

SECURITY OF EMPLOYMENT

The STM has assured the employees that there will be no retrenchment of staff for at least five years. This assurance is not adequate as long as there is a retrenchment clause in the offer given to the employees of the STM.

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There is no security of employment in the STM unlike what prevailed when the telecommunications service was a government department. OVERTIME

The STM, after two years of privatization, is reported to have reduced overtime work by about 80 per cent and some have even been asked to take "book-off'' in lieu of overtime payments. Many staff earning more than $1,000.00 are not eligible to claim overtime. These measures are bound to affect the efficiency and productivity of the employees and the services provided by the STM. HOUSING LOAN

During the first year of privatization, it is reported that not a single application for housing loan has been granted by the STM. This has caused "problems" to about 200 employees who are waiting for their housing loans to be approved. Even in instances where loans are granted late the legal fees that the workers had to pay to the solicitors appointed by the STM are much higher than that charged by solicitors appointed by the purchaser or his Co-operative Society. BONUS

It is said that one of the main reasons that employees opted to join the STM is the payment of bonus. It is hoped that the payment of bonus will be an

incentive for the workers to work harder. Two years of privatization has passed and the Union's claim for two months bonus has not been granted. STM BENEFITS

Some of the other STM benefits which are considered inferior to those enjoyed by comparable government employees include the following: Hospitalization benefits. Mileage rates. Medical leave. DENIAL OF UNION RIGHTS

A good number of employees who are employed in the managerial and professional group and those engaged in confidential or security capacities have been deprived of trade union membership whereas under government service, these workers had the right to be members of the union. INDUSTRIAL RELATIONS

Though the existing union -The National Union of Telecoms Employees (NUTE) - has been recognized by the STM, the Union had to carry out picketing and threatened to lay down tools over the question of bonus and to commence negotiations for a Collective Agreement, which are yet to be

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resolved. The dispute is before the Industrial Court with no quick solution in sight. Implications to the Public The implications to the public after two years of privatization of the STM, include the following: 1.

The connection and re-connection fee has been increased to $50.00, causing hardship to subscribers.

2.

The subscribers' deposits have been increased and the deposit is forfeited if the service is terminated within a year.

These measures will make it more difficult for the poor people in the urban and rural areas to have telephones installed in their homes. According to reports, the STM is reorganizing itself so as to be listed on the Kuala Lumpur Stock Exchange in the early 1990s. The STM has reportedly made $5 million in profits in its first year of privatization and for the year 1988 pre-tax profits in excess of $50 million were projected. With assets of about $8 billion and a turnover of over $1.5 billion, the 1987 profit figure of $5 million is comparatively small. It is too early to assess whether the employees are getting more benefits in terms of pay and conditions of service compared to government employees. The profitability of the STM is also subjective at this point in time because it is still wholly owned by the government. There has been no dramatic change in the style of management except at the bureaucratic level and, as such, the present management's goal towards greater profitability is yet to be witnessed.

A Critical Analysis of Privatization Having looked into the effects of privatization in the recently privatized telecommunications services it is now important to analyse the concept of privatization in relation to the workers, who are by and large also the consumers. The Arguments Against Privatization Privatization trends represent a considerable challenge to the trade unions. Although the arguments put forward in support of privatization are primarily based on assumptions such as the government's inability to perform efficiently and that it will reduce external borrowing, the prime motivating factor is undeniably profit-oriented. Handing over the "goose that lays the golden eggs" to the private entrepreneur is an exercise that goes

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against public interest. At a time when the government is laying strong emphasis on encouraging and maximizing export-oriented and employment-intensive industries, privatization, which will inevitably lead to job reduction for optimum profit, would give rise to unemployment and under-employment. Besides, privatization will tend to increase the burden of the already over-burdened consumer. A factor to be noted is that in the Third World competitive bidding is difficult because of the small number of potential bidders, and selling without the bidding arrangement exposes the government to charges of favouritism and corruption. Another factor to consider is that the sale of a public undertaking to defray budgetary deficits is an economic policy manoeuvre which may produce immediate results but may involve huge risks in the long run. Each sale of a public asset will only allow the government a once-and-for-all source of revenue. Continued disposal of the government's assets will inevitably lead to the depletion of its wealth.

Effects ofPrivatization in Malaysia It must be recognized that the size of the public service in Malaysia is determined by political philosophy. The working population includes fishermen, agricultural, forestry and plantation workers who form nearly 70 per cent of the total work-force. The working population in the urban sector is relatively small. In an environment of this nature where the political power rests with the rural and sub-urban community, which is still relatively poor, services have to be provided to a great extent by the state. The services that are being provided through the machinery of government is twofold in character, namely, services provided by the state governments for the people; and nation-wide services provided by the Federal Government. In a country where the per capita income of the people is still very low, at about $4,000, these services will have to be provided by way of revenue allocations because the community is too poor to pay for them. Here, of course, it is agreed that the burden placed on revenue by inefficient and poorly organized state economic enterprises is great. Thus, the Perbadanan Kemajuan Negeri Selangor (PKNS) and the State Economic Development Corporation (SEDC) could well be privatized. Such state enterprises, which are recent features, are aimed at providing basic needs such as housing, but these objectives do not seem to have been attained because of political inputs in the running of such enterprises. In Malaysian society, there exists wide economic imbalances among the majority in the rural, sub-urban, and urban sectors. An equitable arrangement to provide services in a subsidized form through national revenue is necessary. It is only by this means that the level of income of the poor can be improved. In such an economic environment a high-scale privatization

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exercise, as practised in largely capitalist states, is not feasible. Malaysia is by no means a capitalist state and it is hoped that there is no intention of prematurely making this country a capitalist state. Any such policy under the present state of economic imbalance will result in the exploitation of the poor. The state has the responsibility not only to provide the services but also to protect the poor in so far as costs are concerned. The poor, who make up the majority of the population, have the right to be provided with basic services such as hospital, transport, social and communication services. The national revenue belongs to the people and they have the right to benefit from the revenue through the means of services. In no other way can revenue be passed on to the people. Efficiency the Theme The oft-repeated argument that privatization leads to greater efficiency, better economic performance and better services does not hold water simply because the human factor involved in the process is one and the same, be it in a public enterprise or a private company and notwithstanding the bureaucracy and regulations. Studies done by economists in the United Kingdom have shown that there is no conclusive evidence that private enterprises are more efficiently managed compared to the public service. It has also been found that the public at large pay more for privatized services. If the main argument for privatization is the question of efficiency then it should be tackled as such instead of opting for the easy way out and upsetting the system. If a pruning of establishment cost is required to set the right cost value for the services provided by the state, then that question should be addressed. It seems that the problem lies with the political administrators who are not prepared to act boldly to move with the times to change the structure of government, which is largely administrative in character, into a professional civil service. What is required is greater professionalism in the civil service. The government must be bold in its actions to bring about such changes. The bureaucratic system should give way to a pragmatic approach. Rigid rules and regulations should be revised to meet with the changing circumstances. There should be decentralization of power to enable speedy decisions to be made. Training and re-training should be carried out so that employees can carry out their work efficiently. The employees should also be motivated and there must be consultation with subordinates on policy matters. Their views should be given due consideration. A good staff relationship is vital to secure co-operation which is essential for higher productivity and better service. Ability and initiative should be recognized and rewarded so that the standard of efficiency can be enhanced.

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Shift in the Balance ofPower The concern here is primarily the privatizing or contracting out of public agencies which render essential services. Privatization of existing services is an attempt to undermine the public provision of services and to encourage the transfer of its profit-yielding sections to private interests. It is an attempt to shift fundamentally the balance of power from the public to the private sector. CUEPACS (Congress of Unions of Employees in the Public and Civil Services) is of the view that this shift of power to a smaller group in the society must not be at the expense of the people as a whole. Public services are aimed at ensuring a number of safeguards. These can be broadly classified into the following : 1.

Collective Provision of Basic Needs A fair and just society must provide all citizens with the basic amenities of life such as health, education, housing, water, electricity and social security. It must also provide for the basic economic development necessary to sustain and improve the living standards of the people.

2.

Public Determined Priorities and Needs Public services operate to publicly determined standards. Resources are allocated according to publicly determined priorities and needs. The natural tendencies of private enterprises are to concentrate on those services which produce maximum profits. Those services which are less profitable or serve those with little market power are often neglected or are provided at minimum standards.

3.

Loss of Accountability The providers of services must be responsible to those they seek to serve and must be made accountable for their actions. Privatization will lead to a loss of accountability as the profit motivation always takes precedence over social considerations.

4.

Hidden Costs The often repeated argument that the private sector is always more efficient and able to provide better value for money has been found to be not true in many industrialized countries that embarked on the privatization of their public sector undertakings. The hidden costs emerge as the state involves itself in providing the infrastructure and supervision. The continuing costs imposed on the public authority by the need to monitor and supervise the private sector and the provider of services in this sector have proved that on the whole it is more costly to privatize services such as railways, health, education, electricity

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and water supply. The total cost borne by the taxpayer for privatized services is greater than those provided by the public sector. In many parts of the world, workers transferring to privatized companies have experienced a worsening of their conditions of employment, lower pay, longer hours of work, shorter holidays, inadequate medical facilities, and superannuation benefits. These have often been the main contributory factors to the alleged savings resulting from privatization. The privatization policy, currently pursued by the government has been of concern to the workers. Thus, the privatization of services carried out recently need to be looked at from the view of its impact on the public at large and the cost to them.

Conclusion

In conclusion, it should be pointed out that the overall effect of privatization and contracting out could lead to: both poorer quality and reduced services to the consumer; increased costs to the consumer; reduced control over safety standards; reduced control of confidentiality of information; loss of government revenue from profitable activities; loss of economies of scale; increased costs for the taxpayer; loss of jobs; break-up of bargaining units leading to complications in industrial relations; weakening of the bargaining strength of unions; poorer pay and conditions of service for new recruits; reduced motivation and morale in the public service; loss of parliamentary control over the functions of service; indulgence in corruption, favouritism and nepotism; and the emergence of private monopolies.

XVI. Towards Worker Ownership of Public Utility Firms through Privatization The Case of the Pangasinan Transportation Company

LEONOR M BRIONES AND AILEEN R. ZOSA Introduction

One of the interesting possibilities in the privatization programme of the Philippines is worker ownership of public utility firms. This possibility was identified by the Asset Privatization Trust (APT), the agency responsible for the privatization and reprivatization of public enterprise assets. The impact of privatization on workers in particular, and industrial relations in general, is a serious issue which has elicited much concern and interest. The possibility of worker ownership through privatization is, therefore, an interesting area to pursue. Cases where the workers themselves are active participants and the immediate beneficiaries of privatization would definitely highlight the human side of privatization. Thus, the case of the Pangasinan Transportation Company (PANTRANCO) was selected for study upon the suggestion of the APT. However, subsequent events have shown that progress has not been made and that the interest of the workers in acquiring ownership ofPANTRANCO has waned. Nevertheless, this case illustrates the prospects and problems of worker ownership of public enterprises through privatization in the Philippines.

The Privatization Policy of the Philippines 1

The privatization policy of the Philippines was initiated by the administration of former President Marcos in the wake of negotiations for a US $350 million structural adjustment loan from the World Bank designed to rationalize the government corporate sector. Promulgated by Marcos, Presidential Decree (P.D.) No. 2029 sets the broad policy framework for the creation of government-owned or controlled corporations (GOCCs) and lays down the definition of a GOCC. Presidential Decree No. 2030 provides for the "orderly disposition of certain assets of government institutions." These decrees were formulated after a year of intensive consultations among affected government agencies. Numerous drafts were cleared with World Bank officials who set the terms of reference for the entire exercise.

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On the other hand, Proclamation No. 50 signed by President Aquino in December 1986, broadens the coverage of privatization from the disposal of assets of government corporations to "certain government-owned or controlled corporations which have been found unnecessary or inappropriate for the government sector to maintain." Under the proclamation, the responsibility for the implementation of the policy is vested in a Committee on Privatization composed of the Secretary of Finance as Chairman, the Secretary of Trade and Industry, and the Director General of the National Economic and Development Authority (NEDA). Proclamation No. 50 also created the Asset Privatization Trust to manage and dispose of assets identified for privatization. These are primarily private corporations which were taken over by government financial institutions because of their inability to repay loans from these institutions. Recently, other corporate assets have been turned over to the APT for privatization. At present, however, the APT's activities are primarily focused on acquired assets. The Presidential Commission on Good Government (PCGG), charged with recovering public resources from former President Marcos, started turning over sequestered assets to the APT for disposition. Apart from the APT, government corporations are individually engaged in disposing of their assets and subsidiaries. The powers granted to the APT are broad and sweeping. For example, Section 30 provides for the incontestability of "any sale or disposition concluded by the National Government acting through the Trust ... ". Likewise, Section 31 guarantees immunity from suit for the Committee members and APT trustees. Thus far, much of the privatization efforts of the Philippines has been concentrated on the disposal of acquired asset corporations and assets. However, much of the debate on privatization is centred on the government's efforts to privatize government corporations which had been originally created as such. PANTRANCO, which is the subject of this study, was originally a private corporation sequestered by the government and turned over to the APT for disposition. Privatization and Labour Relations in Government Corporations 2

Since 1935, employees in government corporations with proprietary functions had been allowed to form and join labour unions. When martial law was declared in 1972 and labour laws codified in 1974, government employees were placed under the Civil Service Commission's jurisdiction, which rejected unionism. However, the Constitution passed during the Aquino administration in 1987 allowed government employees to form unions. Thus, the implementation of the privatization policy saw the formation of employees' organizations and unions in a number of government corporations. These unions

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were largely formed to protect the rights of employees in corporations scheduled for privatization.

Proclamation No. 50 and Labour Relations3 The provisions of Proclamation No. 50 of President Aquino which touch on employee relations have generated much criticism and resistance because of its implications for workers. Section 27 of the Proclamation states in full: Automatic Termination of Employer-Employee Relations Upon the sale or other disposition of the ownership and/or controlling interest of the government in a corporation held by the Trust, or all or substantially all of the assets of such corporation, the employeremployee relations between the government and the officers and the other personnel of such corporations shall terminate by operation of law. None of such officers or employees shall retain any vested right to future employment in the privatized or disposed corporation and the owners or controlling interest holders thereof shall have full and absolute discretion to retain or dismiss said officers and employees and to hire the replacement or replacements of any one or all of them as the pleasure and confidence of such owners or controlling interest holders may dictate. Nothing in this section shall, however, be construed to deprive said officers and employees of their vested entitlements in accrued or due compensation and other benefits incident to their employment or attaching to contracts, collective bargaining agreements, and applicable legislation. 4

Various employee associations have submitted position papers pressing for the amendment of the above provision which protects the new employers at the expense of the workers. At the same time, two bills protecting the rights of workers in privatized government corporations have been filed and are still pending in the Lower House of Congress. The "Labour's Declaration on Privatization" has also urged the suspension of the privatization programme as mandated by Proclamation No. 50 and 50-A. This declaration was the outcome of a Conference/ Workshop on "Privatization: Its Impact on Labour Relations in the Philippines" organized in August 1988 (see Annex 1). Upon pressure from affected workers, the APT is taking efforts to protect the workers by granting concessions to buyers in exchange for workers' protection. The Department of Labour and Employment has likewise negotiated on behalf of the workers for their retention. Nevertheless, the fact remains that the legal framework for privatization has not been amended at all and that the workers have been stripped of protection. On the other hand, Section 3, Article XIII on Social Justice and Human Rights of the Constitution declares: The State shall afford full protection to labour, local and overseas, organized and unorganized, and promote full employment and equality

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of employment opportunities for all. It shall guarantee the rights of all workers to self-organization, collective bargaining and negotiations, and peaceful concerted activities, including the rights to strike in accordance to law. They shall be entitled to security of tenure, humane conditions of work, and a living wage. They shall also participate in policy and decision making processes affecting their rights and benefits as may be provided by law 5 . It is within this framework of clear inconsistency between the provisions of

the Constitution and Proclamation No. 50 that the PANTRANCO case unfolds.

Background on PANTRANCO

Evolution of the Enterprise PANTRANCO, or the Pangasinan Transportation Company, spans almost eight decades of bus transport operations in the Philippines. PANTRAN, as it was initially called, operated first in Pangasinan, a northern province in the major island of Luzon. Organized formally in 1918 with an initial capital ofP 75,000, 6 it ran eight buses and expanded in the 1920s to cover two neighbouring provinces. In 1940, PANTRAN, which then added two letters to its name to be known as PANTRANCO, inaugurated the first ever express bus service from Dagupan to Manila, the Philippines' capital city. 7 After World War II, PANTRANCO was rehabilitated and later resumed its routes from Manila to various points in Pangasinan. 8 The company expanded to proportions larger than its pre-war operations and operated up to 350 buses by the early 1960s by buying out several bus companies. 9 With the death of its owner in 1970, First Manila Corporation (FMMC), headed by Ricardo Lopa, bought PANTRANCO. It was renamed PANTRANCO North Express, Inc., or PNEI. During FMMC management, PNEI took over another bus company and extended its operations to three more provinces - Bulacan, Pampanga, and Bataan. By 1972, PNEI had a total of 512 buses spanning virtually the whole of Luzon. It was in 1972 that PNEI's unbridled and aggressive expansion was brought to a halt by financial difficulties and natural calamities. Disastrous floods caused the destruction of roads and bridges. These were the official reasons given for the sharp increases in operating and maintenance expenses of the company. In 1974, the creditors of PNEI took over the company by virtue of a Voting Trust Agreement. From 1974 to 1976, company losses continued unabated as a result of a combination of inexorable factors: spiralling operating costs, large interest expenses on loans, and the peso devaluations. On 1 December 1978, full ownership of PANTRANCO was turned over to

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the National Investment and Development Corporation (NIDC), a subsidiary of the state-owned Philippine National Bank (PNB). Thus, from a private corporation, PANTRANCO became an acquired asset corporation of the Philippine National Bank, a government financial institution. It became part of the government corporate sector. 10 In 1985, the PNB transferred PANTRANCO through a deed oftransfer to Northern Express Transport, Inc. (NETI), which was controlled by Gregorio Araneta, son-in-law of Marcos; NETI was co-controlled by Mrs Dolores Potenciano, owner of Batangas-Laguna-Tayabas Bus (BLTB), another transportation company. PANTRANCO was placed under BLTB management. It was during this period that PANTRANCO suffered heavily, brought about by the intended complete change of employees, resulting in demoralization and a strike that not only stopped operations but decreased revenues as well. Overhead expenses increased as a result of duplication of functions and positions and the hiring of consultants with large emoluments. Decrease in operational buses was caused by delays in spare parts purchases. It was the perception of the employees that this was an intentional and concerted effort to bring PANTRANCO to bankruptcy. 11 Sequestration by PCGG and Management under APT BLTB management of PANTRANCO ended in March 1986, less than a month after the new Aquino government gained power. The Presidential Commission on Good Government sequestered PANTRANCO on the grounds that the Deed of Transfer from PNB to NETI, the corporation owned and controlled by Marcos' son-in-law Gregorio Araneta, was anomalous and largely prejudicial to the interest of the government. The reported anomalous sale transfer ofPANTRANCO's assets resulted in the filing of a case against Araneta and top PNB officials with the Sandiganbayan, the Philippine graft court. From March 1986, PANTRANCO was run by a fiscal agent for the PCGG. PANTRANCO was turned over to the Asset Privatization Trust for disposal on 18 April1988. The fiscal agent designated by PCGG was retained as officer-in-charge ofPANTRANCO for APT and as chairman of the Board of Directors and of the PANTRANCO Executive Management Committee. An additional representative was designated to monitor the company's operations. APT Executive Trustee Ramon Garcia, in a press statement, announced PANTRANCO's improved finances during the first eight months of 1988. It was also declared that the firm was able to rehabilitate ten out of fifteen air-conditioned buses and ten out of twenty regular buses in its main terminal. PANTRANCO was recently granted a certificate of public conveyance for 750 units and eight freight trucks. Role and Status in the Public Transport Sector PANTRANCO is one of the biggest transportation firms in Asia. It is a vital public utility firm that serves about 12 million passengers annually. Its vast

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transport network, particularly in northern and central Luzon, contributes greatly to the economic activity of the area. The extensive routes plied by PANTRANCO buses facilitate distribution of food, clothing and medicines. The operations of PANTRANCO further enhance labour mobility and provide support services for better social interchanges, communication, education and recreation that spur farming, fishing and cottage industries which have sprouted in these areas. Spillover effects to related industries in tires, batteries, oil, paints, textiles, foams, plastics and plywood further increase input availability to the transport sector. PANTRANCO's large parts requirements also help to develop the market for vehicle components.

Financial Status ojPANTRANC0 12 The financial status of PANTRANCO between 1986 and 1988 is shown in Table XVI.l. Capital deficiencies for 1986, 1987 and 1988 are attributed to carry-over deficits in its capital account. These deficits were a result of the pending case filed on the basic issue of ownership of the assets. Some, if not all, real accounts/balance sheet accounts which were used as beginning balances in the books of PANTRANCO as at 1 October 1985, particularly the Deferred Charges account (Asset account) with an original amount ofP466.532 million and the Notes Payable account (Long-Term Liability Account) with an original amount of P730 million are of doubtful propriety/validity. These balances/accounts are still carried in the books of PANTRANCO, as managed/operated by the PCGG and APT. Since the Deferred Charges account is amortized monthly for P 3,335,666.66, or a total ofP40.028 million per annum, the income statement is affected by as much as P40.028 million, corresponding to the yearly amortization expense. 13 These Deferred Charges and Notes Payable accounts were a TABLEXVI.l PANTRANCO's Financial Status, 1986-88 (In million pesos)

1986

1987

1988 1

Operating Revenue Expenses Net Loss

360.33 397.00 36.67

423.94 411.27 12.67

402.24 407.77 5.53

Assets Liabilities Capital Deficiency2

843.38 881.18 37.81

840.64 877.86 37.22

855.87 885.98 30.11

1 2

From January to November 1988. Figures attributed to carry-over deficits in capital account as a result of the pending case filed on the basic issue of the ownership of assets.

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Leonor M Briones and Aileen R. Zosa

result of the strapped financial position of the company in the years before 1986.

Towards Worker Ownership through Privatization: The PANTRANCO Experience

In July 1988, four months after PCGG turned over PANTRANCO to APT, there was speculation that the workers would be allowed to buy into the company through an Employees Stock Ownership Programme. The possibility that 20 to 30 per cent of the equity would be sold to PANTRANCO employees was a new dimension to the privatization experience in the Philippines. It was considered to be a significant and encouraging development in industrial relations in the country. In the light of the main objectives of the Philippine privatization programme, which was to generate revenues to fund vital government programmes such as agrarian reform and to reduce government presence in the economy, the move for employee ownership in PANTRANCO's equity appeared to be an initial step towards democratizing industrial relations and capital markets in the Philippines. However, PANTRANCO's union, which is called the PANTRANCO Employees Association, expressed no interest in the programme from the outset. 14 Organized in the late 1950s, the 1, 700-member union, composed of bus drivers, conductors and mechanics, has different concerns among its priorities. The union, the only recognized negotiating arm of the employees, has been pressing for a pending money claim from the company resulting from a diminution of workers' commission by 25 per cent without agreement from the union. 1 5 It is also primarily concerned with the settlement of said money claims and the protection of workers' rights with respect to severance pay and other fringe benefits in the event of PANTRANCO's privatization. PANTRANCO employees have also been concerned about the alleged overpricing anomalies on the purchase of spare parts and the retention of officials perceived to be corrupt even in the face of repeated reorganizations within the company. Concern has also been raised on the issue of the decreasing number of buses in operation and the general financial condition of PANTRANCO. 16 These concerns of the union were dramatized in a strike, in 1986, during the PCGG management, spurred by a deadlock in negotiations in the collective bargaining agreement. During the APT management, two strike notices were filed with the Department of Labour and Employment. In the course of conciliation, the first notice filed in May 1988 resulted in an assurance by APT that all employees would be given severance pay and other fringe benefits mandated by law and provided for in the collective bargaining agreement in case the new owner decided not to retain them. The second strike notice, filed in July 1988, was still pending conciliation

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with the Department of Labour at the time of writing. It has been observed by the union president that employee-employer relations during the PCGG/APT management have not been satisfactory. 17 Out of PANTRANCO's 2,400-strong work-force, there were 600 employees who had organized themselves into the PANTRANCO Association of Concerned Employees, or PACE. Comprising office/supervisory or white collar employees of PANTRANCO, the PACE was registered with the Securities and Exchange Commission. This was the group which originally floated and supported the Employees Stock Ownership Programme. PACE officials invited the PANTRANCO employees' union to participate in the ownership programme. However, interest in the programme soon waned. The computed P 58 million retirement pay for all PANTRANCO employees would be insufficient to pay even 30 per cent of the P475-500 million selling price of the enterprise. While there were talks of acquiring a loan or foreign financing to undertake the programme, the union was not willing to plunge into the venture. It turned out, therefore, that only a small group of PANTRANCO employees had a serious desire to buy into the enterprise. 18 Thus, while the possibility of employees' stock ownership in PANTRANCO had gained attention, it was not the intention nor desire of at least a majority of its employees to participate in the plan. The party most involved in the proposed programme did not manifest any serious interest. This is not surprising. As in other privatized assets, terms set by the APT for the sale of PANTRANCO shares - 10 per cent cash downpayment of the selling price for all bidders and full cash payment after one month for the winning bidders - were beyond the capacity of most PANTRANCO employees. Furthermore, the limited financial capacity of the employees was such that they could be easily outbidded in the process. There existed no financing opportunities for the employees to avail of. The government's privatization programme did not include any financing vehicle to afford employees the capacity to buy into the enterprise. Without such a mechanism, ownership by the employees of even part of the privatized enterprise is not possible. There is, at present, a big gap between the financial capacity of the employees and the affordability of ownership in PANTRANCO, the appraised value of which is pegged at P 500 million. The financial position of PANTRANCO is a major factor discouraging interested buyers. Although financial statements obtained from the enterprise indicate improved cash flow in its operations, it cannot be denied that its assets-liabilities position need to be improved. Capital deficiency for 1986 and 1987 was in the order ofP 37 million. In 1988, capital deficiency settled somewhere around P 30 million. The enterprise has a shaky asset base because of dilapidated rolling stocks and buses that are constantly under repair. From 1986 to 1988, assets constantly fell short of liabilities. Drops in revenues on a month-by-month basis were constantly attributed to the decreasing number of buses run. 19

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Leonor M. Briones and Aileen R. Zosa

Moreover, the employees of PANTRANCO who know the true state of the buses are hesitant to venture into a major and expensive investment where revenue-generating assets may not be operational for long. Any buyer of PANTRANCO needs to invest more capital to repay debts/borrowed capital, to offset capital deficiency, as operating funds, and to rehabilitate the assets. This is a major stumbling block to privatization and PANTRANCO employees are not willing nor are they capable of undertaking such huge investments.

Lessons from the PANTRANCO Experience Is worker ownership of government corporations possible through privatization? This question has generated interest among scholars who are monitoring the privatization programme in the Philippines, especially those who are concerned with the impact of the programme on industrial relations. So far, out of 113 corporations approved for privatization, there are only two known instances where workers have shown an interest in acquiring ownership of a government firm. These are PANTRANCO and Philippine Airlines, the government flagship carrier. In the latter case, not much has happened except for a press release expressing interest. In the case of PANTRANCO, the blue-collar workers recognized right from the start that it was an "impossible dream", while office workers made initial efforts to identify possible sources of financing. It appears, therefore, that while worker ownership might be possible, such is not feasible under the present policy. There are three major factors which impinge negatively on the chances of workers in acquiring ownership of government firms. Firstly, there is the question of the financial capability of the workers' organization. In the Philippines, less than 5 per cent of the workers are organized into unions. Many of the organized unions are not financially capable of buying or acquiring stock ownership of government firms. In the case of PANTRANCO, even the combined retirement benefits of all the employees would not be sufficient to buy 30 per cent ownership of the firm in cash. A related problem is managerial capability. Would workers have the capability to run and manage a privatized government firm? A possible solution would be to hire professional managers while workers are building up their managerial skills. This would create a financial problem, however. Secondly, the requirements for acquiring ownership ofa government firm are forbidding. Interested bidders are required to make a 10 per cent cash deposit of the bid price in order to qualify. Once a bid is won and awarded, the winning bidder must make payment in full and in cash. The PANTRANCO workers found this requirement particularly difficult because of their financial difficulties.

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Unfortunately, in the Philippines, the pressure to raise funds for government programmes, such as agrarian reform, is much more compelling and irresistible than considerations for broad-based ownership of privatized government firms. If the latter were the primary consideration, then the terms for payment would not be as restrictive. Workers would be allowed a longer time-frame for acquiring ownership. Perhaps, they could even be assisted in availing themselves of possible sources of financing. Cash requirements under the privatization policy give little or no time at all to workers' organizations to mobilize their resources and seek financial assistance. This regulation automatically shuts them out from bidding competitively for government firms. Thirdly, legal problems complicate privatization proceedings to the disadvantage of workers. In the PANTRANCO case, a restraining order was issued by the court prohibiting the sale unless a P 25 million claim for payment, including interest, was settled. The initial phase of privatization in the Philippines is primarily re-privatization, that is, the sale of firms which had originally been privately-owned but were acquired by the government as a result of the non-payment of loans. In the case of PANTRANCO, it was taken over by the government because of non-payment of loans, and then transferred to Marcos' son-in-law under a deed of transfer. Under the Aquino administration, the government took over PANTRANCO again, on the grounds that the deed of transfer was illegal. Because of these circumstances, legal problems arose, making privatization more difficult. Even if the workers were greatly interested in acquiring ownership of PANTRANCO, they would not be able to raise or spare an extra P25 million to comply with the conditions to release it from the court injunction.

Conclusion

In the Philippines, serious questions have been raised about its privatization policy and its impact on industrial relations. Much concern has been raised by academics and workers' unions over the provisions of Proclamation No. 50 which sets the legal framework for privatization under the Aquino administration. The possibility of workers' ownership has been floated as a potential positive outcome of the policy. Under the circumstances where workers' rights are not even guaranteed, much less protected under the policy, it is highly unlikely that they stand a chance of acquiring ownership of government firms. The dice is loaded against them, right from the start.

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Leonor M. Briones and Aileen R. Zosa

ANNEX I Labor's Declaration on Privatization Adopted at the Conference/Workshop on "Privatization and Its Impact on Labor Relations in the Philippines", 19-21 August 1988

The formulation and implementation of any economic recovery program should, first and foremost, consider the needs and aspirations of the Filipino workers, in particular, and the masses, in general. Further, it should be appropriate and relevant to the socio-economic and political needs and realities of the country. The success of such program requires the active and continuous participation of all workers and their organizations. Thus, it is necessary that the spirit of cooperation and accommodation should reign among the various sectors in society. In view of the above, we strongly believe that the privatization program, which is included in the government's plan for development, is against the interest of the Filipino workers. We are bothered by the fact that the program is part of the bigger plot of the World Bank-IMF groups to strengthen their control over the Philippine economy. We are also bothered by the non-redistributions of the program because it has merely transferred ownership to a privileged few, thus defeating the very purpose of privatization. In the light of these developments, we hereby declare in this conference that: a.

the implementation of the privatization program as mandated by Proclamations 50 and 50-A should be suspended pending review of the onerous provisions, particularly sub-paragraph 4 of Section 25 and deletion of Sections 27 & 31 of Proclamation 50 and the corresponding amendments of the latter under Proclamation 50-A, and

b.

the review committee should be tripartite in nature and should be convened by the Secretary of Labour the soonest time possible. Such committee should seriously consider the following recommendations: (1)

that the privatization program has pro-labor objectives with explicit redistributive effect;

(2)

that privatization is not the remedy to the inefficiency of service delivery and that other ways and means should be sought;

(3)

that the state retains control of essential services and undertakes measures to improve their efficiency.

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225

(4)

that these essential services include among others, primary health care, oil, power, transport, postal, water and communications;

(5)

that the National Food Authority and similar entities retain their corporate and regulatory functions as opposed to the on-going regularization of the same;

(6)

that the debt-to-equity scheme of the privatization program be abolished in the light of its adverse economic implications specifically on inflation and increasing foreign control of the economy;

(7)

that workers be given preference to acquire or control enterprises to be privatized; and

(8)

that financial, technical and managerial assistance be provided by government financial institutions (GSIS, SSS, PNB, etc.) to workers' groups/organizations or cooperatives necessary for their acquisition and operation of privatized companies.

In order to uphold the rights of workers in the process of privatization consistent with the labor provisions of the constitution, we also demand that the following provisions be adopted: (a)

tripartite consultation should be made prior to privatization;

(b)

there should be full disclosure of assets and profits of companies to their workers;

(c)

training and re-training programs should be offered to workers with full government assistance; and

(d)

there should be full protection of trade union rights and job security of workers.

Realizing that the privatization program is a deceptive economic recovery strategy which undermines the workers' interests, we shall pursue the following initiatives: (a)

Immediately launch a massive information drive through press conference, public fora and the like on the impact of privatization on labor;

(b)

Pressure the government to compel its department secretaries to undergo labor education seminars and orientation; and

(c)

Develop and strengthen linkages within the trade union movement and cooperation with pertinent non-government organizations and government agencies in pursuing the above initiatives.

SouRCE: School of Labour and Industrial Relations, University of the Philippines.

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Leonor M Briones and Aileen R. Zosa

NOTES 1.

Leonor M. Briones and Aileen Zosa, "Privatization of Public Enterprises in the Philippines: Policy and Implementation", in Privatization and Its Impact on Labor Relations in the Philippines (University of the Philippines School of Labor and Industrial Relations and the Friedrich Ebert Stiftung, January 1989), pp. 104-5, 108-11, and 116-23.

2.

V.A.Teodosio, J.A.F.Palafox and N.O.Barranco,"The Privatization Paradigm and Its Implications for Labor in the Philippines" (Paper presented at the Conference/ Workshop on Privatization and Its Impact of Labor Relations in the Philippines, 19-21 August 1988, School of Labor and Industrial Relations, University of the Philippines).

3.

Based on the results of the Conference/Workshop on Privatization and Its Impact on Labor Relations in the Philippines, 19-21 August 1988, School of Labor and Industrial Relations, University of the Philippines.

4.

Proclamation No. 50, "Proclaiming and Launching a Program for the Expeditious Disposition and Privatization of Certain Government Corporations and/or the Assets Thereof, and Creating the Committee on Privatization and the Asset Privatization Trust", 8 December 1986, Manila.

5.

Section 3, Article XIII- Social Justice and Human Rights, 1987 Philippine Constitution.

6.

Current rate of exchange is $1

7.

"The PANTRANCO Story", PANTRANCO Express II (November 1988):5.

8.

Ibid., p. 6.

9.

Ibid., p. 7.

10.

Ibid., p. 11

11.

Ibid., p. 14.

12.

Financial statements used were those obtained from the management ofPANTRANCO North Express, Inc.

13.

Commission on Audit, Preliminary Findings of a Special Audit on PANTRANCO North Express, Inc. (Commission on Audit, Quezon City, 1988).

14.

Interview with Wilson Saniego, Officer-in-Charge, PANTRANCO Employees Association, 1 February 1989, School of Labor and Industrial Relations, University of the Philippines.

15.

Interview with Professor Calica, Consultant, PANTRANCO Employees Association, I February 1989, School of Labor and Industrial Relations, University of the Philippines.

~

P21

Towards Worker Ownership ofPublic Utility Firms through Privatization

227

16.

Letter to Senators Teofisto T. Guingona, Jr., Rene A.V. Saguisag and Juan Ponce Enrile from PANTRANCO employees, dated 15 November 1988.

17.

Emilio Leachon, "PANTRANCO's Experience on Privatization" (Paper presented at the Conference/Workshop on Privatization and Its Impact on Labor Relations in the Philippines, 19-21 August 1988, School of Labor and Industrial Relations, University of the Philippines).

18.

Interview with Wilson Saniego, 1 February 1989.

19.

Memorandum for the Board of Directors from Accounting Department, PANTRANCO North Express, Inc., dated 5 January 1989.

XVII. Privatization and the European Trade Union Movement GIUSEPPE FAJERTAG In the period since the end of World War II, the economies of Western Europe have registered a considerable growth of their sectors, in terms of both expenditure and employment. Central and local public authorities, administrations and bodies have become the single biggest employers in their respective countries in a period of reduced or negative employment growth and extremely high rates of unemployment. The trade unions are, therefore, extremely concerned about all kinds of policies affecting, and in some cases jeopardizing, public sector employment. The aim of this paper is to give a brief presentation of the attitudes of the European trade union movement vis-a-vis various forms of privatization of public companies and services which have taken place in a number of European countries. The main focus will necessarily be on the case of the United Kingdom, because of the particularly harsh conflict between the government and the unions on these issues, but information is also given on the other countries, such as Italy, where governments have attempted to develop privatization policies along less deliberately conflicting lines. The last part of the paper presents alternatives to privatization in the areas of public and social services and the European trade unions' proposals to increase the efficiency of public services.

The Growth of Employment in the Public Sector

In 1960 the public sector in Western Europe accounted for about 22 per cent of total employment in industry and the services. By the beginning of the 1980s, this figure had risen to at least 30 per cent. In the European countries, employment in general rose at an annual rate of 2.4 per cent between 1960 and 1985, this figure being higher than the rise in employment in the services sector as a whole. The causes of the employment growth in the public sector are linked to the profound changes which affected the role of this sector in the economy

Privatization and the European Trade Union Movement

229

of all the countries of Europe between the end of the 1960s and the beginning of the 1970s. This was the period which saw the development of a range of welfare state services, in particular health and social services and education. The growth in the public sector continued at an extremely fast pace until the mid-1970s but the change in economic situation which followed the first oil shock at the end of 1973, with the initial collapse and then stagnation accompanied by inflation, prompted the vast majority of European governments to adopt policies ranging from simply curbing public spending to major cuts. It was against this background that, towards the end of the 1970s, there began to develop, in Europe and in the USA, a theoretical debate on the need to reduce the role and weight of the public sector to allow more room for the free play of market forces and competition. The principal measure for pushing back the frontiers of the state, advocated by economists of the monetarist school and by latter-day proponents of Adam Smith's eighteenth century liberalism, was the most extensive possible privatization of state-controlled and state-managed services and manufacturing activities. The privatization policies adopted by a number of European governments in the 1980s differ from one another in rather fundamental ways. In Great Britain, the Conservative government embarked, back in 1979, on a sort of crusade in favour of privatization of the public sector as a whole. This policy of indiscriminate privatization is grounded primarily in ideological motivations (pushing back the frontiers of the state, substituting the market for the welfare state, attacking the strongholds of the political opposition and the trade union movement), even if it has been accompanied by more pragmatic short-term economic justifications (such as influx of cash for the state coffers). In France, between 1986 and the beginning of 1988, the Conservative government of Mr Chirac principally endeavoured to put into reverse the policy of nationalization of industrial and financial undertakings conducted by the previous left-wing government, in power between 1982 and 1986. In the Federal Republic of Germany, privatization has been a talking point within the Christian Democrat/Liberal coalition in power but has so far not given rise to any significant action at the federal level. However, West Germany has seen a widespread trend towards privatization of the public services provided at local or regional level by the Lander, or municipalities. In Italy, and also in Spain, privatization has taken the form of the hand-over to the private sector of a number of major manufacturing companies, in the effort to reorganize the financial and productive structures of the state-controlled industrial system. In these countries, there has been little or no privatization of public services. It is therefore possible to identify in Western Europe three major areas which have been or which can be subject to privatization. These are:

230

Giuseppe Fajertag

1.

undertakings whose capital is owned totally or principally by the public authorities, often industrial - and principally manufacturingconcerns, but also in some cases banks, insurance companies and other state-owned or state-controlled financial bodies;

2.

collective public services at national level (often natural monopolies, such as rail and air transport), communications and, in some cases, electricity, gas and water distribution;

3.

public services supplied by local authorities, such as street cleaning, school meals, local transport, hospital cleaning and maintenance services, and social and health services (hospitals, old people's homes, etc.) which normally come under the national health service.

The problems arising for the national trade union organizations in the event of privatization of the undertakings or services in one of the three areas enumerated above vary considerably and it is thus worth examining them one by one. Privatization of Public Enterprises

In the first case, namely, the privatization of public enterprises producing goods and services for the market, the European trade union organizations have reacted in a variety of ways, in accordance with the many-faceted and complex nature of the implications of these choices for the workers concerned and for society at large. In general, it can be said that the trade unions reject a policy of anti-union privatization intended to attack employment and lower the pay and working conditions of the workers involved. They demand that the privatization of public undertakings be justified on sound economic grounds which are not detrimental to national industrial policies. As far as employment is concerned, the figures provided by the CEEP (European Confederation of Public Enterprises) for the public enterprises in the EEC (European Economic Commission) in the period 1982-85 tend to demolish a recurrent myth, according to which public enterprises in these years represented "happy islands" in which artificially high levels of employment continued to obtain. In reality, the European public enterprises did not remain immune from the processes of restructuring and reorganization of production which affected the coal and steel industries, the production of means of transport, shipbuilding and most of the other sectors of production. On the contrary, in the public enterprises union membership tends to be higher than in private sector companies. This means that industrial relations are generally better, insofar as the management has rarely resorted to anti-trade union measures or to acts of intimidation or discrimination with regard to trade union members.

Privatization and the European Trade Union Movement

231

TABLE XVII.l Employment Changes in Selected Public Enterprises in the European Community, 1982-85 (In thousands)

Company

1982

1985

% of'85/'82

British Coal (UK) British Steel (UK) Alfa Romeo Auto (I) Italsider (I) CGE(F) Thomson-Brandt (F) Renault (F)

266.3 81.1 33.7 43.0 192.2 128.7 103.7

179.6 54.2 28.8 31.3 153.8 108.7 86.1

-32.5 -33.2 - 14.5 -27.2 -20.0 - 15.5 - 17.0

SouRCE: CEEP, Public Enterprises Statistics, Brussels, 1987.

When public enterprises producing goods and services for the market have been privatized, the trade unions have endeavoured, in some cases successfully, to maintain the industrial climate which prevailed prior to privatization. It is particularly important for the trade unions to demand and obtain the right to be consulted from the outset with regard to the procedures of privatization and to take part in all the procedural phases entailed in the change of ownership. The major concerns of the unions include the guarantee of employment levels, information on any restructuring plans or programmes and on the investment programmes of the private owner-to-be as well as guarantees regarding the continuation of the existing system of industrial relations insofar as there exist differences between the arrangements in force in the public and private sectors. Moreover, in the event that the privatization plans involve an opportunity for employees to become shareholders, trade unions should attempt to ensure that such forms of worker shareholdings actually entail representation of the work-force on the board and on any other bodies designed for consultation or the provision of information regarding production developments, investment and future prospects. France and Great Britain The method of privatization most frequently employed both in Great Britain and in France has been to float shares of the company on the stock market. In both countries the shares in question w~re offered for sale at prices considerably below their market value, in order to whet the appetite of private investors. Privatization thus became a full-scale "sell-out" which has proved to be beneficial, particularly in Great Britain, to the major private finance groups, while entailing huge financial losses for the state, and hence for the taxpayers.

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Giuseppe Fajertag

The French trade unions did not undertake to wage a full blown campaign against the privatization or denationalization of companies such as Saint-Gobain or Compagnie Generale d'Electricite (CGE). The unions and the workers in the nationalized companies were generally disappointed with the results of the policy followed by the left-wing government in the period 1982-86. Their disappointment related principally to the issue of employment, but also to the management methods used in running those compames. In the United Kingdom, on the contrary, the Trade Union Congress (TUC) has carried out a wide-ranging campaign against the privatization of public assets under the slogan "Public, it's yours; Private, it's theirs". The TUC has based most of its campaign against Mrs Thatcher's policy of wholesale privatization on the profitable companies' "sell-out" argument. Undervaluation of assets sold through the stock exchange can be measured in various ways. The approach used by the TUC was to work out the difference between the value of the offer price of shares (that is, before floatation) and the value of those shares when trading in them started on the stock exchange. By this parameter, the government lost about £3.2 billion on the sale of four companies alone: British Airways, British Gas, British Telecom, and Rolls-Royce. Researchers at the independent Institute for Fiscal Studies have estimated that the discounts on privatization sales have averaged 26 per cent, compared to an average discount of 12 per cent for other private offers of sale.

Italy In Italy, the state-controlled industrial sector is quite important to the national economy: the IRI (Instituto per Ia Ricostruzione Industriale) holding controls more than a thousand different companies in a number of industrial and tertiary sectors with more than 440,000 employees, while the ENI (Ente Nazionale Idrocarbur) holding, with more than 100,000 employees, operates mainly in the oil and natural gas sectors. The major problems for the state-controlled industrial sector in recent years have been to reduce the huge financial losses and to rationalize production. Between 1980 and 1987, IRI, ENI and EFIM (the Ente Partecipazione Finanziamento Industria Manifatturiera, the third, smaller, state-owned industrial holding), handed over no less than eighty undertakings to the private sector. The privatization exercises were not, however, as has been the case in other countries, overlaid with political and ideological premises and were carried out exclusively in accordance with guidelines drawn up by the public holdings themselves. Privatization in Italy has basically consisted of handing over to the private sector shares regarded as "non-strategic". This criterion has never been precisely defined but it is clear from experience that it is taken to mean those undertakings whose area of production fails to "fit in neatly" with that

Privatization and the European Trade Union Movement

233

of other companies owned by the same public holding, those whose production and markets are too small, those in which public share capital is in a minority and impotent to influence financial and production decisions and, finally, those for which financial and production rationalization using public capital is not a viable option. It was in accord with these criteria that, between 1986 and 1987, the two most important privatizations were effected, namely, those of the IRI-controlled motor-car manufacturing firm, Alfa Romeo, and the ENI-controlled Lanerossi textile group. The trade unions have always been involved in the preliminary discussions with the management in order to negotiate the details of the sale and guarantees for the work-force. However, on the trade union side, a need is beginning to be felt for some form of regulation, co-ordination and control of privatization operations. There is a case to be made, in other words, for a law defining the criteria governing privatization, setting out the strategies to be followed, and providing for appropriate monitoring of the whole process.

Privatization of Public Services

Concerning the second area of possible privatization, which covers the supply of collective public services, it has to be stressed that in Western Europe the British Government is alone in having embarked on a policy of privatization, with the handing over of British Telecom and British Gas and the privatization of the electricity production and supply industry, and the regional water supply networks. The European trade unions believe that these are services which must be available to the population as a whole and whose management cannot and must not be based on profit, and even less on the maximization of profit. Moreover, the size of the investment which is required in connection with the supply of certain of these services (energy and transport, for example) is also such as to discourage private entrepreneurs- more so because the investment cannot be recouped over a short period of time. One of the factors militating in favour of public management of these services is precisely the need for a pricing policy which enables even the most disadvantaged sections of the population to have access to them. The European trade unions also reject a policy of privatization of public services based on the specious premise of the greater efficiency of the private sector. In the case of Great Britain, it is now possible to make a comparison based on the performance of the British Telecom, the telecommunications services supplier privatized in November 1984. The fact that its structure has been altered from a public to a private monopoly has not affected the efficiency of the company which, in any case, was already making profits and enjoying a sound financial situation before privatization. There is no evidence to suggest that the quality of service supplied to users

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has been improved as a result of privatization. Indeed, it emerges from official statistics that in 1986 one telephone line in two was out of order or faulty and, according to an option poll conducted by the National Consumer Council in March of the same year, a quarter of those interviewed were dissatisfied with the services supplied by British Telecom, while more than half thought the rates charged were excessive. The British experience shows that the privatization of public monopolies has simply meant that a private monopoly has been set up in place of a public one. In a monopolistic market, irrespective of whether the monopoly is public or private in nature, there is no immediate economic incentive for the monopolist to endeavour to fulfil his customers' requirements. The only way round this would be to alter the nature of the market, turning it from a monopolistic into a competitive one. The proposals put forward by certain governments to privatize specific areas of services provided by the public sector and create competitive markets in these areas appear to be designed, in reality, to "cream off'' the most lucrative and innovatory services for privatization, leaving in the public sector all that is of no interest to private entrepreneurs, rather than developing competition. However, there can be no doubt that a number of European countries have witnessed, over the last few years, a deterioration in the quality of the public services. The lower standards are the results, in more cases than not, of cuts in public spending. The governments have in many cases preferred to take the easier path of lowering the quality of services, rather than face the problems of improving their social efficiency, reorganizing them and restructuring them, while at the same time seeking ways of running them along more economically viable lines. For that reason, in the United Kingdom, while there was overwhelming popular support for the great nationalization initiatives of the 1945-51 period, less than four decades later a programme aimed at selling those same assets back to private owners was greeted with apathy or support by a sizeable part of the electorate. To overcome the problem of the poor public image of nationalized industries, the TUC has defined a six-point reform programme for the management of the public enterprises, namely, more say for consumers, more say for the work-force (that is, more industrial democracy), more say for the local community in order to dispel the impression of distance and centralization experienced by most members of the public, better use of public money, tougher "public interest" regulation (environmental controls, watchdog bodies, etc.) and, finally, more public scrutiny. Even in those countries, such as Sweden, where the public sector has traditionally had a positive image, this has not prevented the trade unions from tackling the question of how to maintain and improve its efficiency. In other European countries too, even in the absence of any immediate threat of privatization, the trade unions attach a great deal of importance to the issue of how to improve the social efficiency of the essential collective

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services. In Italy, for example, it was the workers' trade union organizations which called for and gave their backing to the reform of the railway services.

Privatization of Local Public Services The third and last area of privatization refers to the contracting out of locally provided public services to private firms. This type of privatization has frequently been imposed or proposed by the central government as the fastest means by which the local authorities and the health service can reduce their spending. The local and health authorities have seen an immense increase in their role in the social field and in health protection in the last twenty years. A large proportion of the employment growth in the public sector has taken place in the area of the welfare state, and predominantly at the level of local - or at any rate decentralized authorities. The reduction in state financial support, from the second half of the 1970s, has frequently placed the local authorities in extremely difficult financial situations. To reduce the running costs of the public services, or simply to stop providing some of them, have been the drastic alternatives facing a number of local and regional public authorities in Great Britain, West Germany, France and the Netherlands. Since these are services that are extremely labour-intensive, the only way of reducing their running costs appears to be to cut down on staff-related spending. Privatization in this case always represents a direct attack on the workers, whether on their actual jobs, or on their pay and working conditions. For that reason, the unions in all the concerned countries have conducted forceful campaigns against the privatization of the public and social services, particularly those associated with social assistance and health provision. Some needs are so basic that they cannot be left to the private market. Health care produced and financed on a commercial basis results in the exclusion of people at lower income levels from the enjoyment of their basic rights. This also applies to the care of children and the elderly, as well as to education. A system based on private profit can never succeed in providing as comprehensive an array of social services as that offered by the public sector. The European unions are not, however, unaware of the serious financing problems experienced by the public services as a result of the slow-down in economic growth from the second half of the 1970s.

Alternatives to the Privatization of Public Services There exist alternatives to privatization, namely, finding increased sources of funding and better use and redistribution of existing resources. The path of fairer taxation and the fight to eradicate tax evasion which is still a widespread scourge in a number of European countries constitutes a first

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alternative. Some unions accept that in certain circumstances it is also possible to raise public service tariffs, and hence revenue, without undermining wider social objectives. The demands for the expansion of public sector services can be met in part by a redistribution of resources (including human resources) within the sector. This also means that the public sector has continuously to adapt its provision of services to the changes occurring within the social structure. Certain services may have to be reduced whilst others may need to be expanded.

Increasing the Efficiency of Public Services The European trade unions have also tackled the problem of improving the efficiency of the public services. The public, and this includes the workers themselves, need an efficient public sector. But the efficiency of the public sector cannot always and frequently must not be measured in terms of profitability in the same way as private sector companies. The efficiency of the public sector must, on the contrary, be established in relation to the social objectives which it is its task to pursue. The notion of productivity of the public services can be defined relatively easily in the case of collective services, such as post and telecommunications or the railways. The unions have often proposed to the public authorities solutions likely to increase the productivity of the collective services without jeopardizing employment levels and the agreed rights of the workers concerned. In the case of the social services, however, an increase in productivity may give rise to a poorer standard of services. One of the principal obstacles to the rationalization of the production of services is precisely the fact that direct contact between the consumer and supplier of the service is frequently of the essence of the service itself. If the personal element is reduced in order to increase productivity, it will often mean a poorer quality of service, or reduced efficiency. In other words, an increased degree of productivity achieved, for example, by raising the number of children cared for by one nursery nurse, the number of pupils taught by one teacher, or the number of patients treated by one member of the health service, may involve a reduction in the quality of the service such that its efficiency is in any case compromised. In the final analysis, therefore, the interests of increased productivity in the social and health care sector are not best served by a logic of privatization but rather by improved work organization and improved organization of the actual services themselves. The introduction of new methods of running services and training staff, improving prevention techniques (in the health sector, with regard to occupational hazards, environmental protection, etc.), are such- according to the

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European trade unions -as to permit continuing improvement m the effectiveness of public services.

REFERENCES British Telecom Unions Commitee (BTU C). A Fault on the Line. Report on the First Two Years o{Privatised British Telecom. London, 1986. Di Majo, Antonia, ed. Le politiche di privatizzazione in Jtalia. Bologna, 1989. ETUI. Privatization in Western t:urope. Brussels, 1988. Labour Research Department. Privatization, Paying the Price. London, 1987. Lopez-Claros, A The Search for Efficiency in the Adjustment Process: Spain in the 1980s. IMF Occasional Paper. Washington D.C., 1988. Santini, 1.1. Les Privatisations a l'Etranger: Royaune-Uni, RFA, ltalie, Espagne, Japon. Noles et Etudes Documentaires. La Documentation Franaise, 1986.

The n!fects of Liberalisation and Privatization ol British Telecom. PTTI (Postal Telegraph and Telephone International) Studies no.50. Geneva, 1986. Thiemeycr, T. The Privatization of Public Enterprises: A European Debate. Annals of Public and Co-operative Economy. Belgium, 1986. TUC. Contractors· Failures. The Privatization Experience. London, 1985.

- - . Privatization by Order. The Government Plan for Local Services. London, 1985. - - . Stripping Our Assets. The City's Privatization Killing. London, 1985 - - . The £16 Billion Gas Bill. The Real Cost of Privatisation. London, 1985. - - . Privatization and Top Pay. London, 1985. - - . Bargaining in Privatised Companies. London, 1986. - - . More Contractors· Failures. London, 1986. - - . industries for the People, London, 1986.

Part VII Privatization and Public Firms

XVIII. Privatization and the Performance of Public Firms M R. BISHOP AND J A. KAY Introduction

After decades of continuing expansion of state involvement in economic activity throughout the world, the 1980s have seen a marked reversal. Instead of government control and centralized planning, there has been a renewed emphasis on markets and competition. Privatization has been the symbol of this change. Governments around the world have adopted policies of transferring state enterprises to the private sector. Privatization is now fashionable in the European Community, Australasia, South America, and Eastern Europe. Many developing nations, encouraged by the International Monetary Fund (IMF) and the World Bank, are actively considering privatization as a vehicle for the reform ofparastatals and other public sector agencies. The pursuit of privatization policies has, in most cases, reflected discontent at the inefficiency and poor financial performance of the economic activities carried out within the public sector. By ending ministerial interference in managerial decision-making, and removing the "safety net" of access to unlimited state finance, it was thought that privatization would both allow managers to manage as they wished, and increase the incentives/pressure on them to do so efficiently. In this paper, the relationship between privatization and performance is examined, focusing on the public sector in the United Kingdom since 1979. In particular, the question of whether privatization is necessary to improve public sector efficiency and profitability is discussed. The last section describes the principles upon which government intervention in the economy should be based, and the important determinants of its effectiveness. A variety of methods are also set out by which the performance of the public sector can be improved. These methods include privatization, but extend far beyond simple ownership change. For whilst privatization may, in some circumstances, improve performance, there may be more effective routes to this goal; the appropriate policy depends primarily on the facts of any particular case.

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The Performance of Public and Private Enterprises

The U.K. programme of privatization has been more extensive and widely noted than in any other nation to date. The performance of the privatized companies, and others in the public sector, since 1979 suggest a number of conclusions for future policy-making; in particular, raising questions about the usefulness of ownership change as an instrument to generate improved performance. In this chapter, the central results and implications of the U.K. privatization programme are outlined (drawing largely on Bishop and Kay 1988b ), setting this experience in the context of other studies and theories. Between 1981 and 1988, twelve U.K. public sector companies were floated on the stock exchange, and more than twenty sold privately. Most of these companies have shown increased turnover since privatization (Bishop and Kay 1998b, p. 41 ). Furthermore, this increase is greater than that achieved by those firms which have remained in the public sector throughout the period. However, these results have more to do with the nature of the companies concerned than with their ownership. The privatized firms which have grown rapidly since privatization (Amersham, Telecom, Cable and Wireless) were also growing rapidly before privatization, while Associated British Ports performed poorly throughout much of both periods. The poor market prospects faced by coal, rail and, until recently, steel have made these industries hard to sell, and that is an important part of the reason why they have only recently become candidates for privatization and, excepting British Steel, remain unsold. Britoil and Enterprise Oil have not prospered since privatization- indeed, Britoil has been acquired by British Petroleum- but that is primarily the result of the fall in the oil price. Profits have risen for most of what we call the 1979 public sectorthose firms that were in public ownership in 1979, regardless of whether they were subsequently privatized or remain in public ownership (Bishop and Kay 1988b, p. 43). The most rapid growth has been shown by the two large privatized utilities, Telecom and Gas. It is more instructive, however, to assess profit margins - that is, the return on the capital employed and the return on sales (Bishop and Kay 1988b, p. 44). Margins have tended to increase: the low margin industries by more than those which had already been substantially profitable. Growth has been, to some degree, at the expense of margins. Privatized firms began with greater profitability, but there is little to suggest that they increased it relative to the rest of the 1979 public sector. Employment has fallen substantially across the 1979 public sector (Bishop and Kay 1988b, p. 45). The largest reductions have occurred in those firms that are still within public ownership. Indeed, the cuts in the work-force of the steel, coal and rail industries have been almost as significant in reducing the number of public sector industrial employees as the sale of

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enterprises itself. However, there has been little reduction in employment in those public sector companies transferred to private ownership. The largest work-force reductions took place in industries in which privatization was improbable (although the improvements in British Steel have been such that it has now been returned to the private sector). Employment has actually increased in many of the privatized companies. However, the causation here principally reflects the way in which the market prospects of the industry have affected the probability of privatization. Thus, the overall picture that emerges from the U.K. privatization programme is one of substantial change. Output and profits have grown, margins have increased, and employment has declined. However, the relationship of these changes to privatization is not immediately apparent. The privatized industries have tended to be faster growing and more profitable, but it seems that the causation runs from growth and profitability to privatization, rather than the other way round. This is underlined by the experience of those companies that have been retained in the public sector throughout the period. The changes in total factor productivity of the eight major public utilities in the United Kingdom in 1979 reveal that, while all eight companies have improved considerably between 1979 and 1988, the greatest gains have been in British Steel and the Post Office, which have remained in the public sector throughout the period, while the poorest performance has come from the flagship of privatization, British Telecom (Bishop and Kay 1988a, describes these issues in more detail). The conclusions following from the U.K. experience are underlined by a substantial body of academic research into the effects of ownership on performance. Some studies show superior performance by public enterprises, whilst others suggest that private enterprises do better. Even the principal surveys of the studies carried out in this field reach conflicting conclusions. Borcherding et al (1982), for example, conclude that the empirical findings are "consistent with the notion that public firms have higher unit cost structures", whilst Millward (1982) finds "no broad support for private enterprise superiority". The absence of decisive results partly reflects the difficulties involved in making meaningful comparisons. There are problems in finding a suitable "test-bed" - that is, sectors in which both public and private enterprises operate; and when found, they are almost inevitably unrepresentative. They are, for example, more likely to be competitive industries, in which many public enterprises face distorted input prices (such as access to government finance on preferential terms or obligations to purchase the output of national producers) and are required to fulfil various non-commercial functions. When outputs are not sold in competitive markets, an appropriate measure of outp).lt may need to be devised.

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The most important reason for this diversity in empirical evidence, however, is the varying interaction between ownership and competition and the effects of regulation in markets where competition is absent. This leads us away from simple assertions about the supremacy of one kind of ownership over another towards a number of broad conclusions. In particular, the evidence of academic studies is consistent with the belief that all enterprises (public or private) perform more effectively where product markets are competitive than where competition is absent. Almost all evidence concerning deregulation - the ending of statutory monopoly supports this view (see, for example, developments in U.S. aviation and road haulage [see Bailey 1986]; as well as the recent introduction of competition in the United Kingdom into sectors such as express coach services, telecommunications apparatus, and domestic air services). Where product markets are competitive, some studies also suggest that the efficiency of public enterprises may match that of private firms. In Canada, the publicly owned Canadian National Railroad faced competition both from the privately owned Canadian Pacific and from alternative transport modes. Investigation of their performance has shown no difference in efficiency between the two railroad companies (Caves and Christensen 1978). In the United Kingdom, the recent introduction of competitive tendering for services such as refuse collection and hospital cleaning has resulted in significant efficiency improvements. However, the public sector suppliers have been able to win contracts by matching the efficiency of private sector competitors (see Domberger, Meadowcroft and Thompson 1986 and 1987). The important influence on performance is competition (or contestability) rather than ownership. This is also reflected in the performance of parastatal marketing agencies in less developed countries (LDCs), which, according to the World Bank (1986), "are relatively inefficient". Uma Lele (1976), for example, found that "the marketing margins incurred by the government and parastatal agencies are almost invariably higher than those incurred by traditional (private) traders ... Government agencies usually also have a poor record in timeliness of services in purchasing from the producer and selling to the consumer". However, the World Bank recognized that such "marketing problems are less severe when public marketing agencies are not . . . protected by legal monopoly". There are exceptions to the simple pro-competitive rule, however. The retailing outlets operated by the (then) public sector gas and electricity enterprises have been consistently outperformed by similar privately owned retailers (see Pryke 1982). The publicly owned National Freight Corporation (NFC) was only able to remain in the highly competitive road-haulage industry at the expense of continuing losses. The same was true of the (then) publicly owned Sealink Ferries.

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In each of these examples, the activity in question formed a very small part of the operations of a far larger public enterprise. The financial losses required to retain market share in the face of more efficient private sector competitors was therefore not significant to the enterprises' overall financial health. This suggests that divestment of these activities from their parent enterprise would bring about improved performance (or exit from the market) -a conclusion that is confirmed in the cases of NFC and Sealink. Next, poor performance in a competitive market by privately owned firms leads to remedial action in a manner which is not necessarily assured under public ownership. In practice, however, even where performance is considered weak the threat of management being replaced is not strong. Size is generally a more important factor in safeguarding firms from a take-over than is successful profit performance (see Singh 1975), and the newly privatized British Telecom and British Gas are among the largest private enterprises in the United Kingdom. Restrictions which have been placed on the concentration of their shareholdings mean that a hostile take-over is entirely implausible. This suggests that the interaction of ownership and competition is the primary spur to efficiency. Indeed, the case of cross-channel ferries provides a striking illustration of the combined influences of ownership and competition on performance. In Pryke's 1982 comparison, the privately owned European Ferries emerged with significantly lower costs than the publicly owned Sealink. However, Sealink was not necessarily less efficient than a weaker private operator, P & 0 Ferries. P & 0 operated loss-making services on the channel for several years before reorganizing their activities in the face of a threatened hostile take-over: as part of this restructing, their ferry activities were sold to European Ferries. This company, however, suffered from serious problems of management succession and faced increased competition from the newly privatized Sealink, which had invested substantially in fleet refurbishment. European Ferries was then acquired by the revitalised P & 0 which in turn implemented substantial changes in management structure. There is no evidence here to support any claim of superiority per se of private over public ownership- indeed, all the firms involved, public and private, have demonstrated good and bad performance at different times. Thus, an ambiguous picture emerges again in cases where product market competition is absent. Studies of sectors as diverse as electric utilities in North America and insurance services in West Germany show no general support for the view that the private firms are more efficient than public firms in these circumstances. In fact, there is some indication that the regulation of private firms has distorted incentives in ways which have resulted in performance falling short of corresponding public enterprises (see, for example, Pescatrice and Trapani [ 1980] on U.S. electric utilities, and Finsinger and Pauly [1985] on German insurance companies).

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These results suggest that privatization policies will be most effective in securing an improvement in efficiency where they result in increased competition in product markets. In many parts of the public sector, however, the existence of a natural monopoly appears to impose a significant constraint on policies of liberalization. This is perhaps even more true of the economies of the LDCs, where "conditions of heavy concentration of monopoly power are characteristic of the industrial sectors" (Killick 1981 ), and government parastatals are often monopoly marketers of agricultural produce (see World Bank [ 1982] and the Ndegwa Report [ 1982] for examples of parastatal influence in LDC economies). Inefficiencies resulting from factors including low-level infrastructure development (particularly with regard to the communication of market information), limited trained managerial staff, and narrow and often racially focused capital-owning groups (Killick 1986) may make a competitive solution, in practice, unattainable in sectors of economic activity, including agriculture and industry, that would be potentially competitive in more developed economies. With privatization, therefore, "in many developing countries there would be even greater likelihood of converting a public monopoly into a private monopoly, with uncertain efficiency effects" (Killick 1986). It is clear, then, that both the structure and regulation of a privatized firm are likely to have a central influence on its performance.

The Rationale of Intervention The competitive private market is often regarded as the ideal mechanism for ensuring efficient businesses, and under certain conditions this view is well-founded. Competition in product markets ensures that firms produce goods which match consumer preferences at prices which correspond to the relative costs of supply. Competitive capital markets ensure that only firms which adopt cost minimizing technologies and the appropriate mix of factor inputs are able to survive and prosper. In a number of circumstances, however, markets may fail, in which case this favourable outcome can no longer be guaranteed. Those sectors of the economy which have traditionally been served by public provision are frequently characterized in this way. Indeed, it was the belief that private markets failed to operate efficiently in these sectors that often prompted government intervention in the first place. The relevant types of market failure fall into three broad categories: circumstances in which competitive solutions do not exist; circumstances in which they exist but are not achieved; and circumstances in which they are achieved but are not efficient. In each case, government intervention to remedy ("regulate") the failure may be appropriate. Each of these will be discussed in turn, beginning with those markets in which competitive

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solutions do not appear to exist and, m particular, the case of natural monopoly. Natural monopolies exist when the most efficient means of production is by a monopolist. They are particularly common in industries which involve distribution networks- gas, electricity, water, railways and some but not all, telecommunication networks. Provision by a single supplier is the most efficient outcome in these sectors because it avoids wasteful duplication. Competition in these activities, therefore, would appear to conflict directly with the achievement of an efficient provision of output. Potential competition can, however, exist even where there is a natural monopoly. Under certain circumstances, an inefficient natural monopoly can be replaced by a more efficient natural monopoly; there is competition (because of the threat of entry) even though there is monopolistic supply. Such a market is described as "contestable" (see Baumol et al [1982] for a discussion of the main issues in contestability theory). However, few of the industries in the state sector, with the exception of parts of some "networked" services - in particular, aviation and buses - display the characteristics that make a monopoly "contestable" (in particular, the absence of sunk costs and "stickiness" in the incumbent's prices). In the more usual circumstances where natural monopoly is some way short of being contestable, profit maximization will not be consistent with the public interest. In such markets, profit-maximizing firms are able to raise prices substantially above costs without the risk of competitive entry. Thus, efficiency is unlikely to be achieved without government intervention. The second major area of market failure occurs where there is potentially an efficient competitive market, but this is not achieved in practice. Companies are able to cushion themselves from competitive forces through barriers that prevent either competitive entry or the company itself from exiting the market. These barriers are not "natural" in the sense that they are the result of efficient practice. Rather, they directly prevent the achievement of maximum levels of efficiency. For instance, where there is vertical integration between a monopolistic activity and a potentially competitive activity, such as between distribution and generation in electricity supply, the company can use its monopoly power in the one activity to undermine competition in the other (see also the discussion of incumbent advantage, below). Again, government regulation would appear to be justified. The third area of market failure is that in which a competitive market exists, but is not the most efficient solution. Two principal issues to be considered here are externalities and asymmetries of information. Externalities arise where the production or consumption of a commodity has effects which extend beyond those who are directly concerned with that production or consumption. Thus, for example, it is often argued that the provision of utility services in rural areas yields benefits greater than the

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amount which the purchasers of these services are willing to pay. And efficient markets require some degree of equality of information between buyers and sellers of a commodity- an equality which is patently absent if the commodity in question is, for example, the provision of financial assets or legal advice. Here again, regulatory intervention would appear to offer a way of overcoming this particular form of market failure. So far, the discussion has focused on the ways in which the operation of markets might, potentially, be improved by regulatory intervention. Government intervention, however, can take many forms, and regulatory success is in no way guaranteed. It is not only markets that can fail; there is also a possibility of "regulatory failure" -that interventions intended to correct market failure have adverse, although unplanned, consequences for the achievement of efficiency. The underlying causes of regulatory failure relate to objectives and information. If the objectives of the government regulatory authorities and the regulated enterprise are identical, then the possibility of regulatory failure is removed. It is this essentially normative view of the objectives of public enterprise managers which has often shaped policy towards state industries. The assumption was that if the managers of state-owned firms were told to pursue the public interest, they would be able to determine what that meant and would seek to implement it. In practice, the vagueness of the objectives implied has proved inimical to the efficient management of the industries concerned. If, more plausibly, the objectives of the regulatory authority and the enterprise diverge, then the regulatory problem can be characterized in a principal-agent framework. The principal (the regulatory authority) relies upon an agent (the enterprise) to achieve its objectives in circumstances where their objectives diverge and their access to information is asymmetrical (see Rees 1985a & b for a discussion). It is this model which has increasingly described the relationship between government and nationalized industries. It is a framework in which the problems of objectives and information interact. If the objectives of the regulator and the enterprise were identical then the regulator would have no requirement for information, but it would be easy to obtain. Where objectives diverge, information is required to structure an appropriate framework of incentives but the best source (and in a monopoly industry the only source) of information is the enterprise to which the framework of control is to be applied. It is clear, then, that the potential for regulatory failure is substantial. It should be observed that in the public sector the principal agent problem operates at two levels: do managers have incentives to implement the objectives set by the politicians, and do the politicians have incentives to implement the objectives of the voters? It follows that a number of the difficulties associated with the management of nationalized industries -

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"political interference" - may reflect the weaknesses of the political process as a mechanism for implementing voters' preferences. The problems frequently observed in public sector enterprises are, therefore, not surprising. These failures are well known in the U.K. public sector, and in those of the LDCs. Thus, Ndegwa (1982) observes that " ... parastatals have exceeded their original mandates and have made investments in commercial and industrial activities that should be left entirely to the private sector". The World Bank (1982) finds that "it is impossible to judge the performance of parastatals objectively when they are frequently caught in the cross-currents of mutually contradictory government objectives, only some of which are mandated, and many others exist only by implication" and that "the problems of parastatals are partly attributable to poor management". There is "a lack of concern ... to ensure efficiency ... and willingness to make crucial long-term investment decisions without the necessary financial data". Overstaffing and delay result from "external factors ... patronage distribution and lack of trained manpower". However, although the problems of both market and regulatory failure are familiar, solutions are far from simple. Some of the main policy responses available to governments are outlined in the conclusion. Each of the options has to be considered on its merits in a particular case. A combination of market and regulation has to be devised that maximizes the effectiveness of regulation in tackling the market failure, while minimizing the regulatory failure. This may often require a trade-off between the costs of market failure and those of regulatory failure. The Scope for Public Sector Reform

In addressing the appropriate role of government intervention in the economy it must be acknowledged that such intervention in the past did not, in the main, result from sheer vexatiousness. If removing the intervention fails to remove, or tackle in some different way, the problems which prompted it then the removal is unlikely to prove permanent. The objective should be to relieve market failure in ways which escape or minimize regulatory failure. To this end, policy needs to be tailored to the needs and circumstances of the industry and economy concerned. Privatization Privatization is an appropriate policy where markets are already working perfectly well, or would do so if they were allowed to - where the state enterprise is directly competitive with unregulated private business or where this structure could be easily created. The state has no advantage in running hotels, or ferries, or trucks, or laundries, and these activities suffer only disadvantages in being subject to constraints on their financing and organizational structures which are appropriate or necessary, especially

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where there is no commercial output or where there is political accountability for the results. Moreover, where a firm is engaged in international competition (notably Cable and Wireless), the fact that it is state-owned will affect the way in which it is regarded by other governments and by its customers and competitors. It is in areas such as these that privatization has enjoyed the most successful results. Attention should then turn to those areas in which markets do not work perfectly, but in which the market failure is a relatively trivial one. A good example is the demand for universal service. In the debates on the privatization of British Telecom, the issue of most concern to Conservative backbenchers was apparently the continued provision of public telephone services in the rural areas. There are arguments for extending the provision of basic utilities beyond the areas where that might be strictly economically justified, but there are means of ensuring this which fall a long way short of nationalization. Indeed, it is likely that private firms will see public relations advantages, or social obligations, in such behaviour in any event. Where there are minor non-commercial aspects to what is fundamentally a commercial business, market solutions should, in practice, work perfectly well. More difficult issues arise when the market failure is by no means trivial. Three main problems have been identified: monopoly, public goods, and information. In each of these cases, there is a conflict between an underlying market failure and the inevitable weaknesses of any regulatory intervention designed to tackle it. The answer, whenever possible, is to find mechanisms for making markets work - to lean with market forces rather than against them. Deregulation and Liberalization If it is competition, rather than ownership, that is the key to efficiency, then state industries may be reformed by opening them up to competition, and allowing or encouraging new entrants to the markets of established nationalized industries and regulated monopolies. Liberalization policies fall into two categories: promoting competition by attracting new participants into the market; and restructuring existing companies into more competitive units. Promoting Competition. Many business activities within the public sector take place monopolistically as a result of statute rather than natural monopoly. They may have formed part of an organization of which substantial parts were natural monopoly, or the competitive nature of the activity may not have been recognized. In such cases, it might be expected that competitition would be restored by the simple repeal of the statutory

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monopoly. Experience has shown, however, that the mere removal of legal obstacles to new competition is not sufficient to ensure real competition in former statutory monopolies. The incumbent may retain significant market power. In particular, the endowment of technical and financial advantages which an incumbent brings to a liberalized market is likely either to deter entry or to make the experience of entrants unattractive. There are three issues which may need to be dealt with if competitive outcomes are to be achieved: incumbent advantages, the use of revenues gained in non-competitive markets to cross-subsidize competitive activities, and the exploitation of vertical linkages to extend market power from areas which are natural monopolies to areas which are not. The U.K. experience illustrates each of these issues. The surprising consequences of the deregulation of express coach services in the United Kingdom provide a powerful illustration of the extent of incumbent advantages. In this archetypically contestable industry, liberalization did not significantly reduce the market share of the publicly owned carrier (Davis 1984). National Express used the marketing advantages of a pre-existing natural network, and exclusive or dominant access to city centre terminals, to reinforce its position. Cross-subsidization is apparent in electrical appliance retailing. The public sector electricity industry has been able to maintain a substantial presence in this market despite a level of performance which falls significantly below that of some of its private sector rivals (see Pryke 1982). The financial strength which arises from its monopoly in the far larger market for electricity supply both provides the resources to finance a continued presence in the appliance retailing market and weakens the constraint which poor results might otherwise impose to improve performance. The liberalization of the generation of electricity has faced a similar obstacle, arising from the interrelationship of transmission (a natural monopoly) and generation (which is potentially competitive). Here, the public sector's ownership of the distribution network has led to the distortion of the terms of competition in its favour. Restructuring. Faced with the continued dominance of the express coach market by National Express, despite the liberalizing measures described, the government responded with a programme of fragmenting the business into regional operating companies. The success of this approach suggests that restructuring companies into their constituent competitive parts may offer a more effective route to securing greater competition. In principle, at least, restructuring can be expected to yield three advantages. First, by reducing the size of the privatized firms it will facilitate acquisition or reorganization if performance is inadequate. Secondly, it will facilitate the generation of comparative information by

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which shareholders can assess performance; for example, if each local gas distribution network is separately owned then shareholders can compare the firm with a whole range of similar firms. Thirdly, the regulatory authority can make comparative assessments in determining the appropriate regulatory formula. It follows that the restructuring of public utilities that had been integrated national monopolies has a potentially important role both in the development of product market competition, for activities where this is technically feasible, and in the development of effective capital market constraints on the firm's performance. An appropriate strategy in natural monopoly sectors may then be the separation of the ownership of genuine natural monopoly activities from those in which competition is possible. This principle has in general not been followed in the U.K. privatizations. Where it has, in particular the separation and privatization of subsidiary road-haulage and ferry businesses from British Rail, there has usually been improved performance in the competitive activity. It formed the basis of the reconstruction of U.S. telecommunications. In the case of gas, the internal organization of the public-sector British Gas Corporation (BGC) suggested a structure for the privatized industry in which ownership of the national transmission network, the local distribution networks, and the production of gas was separated (see Hammond, Helm and Thompson 1985). In practice, the privatized BGC retained control of the transmission, distribution and sale of gas and has been permitted, as a consequence of its transfer to the private sector, to re-enter the production of gas, an activity from which it had previously been required to withdraw. Franchising and Contracting Out In areas where competition is apparently impossible, franchising or "contracting out" is an attempt to introduce an element of competition to markets which are unavoidably monopolistic through setting up a competition for the market rather than competition in the market. Potential monopoly power in the market is held in check by the competitively determined terms of the franchise contract. Thus, the government might avoid the problem of taking decisions based on inadequate information by the use of competition between informed potential franchisees: competition acts as a kind of discovery mechanism. The pros and cons of franchising have been debated elsewhere: see, for example, Demsetz (1968), Sharpe (1982), Vickers and Yarrow (1988, section 4.6), and Williamson (1976). The simplest method of franchising is to hold an auction for the right to the monopoly, in which the winner is the bidder who offers the franchisor the largest monetary sum. Such a system helps to transfer the (capitalized) value of the monopoly to the franchisor

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but fails to deal with the underlying problems of market power and allocative inefficiency. Assuming that the public authorities wish to tackle those problems, one form of franchising is that which is sometimes known as the ChadwickDemsetz proposal, in which the natural monopoly franchise is awarded for a period of time to the competitor offering to supply the product or service at the lowest price(s). On the face of it, franchising appears to provide a very attractive way of combining competition and efficiency without any great burden on the regulators. Competition for monopoly seems to destroy the undesirable monopoly of information that hinders traditional regulation, and price is set by competition, not administrative decision. In the United Kingdom, franchising has met with practical success in a number of areas, including competitive tendering in refuse collection, hospital cleaning and catering, and uncommercial bus services, not to mention its widespread use in the private sector. However, franchising is prone to a number of difficulties in some circumstances, and unfortunately the industries in which government control problems are greatest (such as energy, telecommunications and water) are especially prone to such problems. They include the following: 1.

The bidding for the franchise might fail to be competitive, because there may be a) very few competitors, due to scarcity of requisite skills; b) collusion between bidders; or c) strategic advantages possessed by the incumbent franchisee, which deter challenges to him. These could arise from experience effects or superior information over potential bidders.

2.

Problems associated with asset hand-over in the event of an incumbent franchisee being displaced may distort incentives to invest (and, indeed, the nature of competition for the franchise). The valuation of sunk assets is both difficult and costly. If the incumbent expects that their value in the event of hand-over would be set too low (high), and if there is a chance of his being displaced, then his incentive to invest will be correspondingly too low (high).This problem is diminished if the sunk assets are under independent ownership and the franchise is simply an operating franchise, but this raises questions of how the franchisor determines the level of facilities to be provided: as usual the choice is between information or incentive problems.

3.

If there is technological or market uncertainty in relation to the product or service in question, then the specification of the franchise contract will be a very complex task (especially if its duration is long,

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achieved in either private unregulated markets, or state-owned monopolies. Granting franchises to multinationals, which could pay in foreign exchange, would remove what has been a major argument for nationalization - the need for foreign exchange to combat international debt. LDC governmental encouragement of joint-venture partnerships between local producers and multinational owners of capital and technology (see Rweyemamu 1987, and Campanale 1988) also offer a positive role for government that minimizes many of the market and regulatory failures described above. Agency Creation Where functions must inevitably be undertaken within the public sector, there may often be advantages in the establishment of separate agencies, with distinct identities, to perform them. The industrial activities of the government have frequently been conducted in this way, but increasingly, the principle has been extended to more central functions. Why should a change in organizational structure of this kind have beneficial effects on performance? There are several reasons. One is that an element of independence reduces the opportunities for day-to-day political control of activities. It is necessary that the government should retain responsibility for the overall framework within which the agency operates (otherwise there is little reason for the activity to remain within the public sector) but political involvement that is either frequent or on minor issues undermines managerial responsibility and effectiveness. Creating an agency, moreover, requires the government to specify objectives and clarify these for the executives of the agency concerned. The dimensions of performance, such as output, costs, etc, have to be identified and quantified; performance can then be monitored against these criteria. Central public sector activities are often subject to constraints on the ways in which they can be managed. These may relate to salaries paid, grading and promotion structures, and financing - and there can often be benefits to specific activities in being excluded from the restrictions which these imply. Management Culture Our review of the U.K. experience of privatization suggests that its benefits have come less from changes in structure or ownership as such than from changes in the culture with which these firms have operated. New management has challenged the prevalent culture which emphasized engineering rather than marketing and finance, had relatively comfortable industrial relations, and bureaucratic procedures, reinforced by frustrating contact with a sponsoring department. In the 1980s, the new approach stressed the previously relatively neglected functions of finance and marketing. Changes of this kind have been evident in steel, coal, airlines, railways, telecommunications and to some degree, postal services. Other industries, such as gas, electricity, and airports, have seen little change. It

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achieved in either private unregulated markets, or state-owned monopolies. Granting franchises to multinationals, which could pay in foreign exchange, would remove what has been a major argument for nationalization - the need for foreign exchange to combat international debt. LDC governmental encouragement of joint-venture partnerships between local producers and multinational owners of capital and technology (see Rweyemamu 1987, and Campanale 1988) also offer a positive role for government that minimizes many of the market and regulatory failures described above. Agency Creation Where functions must inevitably be undertaken within the public sector, there may often be advantages in the establishment of separate agencies, with distinct identities, to perform them. The industrial activities of the government have frequently been conducted in this way, but increasingly, the principle has been extended to more central functions. Why should a change in organizational structure of this kind have beneficial effects on performance? There are several reasons. One is that an element of independence reduces the opportunities for day-to-day political control of activities. It is necessary that the government should retain responsibility for the overall framework within which the agency operates (otherwise there is little reason for the activity to remain within the public sector) but political involvement that is either frequent or on minor issues undermines managerial responsibility and effectiveness. Creating an agency, moreover, requires the government to specify objectives and clarify these for the executives of the agency concerned. The dimensions of performance, such as output, costs, etc, have to be identified and quantified; performance can then be monitored against these criteria. Central public sector activities are often subject to constraints on the ways in which they can be managed. These may relate to salaries paid, grading and promotion structures, and financing - and there can often be benefits to specific activities in being excluded from the restrictions which these imply. Management Culture Our review of the U.K. experience of privatization suggests that its benefits have come less from changes in structure or ownership as such than from changes in the culture with which these firms have operated. New management has challenged the prevalent culture which emphasized engineering rather than marketing and finance, had relatively comfortable industrial relations, and bureaucratic procedures, reinforced by frustrating contact with a sponsoring department. In the 1980s, the new approach stressed the previously relatively neglected functions of finance and marketing. Changes of this kind have been evident in steel, coal, airlines, railways, telecommunications and to some degree, postal services. Other industries, such as gas, electricity, and airports, have seen little change. It

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may be noted that change has mainly been concentrated on those industries which were losing money, which is why some of the most remarkable improvements have been in industries which have not been privatized rather than those which are. The introduction of a commercial management culture represents a shift in what is considered possible within the overall economic order of the United Kingdom. Whilst previous administrations desired a more commercial approach, and committed themselves to its introduction (the most notable example being the last Labour government's 1978 White Paper, "The Nationalised Industries"), the political implications, notably in terms of large-scale redundancy (375,385 jobs, and more than 27 per cent of the work-force have been shed in the eight major utilities since 1979), meant that this commitment was in practice half-hearted. In this light, privatization should be seen as a symbol of the post-1979 British Government's determination to take seriously the need to instill a commercial spirit into the public sector. In contrast to the actions, if not intentions, of previous administrations, they would neither interfere in managerial decisions, nor intervene to prevent bankruptcy. Most radically, if the new commercial spirit could best be achieved outside public ownership, the government was prepared to transfer its businesses to the private sector. This created an expectation of change (often ahead of any changes actually taking place) which has made effective management at all levels within the organization considerably easier. External recruitment of senior managers - a constant source of difficulty in British nationalized industries - has been both more common and substantially easier. The emphasis on commercial performance has dangers, however. In the United Kingdom, there has been an increasing trend to regard privatization not only as a symbol of the new commercial management approach but as its cause. Thus, the government has been too ready to trust the commercial judgement of its managers and so exchange liberalization policies for policies of asset sale. Although the commercial motivation of such management encourages efficiency, it is unlikely to favour being subjected to increased competition, and in practice it has not done so. In the absence of such competitive discipline, the permanence of performance improvements must be open to doubt.

Conclusions

Throughout the world, governments have begun to recognize that the problems of market failure are not solved simply by taking enterprises into public ownership. The performance of public sector enterprises has often been poor. The emergence of privatization is symbolic of a realization that market forces have an important role in improving efficiency in many areas of the economy.

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The central issue of this paper has been the tension between the failure of markets and the failures of regulation, and the need to find structures which minimize the extent of either. This is a more complicated exercise than chanting slogans about the virtues of private enterprise, but it is also a more constructive one. It is more constructive partly because there are major areas of the public sector in which, as they are at present constituted, private enterprise is simply impossible. It is also because simply proclaiming that what were once public enterprises are now private firms is not, as we have seen, necessarily sufficient to make a difference to their behaviour. The real objective of policy should be to reconstruct, as far as possible, the organization of public-sector activities so as to create the conditions that make private-sector operations effective and efficient- that is, relatively specific objectives, a clearer framework of constraints, and the pressures of competition. The possibilities for undertaking such reconstruction extend far beyond public-sector industrial activities. Nor can they be given full scope within those industries unless the organization of the industries concerned is given careful consideration before privatization occurs.

REFERENCES Bailey, E. E. "Price and Productivity Change following Deregulation: The US Experience". Economic Journal96 (1986). Baumol, W. J., J. C. Panzer and R. D. Willig. Contestable Markets and the Theory of Industry Structure. New York: Harcourt Brace Jovanovich, 1982. Bishop, M. R., and J. A. Kay. "The Impact of Privatization on the Performance of the UK Public Sector". Paper presented at the 15th Annual Conference of EARlE, Rotterdam, 1988a.

- - . Does Privatization Work? Lessons from the UK. Centre for Business Strategy Report, 1988b. Borcherding, T. E., et a!. "Comparing the Efficiency of Private and Public Production: The Evidence from Five Countries". Zeitschrifi fur Nationalokonomie, Supplementum 2 (1982). Campanale, M. "Transfer of Business Ownership & Control to Africans in Independent African States: A Study of Kenya, Zimbabwe & Tanzania". Jubilee Centre, 1988. Caves, D. W., and L. R. Christensen. "The Relative Efficiency of Public and Private Firms in a Competitive Environment: The Case of Canadian Railroads". Social Systems Research Institute, Workshop Series, 1978. Davis, E. H. "Express Coaching since 1980: Liberalization in Practice". Fiscal Studies 5, no. 1 (1984).

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Demsetz, H. "Why Regulate Utilities?" Journal of Law and Economics 11 ( 1968): 55-65. Dombcrger, S., S. A Meadowcroft, and D. P. Thompson. "Competitive tendering and efficiency: The case of refuse collection". Fiscal Studies 7, no. 4 ( 1986). - - . "The impact of competitive tendering on the costs of hospital domestic services". Fiscal Studies 8, no. 4 ( 198 7). Finsinger, J., and M. V. Pauly. The Economics of Insurance Regulation: A Cross-National Study". London: Macmillan, 1985. Hammond, E. M., D. R. Helm and D. J. Thompson. "British Gas: Options for Privatization". Fiscal Studies 6, no. 4 (I 985). Killick, T. Policy Economics. London: Heinemann, 1981. - - . "Twenty-five Years in Development: The Rise & Impending Decline of Market Solutions". Development Policy Review 4 (1986). Millward, R., "The comparative performance of public and private enterprise". In The Mixed Economy, edited by Lord Roll. London: Macmillan, 1982. Ndegwa, P. Report & Recommendations of the Working Party (on Government Expenditures). Nairobi : Republic of Kenya, I 982. Pescatrice, D. R., and J. M. Trapani. "The performance and objectives of public and private utilities operating in the United States". Journal of Public Economics 13, no. 2 (1980). Pryke, R. "The comparative performance of public and private enterprise". Fiscal Studies 3, no. 2 (I 982). Rees, R. "The Theory of Principal and Agents, parts 1 & 2". Bulletin o.f Economic Research 37, nos. I & 2 (1985 a & b). Rweyemamu, N. A. "Developing with Foreign Investment". Commonwealth Secretariat, 1987. Sharpe, T. "The Control of Natural Monopoly by Franchising". Mimeographed. Wolfson College, Oxford, 1982. Singh, A. "Takeovers, Economic Natural Selection and the Theory of the Firm: Evidence from the Post-War UK Experience". Economic Journal 85 (1975). U rna Lele. "Considerations Related to Optimum Pricing and Marketing Strategies in Rural Development". 16th Proceedings of the International Conference of Agricultural Economics, 1976. Vickers, J., and G. Yarrow. Privatization-an Economic Analysis. Cambridge, Mass: MIT Press, 1988. Williamson, 0. E. "Franchising Bidding for Natural Monopolies-In General and with Respect to CATV". Bell Journal o.f Economics 7 (1976): 73-104.

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THE EDITORS

Jacques Pelkmans, Ph. D., is Senior Research Fellow at the Centre of European Policy Studies (CEPS) in Brussels and the Director of EUROSCOPE. Before 1990 he was Professor of Economics at the European Institute of Public Administration, Maastricht, Netherlands, and, among other things, co-organized its EC-ASEAN programme. He writes on economic integration, EC-1992, trade policies, foreign direct investment, and international business. Norbert Wagner, Ph. D., is Advisor and Visiting Fellow at the Institute of Southeast Asian Studies, Singapore, and Representative of the Konrad Adenauer Foundation, Federal Republic of Germany. He is on leave from the Department of Economics, South Asia Institute, Heidelberg University. Dr. Wagner's research interests focus on international and development economics.