The Failure of Privatization
by
Prashant Bhushan

Joseph Stiglitz, the World Bank's Chief Economist for three years
until January 2000 and the winner of the Nobel Prize for Economics in
2001, speaks out with brutal frankness about the Washington Consensus
institutions' hypocrisy and the effects that the globalisation
programme has had on the developing world.



The deferment of the disinvestment of the oil majors, HPCL and BPCL,
by the government has predictably set the alarm bells ringing at the
International Monetary Fund (IMF) headquarters and the U.S. Treasury
Department. "The reforms in India are in danger of being derailed,"
is the cry from Washington. Not surprisingly, Standard & Poor's
(S&P), the credit rating agency nominated by Washington, has
downgraded India's credit rating to `junk status'. The main reason
given was the slowdown of India's disinvestment programme. Most of
India's financial press, which is predominantly owned by big
business, are gleefully using the S&P downgrade to make a lot of
noise about reforms having hit a road block. The loaded word
`reforms' has been deliberately used by the Washington Consensus
institutions (IMF, World Bank and the U.S. Treasury Department) to
describe the structural adjustment programme that they have forced on
the Third World countries. Anyone who opposes this programme is
characterised as obstinate and backward and is believed to have a
vested interest in a corrupt government that misuses the assets of
the public sector.

Unfortunately for the Washington Consensus institutions and their
blue-eyed boys in Third World governments, the Guru himself has
spoken out with brutal frankness about the effects that the
globalisation programme (particularly privatisation and capital
market deregulation) has had on the developing world. Joseph Stiglitz
was the World Bank's Chief Economist for three years until January
2000. Prior to that he was the Chairman of President Clinton's
Council of Economic Advisers. Few can speak more authoritatively or
with greater inside knowledge about the functioning of the Washington
Consensus institutions. Stiglitz received the 2001 Nobel Prize for
Economics and any doubts about his intellectual eminence must be laid
to rest. In his recently published book Globalisation and Its
Discontents1, Stiglitz has commented extensively about how and in
whose interests structural adjustment policies were evolved and the
effects that they have had on the economies of the Third World. He
says: "Despite repeated promises of poverty reduction made over the
last decade of the 20th century, the actual number of people living
in poverty has actually increased by almost hundred million. This
occurred at the same time that total world income actually increased
by an average of 2.5 per cent annually."2



Joseph Stiglitz, professor of economics, business and international
affairs at Columbia University, was one of three Americans awarded
the 2001 Nobel Prize for Economics for their analyses of how markets
function when some people know more than others.

Stiglitz gives some of the reasons why this has happened. "But even
when not guilty of hypocrisy, the West has driven the globalisation
agenda, ensuring that it garners a disproportionate share of the
benefits, at the expense of the developing world. It was not just
that the advanced industrial countries declined to open up their
markets to the goods of the developing countries - for instance
keeping their quotas on a multitude of goods from textiles to sugar -
while insisting that those countries open up their markets to the
goods of the wealthier countries; it was not just that the more
advanced countries continued to subsidise agriculture, making it
difficult for the developing countries to compete, while insisting
that the developing countries eliminate their subsidies on industrial
goods. Looking at the `terms of trade' - the prices which developed
and less developed countries get for the products they produce -
after the last trade agreement of 1995, the net effect was to lower
the prices some of the poorest countries in the world received
relative to what they paid for their imports. The result was that
some of the poorest countries in the world were actually made worse
off."3

In his analysis of how the structural adjustment or the globalisation
programme has damaged the economies of the developing world and
Russia, Stiglitz lays much of the blame on the IMF's insistence on
rapid privatisation and capital market deregulation. The focus here
is on what he says about privatisation, because of its immediate
relevance. The main arguments being used in favour of disinvestment
are: 1. Most of the public sector companies are loss-making and are a
burden on public funds; 2. Since the government is corrupt, the
public sector companies are also corruptly managed; 3. In the hands
of the private sector, the public sector companies would be run more
efficiently.

The major premise of the first argument is factually incorrect since
many public sector undertakings (PSUs) are not loss-making. However,
even if it were assumed to be so, this argument has no relevance for
most of the PSUs which have been privatised or are on the selling
block. Many of these PSUs are highly profitable companies. The oil
majors, HPCL and BPCL, which have already repaid the government's
investment on them several times over. Nalco, which the government is
looking to sell, is one of the lowest cost aluminium producers in the
world and earns gross profits equivalent to 50 per cent of its
revenue. Moreover, most of the PSUs that have been sold or are being
sold now, such as VSNL, IPCL, HPCL, BPCL and even Nalco are in
sectors where disinvestment is likely to lead to the creation of
private monopolies or oligopolies.

Here is what Stiglitz has to say about the dangers of creating
private monopolies. "However, there are some important preconditions
that have to be satisfied before privatisation can contribute to an
economy's growth. And the way privatisation is accomplished makes a
great deal of difference4... the IMF argues that it is far more
important to privatise quickly; one can deal with the issues of
competition and regulation later. But the danger here is that once a
vested interest has been created, it has an incentive, and the money,
to maintain its monopoly position, squelching regulation and
competition, and distorting the political process along the way5 ...
privatising the monopoly before an effective competition or
regulatory authority was in place might simply replace a government
monopoly with a private monopoly, even more ruthless in exploiting
the consumer."6

Lambasting the IMF for almost deliberately encouraging private
monopolies, Stiglitz says: "The IMF chose to emphasise privatisation,
giving short shrift to competition. The choice was perhaps not
surprising: corporate and financial interests often oppose
competition policies, for these policies restrict their ability to
make profits. The consequences of IMF's mistakes here were far more
serious than just high prices: privatised firms sought to establish
monopolies and cartels, to enhance their profits, undisciplined by
effective anti-trust policies. And as so often happens, the profits
of monopoly proved especially alluring to those who are willing to
resort to mafia like techniques either to obtain market dominance or
to enforce collusion7... Yet U.S. and IMF officials paid little
attention to the dangers posed by the concentration of media power;
rather, they focused on the rapidity of privatisation, a sign that
the privatisation process was proceeding apace. And they took
comfort, indeed even pride, in the fact that the concentrated private
media was being used, and used effectively, to keep their friends
Boris Yeltsin and the so-called reformers in power."8

IN India, the sectors in which some PSUs have been privatised, such
as telecom (VSNL) or petrochemicals (IPCL), and some in which PSUs
are on the block, such as oil (HPCL and BPCL) and aluminium (Nalco)
are inherently prone to monopolistic or oligopolistic competition.
For example, in the aluminium sector, Nalco and Hindalco each have a
market share of 40 per cent. If Nalco is sold to Hindalco, which sale
is very much on the cards, Hindalco will have a virtual monopoly in
the aluminium market similar to the one that Reliance has acquired in
the petrochemical sector after IPCL was sold to it. Saying that this
does not matter since there is no restriction on the entry of new
companies in the field is not a valid answer because of the economies
of scale that exist in the sector.

With the economies of scale that will accrue to a Nalco-Hindalco
conglomerate and with the initial advantages that Nalco and Hindalco
already possess (large and cheap captive bauxite mines and power
plants), it would be virtually impossible for anyone else to compete
effectively with the combined power of Nalco and Hindalco. The
creation of private monopolies and oligopolies (usually in the form
of cartels) is being actively abetted by the manner of disinvestment.
At the same time, existing though decrepit, mechanisms that regulate
monopolistic practices, such as the Monopolies and Restrictive Trade
Practices (MRTP) Act and MRTP Commission, are being dismantled.

It has been argued in India that privatisation is necessary to reduce
the malevolent influence of a corrupt state. This, Stiglitz says, is
a very simplistic view of the state. "Privatisation was supposed to
eliminate the role of the state in the economy; but those who assumed
that had a far too naive view of the role of the state in the modern
economy. It exercises its influence in the myriad of ways at the
myriad of levels."9 Regulatory authorities such as the Telecom
Regulatory Authority of India (TRAI), the Electricity Regulatory
Commissions, the MRTP Commission and the Securities and Exchange
Board of India (SEBI) are supposed to be necessary even in a
privatised economy to protect consumer interests from monopolistic
competition, cartels and corrupt private players. If the government
is incorrigibly corrupt, why would these public institutions be less
so? We have seen how SEBI has repeatedly allowed the stock markets to
be ruthlessly manipulated by a dishonest cartel of brokers. Few can
claim that monopolistic or restrictive trade practices do not exist
in India. There are very few cases where the MRTP Commission has
acted to protect consumer interest. In fact, the introduction of
private firms in a sector often increases the incentives of private
players to bribe regulatory authorities. In a corruption ridden
society, that is the easiest way for private players to make a quick
buck.

Moreover if the government is corrupt, there is every reason to
suppose that disinvestment will also proceed corruptly in a corrupt
manner. A honest Disinvestment Minister is certainly no guarantee
against dishonesty in the prevailing atmosphere. How can anyone
justify the transfer of IPCL and VSNL to private companies for an
amount less than even its free reserves (cash in the bank)?

It is important to note what Stiglitz has to say on this issue.
"Perhaps the most serious concern with privatisation, as it has often
been practised, is corruption. The rhetoric of market fundamentalism
asserts that privatisation will reduce what economists call the `rent
seeking' activity of government officials who either skim off the
profits of government enterprises or award contracts and jobs to
their friends. But in contrast to what it was supposed to do,
privatisation has made matters so much worse that in many countries
today privatisation is jokingly referred to as `briberisation'. If a
government is corrupt, there is little evidence that privatisation
will solve the problem. After all, the same corrupt government that
mismanaged the firm will also handle the privatisation process. In
country after country, government officials have realised that
privatisation means that they no longer needed to be limited to
annual profit skimming. By selling a government enterprise at below
market price, they could get a significant chunk of the asset value
for themselves rather than leaving it for subsequent office holders.
In effect, they could steal today much of what would have been
skimmed off by future politicians. Not surprisingly, the rigged
privatisation process was designed to maximise the amount that
government Ministers could appropriate for themselves, not the amount
that would accrue to the government's treasury, let alone the overall
efficiency of the economy. As we will see, Russia provides a
devastating case study of the harm of privatisation at all costs."10

Companies such as HPCL, BPCL, IPCL, VSNL and Nalco, which have
sizeable assets, are enormously profitable and offer opportunities to
private companies to acquire monopoly positions. These firms are star
performers of the public sector and are being greedily eyed by the
private sector. Nalco, which is now on the selling block, has 40 per
cent share of the market. It has a gross profit margin of 50 per
cent. This amounts to annual gross profits in excess of one thousand
crores and these profits are going up every year. Nalco has large
bauxite reserves (with enough mineral supply for more than a hundred
years) and also owns captive power plants of 960 MW. Nalco is
probably the lowest cost producer of aluminium in the world. The
operating cost of its alumina refinery is $100 PMT (per metric tonne)
as against a global average of $140 PMT. It has been reported that
Merrill Lynch, which has been appointed by the government, has valued
Nalco at Rs.9,600 crores. By the strategic sale model the government
may transfer 26 per cent share and management control to a private
company at anything over Rs.2,500 crores, which at current rates
would be Nalco's projected gross profit for just two years. The
replacement value of even the captive power plants is over Rs.4,000
crores. Why then should the government proceed with the sale of Nalco
to private firms? It may be argued that under private sector control,
Nalco is likely to function more efficiently. This would allow the
government to make even greater profits on its remaining stake in
Nalco than it currently earns. However, private companies are even
more notorious for siphoning funds off companies and cheating
shareholders than the public sector. Most of the non-performing
assets (NPAs) of public financial institutions arise due to defaults
on loan repayments by the private sector. Large companies are usually
the culprits and often their owners have become richer, even as their
companies have failed to repay loans.

Not surprisingly, Stiglitz's conclusions on the impact of
privatisation are far from sanguine. "In the World Bank review of the
ten year history of transition economies, it became apparent that
privatisation, in the absence of the institutional infrastructure
(like corporate governance), had no positive effect on growth. The
Washington Consensus had again gotten it wrong11... Not only did
privatisation, as it was imposed on Russia (as well as in far too
many of its former Soviet bloc dependencies), not contribute to the
economic success of the country; it undermined confidence in
government, in democracy, and in reform."12

Stiglitz also dwells at length on the hypocrisy of the Washington
Consensus institutions. "Russia had a crash course in market
economics, and we were the teachers. And what a peculiar course it
was. On the one hand, they were given large doses of free market,
textbook economics. On the other hand, what they saw in practice from
their teachers departed markedly from this ideal. They were told that
trade liberalisation was necessary for a successful market economy,
yet when they tried to export aluminium and uranium (and other
commodities as well) to the United States, they found the door shut.
Evidently, America had succeeded without trade liberalisation; or, as
it is sometimes put, `trade is good but imports are bad'. They were
told that competition is vital (though not much emphasis was put on
this), yet the U.S. government was at the centre of creating the
global cartels in aluminium, and gave the monopoly rights to import
enriched uranium to the U.S. monopoly producer. They were told to
privatise rapidly and honestly, yet the one attempt at privatisation
by the United States took years and years, and in the end its
integrity was questioned. The United States lectured everyone,
especially in the aftermath of the East Asia crisis, about crony
capitalism and its dangers. Yet the issues of the use of influence
appeared front and centre not only in the instances described in this
chapter but in the bailout of long term capital management described
in the last."13

What Stiglitz says cannot be dismissed by the votaries of
globalisation as Leftist new-age fluff or the rantings of a
disgruntled insider. His credentials are far too impressive for that.
Anyone reading his book will understand that he is a conservative
Keynesian economist. He has seen the working of the Washington
Consensus institutions from the inside as closely as anyone ever has.
He merely has the sensitivity to see what the structural adjustment
policies and the market fundamentalism on which they are based have
done to the economies of countries which were forced to adopt them,
particularly those in the Third World and Russia. Stiglitz has the
honesty and courage to state the truth as he sees it. One wishes that
people like Arun Shourie would read and heed Stiglitz rather than
mindlessly pursue the fundamentalist agenda set by Washington. They
should devote more of their time, intelligence and energy to
reforming our regulatory and judicial institutions. They should
concentrate on providing laws that guarantee transparency and
accountability in the functioning of government institutions.

It is clear that without these reforms first, privatisation would
lead India, like it led Russia and many other countries, to disaster.

1. Globalisation and Its Discontents by Joseph Stiglitz, published by
Allen Lane/Penguin 2002.