In the midst of the European Debt Crisis, it is tempting to think that high-debt countries could alleviate the recessionary impact of the budget consolidation process by selling (poorly managed) assets and stakes in their state owned enterprises (SOEs), and by using the proceeds to buy back their debts. In addition to providing a cushion for ongoing adjustment programs and improving solvency, privatizations are deemed to entail long-term efficiency and welfare gains, by attracting foreign direct investment and managerial expertise, spurring competition and growth.
Indeed, privatizations have been part of the Troika’s conditionality in Greece since the outburst of the crisis. In March 2011 an agreement was signed by Greece and the Troika for a very ambitious privatization plan which envisaged the sale of public utilities, tourism resorts, concessions for the Athens airport and the port of Piraeus, the sale of government shares of the OTE telephone company, the partial privatization of the Greek Agricultural Bank. In exchange, Greece could have tapped the EFSF at more favorable conditions. The original plan was to raise €50bn within 2015, about 17% percent of the (then) outstanding debt.
The plan’s progress has been disappointing: in 2012 only 2 out of 35 privatization tenders were completed (see Table 1), mainly due to delays in the required legal and regulatory changes (“Government Pending Actions”, in the Commission’s jargon). In 2013, 10 tenders were completed
Table 1: Greek Privatizations
In the following years, the expected revenue from privatizations of state owned enterprises, real estate and banks, was dramatically scaled down in (see Table 2), dropping to just €8.7bn in the Memory of Understanding of 2013.
Table 2: Expected Revenues from Privatizations
In this column I will focus on the following question: is large scale privatization a viable option to improve solvency of high-debt countries (1)? I will argue that, in practice, the conditions required for state asset sales to improve solvency are unlikely to be met,particularly when a country is in financial distress. Thus the lessons from the recent Greek privatization fiasco are probably quite general. I will first make a simple numerical example, and then describe the relevant empirical evidence.
Consider the following example (Table 3). A country (call it Greece) has a debt coming due amounting to €100, consisting of 100 promises (bonds) to pay 1€. Greek revenues come from two sources: one (Tourism) generates €74 for sure, and one (say, the port of Piraeus) yields, on average, 20€. Since the value of total (expected) revenues (€94 ) falls short of debt coming due, Greece is insolvent, and its debt sells at a discount, for 94cents to the euro (this is the ratio of total expected payments, €94 to the number of outstanding bonds, 100).
Table 3: An Example of privatization
In order to improve solvency, the government (e.g. the Troika) decides to privatize the port of Piraeus, and to use the proceeds to buy back the debt. This example describes a very large asset sale, about one fifth of the total debt at pre-privatization prices. Let’s first consider the benchmark case where the public sector is as (in) efficient as the private sector in managing ports ( first column, Table 3). In this case, the Piraeus will sell for €20 (the present value of net revenues), and, with the proceeds the government will buy back €21.28 (=20/0.94) units of debt. After the privatization, the total outstanding debt will thus fall to €78.72 (=100-21.28)
Has government solvency improved? Not at all. The government has forgone 20€ of revenue from the Piraeus, and now it has to repay €78.72 debt, with only Tourism receipts (74€). It is exactly “as insolvent” as before, and in fact the price of the debt on the secondary market is unchanged (at €0.94 = expected payments/outstanding debt=74/78.72).
Now consider the case in which the private sector is much more efficient (+30%) than the state to run ports, and may generate €26 (instead of €20) from managing the Piraeus (second column of Table 3). If capital markets are competitive, the port will now sell for €26. It will always be profitable for private investors to bid up to this price. It easy to show that, after the sale, the secondary price of debt will rise to 1€, so that the government will buy back exactly €26 of its debt. Thus, only €74 of debt will be left, exactly equivalent to the remaining revenues from Tourism (which confirms that debt must sell at par).
Three Lessons from the Example
This example teaches us three lessons:
- First, the government benefits from privatization only as long it appropriates the increase in the asset value generated by the private sector. However, it takes a very large public inefficiency (-30%) in order to generate a small improvement in solvency (the price of debt improves from €0.94 to €1) ;
- Second, for these benefits to materialize, the government must relinquish the control rights on the privatized asset: selling minority stakes or keeping “golden shares” won’t work.
- Third, financial markets must be competitive and have “deep pockets” , so that the state owned enterprises are priced at the present future dividends they generate;
Finally, note that a “successful” privatization plan should be associated to an improvement in the secondary market price of debt.
1. How large are the gains in profitability, productivity, dividends, capitalization of privatized (ex) state-owned enterprise (SOEs)? There is a large empirical literature, mainly referring to episodes of the1980’s and 90’s. The results are often inconclusive and vary over time, episodes and countries, as issues such as the regulatory and legal framework and the details of the privatization process are crucial. Table 4 is taken from Megginson and Netter, 2001, (2) and compares pre and post-privatization performances of 113ex-SOE’s .
Table 4: Empirical Studies on Privatizations
Whatever measure of efficiency we consider, the gains from privatization appear at least an order of magnitude below the scale required for solvency to improve (30% in the example). Note that, from a methodological point of view, this literature is unconvincing: it does not compare the pre/post privatization changes of SOE and that of a “control group” made of SOE which were not privatized, so the inference of the effect of the privatization “treatment” is quite dubious. Goldstein (2003) looks at the evidence of the Italian privatization experience of the 1990s and compares pre/post privatization changes to those of a control group of enterprises of the same sector. He finds no significant effect of privatizations.
2. The second issue is that of the transfer of control rights. Bortolotti and Faccio (3), 2004 present evidence from a sample of 118 SOE privatized during the 1990s in Europe. The evidence suggests that transfer of control rights after privatization was far from complete: in as many as 65% of the cases analyzed, the Government retained either 10% of the shares of the privatized firms (or more), and/or control rights through “golden shares” (see the Table below). This fact highlights how reluctant are politicians to loosen their grip on SOEs, and provides a possible explanation for the less-than-expected gains from privatizations. The privatization experience in Italy during the 1990s is a case in point: suffice to say that party-controlled Fondazione Monte dei Paschi Siena (MPS), in violation of the law, still ownes more than half the scandal-ridden MPS bank, twenty years after its “privatization”.
Table 5: Control rights, Source: Bortolotti and Faccio, 2004
3. Finally, it seems unlikely that a country which has lost access to the international debt markets can profitably sell assets at its equilibrium price (the present value of the income streams it generates), although this cannot be ruled out in principle. The recent Greek episode provides no example of an improvement in the secondary market price of debt, nor of market access conditions, following the announcement of the first ambitious privatization plan.
Privatizations should be judged for their own merits: for reducing the role of the state in the economy, particularly when this is associated to corruption, illegal financing of political clienteles, distortion of competition, barriers to entry and inefficiency. As an “emergency” tool for improving solvency in harsh times, however, they are unlikely to be effective. A crisis-stricken country has little alternative to resorting to a mix of fiscal restraint, debt restructuring and real depreciation, possibly via wage cuts. The implication is that the (Troika) policy of linking financial assistance to privatizations is inappropriate and self-defeating. It should be dropped
(3) Bortolotti, B. and M.Faccio , 2004,”Reluctant privatization”, EGCI Working Paper n,40