The Economic and Social Impact of Social Divestiture: A comparison between MENA countries and Other Regions

FEM33-08 | February 2011

Title

« The Economic and Social Impact of Social Divestiture: A comparison between MENA countries and Other Regions »

By

Adel Boughrara, Université de Sousse, Tunisie

Contributeurs

Samy Bennaceur : IMF Institute, USA ; Narjess Boubakri : American University of Sharja, UAE ; Samir Ghazouani : Université de Mannouba, Tunisie ; Thomas Lagoarde-Segot : Euromed Management, France.

Note :

This document has been produced with the financial assistance of the European Union within the context of the FEMISE program. The contents of this document are the sole responsibility of the authors and can under no circumstances be regarded as reflecting the position of the European Union.

Summary :

Privatization is considered as one of the main core policies that came to re-enhance government efforts at public sector reforms. Very similar in spirit to the structural adjustment reforms of the 1980s, privatization programs emphasize markets and ?efficiency’. The basic idea that underlines the proponents of privatization is that overstaffed State owned enterprises (SOEs) that are uncompetitive should be restructured under private management. Accordingly, these SOEs will be turned around to become competitive and efficient firms.Privatization has become recommended by international organizations (chiefly, the World Bank) as well as western experts; As a result, the political debates have re-focused on how to transfer assets to the private sector, which assets should be privatized, who should be allowed to buy assets, and how fast should privatization be implemented. Regrettably, the issue of whether to privatize or not has been marginalized, if not neglected. Again, rather than reassessing policies in the light of their social impacts, many governments have made the transition based on the premise that what was considered to be good macroeconomic policy could only be good for poverty reduction. Potential impacts of privatization on poverty and employment have so far been overlooked in the literature. For instance, studies that attempt to empirically assess the effects of privatization on poverty are very rare, and absent from the World Bank analysis. Likewise, very few are the studies that appraise the impacts of privatization on employment.The main objectives of this project have been to shed light on these neglected issues, namely the impact of privatization on employment and inequality while accounting for the regional characteristics of privatization. The project seeks also to assess the impact of privatization on stock market development (liquidity and size). Five regions are considered, namely Africa, Asia, Europe, Latin America and Mena. The empirical evidence put forward in this project indicates that the effects of privatization on inequality are rather mixed, and depend on both the region and privatization measures. It has been found that privatization proceeds are harmful to inequality in African and Latin American countries. Their effects on European and Asian countries are instead beneficial. As for privatization effects on inequality in MENA countries, the evidence is inconclusive. Another social impact of privatization relates to employment. On average, privatization proceeds have been found to lower the unemployment rate in the years that follow privatization. More importantly, privatization proceeds from stock issues seem to decrease employment and their effect is distributed over the few years following the year of privatization.Based on the main results provided by this empirical study, several policy implications car be put forward. Regarding the impact of privatization on stock market development, our empirical results are explained by the way privatization is actually implemented across countries. For instance, only recently, have MENA and African countries started to privatize on a large scale. Also, most past transactions were direct sales to core investors, so a limited number of privatized firms were actually listed on the stock markets. In contrast, in Asian countries, privatization has started since the 1980s, relatively earlier than in any other region in the sample. Thus, the privatization effects on stock markets have had the time to materialize in this latter region, but not in MENA or African countries.Our results show a positive impact of privatization progress on stock market development because it signals government commitment towards market oriented policies, and less policy risk. However, we do not find a common systematic effect in all regions suggesting that the way the privatization signal is perceived depends on the geographical region. For instance, it has been perceived as a positive signal in Asia which led to an improvement in market size and liquidity. The reform progress has had no impact on MENA markets. Nor is there an observable effect for Africa and Latin America, irrespective of the measure of stock market development.Turning to the second aspect of privatization reforms, namely, the method of divestiture (by public share offering or private sale), it is shown that public offerings (SIPs), are in general, insignificantly related to stock market development everywhere except in the Asian bloc. These results can be rationalized as follows: Asian countries have privatized extensively, and heavily relied on public offerings at the time of privatization. Latin America, in contrast, used more often private sales to private investors or a combination of private and public sales for the same firm. In Africa, governments started making efforts to privatize, and put in place some privatization offerings, but the markets were unable to absorb them due to the lack of savings in the hands of investors, and the low initial market liquidity, which did not help to build investors confidence in these markets. The MENA region, in contrast, has been relying on a combination of privatization offerings and private sales, leading to the listing of several large companies in diverse sectors (finance, airlines, etc.).The progress in privatization was a clear signal of government commitment towards market oriented policies, but was not perceived as such every where. Thus investors are still reluctant to heavily invest in the stock market. Admittedly, if most privatization transactions are implemented outside the stock market, there can be no positive externalities for the stock market. In addition, building investors’ confidence must involve a sound institutional environment, where they have no fear of expropriation. If the sequence of reforms is not optimal, and governments implement privatization, deregulation, and liberalization, all simultaneously, the expected positive outcomes can be delayed. On the other hand, one cannot implement successful privatization offerings if the stock market is underdeveloped, and institutionally unsound. We just have to compare the privatization experience of Asian markets to that from the other regions that we examined. Asian governments put in place liberalization reforms, and then embarked on transition of their institutional environment, and regulation of stock markets. When the conditions needed to launch privatization were in place, they started selling public assets. The economic, institutional and social conditions helped to make their privatization a success story. In Latin America, several countries, such as Chile, embarked on intensive privatization programs in the early 1980s, but the experience was not viable because no changes were introduced in regulation, competitiveness laws, investor protection, and market transparency. As a consequence, the newly privatized firms, had to be re-nationalized, and once the institutional environment became more adequate, the country undertook its privatization program for the second time.Privatization is a redistributive policy and as such must assure that investors are treated fairly and that transactions are dealt with in all transparency. This requires a sound institutional environment as a pre-condition for success.As for the social dimension of privatization, the empirical results indicate that the impact of privatization on unemployment depends on the privatization measure used, and is perceived differently across the considered geographical regions. More specifically, we observe that increasing proceeds from privatization reduces unemployment. On another front, the number of privatizations is found to have a delayed effect on employment; the unemployment rate is found to decrease subsequent to a significant increase in the number of privatizations in almost all the regions but Europe.The method of privatization seems to be a significant determinant of employment dynamics. Besides, using stock markets as a privatization device is counterproductive in terms of employment. If governments are willing to reduce unemployment, then privatization should initially be implemented without stock issues. Indeed, despite the fact that it reduces unemployment on the year of divestiture, privatization through stock issues tends to increase unemployment the years after. This finding is particularly strong for African countries. Such finding has been again highlighted by other studies. For instance, it has been argued that once privatized, the requirements for efficiency and competitiveness frequently lead the new owners to lay off more workers. The overstaffing of state-owned enterprises, which is relatively common in developing countries where most firms are working in non-technical areas, could explain why unemployment increases only the year of sale.In order to alleviate the negative impacts of privatization on employment, governments that embark on privatization should implement concomitant policy measures such as making special provisions in privatization plans to compensate laid-off workers. These special provisions should be used without generating excessive political pressure or increasing fiscal dominance. Other such measures could consist in stressing incentives and encouraging voluntary participation instead of job cuts. In addition, governments may create a kind of special fund to cover the costs related to early retirement or transfer costs of employees in redundant positions. Most importantly, these funds should be used to cover the costs related to business training for those employees who have been laid-off and who would prefer to start their own business in the private sector.As for inequality, privatization proceeds are found to decrease inequality only in environments where institutions are well developed and where the initial level of inequality is relatively low, as Europe or Asia. Managing privatization proceeds in an efficient and effective way is a necessary, albeit far from being sufficient, condition to limit the negative effects of privatization on public finance, and in turn on growth and income inequality. Efforts should be made in order to reduce inequality because high inequality is synonym of high poverty rates, and this latter cannot be reduced significantly even at high economic growth rates. In order for growth to reduce poverty, inequality should also be reduced as much as possible. For instance, and as stressed above, a portion of privatization receipts (or funds) might be spent on pro-poor plans, which will help reduce inequality. Better still, to further reduce inequality, financial sector development should be prioritized, saving and investment should be increased, trade openness should be reinforced. Again, the empirical evidence presented in this project indicates clearly that on the one hand the institutional quality reduces significantly inequality, but on the other hand high levels of corruption increase it. Therefore, in order to get the most out of privatization and in order to reduce inequality further, policymakers should adopt a corporate governance perspective that permits to improve institutional quality and eradicate corruption.Far from recommending the abandon or/and reverse of privatization process, this project recommends that privatization process should be carried out circumspectly and correctly. More specifically, decisions to privatize should be assessed soundly, and their expected outcome and impacts on inequality and employment should be evaluated beforehand. For instance, privatization should be implemented while accounting for local conditions, taking advantage of the domestic comparative advantages, and elaborating mechanisms that ensure that the poor have access to affordable essential services. Better still, efforts to promote competition and regulatory frameworks should deepen, and transparency in sales processes has to be enforced. Policymakers should be borne in mind that what is considered to be a good macroeconomic policy will not systematically alleviate poverty and reduce income inequality.Even if privatization enhances enterprise efficiency as it has been argued in many empirical studies, the bulk of its benefits should channel to shareholders, managers, domestic or foreign investors and those connected to the political elite. The experience has shown that privatization costs are instead borne by many stakeholders including taxpayers, consumers, and workers, thus reducing the overall welfare. Worse, the perceived corruption as well as the lack of transparency in privatization transactions in some countries have reduced the expected gains and increased governance problems. Thus, if privatization is applied without proper regard to a country’s economic and social conditions, it will lead to more severe social conditions.Most of the theoretical and the empirical literature on the impact of divestiture has focused on microeconomic evidence, a small number of studies look at privatization as a broad policy reform that may act as a shock on output levels. But, very few studies have tried to assess the social impact of privatization. Although many studies have reported that the privatization record to date is in general positive, privatization process, chiefly in developing countries, has nonetheless often been perceived as undesirable and often gave rise to social trouble and unrest, primarily because privatization is seen as a redistributive policy that favors the richest. Privatizing utility more specifically is often criticized as it is perceived to favor the richest, the foreign and those more corrupt. This criticism is nourished by the perception that workers and customers pay for this reform by losing their jobs and by facing increased prices. The negative perception of the reform is highest when it involves the sale of infrastructure and strategic firms, considered as social-service providers. It is thus imperative that policy makers work on gaining the confidence of investors and citizens alike.