26. Misapprehensions

on Privatization(1)

Alan Walters

A decade ago, when the first Thatcher government began privatization, it was widely thought to be ideologically driven and thus, like other elements of the Thatcher reforms, doomed to fail. The privatization program did indeed have its ups and downs, but overall it must be reckoned to be a great success. One modest measure of the achievement is the Labour party's reluctance to propose any substantial renationalization proposals.

Another measure of success is the emulation of other nations. Privatization broadly on the Thatcher model has been enthusiastically and successfully pursued by socialist governments in France and Spain and by labor governments in New Zealand. Even in the Third World, a start has been made in closing down, liquidating or selling off the many state-owned enterprises (SOEs) acquired when socialization of production was so fashionable. Now these enterprises, if that is the right name for them, are a great burden to the taxpayer; they produce many albeit phoney jobs, but few useable goods. Shortages, queues, black markets and corruption are characteristic of these socialized economies, and it is hoped that privatization will deliver them from these hardships.

In the Eastern socialized economies, the same system and the same conditions prevail. Some of these states, now called emerging market economies (EMEs), comprising Poland, Czechoslavakia, Yugoslavia, Hungary, and now the Soviet Union, have become convinced that privatization is the one hope for their salvation as efficient industrialized democracies. The leaders of the EMEs have looked at the great success of the Thatcher privatizations British Airways, British Steel, housing, Jaguar, even British Telecom and the water companies and they have liked what they have seen. Nationalized British Airways and British Steel began the decade of the 1980s among the worst performers, in terms of productivity and profits (i.e., losses), in the OECD countries. In 1990, they are among the best performing corporations in the West. Privatization was clearly thought to be the essential ingredient that worked such miracles upon the large SOEs.

And so it was. But this is a misleading and dangerous simplification. The naive belief of the EMEs, encouraged on occasion by enthusiasts from the West, is that all that SOEs need is a change in ownership from the state to private persons. The motivation of the new owners would then engender those efficient systems of production so characteristic of the West and so lacking in the East.

There was thought to be no point in trying to reform the existing SOEs while they remained in state ownership. They were managed by the nomenklatura management. I doubt that any political leader will seriously attempt the Herculean task of sorting the sheep from the goats among the nomenklatura. Somehow they hoped that privatization would do the sorting for them.

The SOEs were also vastly overmanned by highly unionized labor. A distinguished Hungarian told me that the state would not dare carry out the appropriate demanning. The nomenklatura managers would protest and, if necessary, botch the job by retaining sinecures and disrupting production, blaming "the inhuman policy of restructuring." The Hungarian asserted that the only way to demand efficiency was to privatize and, he assured me, the private companies could then rid themselves of the make-work jobs that had been so prevalent in the enterprise in its nationalized state.

This prognosis is dramatically different from the successful Thatcher reforms and privatizations. The main contrast is that, under Thatcher, the reform of the nationalized corporation was carried through while it was in the public sector. The reductions in work force, the elimination of unprofitable plant and equipment, and the sharp increases in productivity, quality and service were all achieved while the enterprises were owned by the state. Indeed, the government appointed new managers Ian McGregor and John King in those days with a mandate to turn them into profitable and sound undertakings that could hold their own in the competitive private sectors. The managers and workers had the privatization timetable and, more important, diminishing access to the public purse in order to encourage their efforts.

But privatization occurred only after all the hard work of reform had been completed. Privatization simply ensured that the corporation would not slip back into the bad habits of the public sector such as recourse to subsidies, monopoly privileges, and cheap capital.

Somehow the EMEs expect that they can skip this phase of preparation and reform in the public sector. One can sympathize. In Poland, Hungary, Czechoslavakia and the Soviet Union, the distrust of government and the serried ranks of the bureaucracy is universal. How can one expect the institution that got them into this mess to be the agency that will now extract them from it? But, of course, there has been a change of government, and slowly even the bureaucracy is changing its habits, if not its personnel. A government that is committed to a market economy and private enterprise should be able to institute reforms on the Thatcher model. Poland, Hungary, Czechoslavakia and the Soviet Union all have their incipient McGregors and Kings. The government should appoint, motivate and back them in the ruthless reforms so needed in these arthritic economies.

Of course there are objections. One of those strangest and most poignant is that the Thatcher privatizations were too slow and too little. In economies where up to 90 percent of non-agricultural production is in the hands of the state, the stentorian process of Thatcher privatization would be far too slow politically. Marton Tardos, the distinguished leader of the Free Democratic Party in Hungary, worked out that, at the pace of Thatcher's program, Hungary would take 100 years to privatize its economy. They want a market economy now or, at most, in four or five years.

There was, however, nothing inherent in the Thatcher approach that dictated the pace of privatization. It was determined by legal, political and administrative factors. No insuperable technical reason (even including so-called capital market saturation) prevented the program from being speeded up, as indeed occurred after 1984. But I do not think it feasible to carry out the wholesale privatization envisaged in less than ten years.

Another set of objections arises from the fact that there is no capital market in any EME, so there is no way of valuing the worth of SOEs. Prices, moreover, have been distorted for so long that they are very different from both world prices and true domestic costs. Who knows what the expected stream of profits will be from purchasing, for example, the Gdansk shipyard? It was reported that the shipyard workers thought the yard was worth $500 million, while Arthur Andersen has valued it at between zero and $30 million. This illustrates the enormous uncertainties, both economic and political, that bedevil any potential deal.

This, however, is an argument for taking the Thatcher road and for not attempting to privatize until at least many of these political and economic uncertainties are resolved. Then one can write an honest prospectus for each of them. But there is another reason for the EMEs thrust to privatize, which has, in principle, nothing to do with the improvement of efficiency and management. This is to assuage the thirst of the inhabitants for the transfer of the powers of ownership from the state and its bureaucrats to the people. The establishment of property rights is, perhaps, the essential element of a capitalist system. And the major form of property in EMEs is industrial capital, housing and land. What could be more natural than to give shares to this property away to the people?

There are ingenious proposals for vouchers that would enable ordinary citizens to buy shares in holding companies or mutual funds, which would themselves hold shares in the erst-while SOEs. The mutuals would be required to diversify their holdings in order to avoid the risks of particular enterprises. In the classic phrase of Thatcherism, it would amount to returning the assets of industry back to the people.

But what about management under this system? In effect the management would be controlled by the managers of the several mutual funds or holding companies that have a substantial holding in each enterprise. The experience of Britain and the United States suggests that such institutional shareholders tend to be active portfolio holders rather than active and interested managers. There is no working model of a system built on active and interested management. I think it would be a very risky experiment. And the mind does boggle at the prospect of launching vouchers and an active market in mutual fund shares among the whole populace, where such instruments have been quite unknown for nearly 50 years. I doubt very much that the market would be at all transparent, and the opportunities for misrepresentation, market rigging, etc. would be enormous. One fears that capitalism would soon be discredited.

I have no alternative save the Thatcher model with perhaps a souped-up engine. We know that works. That is a lot.

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