It should be noted that privatization is fundamentally a political processas well as a commercial and economic process. Privatization changes thedistribution of power within a society, as it diminishes control of the economy by the state and government- appointed managers. Workers often feel threatened by the potential changes inherent in privatization, although employeesfrequently benefit from the process. As a result, public support is a majorconsideration in any privatization program and many of the choices made indesigning and implementing transactions reflect the need for such support. Two consequences flow from this factor. 1) choices of approaches are sometimesaltered due to "political" considerations, meaning that equity must be promoted in the privatization strategy, and 2) program implementation must be objectiveand fair to avoid adverse publicity.

What are the goals of privatization?

Many, varied goals are often pursued through privatization programs. These goals often fall along two principal dimensions: 1) broad social ormacroeconomic goals, and 2) enterprise specific or macroeconomic goals.

Macroeconomic goals are numerous. Fundamentally, privatization is advocatedas a means to reduce the governments role in the economy, partly as aphilosophical matter (as in the UK) but principally because governments have performed badly in that role. Many countries can attribute substantial portionsof their external debt to liabilities of state-owned enterprises and significantportions of government budgets are devoted to paying subsidies or otherwiseassisting loss-making State-owned enterprises. Government's objectives in thesesituations is often simply to extricate themselves from these financialcommitments, and focus scarce resources instead on education, infrastructure,and social welfare.

A second macroeconomic goal of privatization is to promote the developmentof the private sector by "levelling the playing field" and ending subsidizedcompetition from state-owned enterprises. There is a danger in some countriesthat emerging private businesses face unfair competition from state enterprises that have access to credit and other inputs at below market rates and betteraccess to government distribution channels. In order to give the private sectora fair opportunity to compete and thrive, state-owned enterprises areprivatized.

A third goal of privatization,is to obtain the sales proceeds and use themto finance shortfalls in the government's budget or retire some of the publicsector debt. While it is widely recognized that focusing on sales proceeds may be short-sighted and ignore other important outcomes of privatization, it is afact that many governments are strongly influenced by the availability of funds from privatization.

A fourth goal is to broaden share ownership so that the public hasmechanisms for saving money and participating in the economies of theircountries.

The macroeconomic goals of privatization focus mostly on the potentialimprovements that private sector operators will bring to an enterprise toimprove this performance and increase chances of survival. These goalsrecognize the need to improve enterprise efficiency by introducing newtechnology and financing sources, improving the quality of the product,enhancing marketing-especially in the international market, providinginformation systems, and generally improving the management of the enterprise.Obviously successful changes of this nature, when applied to a number ofindividual enterprises, will have significant macroeconomic implications aswell.

A final comment on the goals of privatization is to note that in mostcountries privatization is but one part of a broad program of structural reform.This is most evident in former Communist countries, where privatization is anelement of the process of developing a market economy and its associatedfinancial institutions. In such cases, the privatization program designed should take into account the broader economic goals that are being pursued, aswell as the goals specific to the enterprise.

What types of privatization techniques can be used?

There are a variety of techniques that can be selected to use in privatizingstate-owned enterprises of activities. These techniques include the following: Small business auctions--A normal procedure for privatizing small businessesis to auction them to the highest bidder. Especially when dealing with trulysmall businesses, such as sole proprietorships and small partnerships, it isadvantageous to sell to a single bidder. Given the size of the enterprises,elaborate bid evaluations and valuations are not appropriate and will only serveto delay the process. Auctions also create a dramatic setting to promote thevisibility of privatization and allow for broad participation, and they aretruly transparent, in the sense that all participants can see for themselves howthe process was conducted and identify the high bidder.

Auctions are generally not appropriate for larger enterprises because thebids will not be as readily comparable: the quality of the new ownership groupbecomes important--what technology will it bring, is it well-financed, whatinvestments will it commit to making, where will it market the product, will it close the business to limit competition, etc?

Strategic investors--Larger enterprises are often sold on a case- by-casebasis, by soliciting technically and financially capable investors to acquirethe enterprise. In soliciting the investors, the seller normally conducts athorough review of the business and prepares material describing the businessand it's equipment, workforce, financial condition, markets, and prospects.This information is circulated to a group of candidate investors that expressinitial interest in the business. These investors then submit bids outliningthe terms under which they would purchase shares of the enterprise. The offers will discuss the percentage of shares to be purchased, what debts will beassumed, future investment plans and the financing associated with theexpansion, any anticipated changes to the underlying business or the workforce, actions required by the government (sometimes requesting measures such as tariffprotection), and other significant factors. Because bids received in thisfashion are not readily comparable, the seller must prepare a valuation of theenterprise and the bids received, analyze the strengths and weaknesses of thebidding groups, and then engage in a significant amount of negotiation with the highest ranked bidder. This process is often lengthy, as there are significant but difficult issues at stake.

Trade sales have significant disadvantages in that they can take a longperiod of time and substantial expense to conduct. Because of the substantialamount of negotiation often involved, they also have the aura of "back roomdeals" being conducted and are susceptible to complaints from bidders that thedecision process was unfair-- particularly when the bids are structured verydifferently.

Initial Public Offerings (IPOs)--Initial Public Offerings are the sale ofshares directly to the public. Most of the privatizations conducted in theUnited Kingdom during the 1980's were done through 1POs. Because the potential buying public includes a large number of unsophisticated investors, relativelymore information and higher quality information needs to be prepared to conduct an IPO. A valuation of the enterprise is prepared and a pricing strategy isdeveloped that reflects the valuation, but seeks to ensure that the offer issufficiently attractive that the shares available can be sold. IPOs have thevirtue of stimulating interest among the general public in financial markets andincreasing share ownership in society. 'Mey are also less subject to negotiatedagreements than trade sales, although the negotiations between the sellinggovernment and it's agent, the underwriter, may be elaborate.

The disadvantages of IPOs are that they do not bring new capital to theenterprise and do not bring in new managerial talent or resources. As a result, IPOs should only be used if the performance of existing management issatisfactory. In addition, IPOs are very timeconsuming and expensive toconduct, and they generally require the existence of a formal stock exchange andbroker network or other distribution mechanism to be implemented effectively.

Joint Ventures--A common form of privatization in some parts of theworld--especially China--is the joint venture. Under a typical joint venture,an investor approaches the government and offers to contribute something ofvalue to an enterprise, such as capital, management, or technology, and inreturn receives a share of the ownership of the newly constituted business.Joint ventures are often attractive to governments that are not fully supportiveof privatization because the government does not relinquish all control of theenterprise. Over time, and with new investments, it may be possible to minimizegovernment control by diluting it's ownership interest.

There are several significant disadvantages to joint ventures as a form ofprivatization. Because of the government's continued involvement, many of thegoals of privatization set forth at the outset of my testimony are not met: the government remains involved in management and it's liability for poorperformance is retained. In addition, joint ventures are subject to the samecomplaints about lack of transparency and participation as tradesales--sometimes even more so due to the fact that joint ventures are often proposed by the investor on an exclusive basis and are less subject tostandardization than trade sales.

Mass Privatization Programs--One of the significant innovations inprivatization techniques during the last few years is the development of massprivatization programs. In concept, mass privatization programs avoid the time and expense of case-by-case transactions and involve the general public bydistributing shares for free or in exchange for specially created privatization vouchers. The mechanics of mass privatization programs are similar to IPOs,except that vouchers are used to purchase shares, rather than cash. As aresult, significantly less analytical time is required and disclosurerequirements are greatly reduced. The virtues of a speedy process, which Idiscuss in the next section, cannot he overestimated, particularly in thetransitional economies of the former Communist world.

The disadvantages of the mass privatization programs lie principally in the diffusion of owner-ship across broad groups and in the critical role thatmanagement is able to play in the privatization process. It is argued thatsubsequent restructuring of enterprises will be more difficult due to thesefactors. Offsetting this argument to some degree is the fact that potentialinvestors in these enterprises can negotiate with the new owners--rather thanthe government--and can make investments into the enterprise in return for shares, rather than have their funds go into the state treasury. Both of these factors are valued by investors.

Build-Own-Operate/Build-Own-Transfer Programs--Governments facing severeneeds for infrastructure investments increasingly turn to the private sector to finance, build, and operate the needed facilities. In return, the governmentgives certain assurances to the investor and pays fees for the servicesprovided. This technique has proved useful in attracting additional capitalinto infrastructure investments and alleviating Critical shortages of power and transportation, especially in Asia.

The disadvantages of these programs are that they are often very difficultand timeconsuming to negotiate and structure. Because these programs arerelatively new and involve financing of new projects--not assets that arealready existing--many difficult issues emerge that have not previously beenconfronted.

Liquidation--State-owned enterprises with very limited prospects forsurvival are sometimes liquidated and their assets auctioned to the privatesector. Sometimes these "liquidated" enterprises continue as going concerns; inother cases their assets are sold separately. liquidation ends the government'scommitment to support an enterprise and lays the groundwork for private sector investment--if the product has a market and it can be manufactured efficiently. Liquidation is normally a last resort, used when the government has norealistic alternatives. In this sense, it is applicable only in a limited setof circumstances.

In practice, many transactions do not fit neatly into these definedcategories. As an example of transactions that are structured along morecomplicated lines, consider the pattern of telecommunications transactions that has emerged over the last five years. In most of these transactions thegovernment initially sells a minority of shares to a qualified internationaloperator through negotiated trades sales. The evaluation criteria for this bid depend on the purchase price and on the commitment of the operator to expandservice coverage and quality significantly. Following one or more years ofperformance and improvements by the operator, the balance of the government'sshares are sold through several rounds of public offerings, involving bothdomestic and international shareholders.

What is the process of privatization?

Regardless of the privatization technique that is selected, the process ofprivatization is relatively standardized. Governments generally follow several steps in privatizing enterprises. First, the target companies arereviewed to under-stand, in a very general way, their characteristics, markets, and prospects. Second, a privatization plan is prepared to guide theimplementation. This plan should match the goals of the government and thecharacteristics of the enterprise(s) to determine the approach that will betaken. Third, the company is marketed, whether to core investors or the public,depending on the path chosen. Fourth, if necessary, the terms of thetransaction are negotiated and the legal documentation prepared. Finally, thetransaction is closed.

Throughout this process, several factors are critically important to thesuccess of the privatization program. First, speed is absolutely essential.During the period that governments are deciding to privatize, until the pointthat new owners are recognized, the enterprise is essentially under control ofit's management. Few true ownership interests are represented and the interestsof capital-- whether of maintaining existing capital or investing newcapital--are ignored. Great potential exists for asset-stripping or othermisappropriation of assets. In our experience, enterprises lose a substantialpart of their value during this period. Speed in the privatization process iscritical to ensure that any ownership vacuum is minimized.

Second, the transparency of the privatization process must be preserved and publicized. Any questionable ethical conduct has the potential to destroy theintegrity of the process and erode political support.

Finally, the privatization program must be implemented professionally. Ifit is not, the enterprises, investors, and the public could be discouraged from participating--with disastrous consequences.

What developments in privatization are taking place around the world?

james waddell