We Need to Think Beyond Plain-Vanilla Privatization for State-Owned Enterprises

Privatization has traditionally been seen as the simple fix for many inefficient state-owned enterprises, including water utilities.
Privatization has traditionally been seen as the simple fix for many inefficient state-owned enterprises, including water utilities.

By Sunita Kikeri, David Robinett, Susann Roth

Simple privatization was once seen as a catch-all solution to the problems of state-owned enterprises. Today, broader solutions are needed that change the systems in which these companies operate.

State owned enterprises (SOEs) have long had a poor reputation in many countries. These government owned or controlled companies often are unprofitable, poor service providers, and sources of corruption and inefficiency. 

In the past, privatization was seen as the catch-all solution that would improve state-owned enterprise performance, reduce political interference, foster financial discipline, and professionalize operations.

This changed after the global financial crisis of 2008. It saw a shift away from “plain vanilla” privatization to a model that used more complex and sophisticated methods to attract private investors and improve corporate governance. This included greater use of contracting and other kinds of public private partnerships. Objectives and goals of the privatization had to be clearly articulated and backed by political commitment from the top.

A well-defined legal and regulatory framework, along with institutional capacity and good governance of the program, also had to be established. Under this new model, building relationships with key stakeholders and providing deep knowledge work proved critical. A major lesson was that transparency and integrity of the process should not be compromised for speed.

Evidence showed that privatization yields maximum benefits when competition is not hindered, the policy environment is market-friendly, and the process itself is managed in a professional and transparent way that avoids concentration of assets in the hands of a few.

Large and strategic state-owned enterprises often require substantial restructuring, governance improvements, and hard budget constraints to improve performance and attract private partners. For utilities, a key requirement is a sound legal and regulatory framework along with the establishment of an independent regulatory function.

Private operators are often brought in under a management contract or small equity stake to prepare for privatization and coordinate reforms with other parts of the program, especially subsidy and tariff reform. Countries such as Chile, Peru, and the United Kingdom focused on enabling competition while designing regulatory incentives for efficient operation of monopolistic segments. The aim was to preserve a level playing field and establish competitive neutrality principles to prevent broader harm to markets. 

A newer approach of “maximizing finance for development” or MFD (developed by the World Bank in 2018) now aims to leverage all sources of finance, expertise, and solutions to improve efficiency and strengthen service delivery. The focus is on reforming the sector overall, not just the state-owned enterprise.

This often involves changes to sector regulation and structure—like unbundling and establishing independent regulation for electrical utilities, and integrating privatization into wider development policy.  Private investment may be crowded in through grants and concessional funding. The goal is to have a coordinated approach with a spectrum of public and private solutions. This is being done in Ethiopia (agriculture and food system), Jordan (public private partnership policy framework), and Viet Nam (electricity and gas sector).   

To attract private investors in these often-inefficient state-owned enterprises, the business environment must be made more friendly. This includes sound legal and regulatory frameworks and open communications with stakeholders to ensure credibility. The broad policy directions and the rules of the game need to be clear for investors. In addition, the boards must be comprised of qualified and competent directors.

In the past, privatization was seen as the catchall solution that would improve state-owned enterprise performance, reduce political interference, foster financial discipline, and professionalize operations.

Internal controls/compliance/and risk management systems must also be in place to hold the privatized state-owned enterprise accountable for results.

To implement these policies, governments need to be ready. Government agencies are often ill-equipped to deal with private operators and specialized privatization agencies need to be established. Some countries created a privatization ministry (e.g. Czech Republic, Hungary, Mexico, New Zealand). Others created a privatization agency with more independence and clout (e.g. Serbia, Turkey, and Ukraine). Still others with a limited number of large state-owned enterprises created a unit in the Ministry of Finance (e.g. Argentina, India, New Zealand, and the United Kingdom).

A major challenge is to create an environment of trust, transparency, and accountability. Vulnerabilities arise from loopholes in policies and procedures, aided and abetted by weak corporate governance. These shortcomings can be addressed through integrity pacts between contracting authorities and operators bidding for contracts, based on clear guidelines and due diligence procedures, as well as a register of all contracted third parties that captures basic information, and the use of development of e-procurement tools.  

The complexity of the state-owned enterprise privatization agenda requires patience and persistence in engaging with countries, given the long-term nature of the problem. It requires developing trusted relationships built on expertise, and providing more breadth and depth for the policy dialogue on privatization.

A good understanding is needed of both country context and political economy. It requires combining approaches we have used in the past and moving from a silo-ed approach to a more systematic approach, from “quick wins” and a “fast game” to the “infinite game.” And it requires moving from old networks and relationships to relationships built on trusting each other’s expertise and skills.  

We need to move beyond the short-term targets of simple privatization to longer-term targets that change the systems in which state-owned enterprises operate.