Lessons from Argentina's privatization experience.

• Author: Cavallo, Domingo F.
• Position: Privatization: Political and Economic Challenges

Introduction

Privatization is conceived as a drastic change in the role of government. Advocates of privatization maintain that the state administration should desist from production and pricing decisions, and instead focus on the design and implementation of a regulatory process. The government should direct its scarce human capital toward social spending in areas such as education, health, poverty abatement and the creation of a social safety net. Additionally, the government should work, in concert with the private sector, to develop economic infrastructure. This change in the role of government was typically be pursued at the same time that the total level of government expenditure and taxation would decrease. In short, the idea was to reduce market distortions created by the government while reorienting its activities to areas where a case for its involvement based on economic or distributional grounds could be made more sound.

During the period from 1990 to 1996, the Argentine state underwent a broad structural reform, revising regulatory systems and privatizing most public companies, including airlines, telecommunications, utilities, railroads, ports, petrochemical plants, the state oil company and some provincial banks.

Some may argue that Argentina's experience with state-run companies was extreme. Nevertheless, it is still a valuable example of the advantages and shortfalls of privatization. For this reason, we will use it extensively to illustrate why privatization is advantageous. To demonstrate this, we will discuss four main issues: efficiency, capital accumulation, public deficits and corruption. In the following section, we provide a framework for designing privatization programs. The primary objective in the initial step of any privatization exercise is the development of a well-conceived regulatory framework that ensures competitive results. We devote attention to the costs of regulation and the dangers of political impediments and institutional weaknesses. Finally, we conclude that privatization raises social welfare.

Reasons for Privatization

Although there are several justifications for state involvement in the provision of goods and services, there are many instances in which privatization increases economic welfare. One compelling reason for privatization is that it frees budgetary resources. During the 1980s, the losses of Argentine state-owned enterprises and their investments (financed by transfers from the treasury, public debt or tax receipts) amounted to approximately $10 billion per year, which, at that time, was more than 7 percent of gross domestic product (GDP). Privatization can reduce the deficit previously generated by state-owned enterprises, diminishing public debt and the burden of interest payments. The resources that have been freed can then be used to finance effective social programs.

Not only do the resources previously used to finance the continuous deficits of the state's enterprises become available, but the process of privatization itself gives the country the opportunity to attract foreign direct and indirect investment, as well as domestic private investment that can raise capital productivity. Without large investments in infrastructure (roads, railroads, ports and communications), economic growth will be hindered. While the state typically cannot afford such expenditures, private sector and foreign investors can. The privatization of public enterprises makes such investment opportunities possible.

Privatization also eliminates inefficiencies. The frequent inefficiencies of state-run companies has been demonstrated by the necessity of subsidizing companies to ensure their survival in a competitive market, the historically low productivity of public investment, the distorted prices of goods and services, the existence of excess capacity and the insufficient and/or low-quality provision of goods and services.

The inefficiencies characteristic of state-owned enterprises can be grouped into two categories. First, there are allocative inefficiencies stemming from ineffectual investments that result in a low productivity of capital. Second, there are managerial inefficiencies, as evidenced by poor pricing policies, lack of control over the use of resources and problems with quality and access to the services provided.

As demonstrated by several studies over the last four decades, Argentina's public resources were misallocated, and investment was directed toward unproductive activities.(1) Productivity of public investment was much lower than that of the private sector, primarily because public investment decisions did not follow a uniform or coherent evaluation process. In particular, the government did not undertake an evaluation of the social impact of investment that would justify the choice of a given investment program over alternative programs.

This problem was aggravated by the fact that the prices of goods and services versus production decisions were frequently divorced from one another, because the public sector typically ignored the relationship between demand and price. In a market economy, prices charged to users should be based on supply and demand considerations and should serve as an indicator of the health of the market. This basic principle was systematically ignored in the Argentine public sector.

Managerial inefficiency, on the other hand, is typically the result of lax controls over the use of resources. Only a few state-owned companies and public works projects employed such controls, as can be seen by a simple comparison of projected budgets for investment programs and the actual amounts used. An example of such inefficiency is the Yacireta Hydroelectric Dam. After lengthy negotiations, in 1973 the Argentine and Paraguayan governments agreed to a enter into a joint venture to build the dam. It was anticipated that the dam would be producing energy by 1980. Spending began immediately, but the most important decisions were delayed for several reasons. Only in 1983 was the financing secured and the bidding process for the main development and turbines opened, automatically rendering all previous expenses unproductive. The original budgeted cost for the whole project was, in 1982 dollars, between $2.5 and $3.0 billion and the revised estimate for the dam's inauguration was between 1989 and 1991. The dam finally became operational in 1995, and costs are estimated to be close to three times the original budget (all computed in 1996 dollars). The properly apportioned costs of the energy generated today greatly exceeds those of alternative sources.

The electricity sector in Argentina prior to privatization is a good example of public sector inefficiencies. For many years, there was excess capacity in terms of installed power. The prices charged to consumers were completely unrelated to this surplus, and, therefore, did not take into account supply, demand or the cost of production. In spite of the excess capacity, during the...