Feisal Naqvi

The case for privatization

In Uncategorized on March 29, 2016 at 3:12 am

The one question that gets asked most often in relation to privatisation is this: why can’t government-owned entities compete with private-sector entities? Let me try and answer that question.

Let’s first agree that it is theoretically possible for government-owned entities to do a great job. For example, when Syed Babar Ali ran the National Fertilizer Company in the mid-70s, the company did really well. Similarly, the late Shaukat Mirza did a good job of turning around PSO in the 1990s.

The problem though is that these exceptions only prove the rule. Yes, there are some people who are talented enough to tame behemoths like the NFC and PSO. But even in a world full of smart and capable executives, people of that calibre are rare. To give a different analogy, there are times when your lottery ticket will win. But the reason why lotteries make money is because the odds are heavily against the ordinary ticket buyer. Look at the NFC today. As Syed Babar Ali notes in his memoirs, the company is now practically defunct!

But is that really it? Is that why government companies fail?

While there are any number of possible answers, let me focus on two of them: speed and accountability.

The modern day is not an age that rewards the ‘slow and steady’ approach. Opportunities arise and disappear in nanoseconds. Government organisations, on the other hand, are constrained by rules and procedures to move with great deliberation. It takes a private company weeks to complete a deal. But if Pakistan Railways wants to buy locomotives, that’s a process measured in years, not counting the litigation that inevitably attends every major case of public procurement.

Let me repeat a point I have just made: it is not impossible for government corporations to move with alacrity. But the net effect is the same as asking me to sprint. I can perhaps still finish a 100 yard dash. But if you ask me to run a mile, it’s not going to happen.

Economists make a similar argument on the basis of what they call ‘transaction costs’. In simple terms, every decision takes time and incurs a certain economic cost. The more elements in a decision, the more friction involved. Given the complexity of government organisations and the degree to which they are burdened by rules and regulations, transaction costs tend to be higher for them than in the case of private organisations. Government decision-making is like one of those assembly lines in which any worker can pull a chain and stop production. In the case of Toyota, this approach results in very high quality products. In the case of government institutions, the result is institutional paralysis.

To give a different analogy, government companies tend to be like the operating system on your PC. When you first install it, the system runs wondrously fast. But after a year, that same system has accumulated so much internal gunk that it crawls from operation to operation.

The second factor is what Nassim Nicholas Taleb refers to as “skin in the game”. An employee of a private company knows that if he does a lousy job, he is liable to get fired. An employee of the state can be fired only in theory. In practice, golden handshake schemes notwithstanding, a job with the state is a job for life.

On the other hand, public-sector employees also know that there is no penalty for inaction, but huge penalties for taking even sensible business decisions. My favourite example pertains to Air Marshal (r) Waqar Azeem, the former MD of PIA, whose company received a loan from NBP to set up a business. This was during the first government of Mohtarma Benazir Bhutto. Between the time that the loan was approved and the goods actually arrived in Pakistan, that government was dismissed. NBP promptly asked for more securities. When the company failed to provide those securities, the goods were left to rot at the port and the air marshal’s business went bankrupt. A decade later, NAB came along. Not only was the air marshal thrown in jail but the banker who had originally approved his loan was also thrown in jail. As for the banker who was responsible for the goods going to waste, he was the star witness!

Imagine that you are a banker. Imagine that you know of this case. Can you also imagine how petrified you would be of the possibility of a single loan going sour? Do you think that any bank is capable of making intelligent commercial decisions with these incentives in place? Do you now understand why government-owned banks constantly make a hash of their balance sheets?

Beyond the issue of skewed incentives, the general point to note is that private corporations have to constantly reinvent themselves to keep up with the demands of the marketplace. Take, for example, the case of IBM. At one point, it was the most prestigious manufacturer of personal computers. But as Lou Gerstner, the former CEO of IBM details in his book, ‘Who says Elephants can’t Dance?’, IBM was on the brink of bankruptcy back in 1993. Gerstner took IBM out of the PC business and instead decided to focus on the consultancy side of the business. The result, IBM once again became one of the world’s most respected and admired companies.

Government companies can’t handle reinvention. They are set up at particular moments in time to handle particular demands. Quite often, they are initially successful. But when business realities change, they don’t. And that’s where things go wrong. To continue my previous analogy, getting a government company to move quickly is like asking a fat man to sprint. Neither is going handle sharp turns that well.

The final point to realise is that the international discourse on privatisation has moved on from the ‘sell and be damned’ ethos pioneered by Margaret Thatcher. There is a general realisation that privatisation is not a universal solution, but rather a delicate business which needs to be handled with care and sensitivity.

At the same time, we also need to move away from theoretical arguments and examine financial realities. When Pakistan Steel Mills was being privatised, the opposition argued that it was a national asset, that its sale was collusive, that only executive determination was required to make PSM profitable. Even today, the judiciary thinks of the Steel Mills judgement and gives itself a pat on the back.

The facts, on the other hand, are as follows: back in 2005, the winning bid for the Steel Mills was $362 million. The winning bidder had also committed to invest another $250 million. Since 2005, the federal government has been forced to pump in another $2 billion, losses are running at $20 million per month, the mill has shut down and the company needs $86 million just to get started. Even if the Steel Mills had been sold for one dollar back in 2005, the people of Pakistan would have been richer today by two billion dollars!

Nobody disputes that the government has to ensure the provision of public services. Instead, the question is: at what cost? And how?

This column was published in The News on 21 February 2016

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