Privatisation: from the Guru himself
Prashant Bhushan
Joseph Stiglitz, the World Bank's Chief Economist for three years until January 2000 and the winner of the Nobel Prize for Economics in 2001, speaks out with brutal frankness about the Washington Consensus institutions' hypocrisy and the effects that the globalisation programme has had on the developing world.
The deferment of the disinvestment of the oil majors, HPCL and BPCL, by the government has predictably set the alarm bells ringing at the International Monetary Fund (IMF) headquarters and the U.S. Treasury Department. "The reforms in India are in danger of being derailed," is the cry from Washington. Not surprisingly, Standard & Poor's (S&P), the credit rating agency nominated by Washington, has downgraded India's credit rating to `junk status'. The main reason given was the slowdown of India's disinvestment programme. Most of India's financial press, which is predominantly owned by big business, are gleefully using the S&P downgrade to make a lot of noise about reforms having hit a road block. The loaded word `reforms' has been deliberately used by the Washington Consensus institutions (IMF, World Bank and the U.S. Treasury Department) to describe the structural adjustment programme that they have forced on the Third World countries. Anyone who opposes this programme is characterised as obstinate and backward and is believed to have a vested interest in a corrupt government that misuses the assets of the public sector.
Unfortunately for the Washington Consensus institutions and their blue-eyed boys in Third World governments, the Guru himself has spoken out with brutal frankness about the effects that the globalisation programme (particularly privatisation and capital market deregulation) has had on the developing world. Joseph Stiglitz was the World Bank's Chief Economist for three years until January 2000. Prior to that he was the Chairman of President Clinton's Council of Economic Advisers. Few can speak more authoritatively or with greater inside knowledge about the functioning of the Washington Consensus institutions. Stiglitz received the 2001 Nobel Prize for Economics and any doubts about his intellectual eminence must be laid to rest. In his recently published book Globalisation and Its Discontents1, Stiglitz has commented extensively about how and in whose interests structural adjustment policies were evolved and the effects that they have had on the economies of the Third World. He says: "Despite repeated promises of poverty reduction made over the last decade of the 20th century, the actual number of people living in poverty has actually increased by almost hundred million. This occurred at the same time that total world income actually increased by an average of 2.5 per cent annually."2
Joseph Stiglitz, professor of economics, business and international affairs at Columbia University, was one of three Americans awarded the 2001 Nobel Prize for Economics for their analyses of how markets function when some people know more than others.
Stiglitz gives some of the reasons why this has happened. "But even when not guilty of hypocrisy, the West has driven the globalisation agenda, ensuring that it garners a disproportionate share of the benefits, at the expense of the developing world. It was not just that the advanced industrial countries declined to open up their markets to the goods of the developing countries — for instance keeping their quotas on a multitude of goods from textiles to sugar — while insisting that those countries open up their markets to the goods of the wealthier countries; it was not just that the more advanced countries continued to subsidise agriculture, making it difficult for the developing countries to compete, while insisting that the developing countries eliminate their subsidies on industrial goods. Looking at the `terms of trade' — the prices which developed and less developed countries get for the products they produce — after the last trade agreement of 1995, the net effect was to lower the prices some of the poorest countries in the world received relative to what they paid for their imports. The result was that some of the poorest countries in the world were actually made worse off."3
In his analysis of how the structural adjustment or the globalisation programme has damaged the economies of the developing world and Russia, Stiglitz lays much of the blame on the IMF's insistence on rapid privatisation and capital market deregulation. The focus here is on what he says about privatisation, because of its immediate relevance. The main arguments being used in favour of disinvestment are: 1. Most of the public sector companies are loss-making and are a burden on public funds; 2. Since the government is corrupt, the public sector companies are also corruptly managed; 3. In the hands of the private sector, the public sector companies would be run more efficiently.
The major premise of the first argument is factually incorrect since many public sector undertakings (PSUs) are not loss-making. However, even if it were assumed to be so, this argument has no relevance for most of the PSUs which have been privatised or are on the selling block. Many of these PSUs are highly profitable companies. The oil majors, HPCL and BPCL, which have already repaid the government's investment on them several times over. Nalco, which the government is looking to sell, is one of the lowest cost aluminium producers in the world and earns gross profits equivalent to 50 per cent of its revenue. Moreover, most of the PSUs that have been sold or are being sold now, such as VSNL, IPCL, HPCL, BPCL and even Nalco are in sectors where disinvestment is likely to lead to the creation of private monopolies or oligopolies.
Here is what Stiglitz has to say about the dangers of creating private monopolies. "However, there are some important preconditions that have to be satisfied before privatisation can contribute to an economy's growth. And the way privatisation is accomplished makes a great deal of difference4... the IMF argues that it is far more important to privatise quickly; one can deal with the issues of competition and regulation later. But the danger here is that once a vested interest has been created, it has an incentive, and the money, to maintain its monopoly position, squelching regulation and competition, and distorting the political process along the way5 ... privatising the monopoly before an effective competition or regulatory authority was in place might simply replace a government monopoly with a private monopoly, even more ruthless in exploiting the consumer."6
Lambasting the IMF for almost deliberately encouraging private monopolies, Stiglitz says: "The IMF chose to emphasise privatisation, giving short shrift to competition. The choice was perhaps not surprising: corporate and financial interests often oppose competition policies, for these policies restrict their ability to make profits. The consequences of IMF's mistakes here were far more serious than just high prices: privatised firms sought to establish monopolies and cartels, to enhance their profits, undisciplined by effective anti-trust policies. And as so often happens, the profits of monopoly proved especially alluring to those who are willing to resort to mafia like techniques either to obtain market dominance or to enforce collusion7... Yet U.S. and IMF officials paid little attention to the dangers posed by the concentration of media power; rather, they focused on the rapidity of privatisation, a sign that the privatisation process was proceeding apace. And they took comfort, indeed even pride, in the fact that the concentrated private media was being used, and used effectively, to keep their friends Boris Yeltsin and the so-called reformers in power."8
IN India, the sectors in which some PSUs have been privatised, such as telecom (VSNL) or petrochemicals (IPCL), and some in which PSUs are on the block, such as oil (HPCL and BPCL) and aluminium (Nalco) are inherently prone to monopolistic or oligopolistic competition. For example, in the aluminium sector, Nalco and Hindalco each have a market share of 40 per cent. If Nalco is sold to Hindalco, which sale is very much on the cards, Hindalco will have a virtual monopoly in the aluminium market similar to the one that Reliance has acquired in the petrochemical sector after IPCL was sold to it. Saying that this does not matter since there is no restriction on the entry of new companies in the field is not a valid answer because of the economies of scale that exist in the sector.
With the economies of scale that will accrue to a Nalco-Hindalco conglomerate and with the initial advantages that Nalco and Hindalco already possess (large and cheap captive bauxite mines and power plants), it would be virtually impossible for anyone else to compete effectively with the combined power of Nalco and Hindalco. The creation of private monopolies and oligopolies (usually in the form of cartels) is being actively abetted by the manner of disinvestment. At the same time, existing though decrepit, mechanisms that regulate monopolistic practices, such as the Monopolies and Restrictive Trade Practices (MRTP) Act and MRTP Commission, are being dismantled.
It has been argued in India that privatisation is necessary to reduce the malevolent influence of a corrupt state. This, Stiglitz says, is a very simplistic view of the state. "Privatisation was supposed to eliminate the role of the state in the economy; but those who assumed that had a far too naive view of the role of the state in the modern economy. It exercises its influence in the myriad of ways at the myriad of levels."9 Regulatory authorities such as the Telecom Regulatory Authority of India (TRAI), the Electricity Regulatory Commissions, the MRTP Commission and the Securities and Exchange Board of India (SEBI) are supposed to be necessary even in a privatised economy to protect consumer interests from monopolistic competition, cartels and corrupt private players. If the government is incorrigibly corrupt, why would these public institutions be less so? We have seen how SEBI has repeatedly allowed the stock markets to be ruthlessly manipulated by a dishonest cartel of brokers. Few can claim that monopolistic or restrictive trade practices do not exist in India. There are very few cases where the MRTP Commission has acted to protect consumer interest. In fact, the introduction of private firms in a sector often increases the incentives of private players to bribe regulatory authorities. In a corruption ridden society, that is the easiest way for private players to make a quick buck.
Moreover if the government is corrupt, there is every reason to suppose that disinvestment will also proceed corruptly in a corrupt manner. A honest Disinvestment Minister is certainly no guarantee against dishonesty in the prevailing atmosphere. How can anyone justify the transfer of IPCL and VSNL to private companies for an amount less than even its free reserves (cash in the bank)?
It is important to note what Stiglitz has to say on this issue. "Perhaps the most serious concern with privatisation, as it has often been practised, is corruption. The rhetoric of market fundamentalism asserts that privatisation will reduce what economists call the `rent seeking' activity of government officials who either skim off the profits of government enterprises or award contracts and jobs to their friends. But in contrast to what it was supposed to do, privatisation has made matters so much worse that in many countries today privatisation is jokingly referred to as `briberisation'. If a government is corrupt, there is little evidence that privatisation will solve the problem. After all, the same corrupt government that mismanaged the firm will also handle the privatisation process. In country after country, government officials have realised that privatisation means that they no longer needed to be limited to annual profit skimming. By selling a government enterprise at below market price, they could get a significant chunk of the asset value for themselves rather than leaving it for subsequent office holders. In effect, they could steal today much of what would have been skimmed off by future politicians. Not surprisingly, the rigged privatisation process was designed to maximise the amount that government Ministers could appropriate for themselves, not the amount that would accrue to the government's treasury, let alone the overall efficiency of the economy. As we will see, Russia provides a devastating case study of the harm of privatisation at all costs."10
Companies such as HPCL, BPCL, IPCL, VSNL and Nalco, which have sizeable assets, are enormously profitable and offer opportunities to private companies to acquire monopoly positions. These firms are star performers of the public sector and are being greedily eyed by the private sector. Nalco, which is now on the selling block, has 40 per cent share of the market. It has a gross profit margin of 50 per cent. This amounts to annual gross profits in excess of one thousand crores and these profits are going up every year. Nalco has large bauxite reserves (with enough mineral supply for more than a hundred years) and also owns captive power plants of 960 MW. Nalco is probably the lowest cost producer of aluminium in the world. The operating cost of its alumina refinery is $100 PMT (per metric tonne) as against a global average of $140 PMT. It has been reported that Merrill Lynch, which has been appointed by the government, has valued Nalco at Rs.9,600 crores. By the strategic sale model the government may transfer 26 per cent share and management control to a private company at anything over Rs.2,500 crores, which at current rates would be Nalco's projected gross profit for just two years. The replacement value of even the captive power plants is over Rs.4,000 crores. Why then should the government proceed with the sale of Nalco to private firms? It may be argued that under private sector control, Nalco is likely to function more efficiently. This would allow the government to make even greater profits on its remaining stake in Nalco than it currently earns. However, private companies are even more notorious for siphoning funds off companies and cheating shareholders than the public sector. Most of the non-performing assets (NPAs) of public financial institutions arise due to defaults on loan repayments by the private sector. Large companies are usually the culprits and often their owners have become richer, even as their companies have failed to repay loans.
Not surprisingly, Stiglitz's conclusions on the impact of privatisation are far from sanguine. "In the World Bank review of the ten year history of transition economies, it became apparent that privatisation, in the absence of the institutional infrastructure (like corporate governance), had no positive effect on growth. The Washington Consensus had again gotten it wrong11... Not only did privatisation, as it was imposed on Russia (as well as in far too many of its former Soviet bloc dependencies), not contribute to the economic success of the country; it undermined confidence in government, in democracy, and in reform."12
Stiglitz also dwells at length on the hypocrisy of the Washington Consensus institutions. "Russia had a crash course in market economics, and we were the teachers. And what a peculiar course it was. On the one hand, they were given large doses of free market, textbook economics. On the other hand, what they saw in practice from their teachers departed markedly from this ideal. They were told that trade liberalisation was necessary for a successful market economy, yet when they tried to export aluminium and uranium (and other commodities as well) to the United States, they found the door shut. Evidently, America had succeeded without trade liberalisation; or, as it is sometimes put, `trade is good but imports are bad'. They were told that competition is vital (though not much emphasis was put on this), yet the U.S. government was at the centre of creating the global cartels in aluminium, and gave the monopoly rights to import enriched uranium to the U.S. monopoly producer. They were told to privatise rapidly and honestly, yet the one attempt at privatisation by the United States took years and years, and in the end its integrity was questioned. The United States lectured everyone, especially in the aftermath of the East Asia crisis, about crony capitalism and its dangers. Yet the issues of the use of influence appeared front and centre not only in the instances described in this chapter but in the bailout of long term capital management described in the last."13
What Stiglitz says cannot be dismissed by the votaries of globalisation as Leftist new-age fluff or the rantings of a disgruntled insider. His credentials are far too impressive for that. Anyone reading his book will understand that he is a conservative Keynesian economist. He has seen the working of the Washington Consensus institutions from the inside as closely as anyone ever has. He merely has the sensitivity to see what the structural adjustment policies and the market fundamentalism on which they are based have done to the economies of countries which were forced to adopt them, particularly those in the Third World and Russia. Stiglitz has the honesty and courage to state the truth as he sees it. One wishes that people like Arun Shourie would read and heed Stiglitz rather than mindlessly pursue the fundamentalist agenda set by Washington. They should devote more of their time, intelligence and energy to reforming our regulatory and judicial institutions. They should concentrate on providing laws that guarantee transparency and accountability in the functioning of government institutions.
It is clear that without these reforms first, privatisation would lead India, like it led Russia and many other countries, to disaster.
1. Globalisation and Its Discontents by Joseph Stiglitz, published by Allen Lane/Penguin 2002.