MacroScan (Printable Version) - Privatisation and Poverty Reduction : What are the Links ?

1. If poverty reduction is an explicit over-riding concern, any programme, project or policy must be evaluated for its effects on this, which means assessment of its impact on poorer populations in terms of :

productive employment opportunities
access to and price of basic food requirements
access to basic housing/shelter requirements
access to and price of basic infrastructure services, including power, water, sanitation
access to and price of health services
access to and price of education services
access to and voice in the institutions of governance and administration

Focussing on all these indicators in turn implies that poverty is viewed as a multi-dimensional phenomenon, rather than simply in terms of nutritional deprivation, and the effects of material poverty on social exclusion are also recognised.

2. Privatisation of public sector enterprises is not and should never be an end in itself; rather it can be viewed as a means to particular ends. Some of the most common aims of privatisation programmes include the following :

in the case of loss-making enterprises, reducing the fiscal drain on the state, so as to release resources for more important expenditures in physical and social infrastructure, which would directly impact on poverty
in the case of profit-making enterprises, providing immediate relief to the fiscal situation by using the sale proceeds to retire some public debt and thereby reduce the interest burden of the government
reducing monopoly behaviour of large state enterprises
improving management and introducing sound business principles into the organisation of economic activities, on the grounds that private owners impart more "efficiency" into the system
providing positive signals to private investors for fresh investment into the economy.

Obviously, only the first (and to some extent the second) has a direct bearing in terms of a potential positive impact on poverty reduction. But the extent to which resources released by privatisation are actually employed in more socially necessary investment varies, and the fungibility of fiscal resources means that this can never really be clearly predetermined.

However, it is also often argued that the other aims listed above can have indirect impact on poverty by improving the conditions for better growth performance, which may in turn help to alleviate poverty. This issue remains undecided for several reasons.

It is not clearly established either theoretically or empirically that privatisation inevitably helps to improve growth performance, which depends upon a lot of other conditions being simultaneously fulfilled. Indeed, it is possible for high growth to occur with state ownership as well, depending upon other conditions.
Even if growth occurs, if it is sufficiently unequal in its pattern, then it may not lead to any improvement in the conditions of the poor. This is clearly the case in certain types of "jobless growth" with low linkage effects within the local economy, which have been noticed in India recently.
The greater "efficiency" of private sector functioning is not definitively established as this depends upon the particular private agents involved and there are many cases of inefficient private activity also. Indeed, since the basic motivation of private functioning is commercial profitability, it may on occasion be less efficient from a social point of view, especially when social and private rates of return vary and there are significant externalities.

These caveats need to be borne in mind when considering the effects of privatisation.

3. Effects of privatisation on fiscal positions.

As mentioned above, a dominant reason for privatisation is that of improving fiscal balances, by reducing fiscal drain in the case of loss-making units and by improving debt positions in the case of profit-making units. The effects of the privatisation of loss-making units are usually typically positive, unless the assets are sold at below their true value. This means that the manner of the sale and the prior valuation in terms of all possible alternative uses of the existing assets (including land) become very important.

In the case of profit-making units, the fiscal effect is almost invariably negative. This is because of the simple economics of such sales. The issue is essentially as follows: If the government chooses to sell off an asset, say for example to retire the public debt, it must bear in mind the foregone income from this asset. If this asset provides an income flow (profits etc.) that is equal to or more than the prevailing interest rate on government securities, then the government would lose future income by selling it.

On the other hand, from the private buyer’s point of view, it makes no sense to purchase an asset unless it provides at least a rate of return equal to the rate of interest on government securities, because that is where the private investor could otherwise put the money. This means that for such sales to occur, either (a) the private investor must believe that it is capable of generating more profits than the public sector - but that is essentially a management issue and there is no logical reason why the public sector cannot also employ managers to achieve this; or (b) the asset must be undervalued so that the actual rate of return for the private buyer turns out to be higher, which really means that the state exchequer has lost the money.

4. Effects of privatisation on productive employment opportunities.

The immediate effect of most privatisation instances is loss of employment. This is not only because there tends to be substantial overstaffing in public enterprises, but also because new owners typically prefer to begin with less then ideal levels of employment to allow for greater flexibility in both the number of workers and the contracts under which they are employed. In addition, when the units concerned are closed down or substantially cut in terms of operation, there are the linkage and multiplier effects of such reduction to be considered: employment conditions can be adversely affected in upstream and downstream units (linked, for example, by subcontracting) as well as in the local community through the indirect demand effects of workers’ incomes.

However, this need not necessarily imply increasing poverty. Much will depend upon the nature of the retrenchment agreement and the benefits offered to workers as well as the possibilities for re-employment which depend in turn on the overall growth conditions in the economy of the area. In addition, the sheer number of workers facing job loss is important. If the medium term impact of some initial closure and/or privatisation is higher growth in the economy, then obviously that could have positive effects on employment and poverty.

5. Effects of privatisation on access to and price of basic food requirements.

This is critically determined by the degree to which there is a functioning Public Distribution System in the region/area, which ensures stable and relatively cheap basic food to all. The experience with targeting (in the form of TPDS) has not been positive, since it has denied many people at or below the poverty line access to sufficient food. As such, privatisation has no direct bearing on this except insofar as it is directed towards the privatisation of such public activities as are currently engaged in by the Food Corporation of India and state-level departments which manage the system of Fair Price Shops. If privatisation does involve such agencies, then the price at which food is sold subsequently would clearly be critical. This may then imply the need for some sort of regulation.

Similar points may be made with respect to other areas of social expenditure such as health and education, where private ownership may involve the effective exclusion of the poor because of inability to pay.

6. Effects of privatisation on basic infrastructure services, including power, water, sanitation.

This is significant because a lot of recent privatisation is actually directed towards public utilities, which cater to these specific needs. Here the benefits of privatisation (enumerated above) must be counterbalanced against the potential costs, specifically in terms of reduced access and higher prices for consumers. Recent experience, both in India (Orissa) and elsewhere (e.g. California, South Africa, Latin America), has indicated that in the case of natural monopolies such as power and water distribution, the assumption of contestable markets is not enough to prevent private companies from indulging in monopolistic or otherwise undesirable behaviour of various sorts. It has also been found that regulatory mechanisms may be inadequate to prevent practices which effectively prevent the poor and disadavantaged from access to the use of such services – such as high prices, discontinuing services because of non-payment, etc. Since there are large positive externalities in such service provision (and indeed many would argue that access to water and power are among the basic socio-economic rights of all citizens, including the poor) there is a case for ensuring that such services remain available to all. One alternative, with private ownership, is a combination of tighter regulation and direct financial subsidies to private agents to ensure that the poor continue to have access. However, this may not be successful, and may turn out to be more expensive (in terms of public resources) than direct public ownership. Therefore, in the case of utilities, it is usually worth exploring various options of reform and restructuring which improve the functioning of such companies and reduce their losses, while retaining public ownership and/or control in order to fulfil broader social objectives.

7. Effects of privatisation on social and political exclusion of the poor.

The essential fact about privatisation is that, once it shifts control to the private sector, commercial viability and profitability become the dominant considerations. This can be of importance because it implies that the poor, as those possessing weaker consumer power, are effectively denied voice in determining outcomes. While standard institutions of governance typically do face problems of inadequate representation and voice for the poor, the fact remains that in broadly democratic conditions (such as exist in India, at least electorally) there is at least the potential for ensuring greater accountability from units operating in the public sector. For this potential to be realised, it may be necessary to devolve greater power over functioning to decentralised elected institutions such as panchayats (which also have the advantage of one-third statutory representation for women). But with private ownership, ensuring voice for the various stakeholders is much more difficult.

8. All this suggests that the effects of privatisation on poverty reduction are crucially dependent upon.

the areas/sectors in which the privatisation is occurring – the issue tends to be much more complicated for utilities and other economic activities with high externalities, compared to the manufacturing sector
the choice of and the nature of the new private owners and their ability to keep the units functioning on a viable and socially desired basis, and whether the extant regulation is adequate to ensure this
whether it is done for profitable or loss-making units and the associated impact on the state exchequer in the medium term
whether resources released from such state involvement are actually utilised in socially desirable activities which affect the condition of the poor positively.



Themes > Economic Briefs	03.08.2002


Privatisation and Poverty Reduction : What are the Links ?



1. If poverty reduction is an explicit over-riding concern, any programme, project or policy must be evaluated for its effects on this, which means assessment of its impact on poorer populations in terms of : productive employment opportunities access to and price of basic food requirements access to basic housing/shelter requirements access to and price of basic infrastructure services, including power, water, sanitation access to and price of health services access to and price of education services access to and voice in the institutions of governance and administration Focussing on all these indicators in turn implies that poverty is viewed as a multi-dimensional phenomenon, rather than simply in terms of nutritional deprivation, and the effects of material poverty on social exclusion are also recognised. 2. Privatisation of public sector enterprises is not and should never be an end in itself; rather it can be viewed as a means to particular ends. Some of the most common aims of privatisation programmes include the following : in the case of loss-making enterprises, reducing the fiscal drain on the state, so as to release resources for more important expenditures in physical and social infrastructure, which would directly impact on poverty in the case of profit-making enterprises, providing immediate relief to the fiscal situation by using the sale proceeds to retire some public debt and thereby reduce the interest burden of the government reducing monopoly behaviour of large state enterprises improving management and introducing sound business principles into the organisation of economic activities, on the grounds that private owners impart more "efficiency" into the system providing positive signals to private investors for fresh investment into the economy. Obviously, only the first (and to some extent the second) has a direct bearing in terms of a potential positive impact on poverty reduction. But the extent to which resources released by privatisation are actually employed in more socially necessary investment varies, and the fungibility of fiscal resources means that this can never really be clearly predetermined. However, it is also often argued that the other aims listed above can have indirect impact on poverty by improving the conditions for better growth performance, which may in turn help to alleviate poverty. This issue remains undecided for several reasons. It is not clearly established either theoretically or empirically that privatisation inevitably helps to improve growth performance, which depends upon a lot of other conditions being simultaneously fulfilled. Indeed, it is possible for high growth to occur with state ownership as well, depending upon other conditions. Even if growth occurs, if it is sufficiently unequal in its pattern, then it may not lead to any improvement in the conditions of the poor. This is clearly the case in certain types of "jobless growth" with low linkage effects within the local economy, which have been noticed in India recently. The greater "efficiency" of private sector functioning is not definitively established as this depends upon the particular private agents involved and there are many cases of inefficient private activity also. Indeed, since the basic motivation of private functioning is commercial profitability, it may on occasion be less efficient from a social point of view, especially when social and private rates of return vary and there are significant externalities. These caveats need to be borne in mind when considering the effects of privatisation. 3. Effects of privatisation on fiscal positions. As mentioned above, a dominant reason for privatisation is that of improving fiscal balances, by reducing fiscal drain in the case of loss-making units and by improving debt positions in the case of profit-making units. The effects of the privatisation of loss-making units are usually typically positive, unless the assets are sold at below their true value. This means that the manner of the sale and the prior valuation in terms of all possible alternative uses of the existing assets (including land) become very important. In the case of profit-making units, the fiscal effect is almost invariably negative. This is because of the simple economics of such sales. The issue is essentially as follows: If the government chooses to sell off an asset, say for example to retire the public debt, it must bear in mind the foregone income from this asset. If this asset provides an income flow (profits etc.) that is equal to or more than the prevailing interest rate on government securities, then the government would lose future income by selling it. On the other hand, from the private buyer’s point of view, it makes no sense to purchase an asset unless it provides at least a rate of return equal to the rate of interest on government securities, because that is where the private investor could otherwise put the money. This means that for such sales to occur, either (a) the private investor must believe that it is capable of generating more profits than the public sector - but that is essentially a management issue and there is no logical reason why the public sector cannot also employ managers to achieve this; or (b) the asset must be undervalued so that the actual rate of return for the private buyer turns out to be higher, which really means that the state exchequer has lost the money. 4. Effects of privatisation on productive employment opportunities. The immediate effect of most privatisation instances is loss of employment. This is not only because there tends to be substantial overstaffing in public enterprises, but also because new owners typically prefer to begin with less then ideal levels of employment to allow for greater flexibility in both the number of workers and the contracts under which they are employed. In addition, when the units concerned are closed down or substantially cut in terms of operation, there are the linkage and multiplier effects of such reduction to be considered: employment conditions can be adversely affected in upstream and downstream units (linked, for example, by subcontracting) as well as in the local community through the indirect demand effects of workers’ incomes. However, this need not necessarily imply increasing poverty. Much will depend upon the nature of the retrenchment agreement and the benefits offered to workers as well as the possibilities for re-employment which depend in turn on the overall growth conditions in the economy of the area. In addition, the sheer number of workers facing job loss is important. If the medium term impact of some initial closure and/or privatisation is higher growth in the economy, then obviously that could have positive effects on employment and poverty. 5. Effects of privatisation on access to and price of basic food requirements. This is critically determined by the degree to which there is a functioning Public Distribution System in the region/area, which ensures stable and relatively cheap basic food to all. The experience with targeting (in the form of TPDS) has not been positive, since it has denied many people at or below the poverty line access to sufficient food. As such, privatisation has no direct bearing on this except insofar as it is directed towards the privatisation of such public activities as are currently engaged in by the Food Corporation of India and state-level departments which manage the system of Fair Price Shops. If privatisation does involve such agencies, then the price at which food is sold subsequently would clearly be critical. This may then imply the need for some sort of regulation. Similar points may be made with respect to other areas of social expenditure such as health and education, where private ownership may involve the effective exclusion of the poor because of inability to pay. 6. Effects of privatisation on basic infrastructure services, including power, water, sanitation. This is significant because a lot of recent privatisation is actually directed towards public utilities, which cater to these specific needs. Here the benefits of privatisation (enumerated above) must be counterbalanced against the potential costs, specifically in terms of reduced access and higher prices for consumers. Recent experience, both in India (Orissa) and elsewhere (e.g. California, South Africa, Latin America), has indicated that in the case of natural monopolies such as power and water distribution, the assumption of contestable markets is not enough to prevent private companies from indulging in monopolistic or otherwise undesirable behaviour of various sorts. It has also been found that regulatory mechanisms may be inadequate to prevent practices which effectively prevent the poor and disadavantaged from access to the use of such services – such as high prices, discontinuing services because of non-payment, etc. Since there are large positive externalities in such service provision (and indeed many would argue that access to water and power are among the basic socio-economic rights of all citizens, including the poor) there is a case for ensuring that such services remain available to all. One alternative, with private ownership, is a combination of tighter regulation and direct financial subsidies to private agents to ensure that the poor continue to have access. However, this may not be successful, and may turn out to be more expensive (in terms of public resources) than direct public ownership. Therefore, in the case of utilities, it is usually worth exploring various options of reform and restructuring which improve the functioning of such companies and reduce their losses, while retaining public ownership and/or control in order to fulfil broader social objectives. 7. Effects of privatisation on social and political exclusion of the poor. The essential fact about privatisation is that, once it shifts control to the private sector, commercial viability and profitability become the dominant considerations. This can be of importance because it implies that the poor, as those possessing weaker consumer power, are effectively denied voice in determining outcomes. While standard institutions of governance typically do face problems of inadequate representation and voice for the poor, the fact remains that in broadly democratic conditions (such as exist in India, at least electorally) there is at least the potential for ensuring greater accountability from units operating in the public sector. For this potential to be realised, it may be necessary to devolve greater power over functioning to decentralised elected institutions such as panchayats (which also have the advantage of one-third statutory representation for women). But with private ownership, ensuring voice for the various stakeholders is much more difficult. 8. All this suggests that the effects of privatisation on poverty reduction are crucially dependent upon. the areas/sectors in which the privatisation is occurring – the issue tends to be much more complicated for utilities and other economic activities with high externalities, compared to the manufacturing sector the choice of and the nature of the new private owners and their ability to keep the units functioning on a viable and socially desired basis, and whether the extant regulation is adequate to ensure this whether it is done for profitable or loss-making units and the associated impact on the state exchequer in the medium term whether resources released from such state involvement are actually utilised in socially desirable activities which affect the condition of the poor positively.



© MACROSCAN 2002