Editor in Chief: Moh. Reza Huwaida Tuesday, July 17th, 2018

Privatizing System Important to Economic Development

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Privatizing System Important to Economic Development

Afghanistan has the most centralized economic and political system of the day whilst privatization and decentralization system is widely recognized as great means of improving economic performance in developing countries. Privatizing state-owned enterprises (SOEs) is one of the major steps in transforming centralized economies into decentralized and market economies. This article aims to learn the experience of SOEs implemented in china the most occupying economy of the world.
Indeed, an important component of the economic transformation in China has been the privatization of its SOEs. Unlike the “shock therapies” used in transitional economies in Central and Eastern Europe, China took a gradual approach to its enterprise reform. This gradual privatization means that, at the time of privatization, most SOEs were losing money and were deeply in debt. This poses significant challenge in restructuring the SOEs so that they could be sold. On the other hand, the market and the legal-institutional conditions for private ownership were much more developed than were their counterparts those during mass privatization in other transitional economies.
Depending on the ease of restructuring and the incentives and ability of local governments to bear the social cost of restructuring, China adopted multiple approaches to privatizing its SOEs. These approaches included share issue privatization (SIP), joint ventures with foreign firms, management buy-outs (MBO), and sales to outsiders, etc.
More than three decades of reforms in China are marked by the government’s piecemeal and gradual approach. The reform of the state-owned enterprises is no exception. Instead of outright privatization, China concentrated first on productivity improvement by initiating enterprise governance structures that stressed autonomy and better incentives and then later by adopting long-term managerial contracts with pre-specified financial targets (such as profits and taxes). Instead of introducing markets and liberalizing prices overnight, China first created markets at the margin, parallel to the planned economy, by introducing the “dual-track system” in the state industrial sector and by lowering bureaucratic barriers to entry to the once state-monopolized industries. Admittedly, the reforms brought about fundamental improvements in output and productivity.
In 1993, the Third Plenum of the Fourteenth Chinese Communist Party Congress endorsed the creation of a modern enterprise system. In particular, it approved the development of diversified forms of ownership through privatization, which would allow SOEs to compete on equal terms in the marketplace. In 1995, the central government decided on the policy of “retain the large, release the small”. That is, the state was to keep the largest 300 SOEs in strategic industries and allowsmaller firms to be leased or sold. The Chinese Communist Party’s 15th Congress (1997) gave agreen light to privatizing the majority of SOEs nationwide. Regional governments were granted dejure ownership of SOEs within their jurisdictions and were allowed to sell their assets.
Large scale privatization began in the late 1990s. This “delayed” privatization brought about both advantages and difficulties in the designing of privatization programs. On the one hand, the market and legal institutional conditions for private ownership were much more developed than those during mass privatization in other transitional economies. On the other hand, at the time of privatization, most SOEs were losing money and were deep in debt. They were How to restructure the firms so that they could be sold off and / or how to attract buyers pose a challenge to the Chinese government. Restructuring means lying off excess labor, upgrading of plants and machinery, and injecting new capital, all of which were costly both socially and financially. Thus, depending on the cost of restructuring and the financial these problems ushered in a new stage of more fundamental reforms.
To summarize, Privatization in China has greatly changed the landscape of the state-owned firms. In particular, it has created concentrated private ownership and large shareholders essentially control major decision making in their firms. While the control rights of the state have been greatly reduced, its policy support is still important to firm growth. Moreover, the state’s influence remains important in a significant portion of China’s firms, which potentially hinders efficiency improvement.
After privatization, soft budget constraints were substantially hardened and incentives have been enhanced through equity incentives either through compensation or through ownership. China’s privatized firms are moving towards greater levels of professionalization, by hiring professional managers, introducing international accounting standards, and establishing boards of directors.
Privatized firms became more efficient and more profitable based on various measures. Such efficiency gains appear to be most significant among firm in which incentives are better aligned. Specific mechanisms of improved post-privatization performance are considered in a contemporaneous paper.
China’s privatization experience provides several insights into privatization designs in general. First, the Chinese experience highlights the importance of the incentives of large shareholders. Only when the large shareholders’ incentives are in place will firms undertake fundamental restructuring measures to enhance efficiency. Second, the Chinese experience suggests that postponing privatization to create stable market institutions increases the effectiveness of privatization. In particular, privatized firms can benefit from established product and labor markets for expansion and managerial tenant. They can also benefit from better-developed financial institutions to obtain external financing. Legal institutions protect the property rights of the owners of privatized firms and provide them with incentives to grow their firms. Finally, new private owners can use the capital market as an exit strategy to capitalize on efficiency gains.

Mohammad Zahir Akbari is the permanent writer of the Daily Outlook Afghanistan. He can be reached at mohammadzahirakbari@gmail.com

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