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Government Promises To Privatized Firms And The Public Interest

BUENOS AIRES: A danger haunts the market mechanism and threatens the benefits expected from privatization of inefficient state firms everywhere in the world. During the privatization process, promises are made to investors to induce them to bid for companies and to provide incentives for enhancement of efficiency. Soon after privatization, however, governments come under political pressure to renege on their promises once the benefits of privatization begin to be harvested. The danger is that these benefits may vanish. Experience in telephone privatization in Argentina and the United Kingdom offers useful lessons for privatization programs elsewhere, particularly in the transition countries.

By 1989 the long underfunded Argentine telephone company could no longer provide acceptable services. The government had little alternative to privatization. It could not fund the huge investments necessary to replace the aging network and installations. The new private purchasers laid out the necessary funds, having been promised the opportunity to earn substantial profits. Dramatic improvement in service followed. According to one study, before privatization unsatisfied demand for lines averaged about 45 percent of the number of lines already installed. Since then, installation of new lines rose from considerably less than 200,00 to some 700,000 lines per year. Before privatization unrepaired breakdowns were 5.3 percent of lines in service; only one year later, it had dropped to 0.9 percent. Delay in customer repair was 16.4 days in 1990 and 1.2 in 1995.

Huge investments were made by the private firms, induced by the opportunity to reap high profits, after taking the telephone industry over. Now, there is strong pressure on the government to retract its profit commitments in the belief that it is too late for the private firms to withdraw their investment outlays.

Similar scenarios occurred in many countries in which privatization occurred. The British telephone industry is illustrative. Prices charged by British Telecom, the privatized former state monopoly, are regulated under a widely used "price-up" regime. Price caps were designed to overcome a serious shortcoming of earlier forms of regulation which tried to prevent excessive monopolistic profits by imposing a ceiling on what firms were permitted to earn. The trouble was that, with no way to increase their profits under regulation, firms lost all incentive for innovation or, indeed, any other means to increase efficiency. Cost saving through efficiency improvement takes great effort and involves great risk. With no reward, managements saw no reason to make the required effort.