winners and losers: assessing the distributional impact of privatization

WorldDevelopmentVol. 31,No. 10, pp. 1617–1633, 2003� 2003 Published by Elsevier Ltd.

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Winners and Losers: Assessing the

Distributional Impact of Privatization

NANCY BIRDSALL and JOHN NELLIS *

Center for Global Development, Washington, DC, USA

Summary. — Most technical assessments classify privatization as a success. But privatization,especially in transitional and developing economies, is seen as fundamentally unfair both inconception and execution, and it is widely and increasingly unpopular. We set out a simpleframework for assessing the equity (or fairness) and efficiency gains from privatization, and forunderstanding any tradeoff between the two. We then review what is known about thedistributional effects of privatization, focusing on changes in asset ownership, employment andreturns to labor, access to and prices of utility/infrastructure services, and the selling government’sfiscal position. We conclude that many privatization programs have worsened the distribution ofassets and income, at least in the short-run. This is more evident in transitional economies than inLatin America. It is less clear for utilities such as electricity and telecommunications––whereprivatization has resulted in greatly increased access for the poor––than for banks, oil companiesand other natural resource producers, where the benefits have been concentrated.� 2003 Published by Elsevier Ltd.

Key words — privatization, income distribution, wealth distribution, welfare analysis

*Final revision accepted: 4 December 2002.

1. INTRODUCTION

Technical analyses of the outcomes of priv-atization are generally positive. Privatizationhas increased profitability, returns to ownersand investors, economic efficiency, and welfareand growth. But public perceptions of privati-zation are generally negative––and they aregetting worse.For example: a majority of people surveyed

in 2001 in 17 countries of Latin America dis-agreed with the statement ‘‘The privatization ofstate companies has been beneficial. . .,’’ and theextent of disagreement was much greater thanthree years earlier. 1 More than two thirds of1,600 Russians interviewed in 2001 thoughtthat they had lost more than gained from theprivatization of state property; only 5% said theopposite. Of Sri Lankans polled in 2000, mostthought that privatization had increased pov-erty and raised the cost of living, and over 60%opposed the privatization of the remainingstate-owned firms. In Uruguay, a plebiscite re-voked a privatization law narrowly passed byparliament; South African NongovernmentOrganization (NGOs) and community activistshave formed an Anti-Privatization League; inMexico President Vincente Fox has been un-able to make any progress on a promise to

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begin privatization of the energy sector; and inIndia parliamentary opposition halted (tempo-rarily) the national privatization program inSeptember of 2002.Why this disconnect between technical as-

sessments and popular opinion? The reasonseems to be that technical studies focus only onshifts post-sale in operational and financialperformance at the level of the firm, subjectsabout which the general public knows little andcares less. At the heart of popular criticism is aperception that privatization is fundamentallyunfair in both concept and implementation: itis seen as harming the poor, the disenfran-chised, the workers, and even the middle class;throwing people out of good jobs and into poorones or unemployment; raising prices for es-sential services; giving away national trea-sures––and all this to the benefit of the localelite, agile or corrupt politicians, and foreigncorporations and investors. The complaint isthat, even if privatization contributes to im-proved efficiency and financial performance(some question this as well), 2 it has a negativeeffect on the distribution of wealth, income andpolitical power.

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WORLD DEVELOPMENT1618

In this paper we review the burgeoning lit-erature on the distributional effects of privati-zation. We examine which groups have gainedor lost, and, where all have gained by somemeasure, which groups gained the most. Sec-tion 2 outlines a simple framework withinwhich to consider the efficiency and equitygains and losses of privatization. Section 3summarizes assessments of the overall financial,efficiency and macroeconomic effects, usuallyconsidered in terms of gains or losses in finan-cial and operating performance at the level ofthe firm, returns to owners and investors, andlatterly to aggregate welfare and to the com-petitiveness and growth prospects of an eco-nomy. Section 4 reviews what we know fromtheory and from existing studies on distribu-tional issues, using the framework of Section 2.Section 5 concludes.

2. A GENERAL FRAMEWORK

Economists usually frame the question ofequity or distribution in the context of atradeoff with efficiency or growth. In a perfectlycompetitive economy at its production frontier,without any externalities, information asym-metries or other problems of missing or im-perfect markets, there is likely to be such atradeoff––as in Figure 1. On the frontier, theonly efficient means of redistribution is throughlump-sum transfers that have no effect on theincentives of economic agents, on prices, and soforth. A perfectly competitive economy can behighly inequitable (point A), or equitable (pointB), often as a function of some initial allocation

Efficiency

Equity

A

C

D

B

Figure 1. Equity and efficiency: a competitive versus animperfect market.

of the assets that generate income. A movealong the frontier must lead to more efficiencyand less equity or vice versa, the definition of atradeoff.In an economy that is not perfectly compet-

itive, however, there is no such necessarytradeoff. At point C in Figure 1, the economyhas the potential to move to both greater effi-ciency and equity, for example to point D. 3

Most developing and transitional economiesare less efficient than the economies of indus-trialized countries. Their low income is not onlythe result of their limited resources. They alsooften fail to use well what resources they pos-sess, because of lack of enforceable propertyrights, policy deficiencies (e.g., distortionary taxsystems, labor market rigidities), outright cor-ruption, and the protected monopolies thatstate enterprises often represent. 4 Historicalinjustices, civil conflict, political instability,crushing levels of disease or frequency of nat-ural disasters may all also keep economies moreor less permanently inside the efficiency fron-tier.For any given productive capacity, many of

these economies are also highly inequitable––because of government or policy failures thatsustain insider privileges or corruption, or be-cause of historically driven concentrations ofwealth in land, oil, or other assets. Of course itis also possible for a society to be inefficient butequitable (‘‘Cuba’’ in Figure 2) or highly effi-cient but also relatively inequitable (‘‘UnitedStates’’ in Figure 2).The point is that in most developing and

transitional economies well inside the produc-tion frontier there is no necessary tradeoffbetween increasing efficiency and resulting

Efficiency

Equity

United States

Cuba

Figure 2. Examples: the economies of the United Statesand Cuba.

Efficiency

Equity

a

b

Figure 3. Privatization with more equity and moreefficiency.

Efficiency

Equity

E

CB

A

D

Figure 4. Possible post-privatization paths.

WINNERS AND LOSERS 1619

economic growth on the one hand, and in-creasing equity on the other. This means itshould be possible to implement privatizationin ways that promote both equity and effi-ciency. To the extent that privatization reducesmonopoly rents held by the wealthy, for ex-ample, it is likely to increase both efficiency andequity in the economy as a whole. 5

The structure and outcome of each privati-zation event is only one factor in the overallstory of privatization’s effect on equity (ordistribution) at the country level. Pre-privati-zation conditions matter––there will be morescope for an improvement in equity themore inequitable is the initial situation. Ofcourse, the same is true with respect to ini-tial inefficiency (Figure 3, paths a and b). Thepost-privatization environment (degree of com-petition, regulatory arrangements) can rein-force or alter the original path. Complicatingmatters, one-time privatization events, even ifextended over several years, may help deter-mine the post-privatization policy and institu-tional environment, and thus the long-termpath of a society. To illustrate, mass privati-zation efforts in the post-communist transi-tional economies were justified on the groundsthat privatization was necessary and perhapseven sufficient to create competition and induceincreased firm (and overall economic) efficiency(Figure 4, from A to B via privatization, then toC in the post-privatization competitive envi-ronment). But the unanticipated outcome inseveral countries, most notably Russia, wasthat privatization initially increased the econ-omy’s efficiency, but also locked in insiderprivileges (A to D); those insider privileges thenbrought competition-eroding corruption thatundermined efficiency as well (D to E). 6

Because the post-privatization path of asociety, in terms of wealth and income distri-bution, is neither unidirectional nor fully de-termined by transfer of ownership itself, anysingle snapshot-like assessment of where a so-ciety is relative to where it was before may be apoor indicator of the long-run effects of priv-atization. The outcome will be shaped by theamount of time since the process began, theextent to which the process directly affectedthe post-privatization environment, and by ahost of independent factors that can affect thedirection of the path (efficiency gain at point Din Figure 4 was only temporary).We take it that the main or ultimate objective

of privatization everywhere has been, or shouldbe, to secure efficiency gains for the economy asa whole. Where distributional issues have beenconsidered, they have generally been devised inthe context of greasing the wheels to makeprivatization politically more palatable. Behindthe usually paramount goal of improving effi-ciency has been the implicit assumption thatgovernment could and should use other, moretraditional and direct instruments for redistri-bution, through tax and expenditure policies.Of course, that assumption has not always beenborne out, because of political and economicconstraints that are independent of privatiza-tion policy per se.Some stylized examples illustrate the logic of

the framework (all cases are drawn from real-ity; see the sources noted in the text). With itsplanned economy, the former Soviet Unionwas, at the outset of transition, highly ineffi-cient, though possibly reasonably equitable––with everyone comparably badly off (point A inFigure 5). Privatization in Russia made theeconomy both more efficient and at the same

Efficiency

Equity

c

b

a

A

Figure 5. Examples: Soviet Union, Russia.

Efficiency

Equity

c

ba

A

Figure 6. Example: Peru, electricity.

Efficiency

Equity

A

a

Figure 7. United Kingdom, electricity.


time less equitable, as some former state assetswere acquired by a relatively small group ofinsiders (path a). The resulting concentrationfurther worsened equity, and stalled or evenreversed efficiency gains, as many of the newinside owners concentrated on asset strippingrather than productivity-enhancing investments(path b). 7 But, subsequent policy shifts, in-cluding a start on corruption control, seem tohave halted the growth in inequity, by elimi-nating favors, and increasing efficiency. Theelimination of some insider subsidies assisted inpromoting a more competitive environment(path c).In Peru, a state-run electricity utility was in-

efficient initially, with poor management, hightechnical losses, poor revenue collection, andirrational pricing. Its performance was highlyinequitable, providing virtually no services topoor neighborhoods, while under pricing orfailing to charge and collect fees in middle-classand rich neighborhoods or from large indus-trial users. (Point A in Figure 6.) Privatizationincreased efficiency dramatically, with offsettingeffects on overall equity (path a). Offsettingequity effects appear to have resulted from acombination of higher prices for the previouslyinsulated middle class with much better access(and a lower than ‘‘infinite’’ price) for the poor.Many poor, e.g., in rural areas, were still un-served and thus relatively worse off than otherpoor––though not worse off in any absolutesense. Other urban poor––those whose prioraccess through illegal hook-ups was eliminated,a common outcome of electricity privatizationin Latin America and Asia––were made abso-lutely worse off. In subsequent years, equitygains could be reinforced or reversed dependingon political pressures and on the competence

and authority of regulators (paths b, c; seeT�oorero & Pasc�oo-Font, 2001). 8

In the United Kingdom, privatization of theelectricity sector provided large initial efficiencygains, but underestimation of these gains, com-bined with nonaggressive or incomplete regu-lation in the years immediately after sale, meantthat the new owners, and not consumers, cap-tured most of the initial gains (Figure 7, path a;see Newbery & Pollitt, 1997).In Brazil, privatization of state telecommu-

nications monopolies brought huge efficiencygains, with greatly increased coverage andquality for consumers and for productive sec-tors for which communications is a critical in-put. But underpricing of the firm to ensure the

sale was successful 9 may have meant thatmiddle-income taxpayers lost out, and thewindfall gains to a small number of new ownersincreased the overall concentration of assets(path a in Figure 8). If those windfall gains go

Efficiency

Equity

a

b

Figure 8. Brazil, telecommunications.


primarily to foreigners there may be no directeffect on the domestic distribution of wealthand income, but it still could produce aheightened sense of unfairness in the society asa whole. If the fiscal windfall is squandered(e.g., because it temporarily relieves the con-straint on acquiring more debt), leading tosubsequent increases in interest rates or reduc-tions in social and other expenditures that arerelatively progressive, these second-stage indi-rect effects may exacerbate the initial inequity(path b; see Macedo, 2000).The overall point is that there can be no

simple prediction about the distributional ef-fects of privatization; the impact depends onat least three factors: initial conditions, thesale event, and the post-privatization politicaland economic environments. The privatizationevent may reinforce or undermine aspects ofthe environment that are conducive to equity,or may simply reflect that environment, or maybe independent of it. Assessment of those ef-fects will also depend on at what point on the‘‘path’’ we measure the outcome. In the end,the question is an empirical one, unlikely toyield to any simple generalization acrosscountries and over time. Thus, understandingthe distributional impact of privatization re-quires an assessment of real cases, and thesetting of those cases in the larger context oftheir political as well as economic environmentand history.At the same time, our framework suggests

that in most settings there has been room forefficiency-enhancing privatization that is alsoequity enhancing. The conclusion is that wherethere has been a tradeoff it might have beenavoided or diminished by a different process orby earlier or more vigorous attention to con-

structing a different post-privatization envi-ronment (regarding competition, regulation,etc.).

3. THE OVERALL ECONOMIC RECORD

As noted, the shift to private ownershipusually improves a firm’s performance. Post-privatization, profitability has generally in-creased, often substantially, as have output,dividends and investment. After reviewing 65empirical studies at the firm level, touching awide range of sectors and across countries indifferent regions and of different income levels,Megginson and Netter (2001) conclude flatlythat ‘‘. . .privately-owned firms are more effi-cient and more profitable than otherwise-com-parable state-owned firms’’ (p. 380). 10

Privatization’s economy-wide effects on thegovernment budget, and on growth, employ-ment and investment are less established. AnIMF review of 18 privatizing countries reportssubstantial gross receipts from privatization,accounting for nearly 2% of annual GDP(Davis, Ossowski, Richardson, & Barnett,2000). Governments have generally ended upwith about half that amount, reflecting the highcosts of financial clean-ups, labor downsizingand sales assistance. Even 1% of GDP is sub-stantial, but the long-run effects on governmentrevenue generally come not from sales proceeds(a one time infusion) but from the eliminationof subsidies to state enterprises, and fromsubsequent increased tax revenues from moreprofitable and productive private enterprises.Governments as diverse as Mexico, Cooted’Ivoire and Mozambique received, in the firstfew years following sales, more from privatizedfirms in taxes than from direct proceeds ofsales. A ‘‘flow of funds’’ analysis in Boliviashows, in the first four years following sales, apositive financial return to government of US$429 million––and this in a case where govern-ment received not a penny of the sales pro-ceeds. 11 The IMF concludes that markets andinvestors regard privatization as a healthy sig-nal of the political likelihood that governmentwill stick with its overall reform program, im-plying somewhat higher investment rates in theeconomy overall.Privatization does not always work well. In

low-income countries privatization has provenmore difficult to launch, and less likely to gen-erate quick, positive effects. There are settingswhere many privatizations have not, or not yet,


yielded visible, positive performance improve-ments––in Armenia, Moldova and Guinea, forexample. Even in countries where the process isan overall success, not every privatization im-proves firm performance. In three comparablestudies, looking at 204 privatizations in 41countries, between one-fifth to one-third ofprivatized firms registered very slight to noperformance improvements, or, in some cases,worsening situations (Megginson & Netter,2001, pp. 355–356). A two thirds to four fifthssuccess rate is not bad. Still, inherited condi-tions place some firms beyond hope of internalreform, or some new owners operate in suchpoor markets and policy frameworks that achange of ownership is not by itself enough toturn the tide.Because of this, controversy continues about

the effects of privatization, in particular in set-tings where complementary reforms are notin place, competition is still limited, and regu-latory and supervisory capacity embryonic.These institutional-administrative conditionsare especially relevant in natural monopoliesand in such sectors as banking. Nonetheless,the technical assessments generally show thatprivatization has been among the more suc-cessful of the liberalizing reforms from thepoint of view of increasing the efficiency ofeconomies and thus their competitiveness andgrowth prospects. In more cases than notprivatization has yielded good returns to newprivate owners, freed the state from what wasoften a heavy administrative and unproduc-tive financial burden, provided governments inplace with both a one-time and longer-termfiscal boost, and helped sustain a larger processof market-enhancing economic reforms.

4. DISTRIBUTIONAL EFFECTS

(a) What might happen?

So, privatization is generally good for thenew owners. What about the rest of society? Atissue in distribution terms are the effects ofprivatization on the welfare of different initialincome groups or households. Their consump-tion depends on their income and the pricesthey face. Their income, in turn, depends ontheir assets, including their labor, human capi-tal, ownership of land and other physical orfinancial capital, and the return on these assets.We list below the areas where one might en-

counter distributional shifts as a result ofownership change.

(i) Distribution of assetsPrivatization shifts an asset owned (in theory)

by the taxpayers as a whole to one owned byprivate persons or firms. Whether the shift inownership reduces or increases overall equity ina society depends in part on the extent to whichthe price received by the selling state adequatelyreflects the underlying value of the asset. If theseller underprices an asset, for example, to en-sure a quick sale or reward a political crony,equity will decline, in the short-run at least. Theeffect of the change in ownership on the long-run distribution of incomes between taxpayersand new owners ultimately depends on boththe initial price and the post-sale stream ofvalue the asset produces.Privatization might be arranged to spread

direct (i.e., share) ownership widely among theaffected population. Privatization may alsoconfer, or permanently deny, hitherto unreal-ized pension benefits, creating or eliminatingan asset of employees.

(ii) Return on assets––laborPrivatization can change the return on assets,

such as labor, in a manner that affects the dis-tribution of income. For example, low-incomeworkers might be more likely to be laid off thanhigh-income workers, or dismissed low-incomeworkers might have a more difficult time find-ing alternative employment, or the employmentthey do obtain might be less remunerative thaneither the work they left, or the work gener-ally obtained by higher-skilled, higher-incomeworkers who were also dismissed. Conversely,if privatization is an important element in anoverall reform program that leads to highergrowth and general job expansion, then pre-viously unemployed or poorly paid workersmight gain jobs, or better jobs.The frequent allegation of union leaders is

that cost-cutting measures by new privateowners fall disproportionately and unfairly onworkers. Labor leaders argue that it has beenpoor management and poor government poli-cies that are the root causes of the financiallytroubled state of public firms, but it is laborthat is asked to pay the price of reform. Pro-ponents of privatization suggest that poor pastperformance in public firms requires a period ofrestructuring resulting in cuts in employment,part of which might occur before the actualsale. But the job reduction phase might, and it


is hoped, would be temporary. Under moredynamic private ownership total employmentnumbers might eventually recover, and evensurpass, the number originally employed.

(iii) Return on assets––physical capitalPrivatization can also change the return on

the physical capital that is shifted. If the newprivate ownership is more efficient than thestate, the return on the pre-existing capital(profits) will rise. This can constitute a perfectlylegitimate reward to new effort or entrepre-neurial skill, with spillover benefits (e.g., newjobs at higher wages) from the owners of cap-ital to the economy overall. Conversely, if thenew owners further neglect or strip the assets,value can be subtracted, and equity could easilysuffer, as firms scale back or close and morejobs are lost.

(iv) Prices and accessPrivatization can affect prices differentially

across income groups. On the one hand, pricescould fall. If increased competition is part of oraccompanies the change of ownership, the pri-vate owner might be forced to offer lowerprices. If private management is more efficient,some of the savings might be passed on toconsumers. Conversely, prices––particularly inprivatized infrastructure firms––might have toincrease if they had previously been held belowcost-covering levels by government action, or ifnew private owners move to end illegal con-nections to services and collect from previouslytolerated delinquent customers, or if bodiesregulating privatized infrastructure firms areweak or ineffective, etc. The distributional im-pact of price shifts will depend on the extent towhich consumption of the goods and services inquestion varies by income group, and if differ-ent levels of consumption, or categories of con-sumers, face different prices.Privatization might improve access to pro-

ducts by means of business expansion (that theinvestment-constrained public firm could notcarry out). Conversely, the private owner mightwithdraw from or ignore some markets that thepublic enterprise was obliged to service.Pricing and access issues are closely en-

twined. The prices citizens and consumers facecan be broadly conceived to include whether ornot they have access at all to a good or service(the price is infinite if they have no access toelectric power, for example), and to take intoaccount the quality of a good or service ob-tained (a lower quality for a given nominal

price implies a higher real price). Steep priceincreases following privatization have beencommon (but not universal) in divested net-work or infrastructure industries, e.g., electri-city and water and sewerage, less common intelecommunications. Very large increases inquality of service are typical.On the equity side, the argument of reformers

is that trying to protect the consumer bykeeping the price of essential services artificiallylow did not work. It resulted in subsidies to thecomparatively wealthy, and imposed costselsewhere in the economy that outweighed thepolicy’s benefits. Better, it was thought, to letthe firms operate under private, profit-maxi-mizing ownership, and use other state mech-anisms (taxes, regulation) to protect consumerwelfare and acceptable levels of income distri-bution.One can, however, readily think of situations

where rational policies followed by private,profit-maximizing ownership might imposeparticular and disproportionate costs on thelower-income groups in a society. Again, in-frastructure yields the most obvious exam-ples. 12 It is plausible that price increases inelectricity and water––required to cover vari-able costs and expand the network––will fallmore heavily on poorer consumers, who mightbe spending a higher percentage of their incomeon these services than do the wealthy. The oftenvigorous and aggressive moves by new privateowners to collect arrears, and end illegal waterand electricity connections, likely fall mostheavily on the poor, especially the moves to endillegal connections. Even when a privatizedservice expands through investment into for-merly unserved, and thus probably poorerneighborhoods, the residents might not be ableto take advantage of it due to the high costs ofconnection fees or new equipment that theconsumer often must provide to tap the wateror power.In telecommunications, a common result of

reform and privatization has been ‘‘tariff re-balancing,’’ leading to large price increasesin formerly subsidized local ‘‘fixed line’’ tele-phony, while introducing competition––usuallyproducing rapidly falling prices––in interna-tional services and through mobile phone sys-tems. But since the poor might tend to placemost of their calls locally through fixed lines,the price increase could have a negative dis-tributional consequence.Issues of access (or coverage) arise in the

context of infrastructure privatization. Due to

Efficiency

Equity

x

Figure 9. Privatization’s initial effects: the ‘‘average’’case.


lack of incentives to perform, low tariffs andother investment constraints, many publiclyowned infrastructure firms persistently failed tomeet demand. With a relaxation of the invest-ment constraint and a proper incentive struc-ture in place, new private owners might see thelogic of expanding to meet pent-up demand.Moreover, it is commonplace for sales con-tracts in infrastructure to specify investmentand expansion targets, in order to extend theservice to clients and regions formerly notserved. In many instances, a disproportionatepercentage of the new customers will be drawnfrom the lower income groups. The distribu-tional impact of this expansion will be a func-tion of the initial income of the new customers,and the relative shifts in expenditure that resultfrom connection to the network. For example,where the poor were paying vendors for water,connection to the network could result in muchlower unit costs––if they can afford the oftensubstantial up-front connection fee. Theymight, however, face some minimal consump-tion threshold that exceeds the amount theypreviously consumed, raises their costs, andworsens distribution.

(v) Fiscal effectsPrivatization may affect real income net of

taxes if its fiscal effects are to reduce the taxburden differentially across households, or toincrease the benefits differentially of govern-ment services such as education and health thatare funded by new tax flows. The fiscal effectsof privatization on income distribution––whichcome through any changes in revenues (in-cluding via affects on service expansion), and inexpenditures, are indirect and possibly offset-ting. Reduced hemorrhage of tax revenues andany increases in public expenditures probablybenefit the relatively poor. But the indirect ef-fects are easily offset in countries where broaderfiscal problems eat up initial sales revenue andinvite a prolongation of weak fiscal policy––ultimately with costs to growth as well as im-proved equity.

(b) What does happen?

A great deal of empirical work on thesequestions has emerged, all of it after 1990, andmost of it in the last few years. After reviewingthis evidence, we conclude that many if notmost privatization programs list as an objectivemaintaining or improving distributional equity,and many have built in some specific measures

(e.g., vouchers) to achieve this aim. But almostall privatization programs have done muchmore to enhance efficiency than equity. At leastinitially, and on average, privatization hasworsened wealth distribution and, to a lesserextent, income distribution. The increase ininequality has varied across countries, fromslight increases (e.g., in Latin America) to verylarge ones (e.g., in Russia and some othertransition economies). Overall, in the terms ofour analytical framework, the average privati-zation program reviewed in the literature hastaken path x (Figure 9).To disaggregate the general conclusion:

(i) OwnershipTroubling or disappointing outcomes are

particularly common in regard to ownership.For example, privatization programs and tech-niques in many transition countries resultedin a mass and rapid transfer of asset owner-ship from society at large to a small groupof agile, daring, often unscrupulous actors. Onecan argue, as do Anders �AAslund and AndreiShleifer, that despite the admittedly unfair andoften illegal manner of the asset allocation,these owners have now put poorly used assetsto productive work, the results obtained aresuperior to the alternative of leaving the firmsin state hands, and the resulting distributionalloss is an unavoidable, bearable price that mustbe paid for the efficiency gains, and indeed, forthe transition to succeed. 13 Others vigorouslydispute this conclusion. 14 While few woulddefend the notion that state- or socially-ownedenterprises were managed mainly with thepublic interest in mind, there can be little doubt


that ownership has become more concentrated,with negative, if perhaps short-term, conse-quences on asset distribution.The ownership issue has caused concern in

less dramatic (and more empirically determin-able) circumstances: in their study of the priv-atization of the electricity sector in the UnitedKingdom, for example, Newbery and Pollitt(1997) show that in the first years followingsale, the overwhelming bulk of the financialrewards generated by the substantial efficiencygains was captured by the new private share-holders, at the expense of both government andthe taxpayers. In this case both governmentand consumers/taxpayers did reap some gains.The contrast is not winners to losers, but ratherhuge winners to very small winners. In a sub-sequent study Newbery (2001) concluded thatas time passed and electricity regulators gainedexperience, they became increasingly able totransform the efficiency gains into lower pricesfor consumers. As noted above, how one as-sesses privatization outcomes depends partlyon when one makes the assessment. Nonethe-less, the initial wealth distributional impact wasnegative in both the Russian and the British(electricity) cases (path a in Figures 5 and 7).Mechanisms employed ex ante to address the

ownership issue included offering vouchers tothe general population, and reserving a trancheof shares in privatized firms for the employees(and sometimes retirees), usually at a steepdiscount. Both measures proved useful in re-ducing employee resistance to privatization. Inmany cases sharp increases in share pricespost-sale have improved the income positionof the shareholders, the employee shareholdersamong them, 15 though the number of peopletouched by such schemes is, normally, toosmall to make any difference to overall distri-bution patterns.In transition economies vouchers were widely

disseminated, 16 but the distributional impacthas been disappointing, not only in the infa-mous cases of Russia and the Czech Republic,but in Mongolia, Moldova, Kazakhstan, Lith-uania and elsewhere. This is not in the sense ofdirectly worsening the position of the recipi-ents, who obtained the vouchers for free or at anominal price, but rather in the sense of returnson the vouchers being so much less than an-ticipated or promised, and so much less thanthe amounts gained by the agile and/or dis-honest few. In some cases the best companieswere not privatized by vouchers, but ratherwent, in nontransparent deals, to managers and

their supporters. In other instances dispersedminority shareholders (shares obtained byvouchers) found that all assets were ‘‘tunneled’’out of their firm, which suddenly consisted ofnothing but liabilities; or the value of minorityshares overnight fell to zero (as someone gaineda majority stake and had no use for moreshares); or the company was inexplicably de-listed from the stock exchange, or the privati-zation fund invested in transformed withoutnotice, discussion or appeal to an un-sellablestatus, etc. (Nellis, 1999, 2002). Overall, theprincipal distributional problem may be morepsychological than financial: people were told,or it was implied, that the voucher was themeans whereby the mass of state propertywould be equitably shared out among the citi-zens. This did not happen and the disappoint-ment and resentment engendered by this failureis still discernable and of political import inmany transition countries, to privatization inparticular, and to liberalizing reform in general.At the same time, generally positive distrib-

utional outcomes viewed in a few cases suggestthat negative paths are not an automatic orinevitable result of the application of privati-zation. For example, the Bolivian programpromoted both efficiency and equity (roughlyfrom C to D in Figure 1) partly because ofpolitical foresight and clever program design,and partly because the prevailing stable macro-economic situation––in good part, a functionof wise leadership––allowed authorities con-siderable financial latitude. (The public’s per-ception of the program, nonetheless, remainsnegative.) The point, for the moment, is not theextent to or the frequency with which equity-enhancing outcomes occur; it is that they occurat all. 17

(ii) EmploymentIn terms of returns on assets (other than

shares of firms), the main topic of analysis hasbeen the effect of privatization on employmentlevels and returns to labor. Despite the saliencyof the employment issue, the matter has onlyrecently received rigorous attention. It is clearthat public enterprises were overstaffed, oftenseverely so; that in preparing for (or as a sub-stitute for) privatization, public enterprise em-ployment numbers declined, sometimes greatly,and that these declines generally continuedpost-privatization. One survey of 308 privatizedfirms shows post-sale reductions in 78.4% ofcases, with no change or job gains in only21.6% (Chong & L�oopez-de-Silanes, 2002, p. 43).


The question of what kind of jobs people findafter dismissal from public enterprises is justbeginning to receive attention; fragmentary evi-dence suggests a lengthening of hours worked,and reductions in fringe benefits and securityof tenure.Overall, the evidence indicates that more

people have lost jobs than gained them throughprivatization. Assuming that those dismissedderive most of their income from employment,and in the absence of detailed or persuasiveinformation about the incidence and size ofseverance payments, or the amount of timerequired to find alternative employment, 18 weconclude that: in the short-run, the averageemployment effects of privatization have tendedto worsen distribution. These effects are prob-ably overestimated in the public’s perception,given the capital intensity of State-owned en-terprises (SOEs) and the relatively small per-centage of national labor forces employedtherein. 19

(iii) Prices and accessA widespread result of utility privatization is

network expansion and increased access to theservice by the population, especially the urbanpoor (the rural poor are still generally left out);this is seen in Peru (T�oorero & Pasc�oo-Font,2001), Argentina (Chisari et al., 1999; Delfino& Casarin, 2001; Ennis & Pinto, 2002), Bolivia(Barja & Urquiola, 2001), Mexico (L�oopez-Calva & Rosell�oon, 2002), and in a number ofother Latin American examples. The increasein access is very often substantial, the rate ofincrease is far greater than before divestiture,and the studies cited above (note that all arefrom Latin America) have concluded that thepoorer segments of the population have bene-fited, disproportionately, from these increases.Expansion is partly a function of profit-

oriented owners moving to expand their mar-kets––easier now that the firm can tap privateinvestment capital––and partly a matter of salescontracts stipulating investment levels andnetwork expansion targets. In cases where ac-cess increases significantly and prices do notrise greatly, increases in access have a positivedistributional impact outweighing the negativeeffects of price shifts (McKenzie & Mookherjee,2002, p. 55).Often, however, increases in access are ac-

companied by substantial increases in prices. 20

A number of studies reveal that the amountand structure of these price increases––partlydue to the very common need for the privatized

firms to raise their retail prices to cost-coveringlevels, and partly because inexperienced regu-lators have found it difficult to hold down orreduce tariffs in privatized infrastructure firms––are such as to produce, in the short-run, in-creased inequity, e.g., in Peru, Spain (Arocena,2001, and elsewhere). The finding is sufficientlygeneralized to prompt Estache, Foster, andWodon (2002, p. 9), in their review of infra-structure privatization, to conclude: ‘‘One ofthe most painful lessons is that unless govern-ments take specific actions, the gains from re-form take longer to reach the real poor than thericher segments of the population, and henceworsen income distribution.’’ 21

An important part of the price impact stemsfrom the elimination of illegal connections toelectricity and water networks. Delfino andCasarin (2001, p. 23) note that in Argentina,for example, 436,000 of the first 481,000 addi-tional subscribers to the privatized electricitysystem were those who had had illegal hook-ups. In economic terms the shift from theft topaying status results in a clear welfare loss.On the assumption that a majority of thosewith illegal connections were lower-incomepeople, the result is likely to be an increase ininequity.

(iv) Fiscal effectsFinally, we noted above that in studies cov-

ering 18 countries, mostly developing andtransitional, the net fiscal effects of privatiza-tion were receipts on the order of 1% of GDP.That is a substantial amount in a single year,but modest relative to the size of economies oreven of government budgets over several years.In some countries, the critical fiscal benefit ofprivatization has been to eliminate direct bud-get transfers (that subsidized commerciallyunviable enterprises, or compensated for polit-ically determined underpricing of an enter-prise’s service or products). That subsidy flowhad been substantial for politically visiblepublic infrastructure services, such as energyutilities, water and sewerage services, railroads,and telecommunications, and often resulted inthe rationing of underpriced services. In turn,that rationing had affected poorer households,which often ended up without any services atall. The tax-financed subsidies provided bene-fits primarily to the nonpoor in the form ofemployment at wages above the market, orunderpricing for those with access.Tax systems are regressive in many develop-

ing countries. They rely heavily on indirect


trade and value-added (consumption) taxes. Tothe extent privatization reduces the hemorrhageof funds to keep losing firms afloat, it producesindirect benefits, in terms of increased retainedtax revenues. More efficiently managed, higherproductivity private firms do tend to pay moretaxes, thus increasing government revenues. Allthis could result in increased benefits to therelatively poor. That is, since expenditure pat-terns in most developing countries are some-what more progressive than the incomedistribution itself (though hardly very progres-sive), this would also suggest an indirect benefitto the relatively poor. The critical question ofwhether or not this has happened has beenneglected.In many cases, governments have used reve-

nues from privatization to reduce the stock ofpublic debt. Prima facie, that makes sense. Butthe ultimate use of privatization revenues is afunction of the overall fiscal performance of agovernment, since even when revenues reducedebt stock, indiscipline on the fiscal side meansthose revenues are indirectly financing thegovernment’s current expenditures or increas-ing its space to borrow more. Macedo (2000),argues that privatization revenues in the mid-1990s merely prolonged the period duringwhich Brazil tried to sustain the nominal valueof its overvalued currency and put off the dayof reckoning, which finally came in 1998. Thepotential fiscal benefits were thus lost as gov-ernment used reserves to protect the currency.Mussa (2002) describes the same failing in Ar-gentina. Revenues from privatizations in themid-1990s were significant over a period ofthree or four years; despite those infusions thegovernment failed to generate the fiscal sur-pluses it needed. Both the national and subna-tional governments kept on borrowing, andultimately the privatization revenues wereswallowed up in the collapse of the currencyand debt default in 2002.In Bolivia, the initial situation seemed better,

because the government did not accept salesrevenue but in effect retained one-half the valueof the enterprises (as ‘‘shares’’ held to generatebenefits for future pensioners) and exchangedthe other half in return for the new owners’commitment to invest equivalent amounts inthe enterprises themselves. Even in Bolivia,however, subsequent fiscal problems led to thefailure of the government (that succeeded theadministration that had initiated the program)to pay out benefits to its older citizens to theextent originally undertaken.

5. OBSERVATIONS AND CONCLUSIONS

Our analysis is drawn from a limited numberof countries and a limited set of sectors, over arelatively short period. Some important regionsare more or less left out of the story; for ex-ample, very little is known about Africa. 22 TheLatin American studies reviewed treat almostexclusively infrastructure privatizations; 23 lit-tle is known there or elsewhere about the dis-tributional impact (possibly more favorable) ofthe larger number of privatizations of firmsproducing tradable and other goods in com-petitive markets––from large steel mills to smallhotels. Our observations on the effects of priv-atization on asset ownership and wealth dis-tribution depend heavily on findings from thetransitional economies of the former SovietUnion and Eastern Europe, especially Russiaand the Czech Republic. These findings arisefrom initial conditions that if not sui generis arethoroughly unlike those encountered in otherregions and settings, or even in other countriesin transition.In transitional economies, the initial situation

regarding economy-wide inefficiency (generallyhigh) and income and wealth inequality (com-paratively low) has not been systematicallytaken into account in assessing privatization’simpact on changes in inequality. We do knowthat in transition countries in the 1990s grossmeasures of income inequality––as measuredby Gini coefficients; see Figure 10 in the ap-pendix––increased from relatively equitablestarting points, sometimes modestly (CzechRepublic, Hungary, Slovenia), sometimes enor-mously (Russia, Tajikistan, Armenia). Butwhat precise role did privatization play in thelarge increases in inequality? There does notappear to be much of an association betweenthe sheer amount of privatization and the de-gree of increase; slow and fast privatizers arefound at both ends of the spectrum. More likelyexplanations are the method of divestitureused, the type of new owner installed, the se-quencing and intensity of other market reformsand, especially, the nature and density of the‘‘institutional framework’’ 24 prevailing in thecountry prior to, during, and after the privati-zation events.Another limiting factor is that privatization

has been, for the most part, a phenomenon ofthe 1990s. Our understanding of the effects ofownership change is mainly based on analysesundertaken shortly after its implementation(and most of these during an economic boom).


Static snapshots, taken at most within three orfour years after the privatization event, do nottell the whole of what can be a changing story.To illustrate, in the mid-1990s the Czech

Republic’s early, rapid and massive privati-zation program was judged a great success.As more information became available, andproblems of both performance and fairnesssurfaced, the consensus interpretation shifted in1997–98 sharply towards the negative. In Po-land, in contrast, observers were at first criticalof the country’s hesitant approach to the priv-atization of large firms, but then switched togreater enthusiasm as Poland returned togrowth and macroeconomic stability. Indeed,Poland’s overall good performance, in the ab-sence of large-scale privatization (combinedwith comparatively poor performance in rap-idly privatizing Russia and the Czech Repub-lic), led some to question the importance ofrapid and mass privatization––and others toemphasize that quick privatization in the wrongenvironment could have the wrong effects al-together. Now the pendulum has once againswung back; major and recent fiscal and eco-nomic problems are partially attributed toPoland’s failure to privatize a set of large loss-makers when it had the chance. There havebeen similar shifts in interpretation and judg-ment in Argentina, Bolivia, Russia and theUnited Kingdom.Almost all these shifts in interpretation have

been based on variations over time of financialand operating performance of privatized andstate firms, not distributional consequences.But since, as we have shown, distributionaloutcomes often depend on privatization’s effi-ciency and productivity results, shifts in inter-pretation of the overall economic consequencesof privatization imply shifts in the assessmentof the distributional impact as well.This points to a third question. Are observed

changes over time in income distribution asso-ciated with privatization, or are they producedby other reforms and policies taking placecontemporaneously? A few pioneering studies(Galal et al., 1994; Jones, Jammal, & Gokgur,1998; Newbery & Pollitt, 1997; Pollitt &Domah, 2001) construct a ‘‘counterfactual’’that tries to assign to ownership change onlythose performance shifts post-privatization thatare clearly caused by the ownership changeper se. This means that the studies must statewhat would have been the performance had thefirm not been privatized. These studies alsoattempt to determine the winners and losers

from the privatization event, 25 yielding awealthof insights. But, as all these authors readilyadmit, counterfactual construction is based onan element of ‘‘crystal ball gazing.’’ As withother studies cited which employ partial andsimpler devices to gauge who wins and wholoses from privatization, the problem of attri-bution of the outcome––whether to ownershipchange or to something else––cannot be com-pletely solved.The fact is that the other reforms that ac-

company privatization do matter, especially forthe distributional impact. Initial conditions,competition enhancement and market structurereform affect performance of privatized firms asmuch or more than ownership change. 26 Morethan ownership change is required for the ma-jority of households, poor and middle-incomepeople to benefit from privatization’s efficiencygains.In the case of infrastructure, where so much

of the distributional problem has arisen, thekey factor emerging from the above discussionis the creation or reinforcement of an inde-pendent, accountable regulatory regime, notsimply in law, but in functioning practice––i.e.,one that can design and monitor contracts,offer economically rational, legally enforceablerulings, and is resistant to capture by privateproviders. The better the regulatory regime,the better has been the distributional outcomefrom privatization of electric power, telephones,water and sanitation. A practical upshot for thecase of infrastructure privatization is that sell-ing governments, and those that assist them,should invest more upfront attention and effortin the creation and strengthening of regulatorycapacity, and less in organizing quickly trans-actions. This means taking the time to laythe required institutional foundations. In theUnited Kingdom it took five years for theregulators of the privatized electricity industryto master the skills needed to squeeze out bene-fits for the average consumer (Newbery, 2001).If that is the case in an OECD setting, what canone reasonably expect from new regulators indeveloping and transition countries?Advice to move slowly is not a costless pre-

scription. The period between the launching ofa regulatory regime and the assessment that it isin proper working order could be, probably willbe, long. In the interim, losses in the affectedfirms could continue and mount, oppositionto reform harden, reformers grow weary. Wenonetheless judge that the prescription holds.Effective regulation is a double winner: neces-


sary in the short-run to minimize troublingdistributional outcomes, it is equally importantto maximize efficiency.We conclude with three points regarding fu-

ture policy. First, privatization of firms pro-ducing goods and services sold in competitivemarkets has not posed a distributional prob-lem, even in low-income countries (Nellis,2003). This form of divestiture generally opensthe way for small and medium businesses tothrive. All developing and transitional coun-tries should move forward and conclude thissort of divestiture.Second, privatization’s distributional record

even in infrastructure is not as bad as popularlythought. Where attention has been given tocreating the right regulatory framework, thesetransactions have led to increased access, es-pecially for the poor.Our third, admittedly less concrete point is

that selling governments can and should domorein their privatization programs to maximize thepotential distributional gains. We believe it isdesirable and possible for governments––and

those that assist them––to design and implementprivatization to obtain gains in both distribu-tional and efficiency/growth terms. It is folly todismiss equity problems as an unavoidable,temporary price to be paid for putting assetsback to productive use. Equity can be enhancedwithout harm to efficiency; indeed, short-termattention to equity concerns can boost medium-term efficiency. Societies might reasonablychoose an initially less efficiency-oriented ap-proach, in order to diminish long-run risks toefficiency and growth that initial resulting ineq-uities would undermine (through corruption orrent-seeking for example). Minimizing thesometimes real unfairness produced by privati-zation, and––just as important––countering themisperception that privatization is always andinevitably unfair, is worthwhile, so as to preservethe political possibility of deepening and ex-tending reforms. In the end, a democratic gov-ernment cannot implement reform when massesof people are in the streets attacking that reform,and, of course, no government can enact reformif it is not in power.

NOTES

1. Survey conducted by Latinobarometro, interviews

conducted in April and May 2001, results presented in

The Economist, July 28–August 3, 2001, p. 38.

2. See Tandon (1995), who argues: ‘‘. . .there are, of

course, many cases where privatization appears to

have �resulted’ in efficiency improvement; in most of

these cases, however, the privatization appears to have

been contemporaneous with deregulation or other

types of competition-enhancing measures’’ (pp. 229–

230).

3. Birdsall, Ross, and Sabot (1995) argue that the lack

of any tradeoff explains why the East Asian tigers, with

relatively low inequality, grew rapidly in the 1960s

through 1980s compared to Latin America, with its high

inequality.

4. Thus, as Easterly (2001) notes, additional invest-

ment capital or additional foreign exchange provided by

aid will not necessarily yield any additional product or

growth.

5. See for the theoretical underpinnings of this view

Aghion, Caroli, and Garcia-Penalosa (1999), and Ben-

abou (1996); for some empirical refinements, see Barro

(2001) and Birdsall et al. (1995).

6. As argued by Stiglitz (1999a, 1999b).

7. Discussions of the distributional effects of privati-

zation in transition economies positing negative out-

comes include Alexeev (1999), Ferreira (1999), McHale

and Pankov (1999), Nellis (1999, 2002), and Stiglitz

(1999a, 1999b). �AAslund (2001) and Shleifer and Treis-

man (2000), present a countering, much more positive

interpretation of events.

8. For other Latin American cases see Barja and

Urquiola (2001, Bolivia), Delfino and Casarin (2001,

Argentina), Chisari, Estache, and Romero (1999, Ar-

gentina), and Paredes (2001, Chile).

9. Governments often underprice to ensure that the

sale will go forward. The principal purchasers thus get a

bargain. But another reason for underpricing is to

encourage local citizens to take part. A mechanism

devised with at least some distributional purpose may,

overall, add to inequity. Large share price increases in

the first day or days following sale are common;

Megginson and Netter (2001, p. 366) review five studies

documenting ‘‘significant, often massive levels of under

pricing’’ in China, the United Kingdom, Malaysia and

Hungary and elsewhere.


10. Other literature surveys reaching similar positive

conclusions (see Sheshinski & L�oopez-Calva, 1998; Shir-

ley & Walsh, 2000). A review of the effects of ownership

change in transition economies is found in Djankov and

Murrell (2002).

11. The Bolivians ‘‘capitalized’’ a group of the largest

state firms, by selling 50% of equity to strategic

investors, who committed to investing the total sales

price into the firms themselves (Barja & Urquiola, 2001).

12. In many countries many poor people are not

connected to any of the infrastructure networks, making

moot the issue of gains and losses relative to other

income groups. Still, a surprisingly high percentage of

the developing world’s population is connected to the

electricity grid; a smaller fraction has formal water or

telephone services (see Komives, Whittington, & Wu,

2001).

13. �AAslund (2001, p. 21) argues that that any attempt

to avoid or delay privatization in transition economies

would only have compounded the pain; indeed ‘‘. . .the

higher the level of privatization that an ex-communist

country has attained, the higher economic growth it has

achieved.’’ Shleifer and Treisman (2000, p. 38) see the

inequities of Russian privatization as ‘‘. . .troubling, but

not exceptional. . . privatization in Russia worked con-

siderably better than its politically feasible alternative:

doing nothing.’’

14. Again, see Stiglitz (1999a, 1999b).

15. Employees often sell quickly shares acquired in this

manner, but even then they tend to benefit since

government sellers tend to greatly underprice the initial

offerings.

16. According to the European Bank for Reconstruc-

tion and Development (1999), vouchers were the pri-

mary method of privatization in nine of 26 transition

states, and a secondary method in an additional 11.

17. Technical reviews assess the outcomes of Bolivia’s

programs as positive in both efficiency and equity terms

(Barja & Urquiola, 2001), but the program remains

deeply unpopular in Bolivia. Nonetheless, the architect

of capitalization, Gonzalo S�aanchez de Lozada, was

returned to the presidency in the elections of 2002.

18. Galal, Jones, Tandon, and Vogelsang (1994) at-

tempted to estimate these factors for the 12 privatiza-

tions they studied. They concluded that no worker lost

out as a result of privatization, but that conclusion

appeared to rest largely on several questionable assump-

tions; e.g., that workers who lost their jobs had received

the average wage.

19. Behrman, Birdsall, and Szekely (2000) found in a

large sample of reforming Latin American countries that

privatization was not responsible for increasing wage

differentials, and indeed, was probably a factor mitigat-

ing the increasing disparities. Chisari et al. (1999) argued

that privatization in Argentina was not responsible for

the large increase in general unemployment seen in 1993–

95. McKenzie and Mookherjee (2002) calculate that

privatization was not a principal cause of rising unem-

ployment in the 1990s in Argentina, Bolivia or Mexico.

20. This would seem to be easy to determine, but

different studies reach different conclusions, depending

on the base year chosen and several other factors. In the

Argentine case, for example, Delfino and Casarin (2001)

assert large price increases post-privatization; Ennis and

Pinto (2002) state that prices for the privatized utility

services declined significantly.

21. This study contains numerous practical suggestions

on how to protect the poor, in terms of access and price,

in infrastructure reform.

22. The few pioneering studies include Appiah-Kubi

(2001), Due and Temu (2002), and Temu and Due

(1998); see also Nellis (2003).

23. In these (see, for example, Barja & Urquiola,

2001; Delfino & Casarin, 2001; Ennis & Pinto, 2002;

Estache et al., 2002; L�oopez-Calva & Rosell�oon, 2002;

T�oorero & Pasc�oo-Font, 2001) innovative techniques

are used to estimate the distributional impact of utility

privatization using household expenditure survey data.

24. Djankov and Murrell (2000) argue that institutions

particularly relevant to privatization are the function-

ing, accessibility and honesty of the legal/judiciary

systems, particularly with regard to the arbitration of

commercial disputes and the enforcement of contracts;

the structure and prudential regulation of capital mar-

kets and insolvency/bankruptcy regimes; and the capa-

city of the state to regulate remaining natural monopoly

firms to protect consumers from the abuse of monopoly

power.

25. Not specifically in terms of shifts in distribution,

but in terms of what change in total welfare was brought

about by the privatization, and how was this welfare

change, positive or negative, allocated among relevant

societal actors or groups––the sellers, buyers, consum-


ers, workers, competitors, etc. This is similar to if not

exactly the same thing as a calculation of distributional

consequences.

26. See note 2 above, referring to Tandon (1995). See

also Newbery and Pollitt (1997). In one of the only

efforts to review econometrically the question, Zinnes,

Eilat, and Sachs (2001) analyze the relative power of

ownership versus nonownership reform factors in ex-

plaining privatization outcomes in transition economies.

They conclude that both matter: In privatized firms

‘‘. . .economic performance gains. . .. occur once key

institutional and �agency’-related reforms have exceeded

certain threshold levels’’ (Abstract). But, the same non-

ownership changes in the absence of privatization

change produce much less effect.

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FURTHER READING

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winners and losers: assessing the distributional impact of privatization

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