Why Are Developing Countries Privatizing?

Author(s): Ravi Ramamurti Reviewed work(s): Source: Journal of International Business Studies, Vol. 23, No. 2 (2nd Qtr., 1992), pp. 225-249 Published by: Palgrave Macmillan Journals Stable URL: http://www.jstor.org/stable/154899 . Accessed: 17/11/2012 02:42
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WHY ARE DEVELOPINGCOUNTRIES PRIVATIZING? Ravi Ramamurti*

Northeastern University

Abstract. This article tests alternative hypotheses about why developing countries are pursuing privatization, a policy that gained considerable popularity in the 1980s. Univariate and multivariate analysis indicate that privatizationwas more likely to be pursuedby countrieswith high budget deficits,high foreign debt, and high dependence on international agencies like the World Bank and the IMF. In regions such as Latin America and Asia, the trend was also more likely in countries (a) that seemed to have "overused" state enterprises in the past, and (b) those in which the private sector had grown faster than average and was thus more ready to assume tasks once assigned to state enterprises.In Africa,however,the policymay have been imposed by external agencies on countries that were not necessarily ripe for privatization. multinational For firms,the internationalopportunities created by privatization are likely to be greater in the 1990s than in the 1980s.
Privatization refers to the sale of all or part of a government's equity in state-owned enterprises (SOEs) to the private sector, or to the placing of SOEs under private management through leases and management contracts [Vuylsteke 1988: 8-40]. Privatization was adopted on a worldwide scale in the 1980s, covering both rich and poor countries, large and small nations, and governmentssubscribingto the full spectrumof ideologies. The Economist described the trend as the "greatest exchange ever between private citizens and their governments" [Economist 1985: 71]. Well-known examples of privatization include the sale of firms like British Telecom, British Gas, and Japan Air Lines to millions of small investors, and the sale of the Chilean state-owned airline or the Mexican telephone company to multinational enterprises and foreign investors. Privatization is also under way in several communist countries. *Ravi Ramamurti AssociateProfessorof BusinessAdministration, is Northeastern University,andan Associateat the Harvard Centerfor International Affairs(199192). His researchand consultingfocus on topics in business-government relations, the particularly questionof privatization. volume he co-editedwith Raymond A Vernon,Privatization and Controlof State-Owned Enterprise, was publishedlast year by the WorldBank.
Valuableresearchassistanceby Miclhelle Smith,a graduate studentat Northeastern University,and commentsby Alvin Wint are gratefully acknowledged. Received:August 1990;Revised:November1990 & August 1991;Accepted:November1991. 225

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Through much of the 1980s, privatizationtended to touch only the periphery of the public sector in most developing countries [Ramamurtiand Vernon 1991: 7-16]. More recently, it has begun to reach into the core of the public sector in some countries, notably in Latin America, where a few dozen large SOEs in sectors such as airlines and telecommunications have been sold [Glade 1991; Ramamurti 1991]. But will this trend last? And how many countries are likely to follow the example of Argentina or Chile and turn over the core of the SOE sectorto privateowners?As developingcountriesbegin to privatize large SOEs or ones that dominate national markets, opposition from consumers, workers, civil servants, managers, and politicians is likely to get stronger (see, for example, Austin et al. [1986]), and the political will of governments to pursue privatization is likely to be tested more severely than at any time in the past. The purpose of this article is to explore the underlyingcauses of privatization in developing countries so that, among other things, its future course can be predicted on the basis of informed judgment. We focus exclusively on countriesdevelopingcountries-ratherthanboth developingand industrialized because the causes of privatization appear to be somewhat different in the two groups of countries. That apart, developing countries constitute an importantpartof the global economy, accountingfor 76% of world population, 31 % of world trade, and experiencing rates of growth two to three times those of industrialized countries [World Bank 1986, Tables 1, 2, and 9]. We limit ourselves to economic explanations for privatization, as opposed to ideological, historical, or political explanations. This is less of a limitation than one might first think because economic factors often lie at the root of some of the other explanations. For instance, changes in political power may reflect changes in the economic strength of various actors, or changes in a country's ideology may be the result of dissatisfaction with the country's economic performance under a different ideology. in Economic explanationsfor privatization developing countriescan be divided into two types, proximate and enduring causes. From the viewpoint of prediction,it is useful to know to what extent privatizationis driven on the one hand by expediency and on the other by enduring factors. For instance, are governmentsprivatizinglargelybecause it is an easy way to raise cash to fmance budget deficits? Are they being forced into it by powerful international donors on whom they became very dependentin the 1980s? Or are they doing of so because it is likely to improvethe long-tenn performance theireconomies? HYPOTHESES of We begin with a consideration proximateor immediatecauses of privatization. Proximate Causes Fiscal Pressures on Governments. The governments of both rich and poor countries found themselves with large budget deficits in the 1980s. At one

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time, those deficits might have been financed through domestic or foreign borrowing, but the scope for doing so had diminished in the 1980s. In the aftermath of the oil crisis and the debt crisis that followed it, governments found it difficult to squeeze money out of taxpayers and savers at home and from lenders abroad. This turned privatization into a serious option for improving the short-termcash flow of governments [Yotopoulos 1989: 699]. In the case of money-losing SOEs, privatizationwould stem the outflow of public funds in the form of subsidies and grants; in the case of profitable SOEs, it would increase the government's short term cash flow because the firms could be sold for a multiple of their annual earnings. Country studies have noted that governments typically realize less from privatization than might first be expected. As noted earlier, it is common for governments to underprice shares in public offerings to ensure a quick and "successful" sale [Seth 1989: 34]. It is also common for governments to convert an SOE's loans to equity, write off parts of its debt, or to inject cash into the firm before privatizationso as to make it attractiveto prospective buyers. In other instances, governments lower the potential realizations from privatization by deciding not to sell to certain groups of buyers (such as foreigners or specific ethnic or business groups in the country) and by constraining the privatized firm's ability to lower costs in the future-for example, by requiring the buyer to guaranteethat workers would not be laid off or paid any less in the future [Leeds 1989]. Yet, despite such factors, country studies indicate that if a sufficient volume of state assets is sold, a government can rake in a tidy sum of money in the short run. Britain raised over 17 billion pounds through privatization between 1979 and 1988 while Chile raised $850 million between 1975 and 1980 [Aharoni 1988: 25-6; Nankani 1988: 19]. If there is any merit to the "fiscal pressures" explanation for privatization, countries pursuing privatization would have higher budget deficits as a share of GDP than those not pursuing it. In addition, they might also be expected to have higher levels of domestic public debt and external borrowings than nonprivatizing countries, since presumably the inability to finance deficits We is what promptscountriesto considerprivatization. thus have the following hypotheses: H-lA: The governments of privatizing countries will on average have higher budget deficits as a share of GDP than the governments of nonprivatizing countries.
H-1B: The domestic public debt of privatizing countries will on

averagebe higher as a share of GDP thanthat of nonprivatizing countries. H-IC: The external debt of privatizing countries will be higher on averageas a share of GDP thanthatof nonprivatizingcountries.

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These hypotheses assume that there is some thresholdlevel of budget deficits or debt above which governments find deficits hard to finance. H-1A to H-1C are more likely to be accepted if those threshold levels fall within a narrow range across countries. InternationalPressure on Governments.A second proximate cause for privatization is the pressure applied on developing countries by international donor organizations such as the World Bank, InternationalMonetary Fund (IMF), and the US Agency for International Development, to pursue this policy as part of a package of economic reforms [Aylen 1987; Babai 1988]. Whereasprivatizationhas for long been encouragedby USAID for ideological reasons, it took on a new importance in the 1980s in the other two agencies [Babai 1988: 260-7]. The IMF, for instance, was no longer content merely with eliminating government subsidies to SOEs or raising their prices but actively sought to transfer their ownership to the private sector. And the World Bank, which used to be concerned mainly with the soundness of individual projects in the 1960s and 1970s, became concerned with broad economic policies and the question of ownership in the 1980s, especially in the context of structuraladjustment loans. Both international agencies may also have veered towards privatization because of pressure from the conservative governments of industrialized countries such as the United Kingdom and the United States [Babai 1988: 275]. Thanks to the fiscal pressure on governments in developing countries in the 1980s, the exogenous shift in favor of privatization by international aid agencies may have occurred at the same time that developing countries were growing more dependent on those agencies for funds. The nodal role of international agencies would then explain the simultaneous shift in favor of privatization in so many developing countries in the 1980s. H-2A: Privatizingcountrieswill have higherlevels of financialdependence on the World Bank as a share of their GDP than nonprivatizing countries. H-2B: Privatizingcountrieswill have higherlevels of financialdependence on the IMF as a share of their GDP than nonprivatizing countries. Long-tern Causes In contrast to the proximate causes just discussed, case studies of individual countries point to long-term causes that seem to have worked their way slowly but surely into the policy analysis of government officials over the last two to three decades. We consider below three such causes, all of which imply some sort of learning on the part of governments about how best to use SOEs as instruments of public policy. Privatization is seen as a result of that learning process. Excessive Use of SOEs. One long-term explanation is that some countries carried the use of SOBs too far within their economies, presumably into

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activities where state ownership had little justification on economic grounds. Ptyor [1976] and Jones and Mason [1981] have shown that economic factors such as capital intensity, high market power, natural monopoly conditions, high economic rents, and externalities are associated with the occurrence of SOEs in a wide range of countries. But, in varying degrees, countries created SOEs in industries where these economic characteristics were not present. Sometimes, this was the result of historical accident, as when the nationalization of a private monopoly brought into government ownership subsidiary companieswhere state ownershipmade little economic sense. In otherinstances, wholesale nationalization in the chaotic circumstances following a country's independenceor a politicalrevolution(e.g., Bangladesh,Nicaragua,Philippines) brought some firms into state ownership that might not have been nationalized under calmer circumstances. In all such cases, a wave of corrective privatizationmight be expected some years after those SOEs came into being. But how is one to tell which countries carried state ownership too far? A simple measure would be the value added by SOEs, expressed as a share of nationaloutput;countrieswith high sharesmight be regardedas "overusers" of SOEs. However, that measure has flaws. Some countries have higher values of this measure not because they are overusers but because sectors with a high propensity for state ownership account for a high share of national output. Thus, SOEs accounted for 27.5% of GDP in Venezuela [Shirley 1983: 95], not necessarily because that country was an overuser of SOEs but because oil, which has a high propensity for state ownership, accounted for a large share of Venezuela's GDP. In other words, the proper way to judge "overuse" or "underuse" of SOEs is to examine their shares in individual sectors of the economy, not in aggregate output. Unfortunately, estimating overuse rigorously in this manner is not only cumbersome, but infeasible because of the lack of data. Under the circumstances, cruder variables had to be considered. One such variable is the share of SOEs in gross national investment. This variable is less likely to swing violently in value because of the presence or absence of a major naturalresource industryin an economy. (Naturalresource industries are probably most responsible for creating misleadingly high values of SOE shares in GDP.) To take the example of Venezuela again, the share of SOEs in Venezuela's GDP (1978-80) was about three times the average for developing countries (27.5% versus 8.6%) while their share in Venezuela's capital formation during the same period was only one-third higher than the average for developing countries (36.3% versus 27.0%). Thus, the following hypothesisis offered to test whetheroveruse of SOEs is a reasonfor privatizing. H-3: The shareof SOEs in gross nationalinvestmentwill on average be higher in privatizing countries than in nonprivatizing countries.

In the above hypothesis, the share of SOEs in national investment should be measured prior to the launch of a privatization program; otherwise, the

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hypothesis could be falsely rejected. This was ensured in the study by using data on the independent variable for some year before 1980. With the exception of Chile and a handful of isolated cases, large-scale privatization did not occur in the developing world before the 1980s. Disillusionment with SOEs. A second long-term explanation is based on the argument that, over the years, governments have become disillusioned with the performance of SOEs and learned that the inefficiencies associated with state ownership were higher than expected. Thus, it is argued, governments have discovered that solutions to the market failure problem (i.e., SOEs) introduce new problems of their own-described sometimes as "nonmarket failures" or "government failures" [Wolf 1987]. Governments seem to have grudgingly accepted this view after evidence mounted that a variety of solutions to the problem of managing SOEs failed to produce an improvement in the performance of state-owned firms. Although some SOEs have performed remarkably well in almost every country, there is no mistaking the tone of disappointment that rings through government reports on SOEs in developing countries (e.g., Republic of Kenya [1979]; Republic of Korea [1984]). Under these circumstances, privatization would be the strategy to correct past policies based on a miscalculation of the costs and benefits of using SOEs. There is, however, a practical problem in measuring the performance of SOEs objectively. Unlike private firms, financial profitability cannot be used solely to judge the performance of SOEs because they were often created to achieve social or strategic objectives rather than to maximize profits. Moreover, the reportedprofits of SOEs often depend critically upon prices set by government. Nevertheless, there is evidence that in practice policymakers rely heavily on financial profitability to judge the overall performance of SOEs (see, for example, Ramamurti [1987]), despite the criterion's well-known shortcomings [Likierman 1983]. Therefore, financial profitabilityis a reasonableproxy for how satisfied or dissatisfieda government is likely to be with the performance of its SOEs. The financial performance of SOEs has been unsatisfactory for much of the last two decades [Short 1984] and there is no evidence that it worsened sharply in the 1980s. Therefore, disillusionment with the performance of SOEs cannot explain the timing of the privatization revolution but it might provide part of the explanation for why some countries and not others were pursuing privatization in the 1980s. Accordingly, the following hypothesis is offered: H-4: The financial performance of the SOE sector in privatizing countries is likely to be worse on average than that of the SOE sector in nonprivatizing countries.

Obsolescence of SOEs. Another long-term explanation for privatization is that it is a pragmaticresponse of developing countriesto changing conditions

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that have made SOEs less necessary than they were a few decades ago [Vernon 1988]. In this view, governments created SOEs in the early stages of development because they enabled the countryto overcome marketfailures, including the relatively underdeveloped nature of the private sector, product markets, and capital markets. However, the argument goes, many of those constraints no longer apply and the private sector has matured to the point where it can take on tasks that only SOEs once could or would. Whereas the previous hypothesis was based on the premise that governments had misjudged the costs and benefits of using SOEs, this one asserts that the calculations had changed in the last three decades in favor of the private sector. If this were true, countries pursuing privatization should differ significantly from those not pursuing it in terms of the rate at which their private sectors had developed in the last two to three decades. There is, however, no single, all-encompassing measure of the rate at which a country'sprivatesectorhas developed.Severalpartial measuresare conceivable: rate of growth of private sector output; rate of growth of commercial establishments; rate of growth of funds raised in local capital markets; or rate of growth of management graduatesproducedper year. However, multi-country data is hard to come by on variables such as these. A less satsifactory measure, on which data is available, is a country's long-term rate of growth of output (GDP). This can serve as a proxy for a country's potential ability to spin SOEs off to the local private sector, assuming that the higher a country's GDP growth rate, (1) the more likely it is that its home markets would have grown big enough to permit competition in industries once dominated by SOEs; (2) the more likely it is that the local private sector can overcome absolute capital barriers that once made it necessary for the state to enter capital-intensive industries; and (3) the more likely it is that the private sector's technical and managerial capabilities have grown to the point where it can take over complex enterprises that at one time only the state was willing and able to run. Accordingly, the following hypothesis is offered: H-5: Long-term GDP growth will be higher on average in privatizing countries than in nonprivatizing countries.

The proximate and long-term causes mentioned above cover several but not all explanations for privatization. For example, privatization is sometimes seen as a strategy to reduce the power of labor unions, since unions tend to be especially strong in SOEs. Similarly, privatizationcan be used to promote "popular capitalism," although Vickers and Yarrow [1988: 188-94] have argued that this objective can be better achieved through tax incentives. Our study does not directly test the validity of these arguments either because they are difficult to operationalize or because data is unavailable. Note also that the explanations we do consider are not mutually exclusive; in fact, several of them could be operating simultaneously in any country.

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Some of them may even be causally connected: For instance, poor financial performance by SOEs (H-4) could contribute to high government budget deficits (H-1A), which, in turn, could force countries to turn to the IMF/World Bank for funds (H-2A and H-2B). The stronger the linkages between causal variables, the less feasible it is to estimate their individual impacts on privatization; the question of multicollinearity will be discussed further in the section on results. METHOD Sample The sample for the study consisted of all developing countries other than high income oil producing nations (e.g., Kuwait, Saudi Arabia), which were excluded because their economic circumstances are so different from those of other developing countries. For instance, the oil price hikes of the 1970s strengthened the government budgets of oil-exporting countries and boosted the financial performanceof their state-owned sectors because of the inflated profits of their state-owned oil companies. Further, the oil crisis turned oil exporting countries into net contributors ratherthan recipients of international aid. Also excluded from the study were eastern bloc countries and their close allies (such as Cuba and Afghanistan)on which data was eitherunavailableor extremely sparse. This yielded a sample of eighty-three countries. Measures Privatization was defined to cover only the sale or leasing of state-owned enterprises, while the privatization of government services, such as prison management and social security administration,were excluded for want of data. This definition is consistent with the 1988 World Bank survey, which contains the most comprehensivedata on privatizationin developing countries [Candoy-Sekse and Palmer 1988; Vuylsteke 1988]. The eighty-threedeveloping countrieswere divided into three groups, "active privatizers" (twenty-eight countries), "cautious privatizers" (twenty-one countries),based on whether they countries)and "nonprivatizers"(thirty-four had completed five or more transactions,between one and four transactions, or zero transactions,respectively, by December 1987. Data for classification was obtained from Annex E, Table III of Vuylsteke [1988: 177-80]. (See Appendix 1 for the countries in each group.) The adjectives "cautious" and "active" as well as the cutoff levels are arbitrary;our only intention was to distinguish between different degrees of privatization in the absence of more quantitative measures of privatization. Ideally, we would have measured degree of privatization by the value of assets privatized in relation to the total value of SOE assets in the country. Unfortunately, the World Bank survey does not provide uniform cross-national data on such measures, thus forcing recourse to cruder measures.

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It should be noted that only completed transactions or those under way at the time of the survey rather than planned privatizations are used to judge a country's degree of privatization, because a country's commitment to privatization is reflected more reliably in its actions than in official rhetoric or plans. Consequently, a country like Nigeria, that had plans in 1987 to privatize nearly 100 SOEs but had actually sold only one SOE is classified as a cautious privatizer ratherthan an active privatizer. Given our definition, it is more difficult for countries to qualify as privatizers-and especially as active privatizers-than one might suspect from the very low cutoff levels used to define the categories. A simple trichotomy of the sort used in this study has obvious flaws. It places countries such as Brazil, that had privatized eighty-seven SOEs by December 1987 on par with Ghana, which had only privatized six SOEs. At the same time, it makes a sharp distinctionbetween countries like Portugal and Colombia that had completed a single transaction each and those that had completed none. It also ignores completely the size of firms privatized. The crude method by which countries are classified, along with the inaccuracies that probably exist in the World Bank survey, imply that only robust patterns may be detectable in our analysis. Having classified countries into three categories, we limit our statistical tests to a comparison the extremegroups,"nonprivatizers" "activeprivatizers," of and since these groups are likely to differ more from each other than either one of them does from "cautious privatizers." By comparing the extreme groups, we increase the likelihood that our hypotheses, if true, will be confirmed despite imperfect measures and data. We will, however, comment briefly on the results observed for the intermediate group of "cautious privatizers" without cluttering the paper with too many statistics. Table 1 shows that the measures used to operationalizeindependentvariables were standardized by country size (GDP) to permit crossnational comparisons. Since the dependent variable was measured as of the end of 1987, data on the independent variables pertained to some earlier year, usually between 1981-85, except in the case of three variables: GDP growth rate (GDPGRWTH) was measured over the period 1965-84, while the share of SOEs in national investment (SOESHARE) and the past performance of SOEs (SOEPERF) were measured in most cases at some point in the late 1970s. Appendix 2 describes the data sources used. Model Since privatization is being treated as a categorical variable in this study, qualitative choice models such as discriminant analysis or LOGIT models are appropriate.In either case, the objective would be to predict a country's membership in the actively privatizing or nonprivatizing categories based on the explanatory variables proposed in the hypotheses. However, the data available on the domestic debt (DOMDEBT) and past performance of SOBs

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(SOEPERF) were so scanty that a lot of information on the other variables would have been lost if only multivariate analysis had been performed. Therefore, both univariate and multivariate tests were conducted. For multivariate analysis, the LOGIT model was preferred to discriminant analysis since it is believed to yield consistent and more robust coefficients than discriminant analysis. Further, since computational simplicity is not a consideration in the present day of inexpensive data processing, one of the traditional advantages of discriminant analysis over maximum-likelihood LOGIT models no longer holds. Further, in actual runs using our data, LOGIT performed better in terms of prediction than discriminant analysis. Therefore, only LOGIT results are reported. In the binomial LOGIT model, the probability of a country being an active privatizer is derived from the cumulative logistic probability function in which the argument is a linear combination of the explanatory variables [Pindyck and Rubinfeld 1981]: P (probability that a country is an active privatizer)= 1/{ 1+e-(A+BX)}, where A is a constant, B is the vector of coefficients, and X represents the independent variables. Simple manipulation then leads to the result: log{P/(1 - P)} =A + BX. Parameters A and B can then be estimated using a maximum-likelihood estimation procedure. The coefficients indicate the increase in the odds that a country will be an active privatizer for unit increases in the independent variables. RESULTS As seen in Table 1, the explanatory variables are reasonably independent of one another except for (1) the positive correlations between the level of budget deficits and various measures of domestic and foreign borrowing; and (2) the negative correlation between GDP growth (GDPGRWTH) and various measures of external borrowing. The significant inter-correlations between WBANKDEP, IMFDEP, and EXTDEBTsuggest that the coefficients of these variables may be less reliable than some others in multivariate analysis. We begin by testing the hypotheses individually. Univariate Analysis Table 2 presents the differences in means for relevant variables across active privatizers and nonprivatizers. All means shown are simple averages rather

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than weighted averages (using, for instance, GDP as weights) since we are interested in explaining the number of countries privatizing rather than the magnitude of assets being privatized. The last column indicates whether or not the difference in means had the hypothesized sign. Proximate Causes. As Table 2 shows, the hypothesis that, on average, active privatizers would have higher budget deficits than nonprivatizers (H-1A) was rejected. So was the hypothesis that privatizers would have higher domestic public debt than nonprivatizers (H-1B), although this was based on only twenty-six observations. However, the hypothesis that privatizers would have higher external debt than nonprivatizers (H-1C) was accepted at the 1% level: in fact, the difference in this measure between the two groups of countries was twenty-six percentage points. As hypothesized, active privatizers were more dependent on both the World Bank (H-2A) and the IMF (H-2B) than nonprivatizers, with the differences being statistically significant at the 5% and 1% levels, respectively. (The ratio of World Bank loans to GDP is typically greaterthan that of IMF loans to the same country because World Bank loans are of longer maturity.) Indeed, the active privatizers were more than twice as dependent on IMF funding as nonprivatizers. Causes. The second part of Table 2 shows that all hypotheses Long-ternm about the long-term causes of privatizationare rejected. The size of the SOE sector, on average, is not significantly larger for active privatizers than for nonprivatizers (H-3). The operating deficit of the SOE sector as a percentage of value added was not signficantly higher in privatizing countries than in nonprivatizing countries (H-4), although this result was based on only fourteen countries. Neither was the average GDP growth rate of active privatizers significantly higher than that of nonprivatizers (H-5). Taken together, univariateanalysis suggests that proximatecauses, especially externalfinancial dependence, ratherthan long-term factors, are associated with privatization. Moreover, it appears that if budget deficits are financed by domestic rather than external borrowing, privatization may be a less likely prospect. However, one must keep in mind that there were more methodological and data problems in testing Hypotheses 3 to 5 than there were with the "proximate causes" hypotheses. The average values for cautious privatizers (not reportedhere) tended to fall somewhere between those of active privatizers and nonprivatizers on three of the four variables that showed statistically significant differences earlierEXTDEBT, WBANKDEP, and IMFDEP. Only in the case of SOEPERF, where the number of observations is very small, is there a see-saw pattern as one moves from active privatizers,to cautious privatizers,to nonprivatizers. Multivariate Analysis Two variables with missing values for many observations, domestic debt (DOMDEBT) and past performance of SOEs (SOEPERE), were excluded

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from the multivariate analysis because including them would have reduced the number of usable observations to about a dozen. Omitting SOEPERF and DOMDEBT from the analysis should affect the value of only the constant since neither is strongly correlated with any of the other variables (see Table 1). Only twenty-nine observations were available for multivariate analysis, divided 10:19 between nonprivatizers and active privatizers. The LOGIT sample is not representative of the population of eighty-three LDCs. African countries accounted for 21% of the LOGIT sample but 42% of population of eighty-three developing countries, while Latin American and Caribbeancountries accounted for 42% of the LOGIT sample and only 24% of the overall population. However, if our hypotheses hold uniformly across regions, we would predict positive signs for all variables retained in the LOGIT model. Table 3 shows that all (standardized)coefficients but one are indeed positive and significant at the 5% level or better. Only the coefficient for IMFDEP is negative (p<0.10), and possible explanations for this follow. Overall, the model fits the data well (R2=0.95). The correct classification ratio of 100% is a big improvement over random classification with an a priori probability of 65.5 %, which is the proportionof active privatizersin the LOGIT sample. the of Besides corroborating evidence on the importance "proximatefactors"and strengthening it in the case of budget deficits-multivariate analysis provides evidence that "long-term factors" (GDPGRWTHand SOESHARE) are also associated with privatization.However, the standardizedcoefficients of proximate factors (EXTDEBT, WBANKEP, and BUDGDEF) are all greater in magnitude than those of the long-term factors, SOESHARE and GDPGRWTH. Comparingthe results of univariateand multivariateanalyses, two differences stand out. First, IMF dependency seems to be strongly associated with privatization, while the opposite is indicated by the LOGIT model. Second, GDP growth rate shows no significant difference in univariate analysis but has a significant positive coefficient in multivariate analysis. One possible reason for IMFDEP's negative sign in the LOGIT analysis is multicollinearity,since that variableis fairly highly correlatedwith EXTDEBT and WBANKDEP(see Table 1). However, tests suggested by Belsley et al. [1980] indicated only weak dependency in the data matrix.1This leads to a second explanation, namely, that the factors associated with privatization may be differentin the two samples-specifically, in African and non-African countries. Since multivariatetests could not be run separatelyfor the African subsample, t-tests shown in Table 2 were repeated for two subsamples: African countries and countries included in the LOGIT analysis (a few of which were African).Table 4 shows thatthe negative sign for IMF dependency in multivariateanalysis is still unexplainedsince privatizersare more dependent on the IMF than nonprivatizersin both subsamples, although the contrast

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TABLE 3 LOGITModel Results

Variable Constant BUDGDEF EXTDEBT WBANKDEP IMFDEP SOESHARE GDPGRWTH Correct classification ratio Coefficient 16.80 (4.09)*** 12.46 (2.36)** 19.76 (2.35)** 11.76 (2.09)** -5.94 (-1.89)* 3.01 (2.02)** 9.25 (2.31)** 100.0% 0.953 29 (of which 19 are privatizers, and 10 are nonprivatizers)

R2#
N

#Defined as 1 -ESS/TSS, where ESS=Error sum of squares=Eje? and TSS=Total sum of squares=E1(Yi- Y) . See Pindyck and Rubinfeld[1981, 312]. *p<0.10 **p<0.05 ***p<0.01

is stark in Africa. On the other hand, Table 4 provides some explanation for the difference observed on the GDPGRWTHvariable:in Africa privatizers grew at significantly lower rates than nonprivatizers,while the opposite was true in the LOGIT sample. In a final attempt to explain the negative coefficient for IMFDEP in LOGIT analysis, we searched for "influential observations" or outliers that may have produced the unexpected result [Belsley et al. 1980, Chap. 2]. The LOGIT model was run repeatedly omitting one of the twenty-nine countries each time. The sign for IMFDEP remained negative in every instance except when Mauritius was dropped from the analysis. Mauritius was the only nonprivatizer in the LOGIT sample that had above-average dependence on the IMF. We have no reason to believe that Mauritius was misclassified as a nonprivatizer or that it should be excluded from the analysis. But the marked sensitivity of the IMFDEP coefficient to the inclusion of one observation points to the limitations of using a small subsample of LDCs especially nonprivatizers-in the LOGIT analysis. The results are liable to

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JOURNAL OF INTERNATIONALBUSINESS STUDIES, SECOND QUARTER 1992

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WHY ARE DEVELOPINGCOUNTRIESPRIVATIZING?

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change significantly if new observations are added. Thus, these results are

highly sample dependentand hence should not be extrapolatedto other

situations. It should be added, however, that the coefficients of all variables other than IMFDEP were consistent in sign and relative magnitude when countries were omitted from the analysis one at a time, thus adding a measure of confidence to the results on those variables. CONCLUSIONSAND IMPLICATIONS Despite the incomplete data, a few conclusions can be drawn from the preceding analysis. First, as other observers have noted, privatization does seem to be associated with financial problems in developing countries. Privatizing countries, especially in Africa, have higher budget deficits than nonprivatizing countries, and budget deficits do seem to increase the odds that a country will privatize. Second, privatization seems less likely if those deficits can be financed throughdomestic borrowing,while externalborrowing seems to heighten the odds of privatization. Third, the greater a country's dependence on the World Bank, the greater the odds it will be a privatizer. The same appears to be true in Africa with respect to IMF dependency, but the impact of the IMF in other parts of the world is unclear from our data. To what extent are the proximatefinancialpressuresto privatizecomplemented by long-term economic justifications for privatization? The conclusions here are less clear cut because of poor data and shortcomings in our research methods. The data available does not support the proposition that privatization is prompted by dissatisfaction with the past performance of SOEs. However, there is evidence, at least within the non-African developing world, that privatization is partly an attempt to correct for past "overuse" of SOEs. Likewise, in the non-African world, the data on GDP growth rates supports the notion that privatization is more likely to be pursued by countries whose private sectors have grown fast enough to assume tasks once assigned to SOEs. On the last two factors, Africa presents disconcerting patterns: privatizers did not have significantly larger SOE sectors than nonprivatizers, nor did they experience growth rates that were significantly higher than that of nonprivatizers. Perhaps, as Babai [1988] notes, international agencies need to take a closer look at their policies on privatization in Africa: The frequencyof provisionsfor liquidation and divestiture[of SOEs] in [the World Bank's] structural loans for Sub-Saharan adjustment African countriesis as strikingas theirpaucityin loans for Latin Americanand EastAsian countries. the Bank'srecordis a reliableindicator, ability If the of intemational to institutions pushprivatization increasesdirectlywith the borrower'slevel of desperation.The experiences of Togo and Guinea suggest the lengths to which international agencies can go in bringing influenceto bearon poorercountries.[p. 269]

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What are the implications of these findings for internationalbusiness? From the standpoint of prediction, they suggest that privatization is likely to continue in developing countries in the 1990s because the proximate causes-budget deficits, external indebtedness, and the policies of international agencies seem unlikely to change soon. For instance, even in 1989, the government budget was in surplus in only half a dozen LDCs [World Bank 1990]. Likewise, the external debt of LDCs seems unlikely to decline sharply in the 1990s except perhaps as part of a massive debt relief program like the Brady Plan (e.g., Mexico, Venezuela), in which case extensive privatization is likely to be an important part of the economic reforms expected in exchange by Western governments. Finally, the commitment of internationalagencies to privatization shows no signs of waning as we enter the 1990s. On the contrary, as recently as June 1991 the American and British governments applied pressure on the World Bank to expand lending to privateborrowersin LDCs and to reduce lending to public sector borrowers, who dominated in the past because the Bank's charter did not permit it to lend without government guarantees. Apart from these factors, our finding that privatization is driven not just by financial expediency but may have a measure of economic soundness in Latin America and Asia, suggests that the trend may endure in these regions even if some of the financial pressures were to ease. Although Eastern Europe was not part of our sample, and it is purely speculative to assume that the forces driving privatization there would be similar to those in LDCs, it is interesting to see how they compare with LDCs on some of the variables in our study. One variable on which the communist countries truly stand is the share of SOEs in national output, which varies for them between 30%-70% of GNP, compared to the modal range of 10%-15% in nonoil LDCs and OECD countries [Pryor 1976: 11]. In addition, almost all of the communist countries suffer from high government budget deficits. Finally, some among them (e.g., Poland and Hungary) also have high levels of foreign debt, making them vulnerable to the kinds of external pressures to privatize as LDCs in our sample. Thus, as ideology gives way to economic pragmatismin these countries,large scale privatization is bound to follow. Countries like Czechoslovakia, Hungary, and Poland have already announced plans to privatize a few thousand enterprises each [Lee and Nellis 1991; Lipton and Sachs 1990], while in July 1991, the former Soviet Union announced its first major privatization move--the decision to sell a 30% interest in its automaker,the Volga Automotive Plant Association, to a foreign investor for about $1 billion [New York Times 1991a: 1]. Russian president Boris Yeltsin is even more strongly committed to privatization. The privatization trend creates a predictable set of opportunities and threats for international business managers and MNCs. We will discuss these briefly even though they do not follow directly from the empirical core of

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this paper. Three types of opportunities are evident. The first, arising out of the privatizationtransactionitself, creates numerousopportunitiesfor multinational firms that offer privatization services: For instance, multinational investment bankers are often required to help governments set prices and find prospective buyers for SOEs, including foreign investors; law firms are required to help turn government corporations into marketable joint-stock companies; accounting firms are required to help straighten out an SOE's books, capital structure,etc.; and advertising companies are required to help peddle an SOE's stock, sometimes worldwide. In each of these areas, multinational firms with a worldwide experience base tend to have an edge over purely national companies. One study found that in Britain transaction costs were at least 7% of the gross proceeds of privatization [Vickers and Yarrow 1988: 183]. Considering that in Latin America alone $100 billion worth of state enterprisesmay be divested in the next few years, privatizationrepresents a significant business opportunity for multinational service firms. By 1991, a number of US and British MNCs in these sectors had already set up units specializing in privatization. Additional opportunities to sell services arise when SOEs are leased or placed under management contracts with MNCs, a practice widely used by countries like Jamaica, Sri Lanka, Togo, and Niger. For instance, MNCs took over dozens of hotels in LDCs in this manner, sometimes with options to buy equity at a later date. Similar opportunities for selling operational services are appearing in the telecommunications, power generation, and tourism sectors [Sullivan 1991; Stein 1991]. The second set of opportunities for MNCs lies in the possibility of buying firms that are being privatized. To be sure, foreign capital is not always welcome in LDCs, especially when it takes the form of direct investment, but when the domestic private sector lacks the capital or the technology (or both) to take over complex, capital-intensive SOEs, many goveniments seem to be concluding that they have few other choices. Examples include the sale of the telephone companies in Mexico and Chile or the electric power companies in Argentina to foreign investors, sometimes in partnership with local entrepreneurs.The pressure to rely on foreign investors is even greaterin the communist countries,where the domestic privatesector severely lacks the funds and the expertise to take over large or even medium-sized SOEs [Lipton and Sachs 1990]. Not only have MNCs been able to use such privatizations to gain entry into sectors that were previously off-limits, but they have been able to do so under quite attractive terms, even adjusting for the risks of doing business in these countries. In the telecommunications sector, and to a lesser extent in the airline industry,this seems to be occurring partly because a large number of countries wishing to privatize SOEs in these sectors are chasing after a small number of prospective MNC buyers [Solomon Brothers 1991]. Putting up large SOEs for sale to foreignerseven at discounted priceseems to have become one way of reversing the

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sharp decline in the flow of private foreign direct investment into LDCs that occurred in the 1980s [Bergsman and Edisis 1988, Table 1, p. 3]. In Latin America, the foreign capital for privatization has often come via debt-equity swaps, which offer foreign investors an upfront discount on the investment because the government's redemption price is higher than price of the public debt in secondary markets [Bergsman and Edisis 1988: 2-3]. In Argentina, for instance, the privatization of the public telephone company alone helped retire $5.2 billion in public foreign debt [Luis 1991], compared to only $1.86 billion retired cumulatively before the government permitted swaps to be used to purchase SOEs.2 Thus, privatization is significantly boosting the volume of debt-equity transactionsbecause SOEs are typically large firms. Additional foreign direct investment arises when MNCs, as a side condition of privatization, are required to bring in "fresh funds" to modernize the privatizedfirms, which in turn creates opportunitiesfor other MNCs to export capital goods to LDCs. Mexico's privatized telephone company, for example, is expected to require$15-$20 billion of new equipment in the 1990s. The third set of opportunities created by privatization consists of possibilities for foreign portfolio investment by individuals, firms, and institutional investors. When Malaysia, Mexico, New Zealand, and the U.K. privatized their telephone companies, they sold part of the equity to foreign investors in several countries. TELMEX's international issue of $2,000 million in May 1991 was the largest of its kind by any firm in Mexico and the second largest global offerings ever-next only to the British Telecom offering of 1984. Telecom of New Zealand raised $540 million in similar fashion in 1991, and was the most active stock on the NYSE the week its stock was offered [New YorkTimes 1991b: D2]. In each of these cases, foreign investors profited handsomely because the shares rose sharply within days of the offering.3 Internationalstock offerings linked to privatization are speeding up the integration of global equity markets [Economist 1991: 77-78]. In the long run, privatization can also pose a threat to a multinational corporation if it fails to secure entry into a market through privatization but one or more of its rivals do so. For instance, Spain's Iberia Airlines has aggressively sought equity positions in the airlines being privatized in Latin America, while many of its rivals have not [Feldman 1989]. This is likely to give Iberia a competitive advantage in the Latin American travel market. MNCs should not be surprised if the behavior of a privatized firm changes markedly even when it has not been purchased by another MNC. Even SOEs that have been bought by local entrepreneursor those whose shares have been sold to dispersed investors are likely to be far more aggressive than the erstwhile SOE in seeking new customers and new products. As an SOE, the firm may have been preoccupied with maximizing employment or output, even if that meant dropping prices sharply to secure market share; after privatization it is more likely to be interested in cutting costs and

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maximizing profits [Radetzski 1985]. Freed of government ownership and political interference, it is also likely to be more aggressive in seeking export markets, making foreign investments, and entering into international strategic alliances [Vernon 1979; Jones and Wortzel 1981]. For example, British Airways, British Telecom, and Rolls-Royce seem to have displayed such changes in behavior in the post-privatization phase [Business Week 1989; Morley 1986; Stodden 1988]. Indeed, when several players in an industry are privatized, as was the case in the 1980s in the airline industry, the dynamics of competition in the industry as a whole tends to change significantly. In sum, privatization is likely to increase both global interdependence and global competition. MNCs would be well served to monitor the opportunities and threats created by the trend.

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APPENDIX 1 List of Nonprivatizers,Cautious Privatizers, and Active Privatizersa

Nonprivatizers Ethiopia BurkinaFaso Burma* Nepal* Tanzania Burundi India* Madagascar Sudan Lesotho Yemen, Republic of People's Rep. of Yemen El Salvador China Zimbabwe Nicaragua Botswana Mauritius* Congo Jordan Ecuador Guatemala*
Peru*

Cautious Privatizers Bangladesh Zaire Cen. African Republic Somalia Benin Rwanda Liberia Bolivia Indonesia Honduras Egypt Cameroon Thailand Dominican Republic Venezuela Colombia Portugal Israel Kenya Sierra Leone Nigeria

Active Privatizers Mali* Malawi* Niger Uganda Togo Ghana Sri Lanka* Pakistan* Senegal* Mauritania Zambia* IvoryCoast* Philippines* Morocco Papua New Guinea* Jamaica* Costa Rica* Tunisia* Chile* Brazil* Malaysia Panama*
Turkey*

Iran Paraguay* Syria

Uruguay*

Mexico* South Korea* Argentina*

Singapore

Yugoslavia South Africa

Greece*

Guinea

Hong Kong Trinidadand Tobago Haiti* Algeria aas of December 1987, based on Vuylsteke [1988]. Note that developments since then would cause several countries to be reclassified. *included in multivariate(LOGIT)analysis

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APPENDIX 2 Definitions and Data Sources for Independent Variables

Variable BUDGDEF DOMDEBT Definition/Source Overall government budget surplus or deficit in 1983/84 as a % of GNP. Source: World Bank, WorldDevelopment Report 1986 (WDR), Table 22. Domestic public debt (long term and short term) as a share of GDP for some year between 1981-84. Source: UnitedNations,UN Statistical Yearbook1985/86, Issue 26, Table 31. Total external long-term debt, disbursed and outstanding, as a percent of GNP in 1984. Source: World Bank, WDR 1986, Table 17. Cumulative Bank loans and IDA credits outstanding as a share of GDP in 1984 Source: World Bank, Annual Report 1985, Tables 5-6 Use of Fund resources as of April1985 expressed as a share of GDP. Sources: IMF,Annual Report, 1985, Schedule 1 and World Bank, WDR 1986. Share of SOEs in gross fixed capital formation, in most cases in the late 1970s. Source: Short [1984], Table 1. Operating surplus/deficitbefore depreciation and subsidies as a share of value added by SOE sector Sources: Compiled from Short [1984], Tables 1 and 5 Growth rate in GDP from 1965-84 Source: Calculated from WorldBank Report [1986], Table 2

EXTDEBT

WBANKDEP

IMFDEP

SOESHARE

SOEPERF

GDPGRWTH

NOTES
1. The condition index for the data matrix, defined as the ratio between the highest and lowest eigenvalues, was 11.7. Belsley et al. [1980: 105] regard a ratio of 30-100 as indicating moderate to strong dependencies, and those between 5-10 as indicating weak dependency. Accordingly, collinearity appears not to hold much explanation for the negative sign for IMFDEP. 2. Until 1989, Argentina expressly prohibited the use of swaps for privatization [Bergsman and Edisis 1988: 11]. By the end of 1988, only $1.86 billioni of Argentinian debt had been converted to equity [Grosse 1991, Table 3]. 3. According to Seth [1989], the shares of British SOEs were underpriced on average by 51% by the government, compared to only 3% underpricing in initial offerings by private firms in the same counltry. Telecom of New Zealand rose by 14% on the first day of trading on the NYSE [New York Tiomes1991b]. TELMEX of Mexico and other privatizations in LDCs (e.g., the National Commercial Bank of Jamaica, reported in Leeds [19911) have yielded similarly large gains to investors.

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