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Concepts of Privatization of State-Owned Firms


Research has shown that countries with huge dominant state-owned corporations experience low capital growth compared to states with low state-owned corporations. This is attributed to the effective investment allocation by the privately-owned companies as compared to the state-owned corporations. The current trend in the world has seen most state-owned firms sold to private investors. But the question that one may want to ask is why that most governments are moving towards this trend is. The fundamental reason for this move lies with the need to ensure effective resource allocation and efficient corporate governance. Beck (2001) adds that State ownership investments are guided by political interests rather than the return on capital employed. Much state ownership is therefore viewed as a cause of retarded growth rate in most developing countries. The efficient capital allocation has been exhibited by the developed countries where financial allocation has been diverted to where there are profitable returns as contrasted to the underdeveloped nations whose capital allocation to a large extent follows political interests.

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Allocation role of the economy

The most important role of the economy is to ensure the allocation of resources to the most productive sectors of the economy. This is done through the shifting of resources from the highly lucrative sectors while at the same time declining the investments in sectors with declining returns. One mechanism that is used to correct the discrepancy in the manner in which resources are managed is through the formal financial sector and the protection of minority investors’ interests. Efficiency in the formal sector helps in eliminating the problem of asymmetric information among investors. Information asymmetry results in the problem of adverse selection Q situation in which investors make wrong decisions that may result in the loss of their investments. Minority investors also need to be shielded from insider dealings.

Reasons for privatization

These observations are indeed real and can be justified by the following reasons. First, the fact that state-owned corporations do not have the core motive of maximizing the owner’s wealth is a major contributory factor. For private organizations, the economic criteria on investing are by evaluation of whether the planned investments increase the shareholder’s worth. This, therefore, makes this kind of organization allocate their recourses to thei with high growth prospects. Most state corporations are created with the motive of provision of public goods and merit goods which does not necessarily lead to profit maximization.

Secondly, state corporation management is dominated by individuals who are rewarded for showing political sycophancy. This has resulted in poor corporate governance which robs the corporation of many resources. The political appointees further receive backing and protection from the political class making it difficult for the demotion of the management. Likewise, most of the political appointees lack the needed managerial skills instrumental in the management of resources. In addition, continued political interference and the lack of close monitoring have failed to provide an incentive to the management. Incentives as argued by experts’ impact greatly on the performance of any organization. The lack of incentive, therefore, explains the poor performance of a state-owned corporation. On the other hand, privately owned industries are put at close monitoring by the shareholders who are empowered to participate in the decision-making of the firms. As owners, shareholders keep watch of the firm’s performance and participate in the nominations to the board of directors. Such monitoring, therefore, enhances the performance of private firms hence a reason for privatization.

Laxity in the management of state-owned firms as well arise due to the reason that governments always provide soft advances to their corporation. When facing financial hurdles and constraints governments always come to the rescue of state firms to protect them from demise as argued by Tobin (1982). This has created poor financial controls in the operations promoting high operations costs than precedent. The gravity of this financial aid rests with the fact that the resources that ought to place in the most productive sectors of the economy are thereby drained away. Economists view these facts from the multiplier view of spending which argues that the amount spent always has a greater impact on the economy than the amount invested.

Financial Markets and privatization

The expansion of the financial market as a consequence of privatization has also been received positively by an economist. The expansion of the secondary market has allowed for easy change of ownership in the listed firms. Investors have thus taken advantage of the arbitrage process to maximize their wealth by shifting their investments from the low prospects firms to those of high return. The liberation of this market again improves the allocation function of the economy by taking into consideration the market changes in demand and supply. In a liberal market, capital gets to be structured automatically to where they are most needed. Legislations and regulations that were seen as the order of the day and that slowed the pace of capital allocation become extinct and therefore improve efficiency.

The three different forms of the market hypothesis that results as a result of a well-established formal financial sector is as well a hallmark of the allocation of resources in the economy. With privatization, the market can reveal information that is pertinent in decision-making (Shleifer 1998). The weak form of hypothesis implies that investors have information on all the past information. The semi-strong reveals the information that is both current and past to the investors while the strong form hypothesis is where the investors have all the information of the past, current, and information on the prospects of the securities including information about insider dealings. This hypothesis has been promoted by the growth of the financial sector as a result of the privatization of state-owned firms. The information continues to assist investors in the arbitrage process.

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Privatization results in the decline of government intervention in the economy. With most state firms becoming privatized, the government remains with the duty to provide a favorable environment that promotes fair competition and control factors that are beyond the manageable level of the private sector. The Keynesian school of thought urges that minimum government intervention is necessary in the order for the formulation of government policies that are mandatory for the economy’s performance. The government can therefore not eliminate itself from the economy as it has to provide public goods and protect the general public from any exploitation.

Levine (1998) suggests that the banking industry has been one of the sectors that have been dominated by government control through ownership. Despite the fact that great efforts have been made to reduce government ownership in the banking sector in the 1980s, the government still owns almost 20% ownership in banking. There are two views that explain the need for government ownership in the banking industry. The development view advocates for government ownership with the objective of investing the capital accumulated in productive sectors. The political view asserts the need of the political class to be in control of the economy of a state, however, governments’ ownership of banks in underdeveloped countries is viewed positively compared with the government’s need for ownership in the developed countries. Minimal government ownership in banks is optimal in states with a well-established financial system.

In consideration of the political view of state ownership in banks, economists argue that large ownership may be harmful to the economy’s growth. This is because the landings will be to a large extent influenced by the political rather than the economic perspective. Loans may be channeled to sectors that have no capital accumulation ability. Again in circumstances where the state is not up to the protection of the property rights, the public may mot as a resulting trust these institutions with money as savings. The low levels of savings will thus reduce the number of resources that are invested for capital accumulation. The limitations for much state control on the banking industry justify the rationale for privatization (La Porta, 2000). Private commercial banks will channel resources to the best with optimal returns. They will also lend money with the idea of minimizing losses that are prevalent as a result of lending based on political perspective.

Moreover, with privatization competition is enhanced as the state-owned monopolies are torn. Monopoly retards the efficient allocation function as the demand forces and consumers’ changing wants are given the least consideration in the decision process. With the privatization of the state-owned firms, competition goes a notch higher and production takes into account the capital accumulation need where industries invest in the most profitable ventures. Privatization of monopolized firms also contributes to the correction of externalities and inefficiencies characterized by monopolies. Prices get to be competitive and lowed while the quality Is improved and wastage minimized. As a consequence, the allocation becomes better and the accumulation of wealth is improved.


Whether to privatize state opened companies is a matter that still brings different thoughts amongst the leading economists. Different schools at thoughts argue differently and much more contributions are still in the pipeline. What needs to be analyzed in whichever way of argument is that who should be or who is the greatest beneficiary of privatization? The process of privatizing state-owned firms needs to be undertaken in a manner that will not jeopardize the economy of a given state. It should also not make the state becomes a eunuch in the provision of its fundamental functions of allocation, distribution, and growth. Socialists advocates for much intervention f the state as a way of ensuring equity while capitalists on the side believe in the protection of property rights if the economy has to achieve its efficient allocation. In conclusion, the state must consider the trade-off between privatization and nationalization for an optimal decision to be made.

Reference list

Beck, T. et al. (2001). A new database on financial systemsaround the world, in Financial Structure and Economic Growth: A Cross-Country Comparison of Banks, Markets, and Development.Cambridge, MA: MIT Press.

La Porta, R., Lopez-de-Silanes, F. & Shleifer, A. (2000). Government ownership of banks, National Bureau of Economic Research Working Paper No. 7620. Cambridge, MA: Cambridge university press.

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Levine, R. and Zervos, S. (1998). Stock markets, banks, and economic growth American. Cambridge: Harvard university press.

Shleifer, A. (1998). State Versus Private Ownership:Journal of Economic Perspectives. New York: Dow Jones and company.

Tobin, J. (1982). On the efficiency of the financial system. London: Oxford University press.

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