Privatization and Its Benefits: Theory and Evidence

Abstract

Privatization has been a key component of structural reform programs in both developed and developing economies. The aim of such programs is to achieve higher microeconomic efficiency and foster economic growth, as well as reduce public sector borrowing requirements through the elimination of unnecessary subsidies. Microeconomic theory tells us that incentive and contracting problems create inefficiencies due to public ownership, given that managers of state-owned enterprises pursue objectives that differ from those of private firms (political view) and face less monitoring (management view). Not only are the managers' objectives distorted, but the budget constraints they face are also softened. The soft-budget constraint emerges from the fact that bankruptcy is not a credible threat to public managers, for it is in the central government's own interest to bail them out in case of financial distress. Empirical evidence shows a robust corroboration of theoretical implications: privatization increases profitability and efficiency in both competitive and monopolistic sectors. Full privatization has a greater impact than partial privatization and monopolistic sectors show an increase in profitability that is above the component explained by increases in productivity, which reflects their market power. From the macroeconomic perspective, no conclusive evidence can be drawn, but the trends are favorable. (JEL D21, D61, D62, E65 )

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