Privatisation - Hong Kong's Next Frontier

Perhaps the most important measure in the 1999/2000 Budget was privatisation. Long overdue, privatisation is essential to the repositioning of Hong Kong's economy for the twenty-first century.

The privatisation measures in the Budget constitute a major policy shift, and one that came almost as a surprise. There had been some warning. On 11 November 1998, Legislative Councillor David Li asked the Government whether, in order to increase its income, the Government would consider selling some of its assets. He gave examples such as the toll tunnels, the Kowloon-Canton Railway, the MTRC, the Hongkong Post, and the Chek Lap Kok Airport.

In response, Denise Yue, Secretary for the Treasury, stated that the Government would indeed give careful consider to privatisation. The Government recognised that it would gain income thereby, and that privatisation would also generate wider economic benefits for the community.

This reply was possibly the first positive statement by the Hong Kong Government on privatisation, indeed, perhaps its first policy statement on on this topic of any kind. Yet it is now fifteen years after the UK Government began selling British Telecom, and thereby launched a worldwide revolution in the economic role of government. What has been the experience of privatisation in the UK?

 

Why privatise?

After the Second World War, many developed and developing countries around the world adopted a statist economic model. The communist bloc countries naturally followed this route; however, even nominally capitalist economies like Britain veered to the left. The then Labour Government of Britain nationalised the "commanding heights" of the economy, including the coal, steel and rail industries. However, by the 1970s, the statist model in many countries was clearly bankrupt. The state owned industries were burdened with conflicting objectives involving macroeconomic priorities, national social and economic policy, the government's financing needs, and the wishes of the unions. Management was by teams of civil servants. Years of economic stagnation combined with inflation created a willingness to try alternatives, and growing budget deficits gave governments a further incentive. On the advice of Chicago economists, General Pinochet began a privatisation programme in the 1970s. And in the 1980s the Thatcher Government began its historic experiment with the sale of state assets.

The Thatcher programme was conceived in an ad hoc manner - no one could think of another way of financing British Telecom's needed investment in the telephone network. But it was hugely successful as a share offering, raised GBP3.9 billion, and whetted the appetite of government and investors for more. As these privatisations proceeded, they effected a transformation of the British economy. Former state-owned enterprises (SOEs) that had once been a drain on the public purse, like British Steel which formerly consumed an annual subsidy of GBP600 million to GBP1 billion, became world leaders in their field. Prices came down in all industries except water; service improved hugely; competition stimulated the development of new services and opening of new markets; and the discipline of financial reporting created transparency - and in fact price discovery - in areas of the economy like nuclear power that had previously been completely opaque. In most privatisated industries there have been widespread and sustained improvements in occupational safety. Inspired by the British example, most countries around the world - developed, developing and former communist countries - embarked on privatisation programmes of their own. Flotations of privatised assets are expected to take place in more than 100 countries during 1995-2000 and raise more than US$200 billion¹.

To summarise, the benefits of privatisation² are,

to change the corporate governance of state-owned enterprises by introducing incentives based on private ownership;

to improve competitiveness in markets and improve financial discipline by removing the implicit state guarantee;

to create wider share ownership and boost the role of the stock market in the economy;

to boost state revenues.

Potential drawbacks

Despite its substantial and well-documented success, the UK privatisation programme is not very popular with the British people. In 1997, an opinion poll found only 19% in favour of privatising the London Underground. Why this lack of enthusiasm?

In some cases, the UK SOEs were privatised with their monopolies largely intact. Although effort was made to mimic the effects of competition by introducing regulation, such effort was not always successful, and the public perception that the privatised companies were exploiting their franchise was widespread. Such perceptions were inflamed by the high pay increases and share option schemes for the managements of newly privatised companies. Worse, these excesses at management level were often accompanied by pay cuts and layoffs among the staff. And, with hindsight, it became apparent that some of the privatisations had been seriously underpriced - leading to even greater windfall profits for managers holding share option schemes.

Yet these problems do not invalidate the UK privatisation experience. Few argue for renationalisation of the privatised enterprises. The lessons are, rather, that competition in the privatised industry is crucial, and should be obtained by breaking up the dominant supplier; or failing such breakup, that an effective regulatory regime must be set up to monitor the fairness of prices; that public relations by all parties - government and enterprise management alike - must be well-handled.

Way forward for Hong Kong

The state sector in Hong Kong is quite large, providing for example more than half of the population with housing, 98% of hospital services, and the great bulk of educational services. With the proliferation of new public bodies to perform new operations such as mortgage financing and regulation of mandatory provident funds, the state sector is growing larger. To the sector directly owned by the state must be added the subvented sector, and the industries such as gambling and rice importation that operate under Government-granted franchises. Despite Hong Kong's free market reputation, the total proportion of economic activity controlled directly or indirectly by the state is relatively large.

It is sometimes argued that Hong Kong's state-owned enterprises are quite efficient by world standards, and therefore it is not necessary to privatise them. However, there is a great weight of global evidence in favour of economic benefits from privatisation. It is difficult to accept that economic principles operate differently in Hong Kong from elsewhere in the world.

Hong Kong's Airport Authority may be taken as a case for discussion of what is good and bad about Hong Kong's SOEs. Unlike the British Airport Authority and some other airport operators around the world, the Hong Kong Airport Authority is an SOE. However, the airport was built, and now functions well, only some nine years after the formal announcement of the project by former Governor David Wilson. Considering the scale of the project, this should be recognised as a major achievement.

So much for the positive side of the balance sheet. On the negative side, from the start the airport suffered from heavy politicisation. It was announced as a morale booster in the aftermath of the June 4^th Tianenmen incident. However, far from realising this intention, the airport became a hostage to renewed Chinese assertiveness. When Beijing withheld its support, the Hong Kong and British Governments felt unable to proceed without making major concessions, including the appointment of a Chairman with no experience of airport management, and a supervisory committee of political appointees, chaired by a civil servant. At Chinese insistence, the airport funding, with a very high equity:debt ratio, was also grossly inefficient.

Even with these and other concessions, the airport was constantly under a barrage of criticism from the Chinese side. The bickering over funding did not cease until 1995. Later there was the fiasco of the premature opening. The Government's Commission of Enquiry laid the blame for this embarassment on the executive staff. Yet responsibility for the timing of the opening must surely rest with the Airport Development Steering Committee. If this committee was not responsible for the opening decision - which on any reckoning must be a major development decision - then it is hard to see what function a committee with such name could have had. But - whether incompetent or merely functionless - it is clear that a committee of civil servants and political appointees is not an optimal mechanism to run a major development project.

The airport is not the only one of Hong Kong's SOEs to come under critical public scrutiny recently. As the current recession exposes the relative high job security, high pay and less than high performance of the officials in the Hong Kong's state sector, public dissatisfaction is rising. The time is ripe for consideration of new ways of managing these parts of the economy.

Unfortunately, the reaction of the political parties to Denise Yue's above-quoted statement showed a lack of vision. The major political parties expressed concern - concern at the loss of accountability on the part of the enterprise, and loss of control and power of scrutiny on their own part. However, this is to miss the point. The point is that enterprises that are conducting business operations should not be subject to political direction at all. Rather, they should be subject to the discipline of the market, within an appropriate regulatory framework. Public policy concerns about the enterprise should find expression, not in ad hoc arbitrary intervention by politicians, but in the framing of the structure of the enterprise - i.e. whether privatised intact or broken up into competing units - and of the regulatory regime, e.g. in terms of permitted returns.

 

The launch of a major privatisation programme by the Hong Kong Government now would provide long term benefit to the economy, stimulate immediate activity in the financial and business services sector preparing the enterprises for privatisation, and boost the stock market and make it more representative of the Hong Kong economy. Such programme would also raise substantial funds for the Government, although in view of the immensity of the existing fiscal reserves, this is perhaps a less important benefit. Finally, a clear announcement by the Government of its intention, and publication of a list of enterprises to be privatised, would do much to restore local and international confidence in the Government’s economic policy.

Measured against the opportunity, the Financial Secretary's commitment, ground-breaking though it is, falls short. There is commitment to the privatisation of only one enterprise, the MTRC. And even here the Government will remain the major shareholder. There is a commitment to corporatise suitable Government services, with the further promise that these may in due course be earmarked for privatisation. But this is still quite a remote prospect, i.e. the enterprises must go through the corporatisation stage, which they have not entered, before they will be considered for the private sector. There is a further important commitment to private sector participation, for example by contracting out welfare or some aspects of water services. But overall, the Budget speech sets targets scarcely more ambitious than those that were achieved by the UK Government more than a decade ago.

A much more vigorous approach is needed. The Government has to persuade its critics of the benefits of privatisation, and work actively to address the potential problems. Most importantly, in accordance with the OECD advice, it should start by publishing a list of enterprises and operations that may be considered for possible privatisation. The Foundation has prepared such a list to stimulate discussion: see the box on this page.

Policy committee, HKDF

 

(1) The end of privatisation, Economist, 13 June 1998

(2) Successful privatisation: the OECD experience, Stilpon Nestor, International Privatisation Review 1997/98, Euromoney