PRIVATIZATION Privatization in Malaysia, Regulation, rent-seeking and policy failure

2 Introduction: why privatize?public firms do not differ significantly in their economic performance (seeMillward and Parker 1983; Borcherding et al. 1982, cited in Tatahi 2003).Other studies also point to competition and regulation as more important orat least necessary if privatization is to be more efficient (Vickers and Wright1989; Caves and Christensen 1980; Faere et al. 1985; Atkinson et al. 1986;Yarrow 1986; Vickers and Yarrow 1988; Bishop and Kay 1989; Beesley andLittlechild 1989; and Martin and Parker 1997, all cited in Tatahi 2003: 80;Cook and Uchida 2003; also see Hemming and Mansoor 1988; Vickers andYarrow 1991; Parker and Kirkpatrick 2003).Despite this, privatization continues to be widely accepted in principle,and the failure of privatization in developing countries has been normallyattributed to institutional weaknesses leading to problems of patronage andcorruption. The conditions for successful privatization are then said todepend on strengthening institutions, democracy, transparency and accountability.However, these explanations are restricted by a narrow understandingof what privatization and regulation entail, based on an apolitical andahistorical reading of the constraints facing developing countries, andgrounded in theoretically flawed arguments about the incentive benefits ofprivatization.We make two main claims. The first challenges the theory that privatizationimproves incentives by aligning residual control (ownership) with residualreturns (profit). It will be argued that the private sector, both in developedand developing countries, is often unable and unwilling to finance projectswith high capital costs such as infrastructure provision on its own, making itnecessary for the state to share risks even after privatization. In addition, theprovision of public goods or services (such as urban transit and sewagetreatment) in developing countries is often not profitable, partly because universalservice obligations require that these should be affordable. A subsidymay then be required, even by a very efficient operator, if the tariff customersare willing to pay is less than the minimum cost the producer can achieve.But a subsidy may also allow inefficiency to survive, particularly in sectorswith insufficient competition. These state interventions dilute incentivesbecause there is no longer a direct relationship between management qualityand profits, thereby necessitating regulation. However, asymmetric informationwill prevent regulators knowing for sure whether an adequate level ofefficiency has been achieved. In principle, tough regulators can still achieveefficiency over time in a number of ways, for instance, by setting tariff reductiontargets with fixed levels of subsidies. But the success of these strategiesdepends on the credibility of the regulator’s threats that failure to achievetargets may result in the selection of a different operator or the imposition ofa financial penalty. The success of privatization will then depend on institutionalprerequisites for effective regulation that can maintain incentivesfor performance in a context where the state is still providing subsidies andsharing risks.This brings us directly to the second and related claim: privatization