Privatizations and Debt : Lessons From The Greek Fiasco

 In the midst
of the European Debt Crisis, it is tempting to think that high-debt countries
could alleviate the recessionary impact of the budget consolidation process by
selling (poorly managed) assets and stakes in their state owned enterprises
(SOEs), and by using the proceeds to buy back their debts. In addition to
providing a cushion for ongoing adjustment programs and improving solvency,
privatizations are deemed to entail long-term efficiency and welfare gains, by
attracting foreign direct investment and managerial expertise, spurring
competition and growth.

privatizations have been part of the Troika’s conditionality in Greece since
the outburst of the crisis. In March 2011 an agreement was signed by Greece and
the Troika for a very ambitious privatization plan which envisaged the sale of
public utilities, tourism resorts, concessions for the Athens airport and the
port of Piraeus, the sale of government shares of the OTE telephone company,
the partial privatization of the Greek Agricultural Bank. In exchange, Greece
could have tapped the EFSF at more favorable conditions. The original plan was
to raise €50bn within 2015, about 17% percent of the (then) outstanding debt.

The plan’s progress has been  disappointing: in
2012 only 2 out of 35 privatization tenders were completed (see Table 1),
mainly due to delays in the required legal and regulatory changes (“Government
Pending Actions”, in the Commission’s jargon). In 2013, 10 tenders were

Table 1: Greek Privatisazions
Source: European Commission,

In the
following years, the expected revenue from privatizations of state owned
enterprises, real estate and banks, was dramatically scaled down in (see Table
2), dropping to just €8.7bn in the Memory of Understanding of 2013. 

Table 2: Expected Revenues
from Privatizations
Source: European Commission,

In this
column I will focus on the following question: is large scale privatization
a viable option to improve solvency of high-debt countries (1)? I will argue
that, in practice, the
conditions required for state asset sales to improve solvency are unlikely
to be met, particularly when
a country is in financial distress. Thus the lessons from the recent
Greek privatization fiasco are probably quite general. I will first make a
simple numerical example, and then describe the relevant empirical

An Example

Consider the following  example (Table 3).
A country (call it Greece) has a debt coming due amounting to €100, consisting
of 100 promises (bonds) to pay 1€. Greek revenues come from two sources: one
(Tourism) generates €74 for sure, and one (say, the port of Piraeus)
yields, on average, 20€. Since the value of total (expected) revenues (€94 )
falls short of debt coming due, Greece is insolvent, and its debt sells at a
discount, for 94cents to the euro (this is the ratio of total expected payments,
€94 to the number of outstanding bonds, 100).

Table 3: An Example of privatization
In order to
improve solvency, the government (e.g. the Troika) decides to privatize the
port of Piraeus, and to use the proceeds to buy back the debt. This example
describes a very large asset sale, about one fifth of the total debt at pre-privatization
prices.  Let’s first consider the
benchmark case where the public sector is as (in) efficient as the private
sector in managing ports ( first column, Table 3). In this
case, the Piraeus  will sell for €20 (the present value of net revenues),
and, with the proceeds the government will buy back €21.28 (=20/0.94) units of
debt. After the privatization, the total outstanding debt will thus fall to €78.72
government solvency improved? Not at all. The government has forgone 20€ of
revenue from the Piraeus, and now it has to repay €78.72 debt, with only
Tourism receipts  (74€).  It is
exactly “as insolvent” as before, and in fact the price of the debt on the
secondary market is unchanged (at €0.94 = expected payments/outstanding debt=74/78.72).
Now consider
the case in which the private sector is much more efficient (+30%) than the
state to run ports, and may generate €26 (instead of €20) from managing the
Piraeus (second column of Table 3). If capital markets are competitive, the
port will now sell for €26. It will always be profitable for private investors
to bid up to this price. It easy to show that, after the sale, the secondary
price of debt will rise to 1€, so that the government will buy back exactly €26
of its debt. Thus, only €74 of debt will be left, exactly equivalent to the remaining
revenues from Tourism (which confirms that debt must sell at par).
Lessons from the Example
This example teaches us three lessons:
  1. First, the government benefits
    from privatization only as long it appropriates the increase in the asset
    value generated by the private sector. However, it takes a very large
    public inefficiency (-30%) in order to generate a small improvement in
    solvency (the price of debt improves from €0.94 to €1) ;
  2. Second, for these
    benefits to materialize, the government must relinquish the control rights
    on the privatized asset: selling minority stakes or keeping “golden
    shares” won’t work.
  3. Third,  financial markets must be competitive and
    have “deep pockets” , so that the state owned enterprises are priced at
    the present future dividends they generate;
Finally, note that a “successful” privatization plan should be associated
to an improvement in the secondary market price of debt.  

The Evidence
How large are the gains in profitability, productivity, dividends,
capitalization of privatized (ex) state-owned enterprise (SOEs)? There is a
large empirical literature, mainly referring to episodes of the1980’s and 90’s.
The results are often inconclusive and vary over time, episodes and countries,
as issues such as the regulatory and legal framework and the details of the
privatization process are crucial. Table 4 is taken from Megginson and Netter,
2001, (2) and compares pre and post-privatization performances of 113ex-SOE’s . 

 Table 4: Empirical
Studies on Privatizations
Whatever measure of efficiency we consider, the gains from privatization
appear at least an order of magnitude below the scale required for solvency to
improve (30% in the example). Note that, from a methodological point of view,
this literature is unconvincing: it does not compare the pre/post privatization
changes of SOE and that of a “control group” made of SOE which were not
privatized, so the inference of the effect of the privatization “treatment” is
quite dubious. Goldstein (2003) looks at the evidence of the Italian
privatization experience of the 1990s and compares pre/post privatization
changes to those of a control group of enterprises of the same sector. He finds
no significant effect of privatizations.

2. The second issue is that of the transfer of control rights.  Bortolotti and Faccio (3), 2004 present
evidence from a sample of 118 SOE privatized during the 1990s in Europe. The
evidence suggests that transfer of control rights after privatization was far
from complete: in as many as 65% of the cases analyzed, the Government retained
either 10% of the shares of the privatized firms (or more), and/or control
rights through “golden shares” (see the Table below). This fact highlights how
reluctant are politicians to loosen their grip on SOEs, and provides a possible
explanation for the less-than-expected gains from privatizations. The privatization experience in Italy during the 1990s is a case in point: suffice to say that party-controlled Fondazione Monte dei Paschi Siena (MPS), in violation of the law, still ownes more than half the  scandal-ridden MPS bank, twenty years after its “privatization”.

Table 5: Control rights, Source: Bortolotti and Faccio,  2004
3. Finally,
it seems unlikely that a country which has lost access to the international debt
markets can profitably sell assets at its equilibrium price (the present value of the income streams it generates), although this cannot be ruled out
in principle. The recent Greek episode provides no example of an improvement
in the secondary market price of debt, nor of market access conditions,  following the announcement of the first ambitious privatization plan.
Privatizations should be judged for their own merits: for reducing the role of
the state in the economy, particularly when this is associated to corruption, illegal financing of political clienteles, distortion of competition, barriers to entry and inefficiency. As an “emergency”  tool for improving solvency in harsh times, however, they are unlikely to be effective. A crisis-stricken country has little alternative
to resorting to a mix of fiscal restraint, debt restructuring and real
depreciation, possibly via wage cuts.  The implication is that
the (Troika) policy of linking financial assistance to privatizations is inappropriate
and self-defeating. It should be dropped
(1) This
article is based on my discussion at the  Madariaga – College of Europe
  in Brussels on 12/12/2013
(2) William L Megginson, Jeffry M Netter, 2001, From
state to market: A survey of empirical studies on privatization
Journal of economic literature Volume 39, n. 2 , pp. 321-389
(3) Bortolotti, B. and M.Faccio , 2004,”Reluctant privatization”, EGCI
Working Paper n,40