Wednesday, 28 November 2012

Are Privatizations a Good Idea?

The transfer of companies held under the control of the state to private individuals has received great attention over the last months. The latest information from Greece claim that by privatizing 6-7 large corporations the country will receive more than EUR 2.5 billion, money that will undoubtedly be very useful during this current situation.

In economic theory the value of these companies is derived by calculating the discounted value of all future cash flows to be received by the company. In a (very) simple example if a company was expected to bring in EUR200 million per year for the next 10 years and then dissolve, with an interest rate of 0% (a highly unlikely scenario), then the value of this company would be EUR 2 billion. As you may have guessed, the should be no monetary difference between the money received now and the money received as an annuity. Thus, this is what many economists state as "creative accounting": getting more money now, but losing all the future streams of cash; it may look good now, but you will deprive future generations of their cash.

Nevertheless, there can be some good derived by privatizing public companies: corrupt officers and state officials cannot appoint whoever they please as an employee of those companies, without caring for what is best for the company and its consumers. This was the case with many organizations in Greece, and I do believe that very few Greeks will deny this fact. Reducing costs may not, however, result to lower prices for consumers as the popular belief may be, although they are in general a good thing as they may be used in funding new projects or distributing profits to shareholders (which is very good as this increases consumption, savings and investment).

The issue here is that privatizations should not happen just for the monetary compensation as the rationale behind it is fallacious. They should occur as a means to promote a better environment for the state companies and to promote investment as well as consumption. This can also occur when the state does not have controlling interest (more than 50%) in a company.

A rally against privatizations in New Zealand, July 2012. It looks like this is
a worldwide phenomenon. Source: Wikimedia Commons
The optimal solution for this problem would be for the Greek state to keep a reduced amount of equity in the companies it will privatize (around 20% but not more than 30%). This would allow both the company to operate without the state forcing officials or policies to them, and the country can still benefit from both the future cash flow as well as from the income it will receive from selling part of the equity they hold. This is one of the very situations in real life when a true win-win situation occurs: both the company and the state benefit. The only drawback is that the state will not receive as much money as by selling its whole share in the companies. This drawback is however very small compared to the benefits such a decision would have both in the medium- as well as the long-run.

P.S. I do really hope that when the Greek state finally sells its share in state companies (whether all of it or just a part) it will choose to do so to more than one investors. Transferring power to just one person was, is, and never will be a good idea.

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