It used to be trendy to talk about privatization as the solution for corruption. The World Bank, for example, declared back in 1997 that “any reform that increases the competitiveness of the economy will reduce incentives for corrupt behavior. Thus policies that lower controls on foreign trade, remove entry barriers to private industry, and privatize state firms in a way that ensures competition will all support the fight [against corruption].” (See also here, here, and here.) Although this theory declined rapidly after its peak in the 1990s, anticorruption policy ideas, like fashion, seem to be cyclical. Even as the privatization dogma has become démodé in Western anticorruption circles, it has gained new life elsewhere. As “privatization as a solution to corruption” debates reemerge in India and the Philippines, it’s worth reexamining the flaws in such policy proposals that made them fall out of favor twenty years ago.
The logic behind the idea that privatization inherently(or at least usually)decreases corruption is the notion that private shareholders are more interested than government bureaucrats in the efficient usage of whatever resources they control, and are therefore more likely to crack down on corruption. Relatedly, competition in the private market should favor those entities that can provide a service most efficiently—and if graft is inefficient, as many believe, market competition should drive corruption down. On top of this, private organizations also reduce corruption by offering more competitive wages, which means that employees aren’t forced to turn to corrupt means to supplement their incomes.
That’s the theory. The problem is that it isn’t supported by empirical evidence. Starting in the early 2000s and continuing well into the present, scholarship examining the aftermath of the privatization wave of the 1990s has repeatedly found that privatization has been largely unhelpful, and in some cases outright detrimental, to efforts to bring corruption under control (see here, here, here, here, here and here, to cite but a few sources). Why is this? Three main problems stand out:
- First, the privatization process is itself often corrupt. Numerous studies observing mass-privatization efforts—including in post-Soviet transition countries, Latin America, sub-Saharan Africa, and East Asia—have observed that when corrupt government functions are privatized, “managers with good connections to the authorities appropriated many of the former public enterprises.” For example, when Uganda began privatization in 1992, the government alone—although advised by international organizations—was ultimately responsible for overseeing its own divestment. Roughly half of these divestitures were in the form of direct sales of public companies, which senior government personnel were able to manipulate “to the benefit of the well-connected few,” facilitating the “creation of a tiny wealthy class.” Similarly, in post-communist Eastern Europe, “high rates of inflation and access to subsidized credits for the privileged few led to [a] pervasive pattern of manager ownership” that destroyed the credibility of privatization efforts. Other times, officials simply privatized the assets they controlled in government before taking over the private entity that controlled them, in a process that became known as “nomenklatura privatization.” To complicate matters, international oversight of large-scale privatization fails to prevent these problems, as private for-profit auditors displayed a persistent pattern of engaging in bribery within the very countries they were supposed to be monitoring.
- Second, large-scale privatization has long-lasting deleterious effects more often than not. As one 2019 study found, after analyzing data from 141 countries between 1982 and 2014, “conditions mandating the privatization of state-owned enterprises reduce corruption control,” with market-liberalizing reforms on the whole tending to be “detrimental in the long term.” The study found that insiders, having acquired assets or otherwise benefited from a corrupt privatization process, had strong incentives to further weaken anticorruption institutions in order to protect their new acquisitions or to forego punishment. Another study, focusing on 25 European countries between 1995 and 2013, found that although privatization and corruption had only a slight correlation in the short term, in the longer term “privatization has not been effective in reducing corruption, probably because the connection between management and politicians remains after privatization, and because privatization results in the concentration of market share in the hands of powerful elites.” In other words, because corrupt officials transfer public assets to a small group of “inner circle” associates, they retain their influence over those industries. Those industries then have incentives to use “corrupt means to maintain access to resources or exemptions, while other interests will bribe to enforce deregulation and increase the territory of market exchange.” As the World Bank’s chief economist remarked in 1999, reflecting on ten years of privatization efforts in the post-socialist states, “transferring assets to the private sector without regulatory safeguards has only succeeded in putting the ‘grabbing hand’ [of the state] into the ‘velvet glove’ of privatization.”
- Third, privatization weakens the public sector, reducing capacity and damaging morale, and thereby worsens corruption in those functions that remain in publically owned. As the World Bank observed in a 1999 internal staff report, the Bank’s own recommended government “downsizing” reforms resulted in “eroding governance” and led to a large-scale wage decline among civil servants, which left a diminished civil service with a “lack of motivation, low morale and increased risks of petty corruption.” A more recent study found that when public resources are stripped, the “expected constituency for a rule-of-law state” is reduced, thus decreasing the incentives for non-corrupt civil servants to invest in strong institutions. Even though “all individuals with control over productive assets are better off investing in these assets in a rule-of-law state rather than stripping assets in a lawless environment,” a corrupt privatization process sets off a “collective action dilemma” in which state officials collectively choose corruption rather than preservation of what resources remain: a vicious cycle of weakening state institutions.
It is with good reason, then, that the dogmatic application of privatization as an anticorruption solution fell out of fashion. But in some countries, this theory appears to be making a comeback. In India, for example, anticorruption experts are debating privatization as a potential solution to corruption in sectors such as energy, water, and air travel. And in the Philippines, proponents of pending legislation to privatize the state-run medical insurance system explicitly argue that doing so would reduce corruption. To be clear, there are other arguments in favor of privatization, and I’m not in a position to assert that India and the Philippines (or anywhere else, for that matter) shouldn’t privatize certain public functions. Privatization may have important benefits, at least sometimes. But selling privatization as an anticorruption solution is one trend from the 1990s that shouldn’t follow wide jeans back into vogue.
Good points. I was able to drag similar admissions out of one of the World Bank’s most vocal and powerful privatization advocates in the early 2000s.
When thinking about privatization, I think it best to break it down into two categories: one where the privatized entity will have a natural monopoly — electric power, natural gas, other industries where the long-run average cost curve is always declining, and the second where the newly privatized firm will operate in a competitive market. The privatizing government faces challenges in both cases: running an effective public service commission or enforcing competition laws. Where its institutional capacity wanting, either is great challenge. Even rich countries have their problems as the literature on “industry capture” shows.
Great post, Zach! I’m not particularly partial to the privatization argument, but it does seem from your post that you believe some kind of balance in funding between the public and private sectors might be appropriate. Do you have any intuition about what the appropriate balance might be? I can imagine an argument that essentially reverses your third point––concentration of funds in the hands of public sector actors would tempt those actors do engage in corrupt activity for personal gain. How would you respond to that?
Zach makes some great points. Especially in the case of the post-Soviet countries, privatization seems not just to have been riddled with corruption but contributed to the transformation of many of these states into kleptocracies. Yet the European privatization experience is strikingly different than the post-Soviet one. European states may not have reduced corruption through privatization, but they largely avoided the . I guess the question is why? One explanation may be that those states were less corrupt to begin with and that they had stronger states/enforcement mechanism to fight corruption than post-Soviet states. The other is suggested by your third point–the weakening of the public sector didn’t happen nearly to the same extent in Europe as it did in post Soviet countries that privatized their entire economies virtually overnight. I think I’d go a step further and suggest that at least in India there’s a risk that privatization ends up looking more like the post-Soviet example of privatization than the European case.
Thanks Zach, these are great arguments! I especially agree with the first one—the privatization process can be easily manipulated to enrich the powerful few. And when the countries at issue lack a rule of law and transparency to regulate the process at the first place, corruption becomes (almost) inevitable.
I am quite intrigued by the third argument. I wonder whether in the long run, privatization might encourage development and economic growth, and then this money would flow back to the public sector (maybe through higher taxes) to build a more capable government.
Very valid points on why the dogmatic argument presenting privatization as a solution for corruption is simplistic and needs to be set aside. That said, if a government owned business is regularly running losses which the tax payers end up having to pay for, then one can very well argue that privatization will at least bring that to an end even if the privatization process is corrupt. It depends.
More broadly, in a corrupt system, there’s going to be corruption whether you privatize or not. However, it will be in different forms. The question is how do the two forms compare and which one is the lesser evil. And there may not be a cookie cutter answer to this.
Secondly, there are other factors to consider too. For example, privatizing an airline won’t prevent people from having access to air travel. But privatizing a hospital that does cater to the poor could limit their access to healthcare unless the government can find a way to make sure that does not happen. So it’s important to weigh the pros and cons carefully in a case to case basis.
I guess all of the three arguments are about the disadvantages of the corrupt privatization, but not the privatization itself. I have not seen evidence in the post that the fair privatization has any corruption disadvantages.
Great post, Zach. It sheds a critical view on privatization as a solution to all the problems.
For instance, shareholders of a private entity might have the incentives to strengthen compliance programs and fight internal corruption, just like advocated by the privatization defenders. However, in a private business, executives have profit driven goals, what may lead them to engage in illicit acts.
Zachary, great points and overall such a great post! I found your first argument very interesting, particularly the notion that when corrupt government functions are privatized, the new private company goes into the hands of the “well-connected few” which ultimately destroys the credibility of the privatization efforts. One thing that stood out to me was your point that international oversight does not help combat this issue. While I can see this being true, I struggle with this idea because it feels as if there is nothing to help control this issue if private actors, the nation’s government officials nor an international body can help combat it.
Zach, you really raised very good points.
I totally agree with your first argument: the processes of privatization could make room for corruption, particularly in countries that do not have consolidated institutions to oversee these events.
About your second point, it seems that privatization creates another layer of corruption, but maybe it is a solution for some kind of corruption, for example, in the relationship between privatized companies and citizens, for whom they are supposed to provide services. In this sense, do you think that privatization really increases corruption or it develops a more intricate system of corruption?
Considering your third point, I would like to hear some concrete examples related to diminished civil service. Privatization is often accompanied by the creation or the empowerment of independent agencies, which would play a public role in regulating a competitive market. When you mention civil service, do you mean these agencies? If so, how does the government legitimate a privatization process, while, at the same time, it is weakening these agencies?
Zach you make some compelling arguments as to why privatization is not the solution to corruption. Following your second point, it is interesting to note that despite the transfer of public assets to the private sector, government officials were still able to retain their influence over industries and sometimes benefit personally from the privatization process itself – clearly revealing a flaw in the system. It seems the problem might lie in the implementation of the scheme rather than its overall design. Do you think if certain measures were taken to ensure a “truly” privatized system, such as close oversight from multilaterals promoting privatization and increased transparency on the processes, that it might still have a reduction effect on corruption? If citizens are given the opportunity to monitor the privatization process, the possibility of finding corrupt transactions would be higher, leading to reduced incentives for corrupt behavior.