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.