PUBLIC PRIVATE SECTOR PARTNERSHIPS, PUBLIC FINANCE INITIATIVES OR PRIVATISATIONS – HOW BEST TO DEVELOP INFRASTRUCTURE AND PROMOTE ECONOMIC REFORM
Debate about how best to promote economic reform through infrastructure development illustrates the need for a concise theoretical foundation as to how, when and where policies that change underlying economic structures can be applied. This paper outlines such a model, which is based on the perception of gradations in the process of development, and that the introduction of new ownership structures, market mechanisms and financing techniques are not necessarily solutions without providing for changes in economic, societal and legal infrastructures. Often privatisation is advocated as a solution to a deterioration in the industry – for instance in the supply of electricity. However this paper points out the preconditions for privatisation, and suggests that PPPs should be considered as a halfway house where those preconditions are not present.

 

Key Words: Privatizations; Public Private Partnerships; economic reform.

Dr Carolyn V. Currie, Ph.D, M. For. Accy.,M.Com(Hons), B.Ec(Hons), B.Com(Merit),FFinsia, ASA ACSA.
Managing Director Public Private Sector Partnerships Pty Ltd.
P.O. Box 238 Mosman 2088
Phone: +61 (0) 412261568 email: carolynvcurrie@hotmail.com
website: www.carolyncurrie.net.

I. BACKGROUND TO THE DEBATE
Since the fall of the Berlin Wall and the opening up of Communist economies, new ownership structures have been promoted as a solution to the maximisation of welfare. Privatization in particular has been advocated using arguments propelled by ideology and economics, that claim the reduction of state ownership and control of the means of production and allocation of resources is a necessary condition for a transition to a market economy, to democracy and accountability. The rationale is that state ownership is economically inefficient and leads to budget deficits and studies by the World Bank (1995)  and the OECD (2000, 2000a) provide evidence for such viewpoints summarised by Helik (1997, pp. 27-28) in four themes:

• Private ownership is linked to greater efficiency through agency costs by providing managers with adequate incentives to achieve production efficiency;
• Privatization can produce gains due to a shift from monopoly to competitive markets;
• Privatization is considered more efficient by subjecting the firm to the scrutiny of capital markets;
• Privatization leads to the removal of public sector constraints on efficient behaviour.

There are other reasons for privatization and for other mechanisms to reduce the reliance on government. These reasons include the achievement of a stated mission, such as helping finance certain sectors of the economy. Another reason for privatization and related structures occurs particularly in the case of state owned banks where political intervention prevents the true commercial operations of those entities (Culpin, 1999, p. 5).

However the arguments that privatization and related structure involving private ownership or financing, such as public private partnerships and private finance initiatives, promote economic and social development have been the subject of intense debate between regulators. However there is no framework to highlight factors necessary to be developed first, before a successful process of change using such ownership structures to reduce government involvement in the economy can be introduced. Section III points out that solving the sequencing problem is critical to success or failure of an economic reform package. Assessment of the stage of development of these factors must be considered when choosing the desirable mix of state ownership and control, and the mode, method and timing of formal or informally planned change to ownership structures. The author’s contribution to the debate is an attempt to put into a new theoretical context the principal factors that can constitute barriers to the success of economic and social development strategies that are relying on new ownership structures to promote efficiency, and thus raise the production frontier of an economy.

11. DEFINITIONS, BENEFITS AND COSTS OF ALTERNATIVE OWNERSHIP STRUCTURES AS AN AID TO DEVELOPMENT
The debate has failed to clarify both the range of ownership structures that could be used as a staged approach to development in both emerging and advanced nations, and the distinction between development of the economy and the underlying society, as well as the interdependence between the two.

In this paper economic development (Y1) is defined as sustainable growth which can be measured at the level of the individual by the increase in a maintainable and stable level of income per capita, at the corporate or institutional level by the increase in a maintainable and stable accumulated earnings per capita, and at the country level by improvements in the ratio of external debt and current account balance to Gross Domestic Product (GDP), as well as increases in the level of maintainable and stable GDP per capita. This definition avoids the criticism of using an inappropriate yardstick of growth of GDP (used by Stiglitz, 1999a,b), as in transition economies growth may initially be negative as pre-reform crisis conditions impact immediately after reform (Dabrowski, Gomulka and Rostowski, 2001). Also a policy may appear to successful in the short term using growth in GDP as a yardstick, but it is the maintenance of income per capita, corporate profitability and an increasing debt servicing ability at the national level over a long term that is the best criteria of success.

Social development (Y2) is defined as growth in the equitable distribution of wealth, which can be measured by the dispersion and distribution of per capita income, and participation in institutions, which could be measured by a scale ranking the democracy of the government of a country. This in turn is a function of improving the quality of human capital, in terms of education, knowledge and skills, which are vital to social and economic development. Development of human capital permits the embodiment of ethics and values to reduce corruption, the promotion of the understanding necessary to the acceptance of the goals of government in introducing a legal infrastructure necessary to economic development. For instance to privatise state owned enterprises, standards of corporate reporting and securities issuance and trading must be introduced and enforced. This requires that holders of equity or debt have the educational levels to understand their rights and obligations and hence aid in the enforcement of agency relationships, through the supervision of monitoring and bonding contracts. Also in the allocation of credit the quality of human capital is a necessary prerequisite, so that banks and other financial institutions perform within acceptable risk and return parameters their function as delegated monitors in a situation of asymmetric information (Stiglitz and Weiss, 1981).

The degree of development of human capital involves not just increasing the capacity but learn, but enables the individual to participate in a financial system so that social and organisational capital, or the interrelationships and systems for mediation and dispute resolution, can be adapted to increasing stages of development (Stiglitz, 1998a,b). Measuring the level of human capital is an essential input into assessing if the stage of stage of social development is sufficiently advanced so as to permit the benefits of new ownership structures to be utilised and to assess which are appropriate. It could be assessed using a combination of data inputs, such as the percentage of population with basic literacy and numeracy skills, secondary, tertiary education, the number of books sold per capita, education level of women, internet use, standard of health services, longevity, and the number of cooperative and community groups including charities, and their relative size or contribution to GDP.

The distinction between emerging, transition and advanced nations can be made using scores derived from these measurement scales. Y1 and Y2 can interact positively, or negatively depending whether feedback mechanisms exist. For instance a society with only basic literacy skills will not be able to understand the benefits of share ownership, and hence privatization may substitute control by a private elite for state control, leading to dysfunctional allocation of resources. Alternatively a society starting with a grossly skewed distribution of income and control of economic resources, such as in Russia, may need to consider gradations of phasing in ownership structures that introduce the role of the private sector gradually into an economy. This could be done through the financial system first developing a private residential housing, construction, and property development market through targeting loans for these purposes. The next stage would be compulsory pension or superannuation funds that not only can invest in housing but also in the stock market. After that could come the innovation of equity linked home loans. Such a staged development requires however the development of other factors such as an appropriate regulatory and legal structure, as well as increasing the quality of human capital.

Accepting for purposes of this paper the definitions of economic and social development, we still need to understand the variety of ownership structures in order to explain the purported beneficial impacts that changing such structures can have on the development process.

Constructing a scale of reducing state involvement in the ownership and control of the means of production, we could put in the first stage of evolution away from a state controlled economy to a full market driven one, public private partnerships (PPP), private finance initiatives (PFI) in the middle, and as part of a final stage of evolution, privatizations, as PPP has been described as a “third – way economics” (Montanheiro, 2002). This is because if the degree of government ownership rather than control is taken as a criterion, PPP is a halfway house between full state ownership and control and loosening the reins through PFIs and privatizations. There is yet to be an economy where there has been zero state involvement so an economy characterised by large scale privatizations can be taken as the far end of the spectrum.

PPP has been defined as “a collaboration in which the public and private parties concerned realise with combined forces a project in order to realise for both a surplus value” (Braekeleer and Sprundel, 2002). Collaboration can take the form of a concession, joint venture corporation or trust, set up specifically for a concrete and well defined project with a clear public sector character, and creates surplus value in a better price to quality ratio, either socially or financially.

PFI projects were first trialed in the UK in the early 1990s, with a total value of US$1.65 billion undertaken in the period 1992-8 (Montanheiro, 2001). Arguments for PFI devolve around efficiency, value for money, better relationships with users/consumers, greater service accountability but at times appear a way of reducing government deficits. One advantage is the expertise which the private sector, whether foreign or domestic, can contribute which the public sector may lack, and its ability to access the capital markets with a captive customer, the government. Disadvantages are the need to ensure the total contract delivers benefits for the taxpayer and the investor, without costly time and transaction delays. Although a disadvantage may be mark down in country risk borrowing lines, or support from an international agency, the same cost can apply to PPP projects.

PFI can be taken to mean “build operate and transfer” (BOT) whereby the private sector invests in a project, which they maintain and operate. The government can lease essential infrastructure to the private investors, or guarantee a certain usage and revenue in return for the transfer of risk. If ownership of all assets, not just the assets provided by the private sector, passes out of government hands to the private investors, then effectively the utility, service, industry has been privatised – “build, own, operate or BOO” or “BOOT – build, operate, own and transfer”, whereby the private sector totally supplants the government in the provision of services and infrastructure. This is to be distinguished from asset sales, as the private sector adds value by building and operating. Private finance initiatives where the ownership remains in public hands but the private sector takes the risk, is attractive in advanced nations as opposed to emerging nations, as a high sovereign credit rating may be required in the case of a take or pay guarantees which may be part of PFI structures, or to dispel fears of nationalisation of the operation of the asset.

Privatizations involve transferring ownership and control of assets, resources, means of production and services from the state to the private sector. Methods, timing and valuation are critical and can involve full public floats, issuance of shares at a discount to customers, suppliers, managers, and/or an employee share ownership trust, issuance to the general public using vouchers, sale to private sector groups domestic or foreign using a tender system, subsidisation of sale with assisted loans and so on. There are a myriad of methods of privatization which should be linked theoretically to the stage of economic and social development of an economy. The issue of valuation often influences the method but this in turn can be is influenced by two factors – government goals as to proprietorship and property rights and the stage of development of human capital both within the institutions subject to change in ownership, which affects its efficiency, and externally in terms of analytical capacity.

Valuation Techniques
As mentioned privatization can give rise to two difficult problems – allocation of property rights and the skills necessary to conduct a valuation. The former involves political value judgements, so only the latter is considered here. In an advanced economy the usual method of valuation of government corporations operating on a commercial basis, is to offer shares in a public float where the price is predetermined for retail shareholders within a range of bidding set by institutional shareholders. In Australia this was the valuation method used to assess the Commonwealth Bank of Australia, Telstra, Qantas in the nineties. This open bidding system, although backed by a pre-bid valuation phase by the government as vendor, ensures that the final valuation is a true market value as rival bidders set the final price. However the method relies on companies being profitable at the time of the float as the result of efficiency audits conducted during a corporatization phase.

If an organisation is a loss making venture, despite being corporatised, privatization may result in a sale which eventually transfers wealth to the private sector with zero compensation to the government. This occurred in the case of an Australian state owned bank where a government guarantee of 70% of the loan portfolio and a low valuation resulted in the government not receiving any of the final sale price of A$9billion, which was achieved by the initial purchaser in an onsale (Currie, 2001).

There are several methods of valuation that are used – the Discounted Cash flow (DCF) – which calculates the value of the firm as the present value of after-tax net cash flow. In this case value depends on three variables – an estimate of the net cash flow over the useful life of the firm (as an asset), an estimated discount rate which is normally the weighted average cost of capital, and an estimate of the residual value of the firm at the end of the period. Although the method is ideal theoretically, some commentators consider that its built-in problems limit its usefulness for the purpose of privatization (Abdel-Magid, 1999, p.8). These problems are the subjectivity inherent in making estimates of future net cash flows and in estimating the weighted average cost of capital, the question of how to account for future inflation and high uncertainty, incorporation of management expectations in the resulting present value which can result in over-pricing and the inability to price individual assets. In the case of the SBN where the valuation used the DCF method, individual assets were priced, namely the impaired assets, but management expectations regarding those assets led to underpricing.

Other valuation problems are the capitalisation of earnings using rates implicit in the P/E ratios for the industry. This method is difficult to apply to entities that are not publicly listed where no comparable publicly listed institutions exist.

Another approach is to use modern management techniques to forecast future income of the enterprise, and replacement cost and value engineering to value the assets. This approach provides an opportunity for introducing market-oriented, modern management techniques to the privatised enterprise, using techniques such as target pricing, value engineering and activity based costing in order to generate information for decisions crucial to the technical problems associated with privatizations. Examples of such decisions are the redesign of products, the evaluation of future service potential of existing assets, retooling of factories, generating information about future capital outlays and rationalising downsizing and retraining of the existing labour force (Haggis, 1997, pp. 14 -15).

The claimed advantages of privatizations involve four dimensions which can explain why such ownership structures succeed in some economies and not in others. These dimensions are: political, economic and financial, legal and managerial/organisational structure and process (Culpin, 1999, pp. 10-12). The next section interprets these factors and uses them to provide a model, a theoretical framework and a matrix to choose between alternative ownership structures which must depend on assessment of the starting point of the country’s economic and social development, ie Y1 and Y2. This model not only provides a basis for choice of ownership structure and timing and valuation but how to judge success. At times ownership structures have been chosen to  maximise returns to the government as vendor, and/or remove an economic burden by the creation of a privately owned entity that allocates resources in a more efficient and productive manner.

The criteria proposed in this paper are whether the ownership structure will advance a nation along the Y1 and Y2  scales, with that judgement dependent on the four factors of the model.

III. A NEW THEORETICAL FRAMEWORK TO AID CHOICE
The political dimension (or the P factor) reflects a belief that private owners manage scarce resources better than state officials. However political instability, lack of political commitment and a philosophical view of privatization as revenue generating instead of being part of a fundamental transformation into greater market economy can explain the lack of success of privatization in an economy. The P factor can be assessed by the type of government, which can range from that typified by communist regimes which use a command economy with 100% state ownership and control, to a democracy where market mechanisms allocate resources with minimal government interference, ownership and control. The type of government will influence government goals (G) and in turn will determine the allocation of resources. The optimum set of government goals which should result from a democracy are derived from theories of regulation (Sinkey, 1992).

  These can be expressed as G = f (S, S, S, C, C) =  f (R) = f(D, FDI, K, A)                (1)

 Where safety (S), stability (S), structure (S), convenience (C) and confidence (C) are a function of how economic resources (R) are allocated and may require deficit spending (D), direct foreign investment (FDI), private capital formation (K) and foreign aid (A).

     The economic and financial dimension to privatization is that before privatization both state and state owned entities should generate added value for the economy by operating efficiently and effectively. To ensure a private monopoly does not take the place of a public monopoly, or that the newly owned private entity is not asset stripped, it is a prerequisite that a regulatory model be in place in the industry affected which is designed according to the type of market to ensure safety, stability, structural efficiency, convenience and confidence in the newly privatised entity. This is called the M for model factor and is a necessary condition in any change in ownership structure occurring in an industry that was characterised by a high or partial degree of non-contestability, called the C for competitive structure factor. Non-contestability can be due to barriers to entry and exit, either natural, due to high investment required, or legislated, due to particular government goals, or both. Degrees of non-contestability occur in industries such as banking, financial services, airlines, general transport, electricity, water, housing, health, education and defence (Baumol, Panzar, Willig, 1983). Barriers are hence a result of the natural economic resources, human capital, technology and infrastructure necessary to commence operations and thus it may be difficult to both enter and exit by finding a takeout party or purchaser. Or they can be the result of mandatory controls such as licences and regulations that a government deems necessary to achieve economic or social goals.

The legal dimension (or the L factor) refers to legislation being passed that contains the optimum flexible but clear legal framework consistent with constitutional law necessary to the realisation of privatization goals. The L factor could be measured according to compliance with the Compendium of Standards developed by the Financial Stability Institute, a joint cooperative effort between the IMF, the World Bank, the Bank for International Settlements and the Organisation for Economic Cooperation and Development. The objective of the Compendium of Standards is to provide a common reference for the various economic and financial standards that are internationally accepted as relevant to sound, stable and well-functioning financial systems. The Compendium highlights 12 standards, which have been designated as key and deserving of priority implementation depending on country circumstances, and includes around 60 more standards considered relevant for sound financial systems. While the key standards vary in terms of their degree of international endorsement, they are broadly accepted as representing minimum requirements for good practice and cover macroeconomic policy and data transparency, institutional and market infrastructure (insolvency, corporate governance, accounting, auditing, payments and settlements, market integrity) as well as compliance with financial regulation and supervision, such as banking supervision, securities regulation, and insurance supervision. The latter financial regulation standards are included as an L factor as the performance of M and C needs constant checking through legal test cases and convictions, as the form of M may appear to be that of a strong prudential supervisor but the substance may be different. Or the market structure may be permitting non-competitive practices. The IMF now conducts ratings of countries according to compliance with the Compendium of Standards, and this could be used as a scale to measure whether the necessary legal infrastructure is present, together with World Bank assessments of judicial independence.

The final dimension – managerial expertise, organisational structure and process – or the E factor, refers to the quality of those factors. An essential ingredient is the competitiveness of salary packages of government owned entities and the inbuilt structures to prevent frequent changes in leadership within such entities due to changes in government. However there should be agency relationships embodied in the structure and supervised by the operation of the M, C and L factors that prevent overcompensation of government officials prior to changed ownership structures. In the process of privatization, hasty actions without essential preparations can lead to crucial mistakes and delays. “Moreover, bureaucratic formalities slow down the process while the opposing groups to the bank privatization use their influence to cancel the whole process or further postpone the process” (Culpin, 1999, p.12). The state of this factor can be assessed by measuring human capital as above.

Given the spectrum of ownership structures, movement from 100% state ownership and control may require deregulation of industry structures and controls. Here deregulation means protective measures, but should be conducted by increasing prudential supervision of the industry, that is by changing the regulatory model, or the M factor given the type of market structure or C factor. At the same time development of the legal infrastructure or the L factor is a necessary condition. That is development of C, and M is not sufficient without L.

We need to understand the manner in which an industry can be privatised or moved along the spectrum and which modes of deregulation are less likely to produce a successful outcome. Table 1 describes possible ways of deregulating an industry while changing ownership structures.

 

Scenarios	I	II	III	IV
Formal Change (Planned)	Guided or unguided Wind down from 100% state ownership to PPPExisting agency or government given greater powers of prudential supervision while protective measures removed	Transfer of functions to the private sector via a PFI structure. Regulatory agency given oversight to ensure adherence to contract and non abuse of market power	Privatization of all or part of a previous 100% state owned entity or PPP or PFI with some regulatory oversight	Privatization, PPP and PFI used together with minimal government involvement in the provision of goods and services and stripping of all protective measures of regulator which maintains prudential supervision according to government goals
Informal Deregulation (Evolutionary)	Non Enforcement with transfer of functions through contracting out	Life cycle effects – failure to provide goods, services, no supervision

Deregulation can take place in a formally planned or informally planned manner, with various options or stages within each process. Each scenario has a different goal. A formally planned wind down can be managed, guided, or unguided, in response to external demand. An informal or evolutionary form of deregulation would be non or selective enforcement, where a cost benefit analysis indicated that it does not pay to do away with even a poorly performing regulatory agency and it pays to contract out services rather than undertake a planned change in ownership structures. This avoids legislative backing for deregulation.  
The informal alternative is to allow regulatory failure to occur as a regulatory agency passes through all growth stages as its procedures become rigid and it no longer serves public interests, only those of the regulated industry. Mitnick’s (1980) study of deregulatory possibilities referred to above does not equate deregulation with the removal of all controls both direct and indirect in an informal manner, as these are needed to act as systems checks, and hence on that of its participants. In Asia in the nineties, and in Australia and other OECD countries such as Norway, Sweden and Denmark during the eighties, deregulation in relation to the financial system was largely directed at the banking sector, by stripping the principal regulatory agency, the central bank, of the necessity to impose certain protective measures. The taxonomy of regulatory models outlined in this paper is based on the assumption that in economic systems undergoing changing ownership structures and hence deregulation of industry structures, at the same time that protective measures are removed, prudential supervisory measures to monitor the effects of deregulation and changed ownership should be increased (Currie, 2000). The validity of this assumption has now been recognised as a result of the Asian Crisis (Stiglitz, 1998a,b)
 
To understand this statement we need to understand the range of regulatory models that can govern economic systems. According to a taxonomy developed by the author (Currie, 2000) regulatory models (that is the rules and methods of regulation) consist of two halves – a prudential side and a protective side.

Prudential supervisory systems include three essential elements –
• The predominant enforcement mode which can consist of seven types. Each of the types listed can be classified by the strength of enforcement, ranging from type 1, a weak mode typified by a cooperative approach relying on particularistic solutions and fostering self-regulation, to type 7, a strong which uses all forms of regulation until the desired goal is achieved.
• The type of sanctions which can be summarised into two categories of strong and weak and,
• The type of compliance audits (two types of strong and weak).
• 
A prudential system which relies on sanctions and compliance audits typified by a broad based but high pyramid tends to greater effectiveness as the regulator has more tools to utilise before invoking the ultimate sanction and compliance audit, which may be license revocation and appointment of full time regulatory auditors/managers. Prudential supervisory arrangements are thus regulatory measures, which are primarily preventive. They are primarily geared to checking on whether companies are acting prudently in order to ensure the stability of the system. Protective measures have goals of safety in terms of creditor, investor and consumer protection as well as structural efficiency. However the separation between protective and prudential measures of regulation is not entirely mutually exclusive. They interrelate in several ways. First the basic idea of protective regulations is the creation of confidence. For instance to ensure that users of a newly privatised utility company remain with it. At the same time, however, protective measures involve the danger of moral hazard and adverse effects if managers feel they can always rely on a bailout.

Prudential measures are designed to check on the state of risk management, performance and adherence to agency relationships. They are also to check on the success of protective measures, and whether additional protective measures are needed or existing should be removed.  In reverse, protective measures often call for supplementary prudential measures. That is, there are particular bundles or packages of prudential and protective regulations, which go together.

Protective measures are aimed at the entire industry, but can be applied on a discretionary and institutionalised basis. At times some disclosure rules are used in a discretionary sense, and hence become part of the compliance audit process, or at times a form of sanction. The main characteristic of a discretionary intervention is that it is not granted without some element of uncertainty, since some amount of private risk remains. This uncertainty creates obvious incentives for lenders, investors, customers and suppliers, to monitor the riskiness of the institutions. Nevertheless, over time certain traditions and practices can evolve, and authorities can be more or less generous in determining the thresholds beyond which help is supplied. 

Institutionalised protective measures must be applied on an industry basis in order to ensure consistency, so as to promote regulatory goals of safety, stability and structure. Institutional interventions price controls or trust busting cases.

The two halves of the regulatory model – the prudential measures and the protective set of measures can be combined in order to classify regulatory models. The seven enforcement modes adapted from Grabosky and Braithwaite (1986) describe prudential supervisory measures. Together with the variety of strong and weak sanction and compliance audit types, which are an essential part of a prudential supervisory systems, the seven enforcement modes can be combined with the above combination of five protective measure types to define an overall regulatory model governing a sector. This gives a matrix of 2 x 2 x 7 x 5, or 140 possible regulatory models.

We can thus see that design of the regulatory model to govern an industry in which state ownership, control, involvement or intervention is to be reduced is a key starting point to the development process. At the same time it is necessary for the government to decide on the type of market structure they are aiming for in the industry where ownership structures are to be changed. For instance if a banking industry has been characterised by a small number of large financial institutions many of which are state owned, suddenly privatising these banks, while permitting new entrants, while loosening protective measures, and not devoting economic resources to increasing the quality of prudential supervision and human capital, may expose an economy to too great a degree of contestability without the necessary model, legal infrastructure or expertise, that is without government goals directing expenditure to M, L and E.

The new theory of choice of ownership structures espoused in this paper thus conceives of a national economy as set of interrelating systems and subsystems so that the method of liberalising an industry through changing ownership structures can be described in terms of a matrix (see Table 2) and a set of equations. This in turn dictates a staged approach to changing ownership structures.

Table 2: Factors in the Choice of Type, Timing and Method of Valuation of Ownership Structures 

	Ownership of Capital – proportion of direct and indirect ownership by individuals vs institutional/elite vs state   (O)	Type of Ownership Structure, Methods of Valuation and Timing (T)
Stage of Social Development(Y2)	Regulatory Structure (M) and Industry Structure(C)	Stage of Managerial Expertise, Organisational Structure and Processes(E)
Stage of Economic Development (Y1)	Compliance  or stage of legal infrastructure development (L )	Political System (P) which influences Government Goals (G) which influences the allocation of  Economic Resources  (R)

 It is postulated that in the above model Social Development or Y2 may decrease then increase as M, C and E change. This is due to the initial effects of deregulation of protective measures on an industry and the time lag before learning effects of change kick in, and prudential supervision or oversight increases in strength to compensate for the reduction in protective measures. The resulting increase in social development may be at a decreasing rate as decreasing returns to scale of M and C are experienced, as the regulatory model and market structure may become burdensome, clogged and lead to obstacles. This requires input from factors affecting economic development. That is the political and legal systems must allow feedback so that as social development occurs, more reliance can be made on self-regulatory market mechanisms. Hence the regulatory model and performance of the market structure will require continual monitoring. Development of the E factor will contribute to more effective prudential supervision through enhanced skill levels both within the regulator, the marketplace and the entities subject to changed ownership.

Economic Development or Y1 may increase at a decreasing rate as efficiencies are realised or could display a Cobb Douglas pattern due to the political system not adapting quickly to sectoral imbalances particularly in the supply of human capital, or adjusting L as E increases, or due to political instability, or failure to assess and adjust social development policies according to our allocated priorities of M, C and E.

 

The implications of this theory, or choice matrix, are that

• It is vital to assess the stage of P, E, L, M and C before choosing the ownership structure as well as timing and valuation methods;
• That the design of M is a starting point which must take account of the type of existing, and desired market structure, ie C, as well as the calibre of E;
• That if all of the factors are weak at the starting point that a careful staged approach should be used as per Table 1, with continual monitoring both by the government undertaking the change and external aid agencies such as the IMF and World Bank, or otherwise an entrenched elite takes the place of the state in ownership and control, without the requisite spread of advantages of moving an economy to a full free market basis.
   
A staged approach to choice of the development of ownership structures is depicted in Figure 1. This advocates that where E is rated highly together with M, C and L or they have been developed to a high level, that a full public float with reliance on the market mechanism is the optimum outcome. If the industry by its nature is non-contestable such as telecommunications, a privatization can work with prudential oversight of pricing and market practices. PFI is listed as the mechanism where all factors are rated at mid point and PPP where all factors receive a low rating, except for expertise (E) which needs to be injected by the private sector. Indeed this is often the rationale for involvement of the private sector. PPPs can occur in an advanced economy, where due to a long history of state involvement in a particular industry such as education, the industry is one where the regulator does not have the supervisory skills or requisite powers. Also the expertise in modern market practices within the industry may be lacking and the industry may be protected from competition by legislation. Hence it appears as a pocket of state ownership and control within a free market economy and an injection of market expertise from allied industries which have developed private sector practices is sought in a consortium between SOEs and private firms..

    Such a staged approach requires measurement techniques to assess the state of the input factors. The taxonomy of regulatory models described elsewhere (Currie, 2000) could be used to assess M. C could be assessed by a Porter style industry analysis, E by the quantitative measures to assess human capital described in Section II and P by stated government goals as well as the resources devoted to all the other factors, as revealed in the national accounts. L could be assessed not just by compliance with the compendium of standards, but by studies of corruption and independence of the judiciary such as undertaken in Indonesia .

There is one important assumption regarding this theory. It is a theory of ownership change where trade policy is assumed to be neutral, although these two models interact as described by Stiglitz (1998b). Trade liberalisation confers benefits in not only causing an outward shift in the production frontier, but through direct foreign investment enhances economic resources and human capital via the injection of “management expertise, technical human capital, product and process technologies, and overseas marketing channels” (Stiglitz, 1998b, p.37). If a country’s goals are inconsistent with trade liberalisation, and the economic resources and infrastructure required are not there to ensure even transmission of benefits, or if its trading partners are practising protectionist policies towards imports of goods and services and export of intellectual property, then this is another factor which can inhibit economic and social development and prevent financial regulation achieving goals.

The advantages of the approach outlined above are that it focuses on factors not traditionally considered. For instance privatizations have been advocated as a cure all without considering the necessity to combine privatizations with spreading ownership and control through employee share ownership trusts (ESOTs), or structured remuneration packages or discounted share issues to customers to promote economic growth and heighten consensus (Kelso and Kelso, 1991; Ashford and Shakespeare, 1999).  Even these mechanisms can only work with a medium to high level of M, C, E, L and P. A recent IMF survey  highlighted the spread of ownership as a principal contributing factor behind the recent high comparative growth rates of certain economies. In those countries privatization was accompanied by a dramatic increase in direct investment by

 

shareholders in the stockmarket. This was achieved by the issuing of employee options, but also through the mandatory superannuation in Australia, and ESOTs, as well as issuing shares at a discount to customers of a company being privatised. However such an argument ignores the fact that the state of the key factors outlined above may have contributed to the successful of the privatizations, such as in Australia.

Models of economic development have emphasised some of these factors as ends not means, and have not considered absorptive capacities or the necessity to assess the existing capacity and structure then tailor transition stages, taking account of the fact that government goals and economic resources can only be effectively transformed from within. Such models also fail to emphasise the need for ongoing monitoring which requires a measurement technique to assess behavioural changes.
 
The theoretical analysis and choice matrix prescribes a blueprint for reform.

ENDNOTES

1. World Bank, “Bureaucrats in Business: The Economics and Politics of Government Ownership”, (Policy Research Report Series/University Press Book, January, 1995).
2. http://www.worldbank.org/wbi/governance/pdf/judicial_mod_1. Refer also to World Bank, “A Diagnostic Study of Corruption in Indonesia”, Partnership for Governance Reform in Indonesia, Final Report, October, 2001, and a Bookings Institutions Brief in September 2001 http://www.brook.edu/comm/policybriefs/pb89.htm.
3. IMF, 2001. Speakers argue that ownership, not the number of conditions, is key to success of an IMF program.  IMF Survey, 30 (16) August 13, 2001.