Friday, September 29, 2023

Issues of privatisation and institutional structures for Guyana’s economic growth

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Bobby Gossai, Jr.
Bobby Gossai, Jr.
Bobby Gossai, Jr. is currently pursuing the Degree of Doctor of Philosophy in Economics at the University of Aberdeen with a research focus on Fiscal Policies and Regulations for an Emerging Petroleum Producing Country. He completed his MSc (Econ) in Petroleum, Energy Economics and Finance from the same institution, and also holds an MSC in Economics from the University of the West Indies. Mr. Gossai, Jr.’s professional experiences include being the head of the Guyana Oil and Gas Association and senior policy analyst and advisor at the Ministry of Natural Resources and Environment.

There are further problems with the timing and manner of privatisation. The International Monetary Fund (IMF) once urged as rapid a privatisation as possible. They were worried that so long as resources remained under the control of the government, they would not be efficiently utilized and that there was scope for corruption. Yet, corruption was only one of the reasons that governments would get so little for their resources. Bidders would know that the governments are under pressure to privatise quickly, so they bid more conservatively, knowing that the government’s reservation price (the minimum price that it would accept) was low.

However, there are further consequences of the pressure to privatise quickly: Fast privatisation meant (in many countries) that privatisation occurred before the institutional infrastructure – a developed legal system; a tax administration that could collect the revenues due; a corporate governance structure that could mitigate agency problems within firms; or financial institutions that could provide money to finance needed investments to realize the full value of the resources – was in place. This, in turn, had several implications.

  • First, it meant that laws ensuring good corporate governance were not in place, so wealth was shifted from the corporation to those who controlled the corporation.
  • Second, many of the advocates of rapid privatisation said that a rule of law would develop as those with control of resources would demand it. There was, however, no historical or theoretical basis for the claim. Quite the contrary: those who controlled the assets preferred to maintain a system which gave them more leeway to strip assets (Hoff and Stiglitz 2005).
  • Third, in the absence of the financial infrastructure, firms could not get access to the capital they required to improve the efficiency of resource extraction. Again, the balance was shifted towards stripping assets rather than building wealth, and all the other problems noted so far were thereby reinforced.
  • Fourth, privatisations occurred before the development of effective tax institutions, so one had the anomalous situation of the government turning over massive amounts of the country’s most valuable resources to private entrepreneurs and yet having insufficient funds to finance basic social safety net and education programs.

Given all of these problems, it is perhaps no surprise that privatisation has failed to yield the benefits promised – a few people may become very rich, but the country as a whole will see little benefit.

Asymmetric Information

There are adverse consequences of asymmetries in information. It is not just that those who have inside information know what to bid. The effect is more subtle: When some have an informational advantage, the others, knowing that they are informationally disadvantaged, bid less than they otherwise would. They suffer from a version of the “winner’s curse” – the fear that they will win only if they bid too much, in particular, only if they bid more than the “informed” bidder. As a result, companies shave their bids down; the insider, knowing this, can, on average, obtain the asset at a lower price – meaning the government receives less.

Such problems of asymmetric information are likely to arise in many oil-producing emerging countries such as Guyana. They are obviously particularly likely to arise if those involved in the management of the enterprise when it was run by the state are involved in one of the bidding consortiums.

Asymmetric Enforcement

Asymmetric enforcement of contract terms presents further problems. Most leases, for instance, have requirements that the lessee develops the field within a certain period of time. The value of the lease depends on how strictly such a requirement is enforced. If, for instance, there is price variability, then bidding on a lease with a high extraction cost (without such a provision) can be viewed as an option. If the price turns out to be high, the firm develops the lease; otherwise, it does not. Even if the firm intends eventually to develop the field, if extraction costs are high, it pays for it to wait. If most bidders are bidding assuming that the contract will be enforced, an insider who knows that they will not; can easily win the bid – paying far less than the true value (given the lax enforcement).

Experiences with Private Control and Economic Efficiency

Many of the advocates of privatisation are not much worried about corruption. They are often not even worried about the government getting fair value for the resources. They are focused on efficiency. They believed that once resources were turned over to the private sector, they would be efficiently utilized. Corrupt privatizations affected the distribution of income, but they were little concerned with that (Stiglitz 2006).

But they are often wrong in their conclusion that corrupt privatizations would lead to economic efficiency because they did not understand property rights as a social construct. Property rights can only be secure if they are viewed as legitimate. Illegitimately obtained property cannot be secure, and, from a societal perspective, corrupt privatisations generate illegitimately held property.

Those who steal property know that their rights to the property they control are not secure, and so too for those who knowingly buy stolen property. There is an important lesson in this: A successful market economy requires secure property rights; but, in a democracy, property rights can only be secure if they are viewed as legitimate. Property acquired through fraud or coercion has no real legitimacy. Discussions of the sanctity of property rights have to be accompanied by policies and actions which give widespread legitimacy to property holdings. Without that, the turmoil so prevalent in resource-rich countries will continue.

Those who obtained the property in the illegitimate privatisations understood this. Their incentive then was to exploit for themselves as much of the property as they could and to move it to a safe locale – outside of the country. Doctrines of free capital market mobility thus aided and abetted the diversion of the resources. With money fleeing the country, no wonder that many of the resource-rich countries did not obtain the benefits that one would have expected.

In the end, then, privatisation did not always achieve even the modest objective of economic efficiency for four reasons:

  • First, without long run secure property rights (and there could not be long-run secure property rights) there is an incentive to extract as much as one can as fast as one can – faster extraction than is efficient. (In the case of renewable resources, this may even entail pushing extraction beyond the level of sustainability.)
  • Second, without long-run secure property rights, incentives to make the complementary investments required for efficient extraction are attenuated.
  • Third, without long-run secure property rights, there will be reluctance on the part of lenders to provide capital to finance these complementary investments – even if the putative owners had been willing to make those investments.
  • Fourth, it pays for each market participant to take his money out of the country, even though social efficiency would have required leaving it in.
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