Privatization and Competition – I: Why?

In seminars related to competition law, when the privatization topic comes up, it’s common to see that the majority of participants approach the issue with preconceived notions and often ask the following classic question:

Why are we “selling” these State Owned Enterprises (SOEs), which are among “the most profitable organizations” in the country?

The statements in quotations in the above question point to underlying influences and value judgments we often overlook. Since these statements or assumptions have not been deeply considered until now, they can lead to incorrect or careless answers. To provide the best answer to this question, let’s first rewind a bit and look at the reasons for the emergence of SOEs and why the state produces goods and services such as “alcohol, tobacco, matches, shoes, clothing, rugs and textiles, tea, sugar, glass, iron and steel, cement, electricity, and telecommunications.”

Setting aside the ideological preferences that the Soviet Union adopted and couldn’t sustain, for countries that have embraced the market economy from the beginning, it has been proven that the state doesn’t need to produce any of these. For example, in the United States, the private sector has always provided electricity and telecommunications services.

However, for other countries, many variables determine the answer to “Should the state or the market produce?” Among these, the most crucial are “entrepreneurship” and “capital.” For instance, whether the Republic of Turkey preferred a market economy at its establishment, it is well-known that there was neither human capital nor financial resources or equipment to be used in massive investments such as energy production, telecommunication infrastructure, iron and steel, and cement. That’s why the state played a significant role as a “producer” in all these industries.

As the preference for a market economy became more apparent, it was expected that the public would no longer be a producer in the markets but only act as a regulator and supervisor. Therefore, since the 1990s, various privatizations have been carried out, and the number of businesses held by the government has decreased.

Various opinions naturally come into play during the privatization of any company, but ultimately, they are connected to the propositions of whether  “privatization is good” or “privatization is bad.” These two propositions also detach us from this important fact:

“Privatization is a means, not a goal; therefore, when done well, it results in positive outcomes for social welfare, and when done poorly, it adversely affects social welfare.”

However, to avoid leading to another misdirection, we should postpone the issue of “how privatization should be done” to a subsequent article. First, we must focus on the question, “Is privatization necessary? Why do we need to use this tool?”

The purpose of privatization is not to “get rid of public enterprises by selling them to the private sector,” but rather to “transfer public enterprises to private enterprise because they have not been operated efficiently with the logic of the private sector and thus, to eliminate their inertia or inefficiencies, ensuring that they are operated more efficiently.”

To illustrate this, I’ll share four examples from firsthand:

1. In an SOE related to paper production, a friend once visited and noticed that the factory’s chimney was not functioning. When he asked about it, the answer was almost reminiscent of Nasreddin Hodja’s story about selling the wool of a tethered sheep to pay off the debt: In summary, there was a failure with the electrical system that prevented the furnace from working. However, no one could fix it because the technician had retired and was not replaced with a new one. Due to procurement regulations, external services couldn’t be obtained. As a solution, they hired an intern. When the retired staff returned from his vacation and trained the intern, the intern would fix the problem. This would get the furnace working, which took about three months. In the meantime, this idle factory and the employees had monthly expenses, which were approximately 5 trillion TL in 2000, consuming our taxes.

2. In another case, just before privatization, 1,500 (one thousand five hundred) security personnel were hired overnight for an SOE. After privatization, even though many of the personnel from the old SOE found jobs in other institutions, about ten years after the transaction, the new managers of the former SOE claimed that they were trying to become more efficient due to competitive pressures. However, they were complaining that they still had more personnel than necessary.

3. In another example, a sales point in front of a state-owned liquor factory closed at 4:30 p.m. because the clerk, who had to leave to deposit the money in the bank, was obliged to do so. This sales point was in a tourist area and couldn’t meet the increasing demand in the late afternoon. Furthermore, the individuals in charge of sales and marketing at the same facility were limited to three-minute phone conversations, adversely affecting sales.

4. My friend, once the general manager of an SOE that produced shoes, looked at the production line after starting his new position. He noticed that the products piled up in front of one worker up to a certain point, and when another worker replaced them, production increased fivefold in just a few days. However, the worker was relocated, and he brought in a faster worker. Yet, the worker who had been relocated “received support from Ankara” and returned to his place in the production line. This caused production to decrease again, and the general manager was transferred to another role in Ankara.

Regarding the four examples above, the first crucial point to emphasize is the human and employment aspects of the issue. Hiring many people for an SOE without a real need, managing them poorly, and leaving employees idle due to poor management are not the employees’ fault. Blaming the employees is nothing more than a simplification. The fundamental issue is that SOEs cannot easily be managed with the logic of the private sector, no matter what country they are in or what measures are taken.

The second important point is that, although allegations occasionally arise that SOEs were intentionally operated at a loss before privatization, I cannot comment. I don’t know if these three examples can be generalized, either. However, from an evaluation perspective, I believe it is an important starting point to consider SOEs in two main categories: (a) those operating according to competitive market conditions and (b) those operating under monopolistic market conditions.

Therefore:

(a) SOEs that operate according to competitive market conditions cannot show the necessary dynamism, performance, and efficiency when their privileges are removed. When they face competition from private firms, they start making losses.

(b) KİTs operating according to monopolistic market conditions continue to profit by using their monopoly power. However, since they don’t have any competitors, we don’t know if they are efficient, whether they can produce these goods at lower costs, and whether they could supply them to us at a lower price while increasing their profits. For example, when a company with a monopoly in electricity generation, transmission, and distribution adds a certain profit on top of its costs and offers this to consumers, consumers will inevitably consume electricity to some extent. The company wouldn’t be expected to incur losses since it can reflect the costs onto its customers. So, there’s no guarantee that the company will try to lower its costs and become more efficient.

Thus, before labeling the privatization process as “selling profit-making KİTs” and jumping to the conclusion that “privatization is bad,” we should think once again and focus on the question, “How can privatization be carried out so that the inactivity mentioned above is eliminated and a difference and benefit are created for society?” The answer to this question will be the topic of the next article titled “Privatization and Competition – II: How?”