Lessons from Argentina's privatization experience.

Lessons from Argentina's privatization experience. Introduction Privatization privatization:see nationalization. privatizationTransfer of government services or assets to the private sector. State-owned assets may be sold to private owners, or statutory restrictions on competition between privately and publicly owned is conceived as a drastic change in the role ofgovernment. Advocates of privatization maintain that the stateadministration should desist from production and pricing decisions, andinstead focus on the design and implementation of a regulatory process.The government should direct its scarce human capital toward socialspending in areas such as education, health, poverty abatement and thecreation of a social safety net. Additionally, the government shouldwork, in concert with the private sector, to develop economicinfrastructure. This change in the role of government was typically bepursued at the same time that the total level of government expenditureand taxation would decrease. In short, the idea was to reduce marketdistortions created by the government while reorienting its activitiesto areas where a case for its involvement based on economic ordistributional grounds could be made more sound. During the period from 1990 to 1996, the Argentine state underwenta broad structural reform, revising regulatory systems and privatizingmost public companies, including airlines, telecommunications,utilities, railroads, ports, petrochemical plants, the state oil companyand some provincial banks. Some may argue that Argentina's experience with state-runcompanies was extreme. Nevertheless, it is still a valuable example ofthe advantages and shortfalls of privatization. For this reason, we willuse it extensively to illustrate why privatization is advantageous. Todemonstrate this, we will discuss four main issues: efficiency, capitalaccumulation Most generally, the accumulation of capital refers simply to the gathering or amassment of objects of value; the increase in wealth; or the creation of wealth. Capital can be generally defined as assets invested for profit. , public deficits and corruption. In the following section,we provide a framework for designing privatization programs. The primaryobjective in the initial step of any privatization exercise is thedevelopment of a well-conceived regulatory framework that ensurescompetitive results. We devote attention to the costs of regulation andthe dangers of political impediments IMPEDIMENTS, contracts. Legal objections to the making of a contract. Impediments which relate to the person are those of minority, want of reason, coverture, and the like; they are sometimes called disabilities. Vide Incapacity. 2. and institutional weaknesses.Finally, we conclude that privatization raises social welfare. Reasons for Privatization Although there are several justifications for state involvement inthe provision of goods and services In economics, economic output is divided into physical goods and intangible services. Consumption of goods and services is assumed to produce utility (unless the "good" is a "bad"). It is often used when referring to a Goods and Services Tax. , there are many instances in whichprivatization increases economic welfare. One compelling reason forprivatization is that it frees budgetary resources. During the 1980s,the losses of Argentine state-owned enterprises and their investments(financed by transfers from the treasury, public debt or tax receipts)amounted to approximately $10 billion per year, which, at that time, wasmore than 7 percent of gross domestic product (GDP GDP(guanosine diphosphate): see guanine. ). Privatization canreduce the deficit previously generated by state-owned enterprises,diminishing public debt and the burden of interest payments. Theresources that have been freed can then be used to finance effectivesocial programs. Not only do the resources previously used to finance thecontinuous deficits of the state's enterprises become available,but the process of privatization itself gives the country theopportunity to attract foreign direct and indirect investment, as wellas domestic private investment that can raise capital productivity.Without large investments in infrastructure (roads, railroads, ports andcommunications), economic growth will be hindered. While the statetypically cannot afford such expenditures, private sector and foreigninvestors can. The privatization of public enterprises makes suchinvestment opportunities possible. Privatization also eliminates inefficiencies. The frequentinefficiencies of state-run companies has been demonstrated by thenecessity of subsidizing companies to ensure their survival in acompetitive market, the historically low productivity of publicinvestment, the distorted prices of goods and services, the existence ofexcess capacity and the insufficient and/or low-quality provision ofgoods and services. The inefficiencies characteristic of state-owned enterprises canbe grouped into two categories. First, there are allocativeinefficiencies stemming from ineffectual investments that result in alow productivity of capital. Second, there are managerialinefficiencies, as evidenced by poor pricing policies, lack of controlover the use of resources and problems with quality and access to theservices provided. As demonstrated by several studies over the last four decades,Argentina's public resources were misallocated, and investment wasdirected toward unproductive activities.(1) Productivity of publicinvestment was much lower than that of the private sector, primarilybecause public investment decisions did not follow a uniform or coherentevaluation process. In particular, the government did not undertake anevaluation of the social impact of investment that would justify thechoice of a given investment program over alternative programs. This problem was aggravated ag��gra��vate?tr.v. ag��gra��vat��ed, ag��gra��vat��ing, ag��gra��vates1. To make worse or more troublesome.2. To rouse to exasperation or anger; provoke. See Synonyms at annoy. by the fact that the prices of goodsand services versus production decisions were frequently divorced fromone another, because the public sector typically ignored therelationship between demand and price. In a market economy, pricescharged to users should be based on supply and demand considerations andshould serve as an indicator of the health of the market. This basicprinciple was systematically ignored in the Argentine public sector. Managerial inefficiency, on the other hand, is typically theresult of lax controls over the use of resources. Only a few state-ownedcompanies and public works public workspl.n.Construction projects, such as highways or dams, financed by public funds and constructed by a government for the benefit or use of the general public.Noun 1. projects employed such controls, as can beseen by a simple comparison of projected budgets for investment programsand the actual amounts used. An example of such inefficiency is theYacireta Hydroelectric Dam. After lengthy negotiations, in 1973 theArgentine and Paraguayan governments agreed to a enter into a jointventure to build the dam. It was anticipated that the dam would beproducing energy by 1980. Spending began immediately, but the mostimportant decisions were delayed for several reasons. Only in 1983 wasthe financing secured and the bidding process for the main developmentand turbines opened, automatically rendering all previous expensesunproductive. The original budgeted cost for the whole project was, in1982 dollars, between $2.5 and $3.0 billion and the revised estimate Revised estimateThe third estimate of GDP released about three months after the measurement period. forthe dam's inauguration INAUGURATION. This word was applied by the Romans to the ceremony of dedicating some temple, or raising some man to the priesthood, after the augurs had been consulted. It was afterwards applied to the installation (q.v. was between 1989 and 1991. The dam finallybecame operational in 1995, and costs are estimated to be close to threetimes the original budget (all computed in 1996 dollars). The properlyapportioned ap��por��tion?tr.v. ap��por��tioned, ap��por��tion��ing, ap��por��tionsTo divide and assign according to a plan; allot: "The tendency persists to apportion blame as suits the circumstances"costs of the energy generated today greatly exceeds those ofalternative sources. The electricity sector in Argentina The electricity sector in Argentina constitutes the third largest power market in Latin America. It relies mostly on thermal generation (54% of installed capacity) and hydropower generation (41%), with new renewable energy technologies barely exploited. prior to privatization is agood example of public sector inefficiencies. For many years, there wasexcess capacity in terms of installed power. The prices charged toconsumers were completely unrelated to this surplus, and, therefore, didnot take into account supply, demand or the cost of production. In spiteof the excess capacity, during the 1988 drought there was a severeshortage of electricity, because most electric plants were out ofservice due to lack of maintenance. The case of telephone rates and the situation of the statetelecommunications company See telecom company. , Empresa Nacional de Telecomunicaciones(ENTEL ENTEL Empresa Nacional de Telecomunicaciones (Chilean telecomunications company)), are revealing in terms of capital accumulation. The situationhere was very different from that of the electricity companies. Insteadof excess capacity, a marked shortage of equipment and infrastructureprevailed at ENTEL. Almost 64 percent of the requests for new telephonelines were not filled. The company experienced a remarkable inability toimplement investment and pricing policies to accommodate growth indemand. Another reason for transferring public enterprises to privateownership is to reduce the opportunity for corruption that emerges whengovernment contracts are reached in the absence of realistic budgets andeffective controls. The post-privatization rules of the game do notallow for the discretion of public agents in resource allocations nor dothey allow fraudulent contracts with resource providers to the state.However, when a country undertakes a significant privatization program,such as the one that took place in Argentina, it is extremely importantto provide the necessary mechanisms to ensure that haste does not createother opportunities for corruption on a grand scale. To keepprivatization from being discredited dis��cred��it?tr.v. dis��cred��it��ed, dis��cred��it��ing, dis��cred��its1. To damage in reputation; disgrace.2. To cause to be doubted or distrusted.3. To refuse to believe.n. , transparent bidding proceduresneed to be developed. Only after the first few privatizations This list of privatizations provides links to notable and/or major privatizations. See also: Privatization. ArgentinaAerol��neas Argentinas, the former national carrier didArgentina manage to develop such know-how. Prior to privatization, excess prices paid by state-ownedcompanies on the purchases of goods and services were estimated torepresent 30 percent of total spending. However, poorly plannedprivatization schemes would not have fared much better. In 1991, thegovernment declared void a contract by which soon-to-be privatizedstate-owned companies would have paid 15 percent of their total proceedsfrom sales for the distribution of invoices. After privatization, thecost of that service for private companies was less than 0.5 percent.The reduction in the cost of mail services was no doubt helped by thederegulation DeregulationThe reduction or elimination of government power in a particular industry, usually enacted to create more competition within the industry.Notes:Traditional areas that have been deregulated are the telephone and airline industries. of postal services in 1993, but the lack of competition inthat market could have never explained a difference of 30 times in thecost of the services. Contracts such as these were very often the resultof corruption. How Privatization Should Proceed From both the political and economic standpoint, privatization isoften considered a win-win situation. Observing the behavior of manygovernments and the difficulties they encounter in executingprivatization programs, one must seriously question the validity of suchassertions. We contend that privatization does produce unequivocalwelfare gains, but that the political process often hinders therealization of these gains. For this reason, many governments conductprivatization processes that, while politically feasible, do notmaximize economic efficiency. Yet it is possible, once one understandsthe intricacies of the problem, to conduct a sell-off process that isboth politically feasible and economically desirable. There are many instances in which government activity is justifiedon the grounds that it produces services in sectors subject to naturalmonopolies; that is, in sectors where competition between firms istechnically impossible (or nearly so). A natural monopoly In economics, the term monopoly is used to refer to two different things. This has been a source of some ambiguity in discussions of "natural monopoly".[1] The two definitions follow: An industry is said to be a natural monopoly arises whenthere are large fixed costs fixed costs,n.pl the costs that do not change to meet fluctuations in enrollment or in use of services (e.g., salaries, rent, business license fees, and depreciation). , usually associated with physicalinfrastructure or extensive networks that for some reason make littlesense to duplicate. Government ownership can make sense in such cases,since the government could finance the infrastructure development withnon-distortive taxes and could subsequently set the price of products orservices equal to marginal cost Marginal costThe increase or decrease in a firm's total cost of production as a result of changing production by one unit.marginal costThe additional cost needed to produce or purchase one more unit of a good or service. . This has served in many instances as ajustification for state management and can be considered the bestsolution under such circumstances. Rather than debating such a perspective, consider the challengesthat natural monopolies pose for well-designed privatizations. Supposethe government decides that a company should be managed or owned by theprivate sector. How should the privatization be designed? There arethree options. First, we examine the politically palatable pal��at��a��ble?adj.1. Acceptable to the taste; sufficiently agreeable in flavor to be eaten.2. Acceptable or agreeable to the mind or sensibilities: a palatable solution to the problem. option (PP),which would suggest selling the state-owned company at the highest priceto gain as much support for the process as possible. The second, whichwe call the economically sensible and politically feasible option(ESPF ESPF Equal Size Per Flow ), would sell the company but would also ensure that the regulatorystructure would remain tight and would force the price charged by thenewly privatized company as close to marginal cost as possible withoutbankrupting the firm. The third, which we call the economicallydesirable but politically unlikely option (EDPU EDPU Electrical Power Drive Unit ) proposes that thecompany should be given away while regulations are instituted so thatthe price equals marginal cost. The three models can be more effectivelyunderstood by referring to Graph 1. [Graph 1 ILLUSTRATION OMITTED] Graph 1 shows the initial equilibirium, in which a private or agovernment-owned monopoly would produce as well as set prices. Thepicture shows a demand D(p) for the service in question that isnegatively related to price. It also plots a constant marginal costcurve (MC) (for graphic simplicity, it is assumed that marginal cost isconstant). Finally, the graph shows a decreasing average cost curve (AC)with a slope reflecting that costs are proportional to an increasingnumber of units produced. As with any natural monopoly, the unregulated Adj. 1. unregulated - not regulated; not subject to rule or discipline; "unregulated off-shore fishing"regulated - controlled or governed according to rule or principle or law; "well regulated industries"; "houses with regulated temperature"2. (profit maximizing) private producer would choose quantity and price atthe point of intersection of the marginal cost (MC) and marginal revenue Marginal revenueThe change in total revenue as a result of producing one additional unit of output.marginal revenueThe extra revenue generated by selling one additional unit of a good or service. (MR) curves. A government interested in maximizing social welfare,however, would choose the point where the price equals marginal cost.Clearly, at this point the government would have to finance the fixedcosts(2) with the use of non-distortive taxes.(3) Suppose that the government chooses the PP option, selling thecompany at the highest price in order to buy as much support for theprivatization process as possible. Clearly, the maximum price apotential buyer is willing to pay equals the replacement cost ofinfrastructure plus the present discounted value of all the future rentsit can extract from operating the firm. To maximize the rent (and thusthe sell-off price), the government would essentially have to sellmonopoly power, or rents. We illustrate these rents in Graph 1 by theshadowed rectangle between the demand curve and the average cost curve. The strategy is politically palatable only if consumers or thelegislative body are indifferent to the price increases and drop indemand that will follow privatization.(4) There will be large deadweightlosses associated with this restructuring. The deadweight lossesstemming from the PP strategy can be seen in Graph 2 below. Yet, beingable to demonstrate that privatization is highly successful, asevidenced by a large number of bidders and a high selling price for thecompany, makes the program seem appealing. The appeal of this option,however, is only temporary.(5) In Argentina, the privatization of the flagship airline AerolineasArgentinas and the telephone company ENTEL took place in 1990 at anearly stage of the economic reform process. Emphasis was placed onmaximizing the sale price of the companies. These newly privatizedcompanies were given temporary monopoly powers similar to those of thestate-owned companies, but several regulatory issues had not been solvedbefore the bidding process began. Complaints about high telephone ratesfollowed, forcing the government and the new owners of the companies toconduct very difficult negotiations in order to settle pendingregulatory issues. The privatization process was politically palatableand assisted the government in convincing the markets of its commitmentto economic reform, but, in terms of economic and social welfareconsiderations, the privatization of these companies could have beendesigned much better. An alternative privatization scheme, the ESPF, would suggest thecompany be sold at a low price and be made self-sufficient in order torender further government subsidies unnecessary for its survival. Inthis case, the bidding price would equal the replacement cost of capitalinfrastructure. The regulatory structure must be carefully designed suchthat the bidding process does not result in prices that greatly exceedaverage cost. In this scenario, illustrated by a price cap in Graph 2imposed by regulations at the point where the demand curve D intersectsthe average cost curve (AC), the bidder recovers only the price paid forthe existing capital infrastructure over time. Product prices will below and the quantity high, and thus consumer surplus greatly increases. This strategy is more desirable from the consumers'perspective, but it requires a government that correctly understands atleast two factors. First, it is crucial that a regulatory structure bewell-designed in terms of effectiveness and cost. The regulatorystructure that determines future prices must be able to ensure thehighest possible consumer surplus. Second, the government must expectmeager mea��geralso mea��gre ?adj.1. Deficient in quantity, fullness, or extent; scanty.2. Deficient in richness, fertility, or vigor; feeble: the meager soil of an eroded plain.3. fiscal revenues from the sale of the company. In many instances,fiscal needs are the driving force behind privatization initiatives. Alow price does not imply that the government is sacrificing thecitizens' efforts or, as some put it in Latin America Latin America,the Spanish-speaking, Portuguese-speaking, and French-speaking countries (except Canada) of North America, South America, Central America, and the West Indies. , "givingaway grandma's jewels." It simply means that the company isbeing sold for what it is worth rather than what was spent developingthe company. Graph 2 illustrates how, despite a substantial sacrifice inprivatization proceeds (no rents are being auctioned off), consumersurplus increases substantially as the deadweight loss Deadweight LossThe costs to society created by an inefficiency in the market.Notes:Mainly used in economics, the term "deadweight loss" can be applied to any deficiency due to an inefficient allocation of resources. is reduced. [Graph 2 ILLUSTRATION OMITTED] Privatization of the water and electric utilities in the greaterBuenos Aires Buenos Aires(bwā`nəs ī`rēz, âr`ēz, Span. bwā`nōs ī`rās), city and federal district (1991 pop. area provides an excellent example of the ESPF strategy.Electricity distribution and water supply both exhibit characteristicsof a natural monopoly. At the time of privatization, the Argentinegovernment decided to create a regulatory framework that clearly statedthe quality and quantity requirements for the services to be provided.In addition to these requirements, electricity regulation included afixed services distribution fee. The bidding process was based upon theprice offered for the assets and the concession. Participating biddersgenerally commented that the margin (distribution fee) was very low,which we interpret as indicating that it required substantive efficiencyfor the companies to break even (price approximating average cost). Inthe case of water supply, the bidding process was set so as to minimizethe price charged to customers by the company for its services. The bidswould not compensate the government for the cost of the assets (whichwere to a great extent fully depreciated Fully depreciatedAn asset that has already been charged with the maximum amount of depreciation allowed by the IRS for accounting purposes.fully depreciatedOf or relating to a fixed asset that has been depreciated to a book value of zero. ) or for the concession. In thiscase, the demands on the development of infrastructure were importantand hence required that the company recover those fixed investments witha surplus over marginal cost. Thus, in both cases, the objective was toprevent government subsidies and to assure maximum consumer surplus. Afew years later, public opinion polls revealed greater support for theseprivatizations than those of the telephone services and the flagshipairline. The third option, EDPU, involves giving the companies away or, inless extreme cases, conceding production for a marginal fee whileimposing very strict pricing regulation. Since the company does not payto acquire the infrastructure, it is not necessary to compensate it forthe amortization of the fixed investment. If this is the case, charginga price equal to the marginal cost of production may be required.Consumer surplus is maximized and, from an economic standpoint, we reachthe optimal solution. Graph 2 illustrates this case by showing priceequal to marginal cost. Transferring operations of the firm from thegovernment-regulated public sector to the private sector would not leadto a change in price. Rather, this concession scheme mimics theoperations of a corporation run by a government that maximizes socialwelfare. Although, from an economic standpoint, EPDU ePDU Enclosure Power Distribution Unit (Powerware; Eaton)ePDU Enclosure Power Distribution Unit (Powerware)EPDU Electrical Power Distribution Unit is the optimalstrategy, it is difficult to achieve from a political perspective.Because the government receives no revenues or compensation for theprivatization, and merely devolves management to the private sector, itis unlikely to harbor political support for such an EPDU strategyIronically, it is the economic strength of this strategy that leads toits political weakness. Examples of this strategy are the privatization of the Argentinianrailroads and the port of Buenos Aires. In Argentina, railroads andports were notoriously inefficient and continually generated largerevenue losses for the state. The public reluctantly accepted the notionof not charging for the concession in exchange for quality and pricecommitments that would maximize consumer surplus. The three schemes described above assumed that there was noparticular reason for the government to privatize pri��va��tize?tr.v. pri��va��tized, pri��va��tiz��ing, pri��va��tiz��esTo change (an industry or business, for example) from governmental or public ownership or control to private enterprise: "The strike ... a firm, other than aneed for budgetary revenues. As we have seen, however, there are manyother incentives to privatize. For instance, if the operation by theprivate sector promotes more efficient technologies or reduces operatingcosts operating costsnpl → gastos mpl operacionales, then the transfer to the private sector can help avoid largeprice increases (the average and marginal cost curves shift downward).In any event, the design of the privatization program has a directeffect on the level of consumer welfare. Therefore, the creation ofwell-designed regulatory plans is crucial. The Design of Regulation As mentioned above, one temptation in the privatization process isto sell the company for a high price regardless of future developments;in other words Adv. 1. in other words - otherwise stated; "in other words, we are broke"put differently , creating the danger of swapping a poorly managedgovernment monopoly In economics, government monopoly (or public monopoly) is a form of coercive monopoly in which a government agency is the sole provider of a particular good or service and competition is prohibited by law. for an efficiently run private monopoly. Thisproblem can be avoided by creating a highly competitive environment or,where this is not possible, by developing an efficient regulatoryframework. Many privatizers place more emphasis on the corporate aspects ofthe sale than on the regulatory design. Companies are often spruced upto make them more attractive to potential bidders, and managementprepares extensively for the initial public offering or auction.(6) TheArgentine experience suggests, however, that time is best spent on thedesign of an efficient regulatory process that will govern thecompany's activity following its transfer to the private sector. Several important considerations are vital for effectiveregulation. First, privatizers should find ways to introduce competitionand minimize the need for regulation. Essentially, the market, ratherthan a bureaucrat, should be the regulator. Second, when regulation isunavoidable, it is important to simplify the informational requirementsand lower the costs of dealing with the regulator. Third, it isnecessary to minimize the opportunities for politicizing regulation bycreating an explicit and transparent mechanism, as well as anindependent regulatory board. Fourth, the interaction between regulatorsand firms should be minimized to limit the opportunities for corruption.Finally, and this concern affects all others, it is critical not tooverestimate o��ver��es��ti��mate?tr.v. o��ver��es��ti��mat��ed, o��ver��es��ti��mat��ing, o��ver��es��ti��mates1. To estimate too highly.2. To esteem too greatly. the institutional strength of the country. Courts,regulators and policymakers have a very difficult time allocatingresources and expertise to effectively regulate. It is a misconception mis��con��cep��tion?n.A mistaken thought, idea, or notion; a misunderstanding: had many misconceptions about the new tax program. that all privatization schemes requireregulation. In many cases, a government has stepped into productiveareas in which it had no natural reason to operate. Examples inArgentina included steel mills, the paper industry and petrochemicalplants. Privatization of those sectors should have proceeded rapidly andwithout unnecessary emphasis on regulation. Because of the nature ofthese plants, they may develop into local monopolies if the domesticeconomy is not large enough. A natural market-friendly way to overcomethis problem is simply to open up the economy to free internationaltrade. In some cases, some form of regulation is necessary. A typicalexample is the provision of electricity. The Argentine system wasoriginally conceived under a centrally planned organizational system.State-owned and state-operated companies carried out 90 percent of allpower generation, 100 percent of transportation and 50 percent ofdistribution. Energy availability was not matched well to demand.Shortages were common in some periods, while excess capacity was thenorm in most others. When the privatization process began, the systemwas completely reorganized re��or��gan��ize?v. re��or��gan��ized, re��or��gan��iz��ing, re��or��gan��iz��esv.tr.To organize again or anew.v.intr.To undergo or effect changes in organization. to introduce as much competition as possible.This reduced the need for complicated regulations. Electricity generation is now competitive and open to newentrants, and supply must adjust instantaneously to demand. In order toachieve this, a spot-pricing program is continuously being reworked. Theprice is determined by the marginal cost of the last entrant en��trant?n.One that enters, especially one that enters a competition.[French, from present participle of entrer, to enter, from Old French; see enter. into themarket. The transmission and distribution of electricity does requireregulation, however, because they are privately operated naturalmonopolies. In reality, there is substantial competition indistribution--the movement of electricity from regional storage centersto consumers--because medium- and large-size consumers can contractdirectly with the generators for the provision of low-cost energy. Inother words, they bypass the distribution companies. The fact thatcompanies can choose to contract with a local distributor or with agenerator (paying toll charges to the distributor) means there is morecompetition at this end of the market. Small firms and residentialconsumers, however, still need to be sheltered by regulation. The mostimportant lesson to be drawn from this example is that, by breaking upan old industrial structure, a substantial amount of competition hasbeen introduced into the system, with enormous benefits in terms ofenergy availability and price. Properties of a Regulatory Board As illustrated above, there are cases where privatization actuallyrequires deregulation rather than new regulatory structures. In othercases, however, regulation is necessary. In such cases, regulationsshould be transparent and simple. Complicated regulations that requireinformation about cost structure, sales and production create tremendousmonitoring costs and are expensive for the regulated firm. Furthermore,because the regulations are cumbersome to interpret and implement,corruption is more likely. Simple and transparent regulations aredesirable because they minimize the interaction between the regulatorand the regulated. Regulations must also be shielded from political pressures.Regulators should not be subject to political whims and instead shouldseek to provide transparency and predictability, not opportunism OpportunismArabella, Ladysquire’s wife matchmakes with money in mind. [Br. Lit.: Doctor Thorne]Ashkenazi, Simchashrewdly and unscrupulously becomes merchant prince. [Yiddish Lit. to theset of regulations. The Argentine telephone system regulations serve toillustrate some of these problems. Between 1994 and 1996, mosteconomists argued that it was necessary to adjust rates in the industry.Local rates were well below marginal cost, while long-distance callswere priced far above the relevant costs. Although technocrats generallyagreed that a new set of prices was necessary, political considerationsobstructed reform because rates were likely to increase in the mostvote-rich region of the country. Simple rules also minimize legal disputes. This point isparticularly important in developing countries, where the judiciarylacks experience in resolving complicated regulation disputes. Simplerules minimize both litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute.When a person begins a civil lawsuit, the person enters into a process called litigation. costs and the potential for unfairsettlements. It is frequently argued that politicians should play nopart in making regulatory decisions and instead the judiciary shouldsettle all disputes. While this argument makes theoretical sense, inpractice it can yield undesirable outcomes within a court system that isill-prepared to handle such issues. The best way to avoid suchdifficulties is to formulate clear and transparent regulations. Perhaps the best regulatory scheme that complies with therequirements of simplicity and ease of interpretation and implementationis the use of price ceilings. They require limited information, becauseonly prices are necessary. They are very general and transparent, andthey require only periodic revision (roughly every five years). Becauseprice ceilings minimize opportunities for corruption and discretionaryrulings, they are an effective method of regulation in the developingworld. The Impact on Welfare The low productivity of state-owned enterprises creates a welfareloss, because it reduces the quantity and quality of available goods andservices and raises consumer vices. In some instances, prices are fixedfar below the costs of production. However, even in those cases thelosses are nonetheless incurred by society in the form of budgetdeficits. The increase in productivity that is attained with privatization,deregulation, and heightened competition brings about an increase in thequantity and quality of services, as well as a reduction in price, withobvious gains in welfare. Argentine privatization increased production,improved quality, lowered prices and reduced losses in every instance. The tendency for prices or rates to fall after the deregulationand privatization of public enterprises has clear implications forindividual consumers, households, retailers and industries that use theprivatized good or service as an input. The electrical sector inArgentina illustrates this point. Because this sector has adecentralized de��cen��tral��ize?v. de��cen��tral��ized, de��cen��tral��iz��ing, de��cen��tral��iz��esv.tr.1. To distribute the administrative functions or powers of (a central authority) among several local authorities. distribution system, with individual companies servingeach city or region and each provincial government taking a differentattitude toward privatization, there is a considerable difference inrates paid by consumers who live in provinces that have privatized theirelectrical sector and those who live in provinces that still have not.The former enjoy lower household, commercial and industrial rates. Forindustry, this represents an important reduction in costs; thoseprovinces with privatized electric enterprises have a sizable siz��a��blealso size��a��ble ?adj.Of considerable size; fairly large.siza��ble��ness n. competitive advantage in attracting investment. Thus, the privatizationof sectors such as electricity, telephone and water supply gives localgovernments a tool to compete for new investments. Of course, thecountry as a whole benefits from these cost reductions, and lower pricesmake exports more competitive.(7) Finally, the state must no longer subsidize sub��si��dize?tr.v. sub��si��dized, sub��si��diz��ing, sub��si��diz��es1. To assist or support with a subsidy.2. To secure the assistance of by granting a subsidy. the excessiveproduction losses created by public enterprises. The elimination ofthese losses and of tax exemptions, legal or illegal, result in improvedfiscal accounts. The government can choose to reduce the tax burden onsociety (including the inflation tax) or devote more funds to new orimproved social programs. The following graph indicates how, as public spending as apercentage of GDP fell, social spending simultaneously increased, bothas a percentage of GDP and as a percentage of total government spending Government spending or government expenditure consists of government purchases, which can be financed by seigniorage, taxes, or government borrowing. It is considered to be one of the major components of gross domestic product. .The only remaining issue is how such spending should be allocated tosocial programs. Assuming optimal allocation, this increase, takentogether with our previous observations of higher investments, shouldconstitute a clear welfare gain. Conclusions In this paper, we maintain that privatization will typicallyincrease welfare for a number of reasons. A well-designed privatizationscheme increases efficiency, adds greater incentives for capitalaccumulation, resolves budgetary problems and curtails corruption.However, if the privatization design is not undertaken carefully, it caneasily fall prey to the temptation of garnering short-term budgetarygains rather than increased efficiency, fairness and corruptionabatement. The primary lessons to be drawn from the Argentine privatizationexperience are the importance of the market structure, which isdetermined by the privatization strategy that is employed, and the needfor proper regulatory frameworks. "Proper" in this contextdoes not mean extensive, but rather minimal: regulation should begoverned as much by competitive market forces as by simple andtransparent rules and should be enforced by regulators who are removedfrom the political process. Effective privatization both enhances socialwelfare and allows the government to redirect re��di��rect?tr.v. re��di��rect��ed, re��di��rect��ing, re��di��rectsTo change the direction or course of.n.A redirect examination.re its efforts toward areasthat require intervention, such as poverty alleviation, health care andeducation. [Graph 3 ILLUSTRATION OMITTED] (1) An excellent review of many ofthose studies can be found in Carlos Givogri's La Productividad delCapital en Argentina. (Cordoba cor��do��ba?n.See Table at currency.[American Spanish c��rdoba, after Francisco Fern��ndez de C��rdoba (1475?-1526?), Spanish explorer.]Noun 1. , IEERAL de Fundacion Mediterranea, 1993).(2) The losses that need tax financing can be inferred from theimaginary rectangle given by the point of intersection of D(p) and MC,the average cost curve right above that point, and the vertical axis.(3) If non-distortive taxes (usually called lump-sum) are notavailable, the government would have to partially finance the fixedcosts with distortionary taxes and part with an excess of price overmarginal cost.(4) Once more, this will happen only if the cost structure undergovernment operation is close to that under private management.(5) Alternatively, one can imagine that selling the company at a highprice implies that the costs of the privatization are well spread outamongst all users but the benefits, which are given by the highgovernment revenue, go entirely to the control of a small group. In thisparticular case, either the legislature or the executive branch couldreceive substantial resources to (6) Both theory and empirical research Noun 1. empirical research - an empirical search for knowledgeinquiry, research, enquiry - a search for knowledge; "their pottery deserves more research than it has received" show that cleaning up companies to embellish them before putting them onthe block is not money wisely spent. The private sector can and willalways follow the reorganization that might have taken place withfurther reengineering. Often times, the first mechanism adds very littlevalue to the company. On the other hand, the Argentine experience showsthat companies that were brought to sale were in such disarray dis��ar��ray?n.1. A state of disorder; confusion.2. Disorderly dress.tr.v. dis��ar��rayed, dis��ar��ray��ing, dis��ar��rays1. To throw into confusion; upset.2. To undress. that aconsiderable amount of time was necessary to conduct inventories, updatethe accounting and determine the actual levels of debts and payrollsthat the companies had. Time spent on this process is obviously timewell spent.(7) By the end of 1997, most most local state-owned distributioncompanies will have been transferred to private management.Domingo F. Cavallo, This article was written with the assistance ofSonia Cavallo and Guillermo Mondino.