Economic Reform In The GCC: Is Privatization A Panacea?

By - Paul Stevens*

The collapse in oil prices since 2014 has presented serious economic challenges for the countries of the Gulf Cooperation Council (GCC), underscoring the need to diversify their economies away from oil and, above all, develop their private sectors. Brent fell from $111.80/B in June 2014 to just $30.70/B in January 2016.

The GCC states have in response been devising wide-ranging economic reform plans. In many cases, central to these plans are options to privatize state-owned enterprises (SOEs). While media attention has focused on the National Transformation Progam in Saudi Arabia (MEES, 20 May) and particularly on the proposed privatization of parts of Saudi Aramco, across the GCC States interest in privatization extends beyond just energy to other sectors of the economy. Many are suggesting that privatization could act as a panacea to the underlying economic problems facing their economies.

Based upon the very extensive economics literature, privatization is supposed to do many things to promote the performance of state-owned enterprises (SOEs) and their contribution to the greater economic good. It is supposed to create more effective incentives to improve performance; force greater accountability on senior management; reduce government interference in business operations giving management clear commercial targets unfettered by requirements of social policy. It is also intended to reduce the financial constraints on enterprises that have hitherto been dependent on government revenue increasingly constrained by lower oil prices.

However, much of this current discussion in the GCC appears to disregard the lessons learned from privatization experiences elsewhere in the 1980s and 1990s. These lessons raise serious doubts about the effectiveness of any privatization program in the GCC. In particular, the ideological arguments for privatization – derived from the economic theory of politics, theories of public choice and principal-agent analysis – can also be used to explain why there is a strong possibility that governments in the GCC states will fail to privatize effectively. In other words, the ideological arguments used to favor privatization can also be used to understand why governments are likely to make a mess of their exit from the economy.

NEW OWNERS NOT ENOUGH

This previous experience, notably that of the UK under the government of Margaret Thatcher, shows that simply changing the property rights of an enterprise – ie switching it from public to private ownership – is not in itself sufficient to improve performance. Improved performance requires other necessary conditions. These include: increased competition; improved signals that force management to be responsive, flexible and inventive; reduced government interference to allow management to maximize shareholder value; and effective and efficient capital markets to impose the necessary discipline on managers.

The socio-political contexts that characterize the GCC countries are unlikely to be conducive to creating these necessary conditions. These contexts are based upon family and other elite patronage networks. Property rights are dubious, the rule of law may be debatable, and the prospects for the required independent regulation of privatized enterprises are at best uncertain. For example, SOE incumbents that are vertically integrated monopolies and monopsonists, which characterizes most SOEs in the GCC, are more likely to be sold intact to increase the revenue from their sale. This effectively inhibits competition in order to benefit the new owners; but competition is essential if privatization is to work. Such private buyers through their control of the institutions of state are likely to retain advantages associated with lack of competition, subsidized input prices and access to relevant infrastructure to name but a few benefits.

WANTED: COMPETITION

Theory and contextual analysis alike therefore suggest that privatization will not be the panacea that many believe it to be for the GCC states. If the private sector is to flourish in the GCC, an essential development if the economies are to diversify seriously away from oil dependence, a process is required that allows easier entry for new competitors – the proverbial ‘level playing field’. This will force any (hitherto monopoly) SOE to compete and perform. This appears to be a more realistic way forward than simple privatization. However, such an option raises the very basic question as to whether the ruling elites/families in the GCC will be content to see the rise of a significant private sector with its concomitant potential political power. In the 1950s and 1960s, the new military based governments in the Middle East and North Africa arising from what became known as the ‘colonel syndrome’ deliberately destroyed the private economic power of the old elites to undermine the basis of their political power. Economic liberalization through privatization in today’s world is unlikely to succeed in the GCC states without simultaneous political liberalization and reform to release the undoubted potential of the private sector in the GCC. If the current privatization programs simply deliver a set of windfalls for the state while reinforcing traditional patronage networks, this is likely to aggravate the same perceptions of corruption and helplessness that triggered the Arab Uprisings at the start of 2011.

*Paul Stevens is a Distinguished Fellow at Chatham House, Londonwww.chathamhouse.org

This paper summarizes the key findingsof his latest report, released 13 December: ‘Economic reform in the GCC: A panacea for declining oil wealth?’

Summary: Barriers To Effective Privatization In The GCC States

Summary: barriers to effective privatization in the GCC states
What privatization is supposed to offer Barriers in the GCC
‘State sector bad, private sector good’ Competition will not appear if elites buy the enterprises; governments may sell as a monopoly, and large incumbents will inhibit new entrants
More effective incentives for management Government failure will make it likely that exit will be messed up Governments will not allow strategic industries to fail
Greater accountability forced on management Inefficient capital markets likely to be dominated by short-termism
Reduced government interference, providing management with clear performance targets Reduced government interference is unlikely: energy is a strategic sector, and there are objectives concerned with creating employment
Reduced financial constraints on management Serious price reform is needed
Sell-off targets may be too large for domestic capital markets
If only the ruling elites benefit, this will fuel unrest
source: Chatham House.