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Privatization in Bangladesh: 

Some Critical Questions

Syed Akhtar Mahmood* Smahmood@worldbank.org 

* Syed Akhtar Mahmood is with the Private Sector Development Department of the World Bank. This article is written in his personal capacity and does not necessarily reflect the views of the World Bank Group.

As in most developing countries, privatization is a much debated subject in Bangladesh. However, while many developing countries have moved fast, despite such debates, to privatize state-owned enterprises, Bangladesh has been relatively slow in privatization. There is some irony in this for Bangladesh was one of the pioneers in this area. Long before Thatcher had made privatization a household word, and long before the transitional economies initiated a massive experiment with divestiture, Bangladesh embarked on the path in the mid seventies, with significant privatizations in the early eighties.

The slow speed notwithstanding, a large number of enterprises, across several industries and of varied sizes, have indeed been privatized. What have been the results? There is now a growing literature on this subject addressing several key questions: how have enterprises performed after privatization, has efficiency increased, has production gone up, and what has happened to the workers? The findings are mixed: while some enterprises have done well, others have not.

One could debate the quality of the studies, the rigor of the analytic methods used and the appropriateness of the conclusions drawn. We could argue on what constitutes appropriate indicators of performance and how to evaluate performance changes when there are improvements in some dimensions and deterioration in others. Measuring performance is not easy; interpreting the measures is even more difficult.

It is thus no surprise that different people have read different things in these findings. Some see the specter of de-industrialization in the fact that some enterprises have actually closed down after privatization. But others, noting that the closure of intrinsically inefficient enterprises actually benefits society by stopping the wastage of valuable resources, see this as a success of privatization. Some look at the poor loan repayment performance of some privatized enterprises and conclude that privatization was pre-mature; others, noting that the banks whose loans are defaulted are largely state-owned, argue for more privatization, encompassing both the real and the financial sectors. Some look at the poor tax payment record of some privatized enterprises and question the rationale for privatization; others see a weak tax administration as the root problem and argue for greater privatization, so that the government can concentrate on the really core tasks, such as improving tax administration.

The fact that some privatized enterprises in Bangladesh have done well while others have not should come as no surprise to those who have monitored post-privatization performance elsewhere. Variations in performance are common, both across and within countries. Much evidence from middle- and high -income market economies indicates that the results of privatization are generally, indeed highly positive; but such gains are not immediately apparent in a number of countries, in particular those that were once part of the Soviet Union and a number of other low-income countries. Here, the changes in ownership per se have not always led to the expected improvements, at least not fast enough. Problems faced by enterprises after privatization, and their spill-over effects on the rest of the economy, have thus become a matter of concern and the debate is now focusing on how to deal with the post-privatization problems. Should this task be left to the market? Is there a role for government and, if so, what exactly is it? Should governments focus on further policy and legal reforms or should it also make arrangements for providing direct support to enterprises? In country after country, especially in the ex-socialist countries, policy makers and others are now debating these issues.

In Bangladesh too, we need to focus more attention on the post-privatization problems faced by enterprises. All this debate on privatization in Bangladesh seems to have neglected one important set of questions. If privatized enterprises are not doing well, why is it so? What is constraining their performance? What factors determine post-privatization performance? Answers to these questions will let us evaluate better what is needed to improve post-privatization performance. Indeed, as many problems are common to all private enterprises, privatized or not, we will understand better what is required to improve performance of the entire private sector. Thus, if we are committed to private sector led growth, it is urgent that we ask these questions.

Enterprises, privatized or not, often need to bring about changes in their operations. Declining demand for traditional products may require the elimination of obsolete product lines and the introduction of new products. Greater competition may demand improvements in product quality and a strengthening of marketing functions. The presence of surplus employees may necessitate retrenchment. An unsustainable financial structure may warrant financial restructuring, such as debt-equity swaps or rescheduling of debt. And improvements may be needed in the accounting and management information systems to enable better monitoring of enterprise operations. In brief, enterprises often require restructuring to remain competitive and survive, if not expand.

This is especially true for privatized enterprises. State-owned enterprises are usually slow at bringing about necessary changes in their operations; indeed this is a major argument for privatization. The result: they are often saddled with many of the problems mentioned above, such as excess workers, obsolete products, improper financial structures and lethargic marketing departments. For such enterprises, mere ownership changes will not mean much if it does not lead to the required restructuring.

As mentioned above, many privatized enterprises have improved performance, often through bringing about such changes, while others have not. Why do some enterprises change and others do not? To answer this question, it is useful to distinguish between three broad sets of determinants of enterprise restructuring: signals, managerial skills and attitudes, and the enabling environment. For effective restructuring, all three sets of factors are important; the absence of one may considerably dilute the effects of the others.

To initiate changes, enterprise managers need to get the signal that changes are required. Often competition provides strong signals. Increased competition, whether from imports or from domestic producers, often lead to reductions in sales, revenues and profits. This signals to the manager the need to do something: e.g., change the product mix, improve the product quality, strengthen marketing efforts or shed excess workers. If managers know that government subsidies will not finance losses, or that enterprise owners will not tolerate large reductions in profits, they will make an effort to identify the causes of falling profits and take remedial actions.

Empirical evidence supports this view. A recent study of Russian manufacturing firms by John Earl and Saul Estrin found a positive correlation between import competition and several enterprise adjustment indicators, such as labor productivity and introduction of new product lines during 1992-94. Similarly, a study of Polish industries over the period 1991-93 found that total productivity growth was faster in industries subject to greater import competition.

Managers will be much less induced to change when signals are absent or contradictory. This can be the case, for example, if state-owned monopolies or oligopolies are privatized with no change in the competitive environment. Not subject to the discipline of competition, owners and managers of such privatized enterprises will maintain business as usual. They may show good profits--thanks to their monopoly privileges--but not necessarily improvements in efficiency.

Signals may also contradict each other. Enterprises facing competition may survive without improving efficiency if someone is bailing them out. In Bulgaria, for example, trade liberalization in recent years has intensified the competition from imports. And, yet, empirical studies do not document any significant impact of import competition on the performance of privatized enterprises. Why? Because while the Bulgarian government liberalized trade, it continued to provide subsidies to privatized firms and tolerated tax arrears and defaults on loan repayments to state-owned banks. Enterprises could thus survive despite losses induced by competition.

This is a classic example of one signal, i.e., increased import competition, being diluted by another, i.e., the provision of subsidies. By liberalizing trade, government signaled enterprises that, henceforth, they will no longer enjoy a protected market and will have to face up to competition. But, by continuing to provide subsidies, it simultaneously gave the opposite signal, i.e., "Never mind if you cannot face up to competition; if you cannot sell your products and earn adequate revenues to pay your taxes and repay your loans, we won't force you to do so". Not surprisingly, Bulgarian enterprise managers spent little time on introducing efficiency-enhancing measures. Why should they, when it was more worthwhile lobbying the government for subsidies?

Strong and consistent signals are thus necessary. But they are not sufficient. Even when the signals are strong and clear, lack of managerial skills may prevent an enterprise from doing better. Realizing the need to expand markets is one thing. Effectively searching for new markets, assessing demand and aggressively marketing products is a different ball game. Many managers lack these as well as other skills, such as the ability to develop business plans, adopt and adapt modern technology, control quality and put in place modern methods of accounting and monitoring.

Sometimes the problems are cultural, arising from deeply-ingrained attitudes and practices. This has been a pervasive problem in the ex-socialist economies, most of which lack people skilled in managing firms in a market economy. The old system obviously did not help develop market economy skills and attitudes in managers. Deprived of decision-making authority, except in day-to-day technical areas, managers lacked self-initiative and entrepreneurial spirit. Since output was sold mostly through central marketing agencies, and the emphasis was on volume of production, not sales, managers neglected product quality. In enterprise visits in the ex-socialist countries, I have myself encountered many managers still obsessed with trying to expand production volumes with little clue on markets for their products.

Empirical studies are showing that improvements in managerial skills and attitudes do have a significant impact on post-privatization performance. For example, a recent study by Simeon Djankov and Gerhard Pohl of the World Bank has found that, in Slovakia, firms with changes in top management performed better than firms which retained old managers. Another World Bank study of 192 Moldovan enterprises shows significant returns to manager training. Surveys show that managers attach top priority to training in marketing and sales, with accounting training and visits to enterprises abroad also being cited as useful.

Managerial skills are thus important, as are strong and clear signals. However, we see numerous cases where, despite strong signals and skilled managers, improvements in enterprise performance are insignificant. This is usually due to various hurdles in the environment in which enterprises operate. Hurdles may be created by residual government controls, such as restrictions on exports, requirements to maintain the existing line of business, and restrictions on sales of assets, entry of new businesses, and the hiring and firing of workers. Even where outright restrictions are not in place, government policies may effectively restrict managerial discretion. High taxes on proceeds of asset sales which discourage enterprises from selling assets is one example.

Unpredictable and poorly administered government policies also create problems. More than high taxes, frequently changing tax rates, arbitrary interpretations of tax rules and other harassment by tax authorities usually raise the cost of doing business and discourage restructuring. Lack of legal and economic information, including market studies and company diagnostics, could also be a problem. If enterprises have inadequate knowledge of existing laws and their interpretation, they could become vulnerable to the whims of government officials and prevented from implementing appropriate restructuring decisions. Inadequate economic information, whether enterprise specific, such as enterprise diagnostics, or more general, such as market studies, also constrain restructuring. These problems are compounded by the fact that, in many countries, support institutions, such as the consulting, accounting and auditing industries are underdeveloped. Where they exist, they mostly serve larger clients who can pay, bypassing small and medium enterprises. In many countries, even larger firms encounter such problems.

Finally, and this is no surprise, lack of financing often prevents enterprise managers from carrying out restructuring even if they had the incentives and skills to do so. Lacking risk-management skills, banks often resort to excessive risk-averse behavior, leading to inadequate supply of credit even to credit-worthy enterprises. Only a few well-known clients get loans, and credit decisions are based on the quality of collateral, not that of the project. Poor supply of foreign investment exacerbates the financing problems besides depriving enterprises of useful technical know-how.

The above discussion suggests one thing. It is important that, in Bangladesh, we move away from constantly debating whether privatized enterprises have done well or not, to diagnosing the reasons for less than satisfactory performance in some privatized enterprises. If these are not doing well, is it because the environment is not competitive enough, is it because government continues to bail out poor performers, is it due to lack of managerial skills, is it due to bottlenecks created by government policy and its implementation, or is it due to other factors? Once this diagnosis is done, we would be in a much better position to identify policy and other responses required to address the constraints.

The fact that some privatized enterprises have not done well is not enough evidence against the logic of privatization. It is more a signal that further reforms might be required and that, in most circumstances, privatization, especially partial privatization, is not sufficient.

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