Taking Stock / The Other Eight Myths of Privatization

With Benjamin Netanyahu's return to government, the fierce debate over privatization will come to the forefront again - privatization, that magical, divisive word he so loved as finance minister and prime minister.

Last week we showed that the tremendous profits the tycoons ostensibly raked in from privatization, apparently because they'd bought the government companies for a mess of pottage, proved all too ephemeral. They were a figment of the booming financial markets, and when the bubble burst, most of these giant profits evaporated.

The state did make a mistake in selling the shipping company Zim for far less than its value at the time. But most of the huge profit made by the buyer, the Israel Corporation, was driven by the boom in the cargo shipping industry - which didn't last.

Then there was the state's sale of its shares in Discount Bank and Bank Leumi, for roughly their market value, and the buyers suffered huge losses on the stock because of the financial crisis.

So much for the first myth, that the tycoons always hang the state out to dry when it comes to privatization.

Today we will discuss eight more myths that have taken firm root in the Israeli public debate, and shouldn't have.

Most of the media's attention, when reporting on privatization, is devoted to price. Are state companies being sold for peanuts at the public's expense, they ask? (Not necessarily - the reality is that when a tender is held and several potential buyers compete, the companies go for around their market value.)

But the main problem with privatization isn't price. It's whether it achieves its goals.

The purpose of privatization isn't to generate money for the government. The check the government gets should be equal to capitalization of the cash flows that the company is expected to generate throughout its lifetime.

Most of the tycoons robbing the public under government sponsorship aren't doing it by buying state assets. Those are generally sold through transparent processes. The public is robbed after privatization more cleverly: when the state folds before the tycoons and, by omission or commission, lets them milk consumers who need the service the company supplies.

The filthy rich don't become that way by buying government companies, but by influencing regulation, so their businesses become monopolies or cartels. The four most glaring examples are the markets for cars, cellular communications, insurance and banking, which have been shielded by government and are controlled by Israeli billionaires.

At the banks, most of the monopolistic profit went to management and workers: The owners were left with miserable returns on their money. Their main reward was clout in the business sector.

Privatization has three more important goals: to improve service, to intensify competition and to streamline and advance the company. Are these achieved? Onto the next myths.

In the public debate, "privatization" and "competition" are often regarded as the same thing. In practice, often the opposite ensues: competition is choked. Israel's communications market had healthy competition in the 1990s after the government decided to open the long-distance, cellular and Internet markets to new providers. At the end of that process, the government company Bezeq was privatized. That didn't spur competition in itself. Also, it can be easier for the regulator to deal with a government monopoly than a privately-owned one.

The Israel Electric Corporation workers take advantage of the confusion, often warning about the company's "privatization" as though it were a danger to the public. But the electricity market needs to be opened to competition, which would force the company to become more efficient and improve service.

In 1997, the state privatized Bank Hapoalim, selling the bank to the Arison group. To this day the state hasn't managed to sell its stake in Bank Leumi, a controlling interest it has held since the bank shares crash of the early 1980s forced the state to nationalize the banks. So while Bank Hapoalim is privately run, Leumi remains controlled by management and a board of directors chosen by a public committee led by a judge.

Yet wonder of wonders: during the last 10 years, Bank Leumi shares have returned more (including dividends) than Bank Hapoalim shares. Hapoalim's privatization did not dramatically improve its efficiency versus the state-controlled bank, Leumi. The people pulling the strings at the banks, whether privately- or state-controlled, are the powerful unions. Also, under private management, Hapoalim took more risks, which served it during the boom, and ravaged it come the bust.

Or take El Al. More than four years have passed since the airline's privatization, but it retains many characteristics of a government company, in terms of organizational culture and union clout.

Then there's Zim. When the Ofers bought the shipper from the state, Zim undertook far greater business risks. Now it's paying the price, in the form of towering losses.

Most businesses are better managed by the private sector than by the state, but some of the state's services aren't "business," and are better left in public hands.

But the question of which services should be left under government management isn't the right question. It misses the point. The real question is how to improve public sector management, and how to compel the government to provide its services more efficiently. And when services are privatized, the question is how to ensure that the public interest is protected.

Myth 6: When a business is sold by the state, it's 'privatized'

Sounds trivial, you say. That's what privatization means: An asset, to wit a company, is transferred from government to private hands.

Actually, that's not exactly true, economically speaking. Businesses and services that have been sold and operate in the free market often remain subject to some form of government supervision. Often the implications of this government supervision matter more than who the owners are.

Take the banking system, which with the exception of Leumi has been "privatized" - but every banker and every saver (at least, those who left some money in the banks) know that in a crunch, the state will step in and seize ownership and management of the banks.

America's banking system had been "private," and as such, its management and workers helped themselves to stratospheric pay packages over the last decade. But when it turned out that the management, however well rewarded, had been disastrous, whoosh! in a snap all the losses and risks were handed over to the American taxpayer.

The question Americans are ostensibly asking - whether to "nationalize" the banking system - is not relevant anymore. It's been done. The risks have been pushed onto the taxpayer and now the only question is whether the managers and workers will continue to receive stratospheric pay packages, even though their shortcomings have become all too clear.

Myth 7: Privatization is bad for workers

Not only is that not true, in many companies it's a bonanza for them because of union demands in exchange for acquiescence to the sale.

In every case of privatization to date, when the company is sold, the state has to pay off the workers. Naturally, the "compensated" workers already earn double or more the average wage. Also, in all privatizations to date, the state has had to guarantee and/or subsidize the workers' pension plans, providing an option for early retirement. In hindsight, we see that nobody factored in that cost, but it seriously reduces any gain the state made from the sale in the first place.

In some cases workers have profited twice from privatization: Not only does the state participate in their pension provisions, but they get stock options and/or a raise from the new owner. Sometimes the union remains a force after the sale, losing none of its power, as happened at Bezeq. There the state had to sweeten the workers with inflated pension schemes at a cost of NIS 10 billion before it could sell the company. After Bezeq's privatization, the new owners had to pay heavy sums to streamline the workforce.

Myth 8: Right-wing governments push privatization, left-wing governments stop it

In France, but not in Israel. Here most of the cabinets during the last 20 years leaned to the right, yet the Israel Electric Corporation, the Israel Aerospace Industries, the Israel Military Industries and dozens of other companies and organizations are still curled up on the government's lap. Apparently politics is stronger than ideology.

Myth 9: Privatization spurs economic growth

Increasing productivity, spurring competition and attracting foreign capital - all are important to economic growth. Most privatizations in Israel contributed little to any of the above. Privatization has become an empty slogan in both main avenues of economic debate - among capitalists, and among the opponents of competition.

We can only hope that in his next term in office, Benjamin Netanyahu stops trying to bamboozle the public with meaningless slogans and knuckles down to the real job - increasing competition and weakening the juntas of the tycoons and the unions, which are weighing on Israel's economic development.