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Author: 
Dr. Mohamed A. Ramady
Publication Date: 
Mon, 2006-05-08 03:00

One of the key economic reform strategies that Saudi Arabia has publicly announced is for privatization of nearly most of its state controlled assets. The recent announcements that Saudi Arabian Airlines and the Saudi Mining Company (Maaden) will be privatized, illustrates that no industry will remain untouched by privatization. Indeed in both scope and breadth of intended privatization, the Saudi program is one of the most daring and ambitious of any privatization program ever announced in the world. The issue of privatization however raises strong emotions, from proponents as well as opponents, and it is important to clarify what are some of the main objectives and obstacles to a successful privatization program, if this key Saudi economic strategy is to be widely accepted and successful.

The simplest definition of privatization is that it is an instrument of economic policy through which a transfer of property or control of assets, usually owned by the state, passes to the private sector. In its purest form, privatization encompasses the privatization of management and ownership, and this is where some of the disagreements begin.

In the Gulf Cooperation Council countries, privatization has been used as a means of diversifying the economic base of the region, as well as a means of wealth distribution for a larger section of society by creating a share holding class. It is not only in the GCC that privatization, has been used as a political and social tool. In Britain, under Prime Minister Margaret Thatcher, privatization was used precisely for such purposes in the initial stages of her premiership, namely, to create a share owning middle class. Not even present day New Labor governments in the UK can roll that back.

To date, privatization results in the GCC countries have been patchy and lagged behind other regions of the world. The primary reason stems from the manner with which privatization has been carried out. Privatization follows many different forms — ranging from a minimal private sector ownership stake in a government asset, to total ownership and management control. Under minimal private sector ownership are the better-known subcontracting and management contracts for specific delivery of goods and services, with the government entity still in overall control. Then one moves up the privatization scale to leasing, franchising, concessions, build-own-operate (BOT), build-operate-own (BOO), licensing, and, finally, to 100 percent sale of the public asset by the government. Each of these public sector-private sector partnerships entail a different set of agreed commercial and operational elements, with specific penalty clauses for non-performance, especially for the shorter-term subcontracting and management contracts.

For Saudi Arabia, privatization has been a strategic choice, necessitated by the forecasted capital expenditure needs of the Kingdom in key service areas over the next 20 years, estimated at around $800 billion or SR3,000 billion for infrastructure projects, petrochemicals, electricity and water, telecommunications, gas, agriculture and information technology.

The Kingdom’s basic privatization objectives are clear: Increasing employment opportunities, providing services to citizens and investors in a timely and cost efficient manner, rationalizing public expenditure, and reducing the burden on the government budget, as well as increasing government returns from the sale of assets.

What then, are the obstacles to privatization? These objections seem to be based on potential negative employment consequences arising from a fully-fledged privatization drive. For the private sector taking on government assets through privatization the issues faced can be many: Rigid pay structures for employees taken on with the company sale, possible eventual reduction in government subsidies, possible unclear regulatory operating framework for the newly privatized entities, as well as the under estimation of a fair book value price of the sold asset.

One can only assume that privatization is carried out on a transparent basis, as far as book value pricing and regulatory operating framework laws are concerned. Other country privatization experiences, from both developed and developing countries, seems to indicate that over the medium term (2-3 years after privatization), the results have been more positive for most privatized industries in all measures such as higher volume of employment, productivity increases, investment inflows, dividends payment and efficiency criteria.

These bode well for Saudi Arabia’s privatization plans. A major issue however, is that such productivity gains are in the future. One key policy for Saudi Arabia is the seemingly unspoken problem of what privatization means for Saudization and employment. If such measures increase Saudi unemployment in the short term, on the assumption that higher value employment will be generated in the future by the private sector, then both society and the Government will err on the side of caution.

Privatization will slow down as the private sector will not wish to take on “white economic elephants”, where they have limited flexibility in terms of hiring and firing employees. It is not surprising that given social concerns on the issue of employment impact, that privatization has taken on a somewhat different form in Saudi Arabia and the Gulf countries whereby a minimal share of the government assets — usually 30 percent — have been sold to the public with majority share holding and management decision making still kept in government hands.

Such “paternalistic “privatizations only postpone the inevitable question — how will such semi-privatized government institutions fare when they are fully privatized?

In the meantime however, “paternalistic” privatization has been popular as the governments of the region have sold shares in fairly lucrative sectors as telecommunications and internationally robust industries such as petrochemicals. Shareholders have done well. Middle class share holding habits and a long term stake in society develops from such measures. Even advanced industrial economies often start with “softer “privatizations options first, as Mrs. Thatcher showed the way in Britain when she decided on British Telecom, British Airways and later moved to harder asset sales. The British public suddenly found that they really liked share ownership, after many years of dogmatic economic Labor government rule.

Where does Saudi privatization go on from the limited privatization scope that we have seen for government corporations such as Saudi Telecom Co. and Saudi Basic Industries Corp. (SABIC)? Will Saudia’s privatization, even if carried out on a partial basis, be as enthusiastically received by the public? A higher degree of transparency in financial and operating track record is required for sale of the “more” difficult” government assets. What helped to ease recent sharp drops in the Saudi stock market index has been the underpinning provided by the shares of perceived blue chip Saudi government companies such as SABIC and STC. Would the share holding public have had the same faith in less economically, operationally and financially transparent privatized entities?

It is important, that a serious dialogue is established now with the private sector on the issue of privatization and its long term consequences, and how both sides can become effective partners, as privatization is more than just short term gain from the sale of assets priced at or below book value. Saudi Arabia needs to accelerate the pace of its privatization program, as it is a central plank in the policy of economic diversification and helping to nurture a robust private sector.

At the same time this will help to channel investor funds into long term privatized basic industries and services that will provide services on a more competitive, cost efficient and consumer friendly manner. The road will be difficult, and sometimes the final result not as expected, but, on balance, countries that have embarked on the privatization road have seen a long term improvement in the quality, quantity and pricing of services due to more invigorated competition. Just ask STC users in Saudi Arabia or BT and BA users in the UK now and before privatization...

(Dr. Mohamed A. Ramady is visiting associate professor finance and economics at King Fahd University of Petroleum and Minerals.)

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