LATIN AMERICAN SPECIAL — Private investment in developing

Recent years have seen a major and continuing transition from state control of production facilities to private ownership. This trend has been visible in both industrial and, especially, developing countries.

It has included not only manufacturing plants but, more importantly, a set of activities ranging from financial services to infrastructure, the latter including electricity, communications, transportation and port facilities, among others.

Between 1988 and 1992, developing country governments realized more than US$60 billion in revenues from the sale of state-owned assets. In value, two-thirds of these privatizations were concentrated in Latin America, especially in Mexico, Argentina, Brazil and, smaller in value terms, Venezuela and Chile.

Significant privatizations, however, also occurred in a variety of other developing countries, including Malaysia, the Philippines and Thailand in southeast Asia, and Portugal, Hungary, Poland and Czech and Slovak Republics in Europe.

Although much smaller in financial terms, large numbers of transactions took place in such countries as Turkey, Pakistan, Tunisia, Nigeria, Honduras, Ghana and Sri Lanka.

The increasing popularity of privatization is being driven by two primary factors. First, governments have found a major drain on their fiscal accounts at a time when revenues have been difficult to generate. Thus, selling these enterprises to the private sector has permitted governments to cut their fiscal deficits and to allocate funds for other purposes. In addition, of course, proceeds from sales have been a welcome source of revenue. Much more importantly, the move to privatization has been motivated by the simple realization in many countries that public sector companies have not been an effective means for providing many types of services. Efficient operations rarely have been the overriding objective of such enterprises, and the result often has been high costs and slow response, if there was any response at all, to changing markets and consumer desires.

Moreover, because governments became less and less able to finance company deficits, needed maintenance and modernization typically also became a casualty, thus compounding losses and inefficiency.

Although most funding to support privatization came from local sources, the amounts generated from abroad have also been substantial. During 1988-1992, foreign sources provided about $18.5 billion, or 30% of total privatization financing, during this period.

Of this amount, more than a quarter went to various Eastern European countries, where the ability to mobilize local savings was inadequate. However, owing to its much greater importance in overall privatization activity, Latin America also attracted the most foreign funding, amounting to nearly two-thirds of the total.

It should not be surprising to find that of the foreign investments in privatizations, most has come in the form of foreign direct investment (FDI). Besides bringing capital, strong foreign equity partners can provide precisely the types of strengths needed to make enterprises once again productive: technical skills, production knowledge, management practices, marketing intelligence, etc.

In total, FDI accounted for flows of $14.5 billion between 1988-1992, more than three-quarters of the financing from foreigners.

Privatizations also accounted for a substantial proportion of total FDI during this period, more than 10%. This figure varied considerably across regions, however, being much more important in Europe and Latin America than in other areas.

In some countries, of course, the part of FDI going to privatization was much higher, as in Argentina (36%) and Venezuela (41%). In East Asia, FDI flows overall were so large that financing for privatizations, although significant, paled by comparison. In some other areas, countries restricted foreign participation.

The existence of privatization programs, particularly those that encourage foreigners as participants, are an important signal to other investors. It has been shown that FDI destined for privatization, for example, has as one consequence increased flows of other types of FDI.

Investors see privatization as an indication that governments are serious about opening their economies, reducing fiscal deficits, cutting back on the role of government in the economy and improving infrastructural elements. All of these are signs that the investment climate is improving, and investors, foreign and domestic alike, tend to react positively.

— From Discussion Paper No. 20 of the International Finance Corp., an affiliate of the World Bank, Washington, D.C.