Market Economy and Government’s Role
1 Project Objective
The project objective is to investigate the practices of privatization in traditional market economies and the evaluation of their performances, by examining the telecommunication industry, more specifically SingTel.
2 Market Economy and Government’s Role
2.1 Market Economy
A market economy is an economy that operates by the “invisible hand”. Producers and consumers are left to make their own choices regarding production and purchase of product quantity, variety and price. i.e. The economy operates by supply and demand forces, without intervention.
This economy is in direct opposite of a Command Economy, where government committees determine the quantity, variety, and prices of production of goods. As perfect information do not exist in any economies, these central decisions will cause the maximum social benefits to decrease, causing a deadweight loss, because the decisions may not match supply to demand. Following such arguments, it seems that government intervention causes economy to function less efficiently. However, government has a role to play even in a market economy.
2.2 The Role of Government
Governments in market economies play critical roles in providing the economic conditions in which the marketplace of private enterprise can function most effectively.
To name a few, firstly, basic infrastructure for any industries which no producers would willingly create for public use has to be established before the industry can pick up and allow market economy to operate. Secondly, government needs to establish laws to ensure competitive market for any industries, such as Anti-trust laws to prohibit collusive behaviour, where few firms collude and set price high, maintaining a more effective degree of competition in the economic system.
A broad definition of privatization is all reductions in the regulatory or intervention and spending activities in a particular industry or firm.
4 Conditions of Being Not Government Owned or Privatized Business
4.1 Economy Specific Conditions
When an economy is still developing, less mature, a market economy with private firms may not achieve efficiency. For private firms to operate efficiently, several conditions need to be present. Firstly, a defined property system has to be established. Secondly, an effective legal system must exist. Thirdly, the government has to be clean and efficient. This is because, the first 2 conditions which are crucial for privatization to be effective, requires the government to establish them to protect the interest of private firms and consumers.
Before the government decides to divest state property, the conditions, mentioned above, need to be present to ensure a smooth transition from a state to a private property. On top of that, the government should also provide adequate performance records of the business as well as clearly define their interest in the business after the privatization process.
By 1992, Singapore’s economy is by large a market economy, with defined property system, effective legal system and a clean and effective government. These conditions made it possible for privatization to be effective.
4.3 Industry Specific Conditions
For the industry to be ready for privatization or liberalization, the industry has to be relatively mature, so that the business could thrive without the government’s aid. In addition, basic infrastructure must be developed because infrastructure is usually seen as a public good which few or no firm finds it beneficial to provide.
Singtel, before 1992, is government owned. It is a natural monopoly, whose services are most economical to be produced by 1 firm. Permitting several sets of entirely separate telephone or electrical lines would be wasteful and inefficient in the extreme. Instead of controlling costs and maximizing efficiency through competition, the government regulated the prices and services to ensure that the best possible prices were offered to consumers (protecting consumers’ benefits) and Singtel would still receive a satisfactory rate of return on its investments (ensuring producers’ interests).
By 1992, the telecommunication industry, and thus Singtel has begun to mature. Also, the telecommunication infrastructure has been developed. In addition, the existence of the basic infrastructure and increasing demand brought by technological progress, telecommunication services are then economical to be provided by more than 1 firm. These conditions made Singtel ready to be privatized.
5 Reasons for Being Not Government Owned or Privatized Business
The main reason for privatization is to improve efficiency in the industry or firm. It is believed that when a firm is privatized, management has more incentive to operate more efficiently, when their compensation is tied to the performance of the firm. This is so as the private rate of return is now closer to social rate of return. Hence, the firm will seek to maximize the social benefits by managing its business more efficiently, as in doing so, its private payback will be increased.
There may be social pressure by the public that makes it politically strategic to privatize some firms as failing to do so may cause public unhappiness and lose political power. In some cases, such move is taken not due to potential loss in popularity, instead to gain favour. Government -owned firms may also be spun off to raise capital to cover for the country’s deficits.
When certain services or products needs have grown to relatively large proportion, the government may not be able to cope with or satisfy these needs. Thus, government may privatized the firm or liberalized the industry to encourage supply to meet these private demands that have out-stripped public provision.
5.2 Telecommunication Industry
In many countries, governments have traditionally owned and operated telecommunications. This monopoly arrangement was intended to ensure economies of scale and social goals such as universal telephone service. However, as the world economy becomes more information intensive, the need to be more responsive to free-market needs increases. But, state monopolies tend to be slow to respond thus governments began to take on the idea of privatization.
The pace and scale of change in the telecommunications industry is now characterized by rapid advancements in technology, service innovations and changing industry structure. As governments all over the world come to realize that a vibrant telecommunications industry is an important pre-requisite for a healthy economic growth in this age of advanced info-communications, there is a tendency to privatize and liberalize the industry to keep up with the pace and scale of change. Trends of deregulation, technological advancement and privatization, thus caused turmoil in the once stable and highly profitable industry. Asia has not been spared these trends, which are global and sweeping in nature.
5.3 Singapore’s Telecommunication Industry
Singapore is an international communication hub and national infrastructure, and information infrastructure in particular, has played a key part in Singapore’s development [Knoop, Applegate, Neo and King, 1996]. In order to attract companies to Singapore as a base for their business enterprises, Singapore must provide an attractive variety of telecommunication services at competitive prices.
Singapore’s telecommunications industry operates under the conditions of high teledensity, high income levels and lower income disparity, high quality in fixed-line services, higher demand for specialized features, lower vulnerability to credit risks and regulated but falling tariffs (the average international call charge declined by 42 per cent between 1993 and 1998 [Singh, 1998]. These conditions are very different from those which other telecommunications providers experience in the rest of Asia. This has given Singapore an edge in providing better telecommunications services.
The Singapore government has viewed the telecommunications infrastructure as a national asset, aiding its early development by providing financial support, protection from market forces and managerial talent, while urging the adoption of competitive rates. At a later stage, the state did not provide public funds to Singapore Telecom, in order to enforce market discipline on it.
5.4 Reasons for the Privatization of SingTel
In 1989, the Singapore Governement announced its intention to privatize Singapore Telecom and to list it on the Stock Exchange by 1993. Singapore Telecom was privatized as part of an effort to reduce the government’s involvement in business [Tan, 1992; Low, 1995].
With the evolution of rapid technological improvements, many new products and services are innovated. An example of a new service would be Internet telephony, which is inexpensive and flexible in price and services to consumers, threatening to gain substantial market share in domestic and international voice traffic at the expense of established telecommunication companies. Thus, such technological improvements pose as a huge threat to traditional telecommunication services, but also create opportunities which can be exploited through entrepreneurship and innovations, hence shifting the industry from proprietary to open standards.
Facing the vast challenges to remain competitive and efficient, to continue being an international communication hub, in the midst of the technological advancement, Singapore Telecommunication industry has to acquire a cultural change, moving from operating in a slow-moving, monopolistic and protectionist system to a competitive market. With such rapid changes in the worldwide telecommunication industry, Singapore encounters increasing global challenges. The Singapore government deregulated the management of SingTel so as to prepare the telecommunication industry to be responsive, flexible to any competitions.
In addition, with the development on innovative products and services, consumers demand for higher product qualities and variety are inevitable. The privatization of SingTel, hence serves to cater to higher consumer expectations, so as to maximize its returns as its returns now depends greatly on the social returns of its services, instead of a return controlled by the government with its intervention in the business.
Preparation for Liberalization
The privatization of SingTel was also done to prepare for liberalization of the industry in later years. Liberalization of this industry was seen as necessary to meet the growing and changing demand of telecommunication services resulting from technology advances.
Stimulation of the Singapore Stock Market
By privatizing SingTel via the issuance of stocks, it encourages public involvement in the stock market as the general public has confidence in a large and strong company like SingTel. This stimulates the development of the Singapore stock market which at that time was overly dependent on the Malaysian Stock market and lacked both depth and scope [Kuo et al., 1989; Toh and Low, 1990a, 1990b; Low, 1995].
6 Practices of Privatization
Categories of Privatization
There are four main categories of ways in which governments can privatize state owned property. As the factors that affect the choice of privatization are plenty and highly political, and the goals of privatization are complex, empirical evidence on the determinants of the privatization is limited. Among the 4 categories, privatization through the sale of state property has been the most common method used by government in the past two decades [Megginson and Netter, 2001], and the most controversial method is mass privatization.
6.1 Privatization through Sale of State Property
There are two main ways in which this method of privatization can be carried out:
In the direct sales of state property, individuals, existing corporations or a group of investors pay the government for ownership rights on the property.
Share Issue Privatization (SIP)
In share issue privatization, the government sells its stake in the state property through a public share offering.
According to an empirical study by Megginson, Nash, Netter, and Annette Poulsen (2000), several factors influence the choice of privatization methods. These include capital market, political, and firm-specific factors. Specifically, they found that SIP is the preferred choice when 1) there is more even distribution of income, 2) the government hopes to simultaneously develop the capital market, and 3) the state business is profitable. On the other hand, those economies with an established property system would be more likely to use direct sales.
Another study by Bernardo Bortolotti, Marcella Fantini, and Domenico Siniscalco (1999a) has shown that SIP is more likely when the selling government’s deficit is great and the government is conservative.
6.2 Mass Privatization
This method involves the government issuing vouchers to citizens who can then use the vouchers to bid for stakes in the state property. Although this method resulted in an ownership change in the business, empirical results have shown that it may not change the effective control [Megginson and Netter, 2001].
According to a study by Boycko, Shlefifer, and Vishny (1994), it was found that decisions to undertake mass privatization is largely shaped by politics. From the economic perspective, mass privatization is beneficial as it is in line with the free market practice and promotes effective corporate governance. However, this is only the case if the new owners have the required management skill to continue the business operation efficiently. As the proportion of ownership resulting from a given voucher bid is unknown, the benefits are not guaranteed.
6.3 Privatization from Below
This method is employed mainly in transition economies whereby the governments allow new private businesses to be set up in former centrally planned economies. In this case, shortage of entrepreneurs may hinder the privatization process. Also, the goal of efficiency may not be achieved in the short run if the new owners lack the skills to manage the business privately.
6.4 Privatization through Restitution
As the name suggests, this method of privatization simply involves the return of the property to its original owner. Simple as it seems, its implementation can be difficult when there is a lack of record to prove ownership. Hence, without a proper property rights system in place, the transition may turn out to be rather messy.
6.5 Implementation of Methods
Even after the government has decided on the method of privatization, decisions as to when and at what pace to privatize, how to go about implementing the method of privatizing etc, still has to be made. Several studies have been done on the mentioned issues. Some of the important factors that need to be considered when deciding on how to carry out privatization include the necessity of sequencing and staging the privatization process to build reputational capital with investors by the privatizing government, the building of domestic support for the program, and the identification of bidders who will maximize the efficiency of the firm [Megginson and Netter, 2001].
In particular, Jones et al. (1999) has shown that political factors affect the offer pricing, share allocation, and other terms in SIPs. For instance, even if governments have cease to be responsible for the operation of the state enterprise, they can still retain effective veto power through a variety of techniques, such as the retention of a “golden share”, which gives the government the power to forbid certain actions, for example, foreign takeovers. Also, it has been found that governments that are ideologically committed to privatization and economic reform will deliberately underprice SIPs and will privatize in stages to signal their commitment to protecting investor property rights [Megginson and Netter, 2001].
Generally, to affirm the success of privatization, firms should be privatized, in as transparent a method as possible, and through an auction or sale process that is open to the broadest possible cross section of potential buyer [Megginson and Netter, 2001].
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