By Ali Mostashari, Executive Board Member, Iranian Studies Group at MIT

Introduction

Nearly a month has passed since Iran’s Expediency Council decided to rescind articles 43 and 44 of the Constitution. The decision enabled all major industries, manufacturing and service sectors, except for downstream oil and gas industries, to be ceded to the private sector. It is expected that foreign trade, banking, insurance, power generation for domestic consumption and export, telecom and postal service, railway, airlines, and shipping will be soon open for private sector takeover. While few private sector actors have showed any initial interest in purchasing shares of four major industrial companies on sale active in cement, manufacturing and power sectors that the government put out for sale so far, the importance of this event is not to be overlooked.  This decision has resulted in the rejoicing of many economists and private sector advocates in Iran and in the Iranian expatriate community. There are however grounds for caution, given that Iran’s economic and institutional structure are anything but ready for this change.

Conditions for Success of Large-Scale Privatization

The rationale for the privatization of state-owned enterprises is government inefficiency in operating industries and service sectors, due to the adverse interactions of the political sphere with the market. Therefore, the goal of privatization is to increase the efficiency of those enterprises previously owned and operated by the state, allowing the state to focus on policymaking (Bell, 1995).

Yet privatization efforts are often not successful, because the necessary conditions for their success simply do not exist. Among the two most important sets of conditions for the success of privatization, one can mention country conditions such as an open trade regime, a stable and predictable environment for investment and a well-developed institutional and regulatory capacity, as well as market conditions such as developed capital markets, competitive goods and services markets (Kikeri, 1994). Also important is the ability of the market to absorb the labor force that is laid off as a consequence of the privatization process (Adam, 1992). In the case of Iran at the current time, nearly all of these elements are currently missing.

The effect of Institutional Conditions

A precondition for successful privatization is to create an enabling environment in which the private sector can effectively operate. Such an environment does not yet exist in Iran. There is a need for macroeconomic reforms, improving regulatory frameworks, strengthening the financial system, increased competition, deregulating product and factor markets and improved governance (Boubraki, 1998). Privatization practices in many Latin American countries in the 1990s mostly failed to take these issues into consideration, resulting in large-scale harms to societal welfare while not fulfilling the promise of more efficient operations.

Transparency is also an important issue in the privatization process. While usually, any reform that increases the competitiveness of the economy helps to reduce corrupt incentives, the privatization process itself can become an attractive opportunity for corruption. Often in such instances, the bidders with the best connections to public officials receive preferential treatment, and purchase the SOEs far below market price (Rose-Ackermann, 1996). There are hundreds of examples in the developing world, and many in Iran itself. Machinery purchased at government-set exchange rates in the 1990s are priced at those nominal rates, while their market value is several folds higher.

Where countries are not yet at a stage where it is politically or economically feasible to embark on a privatization program, then privatizing management, asset leasing, franchising and management contracts can lead to important economic benefits without having to change ownership (Kikeri, 1994).

The Importance of Market Conditions

Past experience shows that the competitiveness of the industries being privatized plays a major role in the success of privatization. While privatizing state owned enterprises (SOE) that operate in competitive or potentially competitive markets can lead to improved efficiency, privatizing monopolies with little prospect for a competitive market in the short and medium-term may result in a loss of service level (Frydman, 1999). This is particularly true of infrastructure systems (other than telecommunication) and utility companies. Telecommunication companies are the only companies in developing country contexts, which have shown immense increases in efficiency when privatized. Privatization becomes much more complex in sectors where competition is weak or absent, investments are lumpier and where payback periods are lengthy (Ramamurti, 1999).

In the current privatization effort, the best prospects are for the service sectors (banking, insurance, etc.). Among the infrastructure systems, the telecommunications sector has the best prospects of growth under private sector ownership, followed by the power sector.

Labor Issues

There has been much concern about the employment and broader distributional

impacts of privatization. Studies show large-scale job reductions in highly protected

infrastructure sectors (Galal, 1999). When state-owned enterprises preparing for privatization have very high levels of redundant workers and when social safety nets and redundancy provisions in labor laws are inadequate or lacking, the political and social implications of layoffs mean that the governments should be involved in the design and funding of special programs to deal with unemployment and labor unrest (Kikeri, 1998). This is one of the main challenges facing the Iranian textile industry today, and may become a major driver of social unrest, if retrenchment programs are not planned for.

Welfare Issues

Laissez-faire privatization may have a positive impact on the firm level, but an overall negative impact on the societal level (Cook, 1995). Selling an inefficient public sector monopoly to an unregulated private owner will almost certainly result in increased firm profitability and higher returns to the new shareholders. But these gains can easily be outweighed by the welfare losses imposed on consumers and the economy as a whole from inadequate access to products and services, their sub-optimal supply, or their excessively high price (Kikeri 1999).

Conclusion

The rescinding of article 44 of the Iranian constitution herald a new era in economic reform in Iran. Privatization is definitely a necessary step, but not a sufficient one. Large-scale privatization can only be effective when it is embedded within large-scale reforms in the economic and institutional structure of the country. There are extensive short- and mid-term impacts on societal welfare and employment that the government needs to prepare for. Such a large-scale change requires teams of competent planners and advisors, with the government present at all stages of the privatization. This seems to be currently missing from the current process, where the rate of privatization has garnered more attention than the quality of the process.

About the Author

Ali Mostashari is a LEAD Consultant to the United Nations Development Programme (UNDP) in New York. He is currently a Ph.D. Candidate in Engineering Systems/Technology Management and Policy at the Massachusetts Institute of Technology. He received his Bachelor of Science in Chemical Engineering from Sharif University of Technology, a Master of Science in Chemical Engineering from the University of Nebraska, an Master of Science in Engineering Systems/Technology and Policy from MIT and a Master of Science in Civil and Environmental Engineering/Transportation from MIT. His main area of research interest is the sustainable technological and economic development of developing countries, with a main focus on Iran and the Middle East.

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