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Privatization: Successes and Failures resources

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xii FOREWORD gain. None of these hypotheses is, in fact, correct under general conditions (e.g., when there is imperfect information or incomplete risk markets). The fi rst hypothesis is, of course, simply Adam Smith’s invisible hand conjecture; Arrow and Debreu (1954) showed that it was correct, but only under highly restrictive conditions. Subsequently, Greenwald and Stiglitz (1986) showed that whenever information is imperfect or markets are in- complete, markets are not in general constrained Pareto effi cient (i.e., even taking into account that information is costly and that there are transac- tion costs). Shareholder maximization in par tic u lar did not result in (Pa- reto) effi 8 Grossman and Stiglitz (1980) showed that in the absence ciency. of a complete set of securities (markets), different shareholders might want the fi rm to pursue different objectives. For instance, some might want the fi rm to maximize stock market value today, but others (especially share- holders who are planning to hold onto the shares for a long time) might ar- gue that most stock market investors are shortsighted and that the fi rm should focus on long- run profi ts. Finally, the takeover mechanism is far from perfect9—and it is in man- agers’ interest to keep it that way. They can create information asymme- tries and other barriers to takeover.10 There is ample evidence that fi rms can and do pursue policies (over extended periods of time) that are not value maximizing.11 As an almost immediate corollary of these results, Sappington and Stiglitz (1987) showed that the only conditions under which privatization could be guaranteed to be an effective way of implementing social objectives are pre- cisely the same conditions under which markets are Pareto effi cient: there can be no market failures—including no information asymmetries or other market imperfections of the kind discussed by Greenwald and Stiglitz. In short, the theoretical case for privatization is, at best, weak or non ex- is tent. It is strongest in the areas in which there is by now a broad consensus—areas like steel or textiles, conventional commodities in which market failures may be more limited. But by the same token, these are precisely the sectors in which abuses can most easily be controlled, appro- priate incentives can best be designed, and benchmarks against other fi rms can most easily be set. E X A M P L E S In other areas, there are many examples illustrating the diffi culties in de- signing appropriate incentives for private sector own ers to act in society’s

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