Why privatise? And how?

The rationale for privatisation of state enterprises is not well understood in Indonesia. Most seem to think that the objective is to generate extra revenues for the government, but the government can easily issue more bonds if it needs to generate more funds.

The true economic rationale is in fact the desire to increase the efficiency with which productive resources are used—thus raising national income—and to avoid undesirable redistribution of income, through corrupt practices, in favour of those already well off. Privately owned firms have no scope for shifting funds from the general public to particular individuals, because they do not have the power to impose taxes. And they are almost always better managed than those in the hands of the state, for several reasons.

The first is that they have much stronger incentives for efficient management. If they fail to achieve this, their owners will make losses, and they will respond by replacing the managers. By contrast, the ultimate owners of state enterprises—namely, the general public—are in no position to replace managers, regardless of how bad their performance. Nor do they have any opportunity to divest their ownership in order to avoid future losses.

The second is that recruitment, promotion and remuneration of employees in state enterprises tends to be modelled on the practices of the civil service. In particular, there are typically far too many employees at the lower levels, while at the other end of the hierarchy, salaries for top management are so low that it is virtually impossible to recruit or to retain individuals with the skills required to generate efficient performance.

The third is that there tends to be a much higher degree of political interference in the operations of state enterprises, always with deleterious effects. Selling prices are held well below levels consistent with making a profit, resulting in an inability to undertake new investment on the basis of either profit retention or new borrowing. The consequences are epitomised by PLN’s chronic and worsening inability to maintain reliable supplies of electricity, and Telkom’s abysmal record in the provision and operation of fixed line telephone connections. Political interference can also be seen, for example, in the context of state-owned banks, which come under pressure to provide poorly secured, low interest loans to friends of the regime.

For all of these kinds of reasons, it is to be hoped that the central government will not be swayed by arguments from regional governments in North Sumatra that they should be given priority treatment in the purchase of shares when state plantation enterprises are privatised. Privatisation that simply transfers ownership between different levels of government will achieve nothing useful whatsoever.

Likewise, privatisation through the mechanism of an IPO—that is, sale of shares to the general public by way of flotation on the stock exchange, as seems to be the likely fate of Krakatau Steel—will also achieve very little. What is needed in order to bring about a significant improvement in efficiency is a thoroughgoing change of management, which requires the introduction of a strategic shareholder with a high level of expertise in the steelmaking business. Although there is always the possibility of corruption within the divestment process, the solution is not to avoid divestments of this type but, rather, to ensure that the bidding process is highly transparent.