INTERNATIONAL TELECOMMUNICATION UNION		

Geneva, 22 January 1996
The Promise and the Pitfalls of Privatization
Dr Pekka Tarjanne
Secretary-General, International Telecommunication Union 
Conference on "Liberalization and Privatization of international telecoms"
Mr Chairman,
Ladies and Gentlemen,
Let me begin by welcoming you to the City of Geneva. To participate in this conference, I have walked a couple of hundred metres from the headquarters of the International Telecommunication Union,  but I know many of you have come a lot further, and I hope you enjoy your stay in this fine city.
But in another sense, I may have come further than you. I have chosen, as the topic of this keynote speech, to address the subject of privatisation. What, you may ask, does a representative of an inter-governmental organisation, know about privatisation? I would offer two explanations:
•	first, the ITU is virtually unique among the international organisations in having a strong and very active participation by the private sector. The ITU counts more than 350 telecommunication service providers, equipment manufacturers and satellite organisations among our membership. These companies play a vital role in the work of the Union, notably in telecommunication standardization, but also in radiocommunications and telecommunication development;
•	second, when the ITU was founded 131 years ago, many of the original participants were private, or semi-private, organisations. The fact that public telecommunication operators are now becoming private again is not something new, but rather a sign that the wheel has turned full circle. I am sure that Adam Smith, who predates even the ITU, would approve.
The current wave of privatisations in the telecommunications sector dates from the early 1980s when Cable & Wireless and BT were privatised in the United Kingdom. Subsequently, there have been more than 20 privatisations throughout the world touching every continent, including Africa. During 1996, we will see the “Mother of all privatisations”, namely that of Deutsche Telekom. Consequently, this is a good moment to review the successes and failures to date, or, as I have entitled this presentation, “The promise and the pitfalls of privatisation”.

Let us begin by taking a perspective on how far the telecommunications services industry has come. At the start of 1994, there were around 650 million users of fixed-link telephone lines worldwide, and a further 53 million users of mobile telephones. More than 25 countries have succeeded in eradicating their waiting list for telephone service. The majority of these countries did so under monopoly service provision, usually a state-owned monopoly. 
Not a bad record you may think. Except when you remember the remaining 200 or so countries that have not eradicated their waiting list. Or the fact that the average wait for a new telephone line is more than a year, and that there are more than 40 million people worldwide still waiting to be connected. The telecommunications sector has, for too long, operated in an environment of scarcity and rationing. The persistence of state-owned monopoly service providers, whether by intention or not, has perpetuated that environment of scarcity. Monopolies in the telecommunication sector have worked well, but not well enough to supply the ever increasing needs of the telecommunications community. The demand for efficient, low cost telecommunication services is higher than ever in today’s service-oriented economy. Maintaining barriers to market entry now makes little sense.

The recipe for reform in telecommunications includes three main ingredients: competition, regulation and private enterprise. I would like to focus on the third of these ingredients, namely the introduction of private enterprise. This can be done in a number of ways:
•	by licensing private competitors to enter the telecommunications market, or some part of it such as mobile communications;
•	by hiving off, or sub-contracting, certain functions previously provided by the state-owned public operator to the private sector;
•	by awarding franchises, or build-operate-transfer agreements, to private sector companies to involve them in providing public telecommunication services;
•	by liberalising the construction and self-provision of telecommunication infrastructures.
But the most high-profile approach to introducing private enterprise is, of course, privatisation. The motivations differ between countries, but they tend to include issues such as renewing management and freeing the sector from political interference. The economics of the telecommunications sector are changing. These days, competitive advantage is gained not so much by being large, or being able to provide a complete range of services, but rather by being flexible and responsive to customers. In this new environment, customer demands are arguably better served by a series of smaller, private companies than by a single, state-owned operator. 
The major motivation for privatisation is to improve performance, and here the evidence from the early privatisations suggests that it does work. A study by the World Bank of the welfare gains of privatisation, in terms of net monetary gains to producers, consumers and employees, shows positive results, notably in the case of Chile where these welfare gains were equivalent to 155 per cent of annual sales.

It is worth examining the case of Chile in more detail because it was one of the first privatisations in an emerging market and also because it appears to have been one of the most successful.
The graph shows the development of the Chilean infrastructure in the four years before privatisation and in the five years after it. Prior to privatisation, the network growth rate had hovered around 5 per cent per year. Adequate, but not spectacular. In the first year after privatisation, growth exceeded 30 per cent and stayed above 15 per cent for each of the next three years. In 1994, growth in the fixed-link network returned to more normal levels, but this was in a context in which the fixed-link network was experiencing real competition from mobile communications.
Chile is a good example because, unlike other countries, the process of privatisation was rapidly followed by the introduction of competition and the establishment of an independent regulator. Thus the immediate boost given by privatisation has been sustained and Chile now has one of the most dynamic telecommunication markets in the southern hemisphere.

The motivations for privatisation vary between country and so too do the modalities. In countries such as the United Kingdom or Germany, which have already succeeded in eradicating their waiting list for telephone service, the primary motivation for privatisation is to broaden share ownership and to raise revenue for the government. It must be pointed out that the motive of raising as much money as possible from the sale of an operator often comes into conflict with other policy objectives, such as widening choice or introducing competition. Interestingly, in the case of the UK, a much better price was obtained for the later sales of tranches of shares in BT than for the early sales, even though BT’s market share had fallen by then. The creation of the duopoly increased the total size of the total telecommunications market, and therefore increased the value of the incumbent. The lesson for other countries is not to use privatisation as an excuse to delay the introduction of competition.
Elsewhere, particularly in Eastern and Central Europe and in Latin America, the modality of privatisation has been to introduce a strategic partner. In some cases, that partner is itself state-owned, such as Deutsche Telekom in Hungary, France Télécom in Mexico, or Telecom Italia in Argentina and Russia. It seems hypocritical, to say the least, to participate in the privatisation of a foreign operator when one’s own market is closed to private or foreign ownership. It is to be hoped that this anomaly can be rectified as soon as possible.
A third type of privatisation involves selling a small percentage of the shareholding of an operator in order to provide access to private capital markets or to free the operator from debt. This raises another issue: What happens to the profits from privatisation? In countries where the demand for telecommunication services exceeds the supply, the profits from privatisation really ought to be re-invested in the sector. I fear this is not always the case ...

Given the high level of growth and profitability sustained by public telecommunications operators, it is not surprising to find that the sector has been in the vanguard of the privatisation process. Between 1988 and 1992, the World Bank counted telecommunication privatisations in 14 developing countries, including the licensing of private operators and the award of franchises and BOT contracts. The cumulative value of these was some US$12 bn by 1993, or more than half the total sum raised from privatisations of infrastructure utilities. If one adds to this sum the US$100 billion or so which has been raised to date from privatisations in developed countries, one has a good indication of why the telecommunication privatisations have proved so popular with governments.
Recently, concerns have been raised as to whether the assets of telecommunication companies are being priced at too high a level by the stock market. Asset valuations are typically based on past performance, when the companies concerned often enjoyed a monopoly; a situation which probably won’t continue. The recent placement of shares in PT Telkom of Indonesia in the international market was undersubscribed so that “only” US$1.59 billion was raised, for 19% of the shares. Indonesia has been following a dual track approach to introducing private enterprise, by awarding franchises at the same time as privatising the incumbent. The lack of clarity about this dual-track approach, in particular who would be allowed to compete with whom and where, was a major factor in the shares being undersubscribed. I suspect that there will be some readjustment in the valuation of telecom companies to reflect the greater competition they now face, but I do not see the problems experienced by Indonesia as part of a wider trend. Rather they offer a cautionary tale to governments that see the telecommunications sector as providing a “quick buck”. The message is that financiers need clear information and transparent regulatory structures.

The acid test of privatisation is whether or not it succeeds in raising the level of investment. In the earlier slide showing Chile, the effect on investment was immediate and sustained. In other countries in the Americas region, the results have been more mixed, though always positive.
In Argentina, the level of telecommunications investment as a percentage of revenue has risen from below 20 per cent before privatisation to almost 60 per cent in 1994, and this indicator has continued to rise. In Venezuela, this indicator rose from below 20 per cent before privatisation to almost 60 per cent in 1993 before declining slightly in 1994. In Mexico, which had been investing relatively well even before privatisation, there was a short-term gain in the year following privatisation, before levelling off. However, in all three privatised operators, investment as a percentage of revenue remains above the regional average.
In these countries privatisation has not yet been followed by the introduction of competition, though each has established a timetable for the ending of monopoly. Consequently, the results they have achieved have not been as impressive as in Chile. Nevertheless, they have all reached the targets set before the privatisation process began and, in that sense, can be deemed a success.

I suggested earlier that privatisation on its own was good, but privatisation combined with competition is much better. Nowhere is this maxim better illustrated than in the case of the United Kingdom which privatised its two main carriers -- BT and Cable & Wireless -- at the start of the 1980s, but thereafter persisted for almost a decade with a duopolistic market structure. In mobile communications too, a duopoly of Vodafone and Cellnet continued until the early 1990s. Since the introduction of full competition in fixed-link services in 1991, and two additional mobile operators in 1992/93, the improvement has been striking. The number of new subscribers added each year to the network has risen from a low of 700’000 in 1991 to a high of 2.5 million in 1994. In retrospect, the market entry barriers in operation in the United Kingdom during the 1980s were too cautious and may have been harmful to the further development of the industry.
For others planning sector reform, the message is “be bold”.  There is no evidence to date of a country which has licensed too many competitors but many examples of countries which have licensed too few. Privatisation is likely to bring short-terms gains in efficiency and growth. But if these gains are to be sustained, they need to be backed up by a full commitment to competition and an adequate, and clear, provision for regulation.
For developing countries, the difficulty is not so much in licensing operators but in attracting investment. While there are plenty of examples of privatisations in middle-income developing countries -- such as Chile, Indonesia or Malaysia -- there are few examples to date among the Least Developed Countries (LDCs). Guinée is likely to be the first.
Nevertheless, there are several Public Telecommunication Operators among the LDCs which are partly or wholly foreign-owned, for historical reasons, and some are also privately-owned. As this slide shows, those LDC PTOs which are partly private-owned have generally outperformed the other LDCs. Nevertheless, the general picture is that the LDCs as a whole are falling further behind other low and middle-income developing countries. Privatisation can help here, but there are wider structural problems outside the telecommunications sector, in many cases concerning civil instability, which would need to be addressed first. The example of Rwanda, where an invitation to tender for privatisation in 1993 had to be abandoned due to civil disturbances, is a good illustration of the problems faced.

One of the most common mistakes that policy-makers make when planning a privatisation process is that they forget to require the newly-privatised operator to report information on a systematic basis. Governments that own operators tend to take this market information for granted and forget that they will not necessarily have access to it after the company is privatised.
Information flow is vital for the efficient operation of markets. Without adequate information, for instance on comparative tariffs or quality of service data, how can consumers hope to make the right choice between competitors? 
Information is also vital for policy evaluation and for regulation. When BT was privatised, it was under no obligation to provide data about quality of service or about the extent of network development and service introduction. It is only within the last year that OFTEL has finally managed to compile a databook concerning the true state of the market in the United Kingdom, and it has experienced difficulty in applying reporting requirements retroactively to other companies active in the market. It would be much better to have applied these obligations from the start. I would personally go further and require also the publication of accounting rates and interconnection fees. The development of a competitive market will occur much more quickly if this information is in the public domain.
Privatisation in telecommunications works well, but it is just one ingredient of the policy mix. The privatisation process entails pitfalls as well as great promise. This final slide summarises some of those pitfalls for the unwary: 
•	privatising without introducing competition means simply creating a private monopoly. As Adam Smith argued, a private monopoly is, in many ways, worse than a public monopoly because it compounds the sins of bureaucracy, inefficiency and tardiness with that of greed;
•	privatising without first creating an adequate and transparent regulatory environment will not only scare away investors, as occurred in Indonesia, but will also permit the incumbent to crush any competition before it can be formed, for instance by failing to supply leased lines or by charging exorbitant interconnection charges;
•	privatising without ensuring reinvestment largely defeats the purpose. The government itself can take a lead here by ensuring that the revenue it gains from privatisation is re-invested, at least in part, in the telecommunications sector. Policy-makers must also ensure that the efficiency gains made by the newly privatised operator go to consumers as well as to shareholders;
•	finally, privatising without ensuring adequate reporting of information leads to the “blind regulator syndrome” whereby the regulator has to make decisions without full access to the fact or, worse still, is spoon-fed just the tidbits of information which the privatised operator wants to give out.
All of these pitfalls can be avoided given adequate preparation. They all presuppose that the ultimate motivation for privatisation is to provide better, and cheaper, services to users, not just to contribute to government coffers. In conclusion therefore, privatisation is an effective and a necessary part of the reform of the telecommunications sector. In the examples I have quoted, from Latin America and the UK, the results of privatisation have invariably been positive. But is should be remembered that privatisation is not the only way of introducing private enterprise. While privatisation may bring highly visible short-term gains, the longer term gains are likely to come from the introduction of competition and the establishment of a competent, independent regulatory process.
*******