South Africa is grappling with the public-private partnership versus the privatization decision

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Daniel Makina, University of South Africa

Disclaimer: This article expresses the personal views of the author and not specifically those of SAIFM.  SAIFM encourages members with alternate views to please submit the same.  SAIFM encourages discussion and debate in the financial markets.

Market economies are underpinned by the free-market theory popularized by Adam Smith, an 18th-century Scottish economist who is best known for his seminal work, “The Wealth of Nations,” published in 1776. In the book he outlined the principles of a free-market economy, emphasizing the importance of self-interest, competition, and the invisible hand – the idea that individuals pursuing their own interests can unintentionally contribute to the well-being of society via the market mechanism. In essence, free market theory is an economic philosophy that advocates limited or minimal government intervention in economic activities, meaning that markets should operate with little to no regulation or government interference.

Notwithstanding the advantages of the free market theory, some critics argue that it can lead to market failures, income inequality and other social and economic issues. As a result, real-world economies are mixed economies that incorporate elements of both free markets and government regulation to advance economic growth and development.

The case for government intervention

Government intervention in the economy is often justified by various arguments. These include, among others, the need to address market failure, to provide public goods and services, to address income inequality, to protect consumers, to protect the environment, and to provide public health and education. These arguments highlight the role of government in addressing market failures, promoting public welfare, and maintaining social and economic stability and stimulating economic growth and development. In recent times, no one has done a better job of combining government intervention and market forces than the “developmental” states of East Asia. Japan, South Korea, Taiwan, and, most spectacularly, China. They have all relied on a mix of policies that both encourage market forces and government intervention in selectively key sectors. Each shaped its own economic future through a wide range of industrial policies – directed credit, subsidies, tariff and non-tariff barriers, and local-content and other requirements for foreign investors – that helped it develop new areas of economic competence. These polices resulted in economic growth that lifted hundreds of millions of people from abject poverty, and elevated some of them to the status of advanced economies in less than two generations.

Privatization versus public-private partnerships

At some point, governments that take on activities beyond those required to address market failures and externalities, become riddled with corruption and widespread inefficiencies. In desperation to save the situation, they consider involving the private sector, either through privatization of inefficient state-owned enterprises (SOEs) or through public-private partnerships (PPPs). Privatization involves the transfer of ownership and control to the private sector, while PPPs maintain public ownership and seek a collaborative approach with the private sector in some activities, including infrastructure development and service delivery. The choice between these approaches depends on the specific objectives of the government.

In essence, privatization and public-private partnerships (PPPs) are distinct approaches to involving the private sector. However, there are key differences between the two. Firstly, in privatization the government transfers ownership and control of a public asset or service to the private sector. The private entity becomes the sole owner and operator. Whereas, in a PPP the public sector retains ownership of the asset or service, while partnering with the private sector for its operation. Secondly, the primary objective of privatization is often to reduce government expenditure and improve efficiency. On the other hand, PPPs aim to leverage private sector expertise and resources while maintaining public sector influence to achieve specific public policy objectives. Thirdly, in privatization most risks are transferred to the private entity, which now would bear the responsibility for performance, financial, and operational risks whereas in PPPs risks are shared between the public and private sectors. This sharing of risk encourages collaboration and helps manage uncertainty. Fourthly, in privatization services are delivered solely by the private sector, with the goal of maximizing profit whereas in PPPs, services can be delivered by both public and private entities working together. And emphasis is achieving a balance between public and private interests.

South Africa’s weird circumstances

The economy of South Africa is mixed, and the government sector includes state-owned enterprises (SOEs) that are a large component of the economy. SOEs are a product of the ideological orientation of the governing party which is guided by the Freedom Charter adopted in 1955 by the Congress of the People which sought to nationalize what it considered to be strategic sectors -the mining industry, the banks, and the leading monopolies. Over the years the Freedom Charter became the guiding tool for the National Democratic Revolution (NDR) spearheaded by the Tripartite Alliance comprising the ANC, the SACP and COSATU whose aim is to control the strategic sectors of the economy via policies of cadre development, preferential procurement, among others.

Unfortunately, the policies adopted for spearheading the NDR were not entirely based on merit. As a result, they produced unintended results such as mismanagement, inefficiencies, and corruption in state entities. An American management consultant, Ed Ryan, provides some useful insights into why organizations, both public and private, fail to build a team of capable management. He says: “The reason why so few companies [or organizations] succeed in building a true ‘Dream Team’ is this: it’s been said that talent goes downhill. By that I mean, if you are a ten, you will hire a nine. The nine who is working for you will hire an eight. The eight hires a seven and down it goes. Inferior people work for superior people. But, for any company [or organization] to grow, it must be full of tens — people who are best at what they do in their area of expertise.”

Apparently, Ed Ryan’s observation aptly summarizes how the SOEs are staffed. First, the government itself that appoints chief executives of these enterprises is nowhere near being a ten. Because its decisions are crowded by political considerations, it is on the lower end of the talent hill. Suppose that by chance the government picks the right and ideal chief executive, something it occasionally does. The second problem is that the appointed chief executive is not given a chance to hire a nine to work under him/her either. All staff positions are filled up for him/her with people selected through a process riddled with political patronage, chicanery, nepotism, kickbacks and so forth. The criterion of picking those that are best at what they do in their area of expertise is rarely applied, save by accident.

Hence, problems at SOEs have been attributed to corruption and mismanagement by senior management in cahoots with political elites and gullible private actors. The government’s response had been to suspend senior management pending investigations and prosecution. In fact, there is a discernible pattern of events in state enterprises. The government, amidst pomp and fanfare, appoints chief executives with generally good credentials to run these enterprises. However, after a short period in office, on average two to three years, allegations of corruption and mismanagement emerge. The government responds by suspending senior management pending investigations and prosecution. Senior management contests the allegations in the courts. The investigations and the legal process drag on for several months or even years. Eventually, the suspended senior management are given golden handshakes as retrenchment packages. New senior management is appointed, and the process starts all over again. The result is that you never get a dream team to run an SOE or even just a semblance of it, but only something akin to a pyramid scheme. Hence there is generally management paralysis in most SOEs because the pyramid scheme has now reached unsustainable levels.

South Africa is experiencing state failure rather than market failure

Because of ill-conceived policies not grounded on merit, the state is now experiencing state failure to the extent that the private sector is intervening to save the state. This is a weird situation. The orthodox approach is for the state to intervene in private markets to prevent market failure as what happened during the Global Financial Crisis (2008 -2009) and the COVID-19 pandemic (2020 -2022).

Apparently, South African business justifies its intervention based on evidence and argues that they  have a responsibility to the country’s citizens to help. It refers to recent data from the Edelman Trust Barometer that found that 62% of South Africans trusted business more than the government. Furthermore, a recent Stats SA report, the 2022/23 Governance, Public Safety And Justice Survey, showed that citizens are using fewer government services now than they did in 2019/20. It found that, due to corruption, maladministration, and a lack of trust, they are requesting the private sector to perform services previously offered by the government.

The folly of delaying privatization

Despite privatization of inefficient SOEs in South Africa being ideologically considered taboo, eventually, it will be driven by push factors. The delay in embracing it will only serve to exacerbate SOEs being a very big fiscal burden, an albatross around the government’s neck. The burden manifests itself in poor, obsolete, and inefficient infrastructure. Eskom and Transnet are evident cases. Because they have borrowed heavily on the back of government guarantees, their creditworthiness is very low and so they cannot access cheap finance anymore and now survive on government bailouts. Because the government itself is struggling to meet its own obligations, it cannot help. At the same time, it does not want privatize the inefficient SOEs because of ideological reasons.

The folly of delaying privatization of inefficient SOEs is best exemplified by the experience of Zambia. The delayed privatization of Zambian copper mines provides a painful lesson that South Africa should learn from. By the time the Zambian government allowed the privatization to fully go through, the copper mines were in such a dilapidated state and insolvent that they fetched very little for the fiscus.

Recommendations for the way forward

The Government should come up with a coherent reform strategy for SOEs and the envisaged private sector involvement. The reform strategy should identify those SOEs that the state can retain control, those that should be privatized, and those which it can partner with the private sector in a public-private partnership arrangement. The present muddling along whereby the private sector is intervening to avert state failure is unsustainable.  In its dealing with the private sector, the government should take its cue from the late American economist Milton Friedman who aptly stated: “There is one and only social responsibility of business – to use its resources and to engage in activities designed to increase its profits as long as it stays within the rules of the game.” The rules of the game meant here are the external constraints imposed on managers by governments and society. The Government won’t go wrong if it embraces this cardinal principle.

Given that the Government is generally averse to privatization but amenable to PPPs, it is advised to note that the private sector would not want to share the burden of debts accumulated by SOEs. The private sector can only participate in PPPs not burdened by debt. Even one of the SOEs, the DBSA is indicating that it can only lend to Transnet when revenue streams are ring-fenced so that it can have its loans repaid.

Presently, PPPs are not working as desired. The largely insolvent Transnet’s experience is testimony to this as it is struggling to attract private sector participation. For PPPs to be successful, there are several conditions that must be satisfied. Firstly, well-defined goals and objectives are crucial for a successful PPP and not the ad hoc approach currently in place. Secondly, there should be a strong legal and regulatory framework to ensure accountability and dispute resolution. Thirdly, there should be an effective risk-sharing mechanism and allocation system between public and private entities. Presently, there is none and hence the failure of the few that has been tried, especially with Transnet. Fourthly, the government should recognize that the private sector will only be interested in projects that are financially viable. Fifthly, a competent governance structure and oversight mechanisms should be put in place for every PPP.

In conclusion South Africa is advised to come up with a comprehensive home-grown reform strategy of its SOEs. East Asian developmentalism offers an important lesson for South Africa. If dirigisme in South Africa focuses on creating a strong, inclusive domestic economy, it will do much good to address the country’s development challenges of high inequality, poverty and unemployment. Otherwise, it will do much harm to the rest of the economy and worsen the country’s development challenges.