By Ali Mostashari, Executive Board Member, Iranian
Studies Group at MIT
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
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.
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,
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
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.
There has been much concern about the
employment and broader distributional
impacts of privatization. Studies show
large-scale job reductions in highly
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
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
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.
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
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