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Privatizing the Privatized

May 1999
Stanford King Center on Global Development Working Paper
37
In the first part of this paper we argue that three reforms must be implemented if privatization is to increase efficiency. First, establishing unitary control rights within the firm. Second, making privatized firms face hard budget constraints. Third, establishing a non-corruptible judicial system and transparent bankruptcy procedures. The question arises as to what course of action should be undertaken when these reforms have not been undertaken and privatizers have only a small window of opportunity. Either they privatize hastily today, or not at all. Should they go ahead with privatization and hope that the newly privatized firms will create the demand for good laws? In the case of behemoths, the answer is not clear cut. Privatization without prior implementation of the three reforms mentioned above risks simply replacing government bureaucrats with private mafias (i.e., private groups with the power to extract fiscal transfers). These private mafias might behave more voraciously than the bureaucrats they are replacing, reducing aggregate efficiency and further hindering the growth of a competitive private sector. In the second part, we address the more traditional issues of auction design and of restructuring and regulation of monopolies with network externalities.