Policy Sequencing

A key issue in reforming state-owned enterprises is policy sequencing.  Three broad policy areas are restructuring,  which focuses on improving the efficiency and financial position of the enterprise; privatization, which changes the ownership structure of the enterprise; and liberalization/regulatory reform, which changes the economic environment in which the enterprise operates.  A strategic plan for reforming state-owned enterprises needs to consider in what order these policy areas will be the focus of reform efforts.

The Case of  Kenya Airways

The reform of Kenya Airways since 1991 illustrates a particular form of sequencing.  As the timeline indicates, the appointment of Philip Ndegwa as Chairman of Kenya Airways in 1991 signaled the start of an effort to restructure Kenya Airways operations.  New initiatives included bringing in outsiders as Managing Director and Chief Financial Officer,  redefining middle level managerial jobs and reducing over-all employment, a review and reduction of capital expenditures, and instituting a new program of employee training with an emphasis on customer service and total quality management.  In addition, a debt restructuring program was negotiated with the government.  This debt restructuring package was necessary to make Kenya Airways a solvent company that could attract private investors.

Privatization of Kenya Airways came after the significant operational and financial restructuring outlined above.  The final agreements with creditors under debt restructuring package were signed in July 1995, over four years after Kenya Airways operational restructuring began.  Once conditions were propitious, privatization was carried out relatively rapidly: by June 1996, Kenya Airways had a strategic partner with a major ownership stake, additional foreign and domestic portfolio investors, and over 100,000 individual domestic shareholders.  The share of state ownership was reduced to 23%.

Liberalization and regulatory reform of the airline industry in Kenya has not yet been enacted.  As part of the privatization agreement, the Kenyan government made commitments to retain the existing regulatory structure of the Kenya airline market for at least five years.  In particular, the Kenyan government committed

While these commitments give Kenya Airways a certain measure of protection from possible domestic competitors, they do not imply a grant of monopoly power to Kenya Airways.  The foreign correspondent on any bilateral route provides some competition for carrying passengers from and to Kenya on that route.  A more radical liberalization of airline markets, such as one which eliminates the bilateral route structure and allow open competition for carriage between country pairs, would require an international agreement rather than merely Kenyan government action.

Comparison with Other Airline Privatizations
 
The reform of the Mexican airline industry had a similar policy sequence to that of Kenya Airways, but reforms took place more quickly.  Both Mexicana Airline and Aeromexico, the major Mexican airlines, were initially private companies that the government acquired in order to support them in times of financial distress.   In 1988, facing a labor dispute, Aeromexico went bankrupt, and all its workers were released with the legally required severance compensation.  The bankruptcy implied a radical restructuring of the airline's capital and labor.  In 1989 a new company was formed from Aeromexico's assets and sold to Dictum, a consortium of investors.  Restructuring Mexicana Airline was more difficult, and two privatization efforts during the period 1986-1988 were abandoned because potential buyers demanded a reduction in the company's workforce and debt prior to the sale.  In 1989 the Mexican government changed its offering from a sale of shares to an infusion of capital, and allowed the buyer to exercise voting control of the company for a period of three years.   With these concessions, which facilitated restructuring, Mexicana Airlines was privatized.  About two years later, in July, 1991, a far-reaching deregulation of the airline industry was announced: airlines were given the freedom to add new flights, new routes, and set new fares without having to seek government approval.   Overall, the general pattern of reform was restructuring, followed by privatization, and then liberalization and deregulation.

The case of the Chilean airline illustrates a much different policy sequence.  Up to 1979 Linea Aerea Nacional of Chile (LAN) had operated as  dominant state-owned airline.  In March 1979 the Chilean government opened domestic and international airline markets, albeit with some provisions requiring reciprocal market access in the home countries of foreign carriers entering the Chilean market.  Pricing and capacity decisions were largely deregulated, and the law stipulated that LAN could not be granted any special privileges in relation to existing or future private competitors.  The state-owned LAN's financial condition deteriorated dramatically in response to competition.  By 1983 LAN had negative working capital, and, according to one analysis, was technically bankrupt.  In 1984 LAN underwent major restructuring.  The existing company was shut down, and all labor contracts were terminated. A new LAN was formed that took over LAN's routes and assets, but not its debts, and the new LAN selectively hired needed workers on a new contractual basis.  The new LAN showed dramatically better market performance: its share of the domestic market rose from 37% in 1983 to 49% in 1986.  In 1989 the Chilean government sold 51% of shares in the new LAN to a private investment company, ICAROSAN, which then sold 35% of LAN's shares to Scandinavian Airline System (SAS).  Thus the overall pattern of reform was liberalization and deregulation, followed by restructuring, and then privatization.

These cases are drawn from Privatizing Monopolies, ed Ravi Rmamurti (Baltimore: Johns Hopkins Press, 1996).

General Considerations

The policy issues concerning restructuring, privatization, and liberalization/deregulation interact in complex and subtle ways.  For example, restructuring prior to privatization may be necessary to make a company attractive to private investors.  On the other hand, a major motivation for privatization is to improve management decision-making, and one would like to give the new private owners, rather than the government, responsibility for key restructuring decisions.   Delaying liberalization and deregulation until after enterprise restructuring may give the enterprise a safe environment for painful changes, while on the other hand liberalization and deregulation can expose enterprise weaknesses and inefficiencies, and serve as a powerful spur for restructuring.   In addition, carrying out liberalization and deregulation prior to privatization helps to mitigate the incentive to package monopoly privileges with an enterprise in order to enhance its value and to increase government revenue from privatization.  On the other hand, liberalization and deregulation may create significant business uncertainty and make privatizating a company infeasible.  Finally, in the face of a limited window of opportunity, a need to signal and implement a major change in economic regime, and weak state administrative capability, privatization might take preeminence over both restructuring and liberalization. This is a rationale for the privatization policies enacted in Eastern Europe and the former Soviet Union.

Bureaucrats in Business, a major World Bank study of state-owned enterprises, included a decision tree useful for considering appropriate policies in different contexts. You can explore that decision tree and consider the policy suggestions.

Questions for Discussion
  1. Should there have been more deregulation and liberalization of Kenya's domestic and international routes prior to privatization?

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  2. Should the Kenyan government have tried to privatize Kenya Airways with less restructuring prior to privatization?

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  3. What factors will affect whether further deregulation and liberalization of Kenyan airline markets occurs?

Go to Kenya Airways: Case Study in Privatization

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