Budget Issues: Privatization Practices in Argentina (Letter Report,
03/19/96, GAO/AIMD-96-55).

This report, part of GAO's ongoing work related to privatization
practices in other nations, focuses on the divestiture experiences of
Argentina. In a December 1995 report (GAO/AIMD-96-23), GAO examined the
divestiture experiences of Canada, France, Mexico, New Zealand, and the
United Kingdom. For Argentina, GAO focused on policies and procedures
for the divestiture of entities, as it did in its reviews of the above
countries. GAO also examined the policies and procedures used to award
concessions--the process by which the government gives a private firm
the right to operate a government entity. Between 1990 and 1993, more
than half of the privatizations in Argentina occurred through the
awarding of concessions. Specifically, this report discusses (1) the
privatization process in Argentina, (2) the valuation and the
preparation of assets for sale, and (3) the use of sale proceeds.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-96-55
     TITLE:  Budget Issues: Privatization Practices in Argentina
      DATE:  03/19/96
   SUBJECT:  Privatization
             Foreign governments
             Assets
             Deficit reduction
             Comparative analysis
             Economic analysis
             Appraisals
             Federal social security programs
             Profits
IDENTIFIER:  Argentina
             Mexico
             New Zealand
             Canada
             United Kingdom
             
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Cover
================================================================ COVER


Report to the Honorable
Scott Klug, House of Representatives

March 1996

BUDGET ISSUES - PRIVATIZATION
PRACTICES IN ARGENTINA

GAO/AIMD-96-55

Privatization Practices in Argentina

(935192)


Abbreviations
=============================================================== ABBREV

  OECD - Organization for Economic Cooperation and Development
  GDP - gross domestic product

Letter
=============================================================== LETTER


B-271291

March 19, 1996

The Honorable Scott Klug
House of Representatives

Dear Mr.  Klug: 

This report responds to your request that we continue our work on
privatization practices in other nations with a review of the
divestiture experiences of Argentina.  Specifically, we examined
issues relating to (1) the privatization process, (2) the valuation
and preparation of the assets for sale, and (3) the use of the sale
proceeds.  In common discourse, the term "privatization" can refer to
contracting-out, public-private partnerships, vouchers, and
franchising or the awarding of concessions, as well as the actual
sale--divestiture--of government assets and operations.  Our review
focused on the last activity, the transfer of ownership from the
government to the private sector.  In our earlier report Budget
Issues:  Privatization/Divestiture Practices in Other Nations,\1 we
examined the divestiture experiences of the governments of Canada,
France, Mexico, New Zealand, and the United Kingdom.  For our work on
Argentina, we again focused on policies and procedures for the
divestiture of entities.  We also examined the policies and
procedures used to award concessions--the process by which the
government provides a private firm the right to operate a government
entity.  We chose to include concessions as well as divestitures
because of the significant role they have played in the privatization
process in Argentina.  Between 1990 and 1993, over 50 percent of the
privatizations occurred through the awarding of concessions. 


--------------------
\1 GAO/AIMD-96-23, December 15, 1995. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

The privatization process in Argentina was less centrally controlled
than in the other countries we have studied.  A central executive
unit did not oversee or coordinate the privatization process. 
Instead, special privatization committees--generally within the
Ministry of Economy and Public Works and Services or the Ministry of
Defense--were established for each privatization.  As with many of
the other countries we have studied, however, private sector
financial advisors, technicians, and consultants assisted the
privatization committees throughout the sale process. 

The Argentine government engaged in some limited restructuring of
entities prior to sale.  For example, the government generally
retained the liabilities or obligations, including debt, of the
entities being privatized in order to enhance their sale price and,
in some cases, to ensure that they would sell.  The government also
broke industries into their component parts--for example, generation,
distribution, and sale in the case of electric power companies--and
converted the components into distinct business units.  Generally,
the government did not, however, significantly restructure the
entities beyond this.  As in all of the other countries in our
earlier study, the government believed that the private sector could
do a better job of investing in and improving these enterprises. 
While the government generally broke up industries in an attempt to
foster competition, some of the component parts remained natural
monopolies\2 and required the creation of a regulatory framework. 
The Argentine government did not have a well developed regulatory
scheme when it began its privatization initiatives at the end of 1989
and has been working to develop the regulatory capacities of the
country. 

The Argentine government was required to value the assets of an
entity prior to the entity's sale and, like the other governments we
have studied, used a combination of valuation techniques to complete
these valuations.  The government used the proceeds from
privatization primarily to reduce the country's internal and external
public debt. 


--------------------
\2 A natural monopoly arises when the entire output of an industry
can be most efficiently produced by a single firm, for example, when
the firm has significant economies of scale.  For this reason natural
monopolies are often regulated or government run.  Statutory
monopolies are monopolies where an exclusive right to sell is granted
by law, and may include natural monopolies. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Argentina President Carlos Menem came into office in 1989 with the
broad goal of restructuring the economy and reducing both annual
fiscal deficits and the external public debt.  The public sector was
extensive at that time and most public enterprises were money losers. 
Publicly owned enterprises had historically been one of the primary
sources of chronic budget deficits in Argentina.  In the 1980s, the
national government owned the 17 companies that produced minerals,
petroleum, natural gas, and refined fuels, as well as those that were
involved in the provision of public utility services, including
telecommunications.  The government also owned approximately 40
military-related enterprises, which ranged from weapons to timber,
petrochemicals, strategic minerals, and construction.  It also owned
100 smaller enterprises, including radio and television stations,
hotels, and several airlines; and owned and operated the national
railroad, which included freight and passenger services. 

Privatization was an important part of the broader goal of
restructuring the economy, but it also enabled the government to
reduce what had become an unmanageable level of external public debt. 
The government used the sale of state enterprises to generate cash as
well as to conduct what are called debt-equity swaps.  In a
debt-equity swap, bank debt is replaced with an equity investment. 
For example, stock in an entity that is being privatized is exchanged
for external public debt owed to a foreign creditor bank.  This type
of transaction enabled the government to retire its external debt
directly.  Based on our calculations, the cumulative proceeds from
privatization from 1990 through 1994, including cash and debt
reduction, equaled approximately 9 percent of Argentina's economy, or
average annual gross domestic product (GDP), during this period. 
This exceeded the level of cumulative proceeds realized by Mexico
from 1989 through 1992, which was 6.3 percent of Mexico's average
annual GDP.  However, New Zealand remains the country in our study
with the highest level of cumulative sales proceeds as a percent of
average annual GDP--at 14.1 percent from 1987 through 1991.  Table 1
provides additional comparative detail on all of the countries in our
study. 



                                                                       Table 1
                                                       
                                                       Types of Entities Privatized by Country
                                                                     and Industry


                                                                                                                                  Cumulative sales
                                                                                                                                  proceeds as
                                                                                                                                  percentage of
                                                                                                  Finance,                        average annual
                    Agricultural        Mining and                          Transportation and    insurance, and                  gross domestic
Country             services            construction        Manufacturing   public utilities      real estate     Services        product\a
------------------  ------------------  ------------------  --------------  --------------------  --------------  --------------  -------------------
Argentina                               Mining              Steel           Airline               Financial       Hotel           9.0 (1990-1994)
                                        Oil                 Petrochemical   Rail                  services        Radio
                                                                            Ports                 Buildings       Television
                                                                            Toll roads
                                                                            Telecommunications
                                                                            Water
                                                                            Sanitation services
                                                                            Electricity
                                                                            Natural Gas

Canada              Fishing             Mining              Aircraft        Airline                               Hotel           0.6 (1984-1990)
                                        Oil                                 Trucking
                                                                            Telecommunications

France                                  Oil                 Petrochemical                         Financial                       1.5 (1983-1991)
                                                                                                  services
                                                                                                  Insurance

Mexico                                  Mining              Automobile      Airline               Financial       Hotel           6.3 (1989-1992)
                                                            Steel           Trucking              services
                                                            Iron            Toll Roads
                                                            Cement          Telecommunications
                                                            Petrochemical
                                                            Foodstuffs

New Zealand         Forestry            Oil                 Steel           Airline               Financial       Hotel           14.1 (1987-1991)
                                                            Printing        Shipping              services
                                                                            Rail                  Insurance
                                                                            Telecommunications

United Kingdom                          Oil                 Automobile      Airline               Financial       Hotel           11.9 (1979-1991)
                                                            Steel           Airport authorities   services        Public housing
                                                            Ordnance        Trucking
                                                            Aerospace       Shipping
                                                            Foodstuffs      Harbors
                                                                            Bus companies
                                                                            Telecommunications
                                                                            Water
                                                                            Electricity
-----------------------------------------------------------------------------------------------------------------------------------------------------
\a The source of the data on the cumulative proceeds for Canada,
France, Mexico, New Zealand, and the United Kingdom is the
Organization for Economic Cooperation and Development (OECD).  We
have derived the data pertaining to Argentina from the World Bank and
the Argentina Ministry of Economy and Public Works and Services.  We
have not verified this information.  The cumulative sales proceeds
have been divided by the average annual GDP for the years indicated
for each country. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3

We obtained our information on the privatization process in Argentina
through interviews with government officials directly involved with
privatization in Argentina, and through the use of academic and
economic literature and official government material.  We conducted
this work in Washington, D.C., from January through March 1996 in
accordance with generally accepted government auditing standards. 
World Bank experts on privatization and a privatization expert in
Argentina reviewed this document, and we have incorporated their
comments where appropriate.  We did not verify the accuracy of all of
the information provided to us nor did we evaluate the relative
success of the privatization program in achieving national goals. 


   THE PRIVATIZATION PROCESS
------------------------------------------------------------ Letter :4

Four of the five countries we studied in our earlier report have
parliamentary systems of government,\3 but Argentina, like the United
States, has a presidential system, with an executive branch, a
judiciary, and a bicameral legislature.  In Argentina, the executive
branch had primary control over the privatization process, while the
congress maintained an oversight role.  Two laws were passed in 1989
which facilitated privatization:  the State Reform Law and the
Emergency Law.  According to the World Bank, the State Reform Law
gave the executive branch sweeping powers to reform the state.  The
State Reform Law established objectives and procedures for
privatization, and the Emergency Law suspended subsidies and removed
barriers to foreign investment.  We were told that the State Reform
Law specified which enterprises were subject to privatization: 
Additional privatizations required congressional approval.  The State
Reform Law also created a bicameral legislative oversight commission
on reform and privatization, which was composed of members from the
majority and opposition parties. 

The Argentine privatization process was less centralized and more
flexible than in the other countries we studied.  Separate unique
privatization committees were created for each privatization, and the
planning and implementation of the privatizations occurred primarily
within the committees.  A subsecretariat for privatization was formed
within the Ministry of the Economy and Public Works and Services
several years after the Menem privatization initiatives began, but an
expert on privatization in Argentina stated that the unit was created
primarily to gather and disseminate information about privatization
and to keep foreign investors informed about the status of the
privatization initiatives.  Most of the state-owned companies in
Argentina were located within the Ministry of the Economy and Public
Works and Services or the Ministry of Defense, and the Ministers of
these units were responsible for appointing the members of the
committees within their respective ministries.  The committees
generally included representatives of the entity being privatized and
staff from within either the Ministry of the Economy and Public Works
and Services or the Ministry of Defense.  The work of the committees
was reviewed by the office of the auditor general, and the committees
relied extensively on the expertise of consultants, private sector
industry experts, and legal advisors to assist them with the sale
preparations and transactions. 

The Argentine government implemented its privatization program
quickly--in 3 years, it privatized almost all of its state-owned
enterprises.  It began with large, complex entities, such as the
telecommunications company and the state airline.  We were told that
the less rigid structure of the privatization process in Argentina
facilitated this speed.  The Menem government used the successful
completion of privatizations to develop credibility for its far
reaching program of economic change.  The World Bank has reported
that from 1990 through 1993, Argentina sold 34 enterprises and
awarded concessions for 19 services. 


--------------------
\3 Canada, France, New Zealand, and the United Kingdom. 


   VALUATION AND PREPARATION FOR
   SALE
------------------------------------------------------------ Letter :5

In Argentina, the government was required to estimate the worth of an
entity prior to sale as well as determine what level of improvements
and investment should be required from the purchaser once it acquired
the entity.  The government used this information to establish a
minimum bid.  In most cases, the purchasers of all newly privatized
firms were also required to invest a certain amount in the entity in
addition to the purchase price, and each sale had to include
specifications related to investment and improvements.  We were told
by a privatization expert in Argentina that the government used a
variety of valuation techniques, including, in some cases, net
present value analysis.  We were also told that the government used a
market based discount rate \4 for calculating the net present value
of the entity. 

The government generally retained the entities' liabilities,
including debt, but did not attempt to improve the entities'
efficiency in advance of their sale.  The market price of an entity
is reduced by the liabilities that come with it; the price may be
reduced further by the risk premium associated with any
contingencies.  The Argentine government absorbed most of the known
liabilities but let the market make decisions regarding the future
efficiency of the firm.  We were told by government officials that
entities in poor condition offered the private sector an opportunity
for improvement and profit, similar to "fixer-uppers," where profits
awaited those who could achieve efficiency improvements.  Argentine
government officials stated that the efficiency of the privatized
firms has significantly improved.  For example, we were told that
freight productivity has increased and a greater annual volume is now
shipped with fewer employees.  According to a former government
official, telephone lines of the former state telecommunications
company have increased and waiting periods for repairs have
decreased. 

The government generally broke up state monopolies and sold the
components separately in order to promote competition.  Public
enterprise assets, such as telephone networks, gas transmission
systems, and electricity generation plants, were either sold or
awarded through concessions to private sector bidders.  The new
owners were then required to create private sector corporations to
control the assets of the privatized entities.  In our earlier study,
the countries we examined generally either privatized entities that
were already in a corporate form or converted agencies into a
corporate form prior to privatization.  Sometimes they did this in
order to increase the efficiency of the entity and help establish a
track record for the entity as a commercial enterprise.  In other
cases, the governments used this as an opportunity to clean up the
entity's outstanding obligations prior to sale and thus facilitate
the sale process.  In Argentina, incorporation did not involve an
operational restructuring of the entity; rather, it was a legal
proceeding to allow the new owner to acquire the assets of the former
government enterprise. 


--------------------
\4 A market based discount rate reflects the cost of borrowing in the
private sector.  It is generally higher than the government borrowing
rate. 


   EFFECTS OF PRIVATIZATION ON
   EMPLOYEES
------------------------------------------------------------ Letter :6

Public sector employment was reduced significantly as part of the
privatization process, but the government also provided generous
severance packages, and a World Bank study and government officials
have reported that many of the separations were voluntary.  The
Argentine government reported that, from 1990 through 1994, the
number of employees working for public enterprises was reduced from
about 348,000 to about 67,000, an 81 percent drop.  Of this
reduction, 40.8 percent was reportedly due to voluntary or compulsory
separation, 41.5 percent to transfers to other levels of government
or private firms, and 17.7 percent to normal attrition. 

Even though public sector employment was significantly reduced, World
Bank reports indicate that the Argentine government met with limited
resistance from labor during this period of restructuring.  The World
Bank stated that factors such as low public sector wages, the large
number of employees holding more than one job, and generous severance
benefits, may explain this limited opposition. 


   TYPE OF SALE AND SALE PROCESS
------------------------------------------------------------ Letter :7

The Argentine government privatized public enterprises primarily
through divestiture and the awarding of concessions.  A concession,
or franchise, provides a private sector company with the exclusive
right to provide services in a geographic area.  A key issue in the
Argentina privatization process was whether to sell or to award a
concession.  A privatization expert told us that there were no
explicit criteria for awarding a concession as opposed to selling an
entity but that there were implicit criteria.  If an asset was
considered strategically important to the nation, the government
would not sell it.  This has often meant that natural monopolies, or
entities that have a strongly monopolistic infrastructure, have not
been sold.  The government awarded concession rights in the following
areas:  freight and passenger rail, ports, tollroads, water supply,
and sanitation services. 

In preparation to offer concessions for the railroads, the government
separated rail into three components:  freight, intercity passenger
rail, and urban passenger rail, which included the Buenos Aires
Metro.  Intercity passenger services were then either transferred to
provincial governments or closed.  The government awarded 10-year
concessions (20 years for the Buenos Aires Metro) for the urban
passenger lines and 30-year concessions for freight services.  The
terms of the passenger concession agreement defined the tariffs to be
charged, service levels and quality to be provided, and the capital
improvements to be carried out.  The winning bids were chosen based
on the minimum cost to the government for the combined operating
support and capital program costs.  By contrast, freight concessions
were awarded to the highest bidder, including an allowance for
proposed capital investment and the number of existing employees to
be hired by the concessionaire. 

Most sales involved open, competitive bidding, for the controlling
interest in the entity.  The government generally retained a
noncontrolling portion of the shares, typically about 39 percent, to
be sold later in a public offering.  It did this to ensure that it
would share the benefits if the price of the entity's stock rose once
the entity was established in the private sector.  This procedure has
similarities to the use of the "clawback" in New Zealand and the
United Kingdom.  (Clawbacks are stipulations, that under certain
conditions, require the buyers to return a share of profits--or
losses--to the government.)

The government also retained a portion of the shares for purchase by
the employees that were transferring from the public enterprise to
the new private entity.  The employee share was generally close to 10
percent, although some privatizations reserved as little as 2.5
percent for employees.  Worker-shareholders also had the right to
elect a representative to the company's board of directors.  The
number of shares that each employee could purchase was determined by
factors such as the employee's years of employment and salary level. 
Upon retirement, death, or employment termination, an employee's
shares were sold back to the company. 

There are few restrictions on foreign investors in Argentina. 
According to the Organization for Economic Cooperation and
Development (OECD), foreign investors have full access to the local
capital market.  The World Bank and the OECD also have reported that
there is a concentration of asset ownership in Argentina and that
most of the public enterprises were sold to financial consortia,
which were composed of several Argentine companies allied with
international groups. 


   COMPETITION AND REGULATION
------------------------------------------------------------ Letter :8

Although the Argentine government generally tried to foster
competition through the privatization process, it has experienced
some problems promoting competition.  One example of a problematic
privatization involved the sale of Aerolineas Argentinas, the
state-owned airline.  When the airline was offered for sale in 1990,
the only qualified bidder was a consortium that included the only
other airline in the country.  According to the World Bank, instead
of disallowing the bid, the government allowed the sale to occur. 
Service was poor and losses continued, and in 1993, the government
bought back approximately 30 percent of the airline's shares.  As a
result of this sale, the government now makes a greater effort to
ensure that there is more than one bidder and that a regulatory
framework is in place prior to the sale.  The government ultimately
sold the shares of Aerolineas Argentinas back to the private sector. 

The government has had difficulty establishing a regulatory regime,
as illustrated by the privatization of the former state
telecommunications company, the first company to be privatized in
Argentina.  In some instances, the government preserved the
monopolistic structure of the entity being sold to facilitate the
attraction of private capital.  A 1995 World Bank report\5 stated
that the government in Argentina split the telecommunications market
into two regional monopolies to increase the competitiveness of the
industry, but we were told that the government also used the monopoly
rights to increase the proceeds from the sale.  Although a regulatory
agency had been established to monitor the telecommunications
industry, the government did not, according to the World Bank,
develop clear regulatory processes prior to the sale.  The government
subsequently brought the regulatory agency under closer scrutiny and
formed a plan for improving its regulatory framework.  There have
been improvements in the agency's performance, but a 1993 World Bank
report\6 stated that the regulatory capacities in Argentina may take
many years to develop.  We were told by government officials,
however, now that the government has experience with both regulated
monopolies and with competition, that the government strongly prefers
the latter. 

The speed and variable manner in which Argentina privatized may help
to explain why the country's regulatory capacities are not more
developed.  A privatization expert told us that Argentina's
decentralized privatization process allowed the government to
privatize quickly and to formulate solutions for problems as they
arose.  While this speed and lack of a rigid structure may have had a
positive effect on the ability of the government to sell enterprises
and award concessions, we were told that these factors may have had a
negative effect on the government's ability to create an adequate
regulatory system within a relevant time frame. 


--------------------
\5 The World Bank, Bureaucrats in Business:  The Economics and
Politics of Government Ownership (Washington, D.C.:  The
International Bank for Reconstruction and Development, 1995). 

\6 The World Bank, Argentina's Privatization Program:  Experience,
Issues, and Lessons (Washington, D.C.:  The International Bank for
Reconstruction and Development, 1993). 


   USE OF PROCEEDS
------------------------------------------------------------ Letter :9

We were told by a government official in Argentina that the
government is required to use the proceeds from privatization to
finance the social security system or to buy down existing debt. 
According to OECD, by the end of 1992, debt-equity swaps enabled the
government to retire over $11 billion in external public debt, which
represented approximately 5 percent of GDP in 1992.  According to the
World Bank, the government also received about $8.5 billion in cash
during this period. 

Although it is difficult to determine the amount of net proceeds that
Argentina realized from its privatization program, the World Bank and
OECD have stated that increased tax revenues from the new
corporations, as well as the savings from the discontinuation of
subsidies to money losing enterprises, were more important to the
economy than the privatization proceeds. 


   CONCLUSIONS
----------------------------------------------------------- Letter :10

In our previous report, we noted that in the United States--as in
other nations--divestiture raises the issues of how best to evaluate
a proposal to sell, who should manage the valuation and sale
processes, how to estimate future proceeds, how the sale should be
structured, and how the proceeds should be treated in the budget. 
Although the experiences in the governments we examined suggested
that often no single answer is widely applicable to all governments
in all situations, we found that the information these governments
provided may help the United States smooth the transfer of viable
operations from the public to the private sector. 

With respect to the privatization process, we noted that a
centralized approach was common and offered a number of advantages. 
We suggested that the Congress assign responsibility for all
divestitures to a central agency in the United States as a means of
developing a consistent management process.  With respect to
treatment of the proceeds in the budget, we found widespread use of
budget rules designed to prevent the use of one-time proceeds to
finance ongoing spending.  We also said that budget rules should not
dominate the divestiture decision; the decision to privatize should
be made on other grounds. 

Although the Argentine government had--as did the other governments
we studied--certain unique approaches to privatization, it also
displayed a number of the common elements we identified in our
earlier report.  For example, the goals for privatization, which
included reducing debt and restructuring the economy, were very
important in determining the speed and scope of the privatization
program and, like the other governments we studied, the Argentine
government generally used the proceeds from privatization to reduce
debt and thus interest costs.  Unlike the other governments in our
earlier report, Argentina did not centralize the privatization
process.  Instead, the government created separate unique
privatization committees for each privatization and allowed the
process to remain somewhat flexible.  This allowed the government to
privatize quickly but may have hindered its ability to establish a
regulatory framework at the same pace with which it privatized the
state-owned industries. 


--------------------------------------------------------- Letter :10.1

We are sending copies of this report to the President of the Senate,
the Speaker of the House of Representatives, and the Chairmen and
Ranking Members of the House and Senate Budget Committees.  We are
also sending copies to the Director of the Congressional Budget
Office, the Secretary of the Treasury, and the Director of the Office
of Management and Budget.  Copies will be made available to others
upon request. 

Please contact me at (202) 512-9142 if you or your staff have any
questions.  Barbara Bovbjerg, Assistant Director, and Hannah Laufe,
Senior Evaluator, were major contributors to this report. 

Sincerely yours,

Susan J.  Irving
Associate Director, Budget Issues

*** End of document. ***