SHOCK THERAPY VS STATE CAPITALISM AND WHAT TO PRIVATIZE WHAT TO NOT?

Submitted To
Mam Amina Rizwan

Submitted By
Hafiz Mohammad Umer L1F11MCOM0149 Mohammad Umer L1F11BCMH2022 Arslan Nawaz L1F11MCOM2165 Mohsin Khan L1F11MCOM0156 Okasha Safdar L1F11BCMH2023 Qaiser Ayub L1F11MCOM2158

Concept of Shock Therapy

The term shock therapy originates from Bolivia's tackling of hyper-inflation in 1985, and was thought to have been coined by the media. Economist Jeffrey Sachs is widely associated with shock therapy. He developed a plan of shock therapy for post-communist Poland in 1990, for post-communist Russia in 1992. Sachs did not like the term "shock therapy," which he said was coined by the media and made the reform process sound more painful than it actually was. In the field of economics, shock therapy refers to the phenomenon that takes place when actions are taken that generate immediate and rather drastic reforms in the economy. It changed national economic policy from state-controlled economy into a free-market one. Principally, this would include privatization of publicly run institutions such as utilities and public transport; removal, or more realistically reduction, of trade barriers; and a removal of government imposed artificial market constraints - such as price fixing and production limitations. Shock therapy is intended to cure economic maladies such as hyperinflation, shortages and other effects of market controls in order to jump-start economic production, reduce unemployment and improve living standards. Detractors of shock therapy point to the fact that too much change within a short period of time has as much potential to drive the economy downward as it does to move it upward. As a result, people and businesses may be in worse shape after the therapy effort is launched. Shock therapy can entail a rocky transition while prices increase from their controlled levels and people in formerly state-owned companies lose their jobs, creating citizen unrest that may lead to forced changes in a country's political leadership. Those who oppose the use of shock therapy to bring about economic change prefer methods that involve making incremental changes that are measured before additional changes are initiated.

Poland and Shock Therapy

(Best example of Shock Therapy)

Poland officially the Republic of Poland, is a country in Central Europe, bordered by Germany to the west; the Czech Republic and Slovakia to the south; Ukraine, Belarus to the east; and the Baltic Sea and Kaliningrad Oblast, a Russian exclave, and Lithuania to the north. The word "Poland" was written officially for the first time in 966. In 1569, Poland formed a strong union with Lithuania called the Polish-Lithuanian Commonwealth. The Commonwealth collapsed in 1795 and the Polish people did not have a nation for 123 years.

The Second Polish Republic was established and existed from 1918 to 1939. It was destroyed by Nazi Germany at the beginning of World War II. Millions of Polish citizens perished in the course of the Nazi occupation. The Polish government in exile kept functioning and through the many Polish military formations on the western and eastern fronts the Poles contributed to the Allied victory. Near the end of World War II, the advancing Soviet Red Army pushed out the Nazi German forces from occupied Poland which led to the creation of the People's Republic of Poland. The People's Republic of Poland was the official name of Poland from 1952 to 1989. The Soviet Union had much influence over internal affairs and foreign affairs, and Red Army forces were stationed in Poland. Therefore the People's Republic of Poland has been described as a satellite state of the Soviet Union. Poland largely lost its traditional multi-ethnic character and the communist system was imposed. By the mid-1960s, Poland began experiencing increasing economic, as well as political, difficulties. In December 1970, a price hike led to a wave of strikes. The government introduced a new economic program based on large-scale borrowing from the West, which resulted in an immediate rise in living standards and expectations, but the program faltered because of the 1973 oil crisis. In the late 1970s the government of Edward Gierek was finally forced to raise prices, and this led to another wave of public protests. This vicious cycle was finally interrupted by the 1978 election of Karol Wojtya as Pope John Paul II, strengthening the opposition to Communism in Poland. In early August 1980, the wave of strikes led to the founding of the independent trade union "Solidarity" by electrician Lech Wasa. The growing strength of the opposition led the government of Wojciech Jaruzelski to declare martial law in December 1981. Despite persecution and imposition of martial law, it eroded the dominance of the Communist Party and by 1989 had triumphed in Poland's first partially free and democratic parliamentary elections since the end of the Second World War. Lech Wasa, a Solidarity candidate, eventually won the presidency in 1990. The Solidarity movement heralded the collapse of communist regimes and parties across Europe. A Balcerowicz Plan, initiated by Leszek Balcerowicz also termed "Shock Therapy. Named for its author, the Polish minister and economist Leszek Balcerowicz, the plan was adopted in Poland in 1989 enabled the country to transform its socialist-style planned economy into a market economy. The plan was Act on Financial Economy Within State-owned Companies, which allowed for state-owned businesses to declare bankruptcy and ended the fiction by which companies were able to exist even if their effectiveness and accountability was close to none. Act on Banking Law, which forbade financing the state budget deficit by the national central bank and forbade the issue of new currency. Act on Credits, which abolished the preferential laws on credits for state-owned companies and tied interest rates to inflation. Act on Taxation of Excessive Wage Rise, introducing the so-called popiwek tax limiting the wage increase in state-owned companies in order to limit hyperinflation.

 Act on New Rules of Taxation, introducing common taxation for all companies and abolishing special taxes that could previously have been applied to private companies through means of administrative decision. Act on Economic Activity of Foreign Investors, allowing foreign companies and private people to invest in Poland and export their profits abroad. Act on Foreign Currencies, introducing internal exchangeability of the zoty and abolishing the state monopoly in international trade. Act on Customs Law, creating a uniform customs rate for all companies. Act on Employment, regulating the duties of unemployment agencies. Act on Special Circumstances under Which a Worker Could is Laid Off, protecting the workers of state firms from being fired in large numbers and guaranteeing unemployment grants and severance pay. The packet of reforms passed by the parliament drastically limited the state's influence over the economy. The plan released price-fixing for many products, allowing them to be dictated by the market instead of the Central Statistical Office. Also the internal debt was drastically limited, by circa 3% of GNP, by cutting down on state subsidies to coal, electricity and petroleum. Initially the social costs of the reforms were seen as extremely high, and roughly 1.1 million workers at state-owned firms lost their jobs. Although inflation seemed to be out of control, the Polish economy gradually started to get back on track. By 1992, more than 600,000 private companies had been set up, providing jobs for approximately 1.5 million people. Most economists agree that without this shock therapy, which sacrificed short-term gains for long-term growth, modern Poland would be a much poorer country. For example, Poland's annual growth rate between 1989 and 2000 was the highest of all post-Communist economies. Most visibly, there were numerous improvements in human rights, such as the freedom of speech, civil liberties (1st class) and political rights (1st class), according to Freedom House. In 1991, Poland became a member of the Visegrd Group and joined the North Atlantic Treaty Organization (NATO) alliance in 1999 along with the Czech Republic and Hungary. Poles then voted to join the European Union in a referendum in June 2003, with Poland becoming a full member on 1 May 2004. Today Economy of Poland is a high income economy and is the sixth largest in the EU, and one of the fastest growing economies in Europe, with a yearly growth rate of over 3.0% before the late-2000s recession. It is the only member country of the European Union to have avoided a decline in GDP, meaning that in 2009 Poland has created the most GDP growth in the EU. As of December 2009 the Polish economy had not entered recession nor contracted. According to the Central Statistical Office of Poland, in 2010 the Polish economic growth rate was 3.9%, which was one of the best results in Europe. Since the end of the communist period, Poland has achieved a "very high" ranking in terms of human development.

Russia and Shock Therapy

(Worst example)

Russia is a country which is partly in Eastern Europe and partly in Asia. It is the largest country in the world by land area. About 145 million people live in Russia. The official name for Russia in English is The Russian Federation. Russia shares borders with Norway, Finland, Estonia, Latvia, Lithuania and Poland, Belarus, Ukraine, Georgia, Azerbaijan, Kazakhstan, China, Mongolia, and North Korea. It also has maritime borders with Japan by the Sea of Okhotsk, and the United States by the Bering Strait. At 17,075,400 square kilometers (6,592,800 sq. mi), Russia is the largest country in the world, covering more than one-eighth of the Earth's inhabited land area. Russia is also the world's ninth most populous nation with 143 million people as of 2012. Russia is a very large and diverse country. Its government is now based on a democratic form of rule. The president is chosen in direct elections, and its current President is Vladimir Putin. The official language is Russian. Russia produces a lot of energy made from oil and natural gas. The Russian Federation became the successor state of the Russian SFSR following the dissolution of the Soviet Union in 1991. The Union of Soviet Socialist Republics abbreviated to USSR or the Soviet Union, was a constitutionally communist state that existed between 1922 and 1991, ruled as a single-party state by the Communist Party with Moscow as its capital. The economy of the Union of Soviet Socialist Republics (USSR) was based on a system of state ownership of the means of production, collective farming, industrial, manufacturing and centralized administrative planning. The economy was characterized by state control of investment, public ownership of industrial assets, and during the last 20 years of its existence, pervasive corruption and socioeconomic stagnation. On 12 June 1991 Yeltsin was elected by popular vote to the newly created post of President of the Russian Soviet Federative Socialist Republic (SFSR), at that time one of the 15 constituent republics of the Soviet Union. He won 57% of the vote in a six-candidate contest and became the third democratically elected leader of SFSR and first direct presidential election in history. On 25 December 1991, the USSR was dissolved into 15 post-Soviet states. On 26 December 1991, Russia was internationally recognized. Yeltsin remained in office as the President of the Russian Federation, the USSR's successor state. Yeltsin announced that Russia would proceed with market-oriented reform similar to Poland's, known as "Shock Therapy." Poland has been cited as an example of the successful use of shock therapy. From Russia's parliament, Yeltsin received one year of special powers: the ability to issue laws by decree for the purpose of remaking Russia's economy. The method of remaking of Russia's economy has been described as "shock therapy," which refers to a sudden privatization of Russia 225,000 or so state-owned businesses, a sudden release of price and currency controls, withdrawal of state subsidies, and sudden trade liberalization. Yeltsin had assembled a team of economists devoted to free-market economics. They were admirers of the U.S. economist Milton Friedman and referred to in Moscow as the "Chicago Boys."

The Soviet Union was sailing into free enterprise without people who had a lot of experience with decision-making in a free market economy. Almost no Soviet employees or managers had such experience. Also, laws that fit a free enterprise system were not in place. It was to be described as like building a house with no plumbing. Yeltsin promised difficulty for approximately six months but that then recovery would come and Russia would become a great economic power the fourth largest in the world. On 2 January 1992, Yeltsin ordered the liberalization of foreign trade, prices, and currency. At the same time, Yeltsin followed a policy of 'macroeconomic stabilization,' a harsh austerity regime designed to control inflation. Under Yeltsin's stabilization program, interest rates were raised to extremely high levels to tighten money and restrict credit. To bring state spending and revenues into balance, Yeltsin raised new taxes heavily, cut back sharply on government subsidies to industry and construction, and made steep cuts to state welfare spending. Through the 1990s, Russia's GDP fell by 50 percent, vast sectors of the economy were wiped out, inequality and unemployment grew dramatically, while incomes fell. Hyperinflation, caused by the Central Bank of Russia's loose monetary policy, wiped out a lot of personal savings, and tens of millions of Russians were plunged into poverty. By mid-1993 from 39 to 49 percent of the population was living in poverty. According to Wikipedia, alcohol-related deaths in Russia increased 60 percent in the 1990s, and deaths from infectious and parasitic diseases increased 100 percent, "mainly because medicines were no longer affordable to the poor."

Concept of State capitalization

State capitalism is the ownership and control of corporations by a sovereign government. It occurs frequently in energy, natural resource, and military technology markets. In some forms, the state operates publicly traded corporations, while other varieties involve businesses funded and administered entirely through government channels. As a hybrid form of public and private business, the proper role and benefits of state capitalism remain controversial. This makes the government a major market participant, not merely its regulator. The state uses markets to create wealth and enhance political power, and then implements economic and legal control of industry to inhibit competition. State capitalism has also come to refer to an economic system where the means of production are owned privately but the state has considerable control over the allocation of credit and investment. Advocates of state capitalism sometimes argue it is necessary in developing countries, where profits from national assets like oil reserves must be directed toward domestic growth and employment, and only the government can ensure this. Critics have called these arrangements monopolistic and "crony capitalism," noting how often authoritarian regimes have such firms, and the ease with which friends of rulers and members of the governing class profit from and direct these businesses.

China and State Capitalism

State-owned companies dominate the global hydrocarbons sector. National oil companies (NOCs), as they are referred to, hold a staggering 77% of the worlds oil reserves. The biggest oil company in the world is Saudi Arabias Saudi Aramco, which has 280-million barrels of proven reserves and has a production capacity of 12.5-million barrels per day (although it usually keeps its production at lower levels, partly to preserve reserves and partly for politico-economic reasons). From second to tenth place (in terms or production), the remaining top ten oil companies are the National Iranian Oil Company, Petroleos Mexi- canos (better known as Pemex), the Iraq National Oil Company, Exxon Mobil, BP, the China National Petroleum Corporation (which has a publicly listed subsidiary called Petro China), the Abu Dhabi National Oil Company, the Kuwait Petroleum Corporation and Petroleos de Venezuela (known as PDVSA). Of these companies, only two, Exxon Mobil and BP are not State-owned. China as a country has very significant mineral and metal reserves. In 2008, its share of global production was 37% for iron-ore, 39% for coal, 16% for copper and 97% for rare- earth minerals. In 2009, the country accounted for 6% of copper, 12% of gold and 25% of zinc production. But this production is spread across some 200,000 mining companies, most of them tiny. However, a small number of major mining companies have emerged, with the big three being China Shenhua, the Aluminium Corporation of China (usually known as Chinalco) and China Coal Energy. All are wholly or partly State-owned. Thus, State capitalism is huge in the global oil and gas industry. However, there is an important qualification to the latter observation. Chinese State capitalism is characterized by State-owned central holding agency, the State-Owned Assets Supervision and Administration Commission, which controls groups of vertically integrated companies (although this control is often, in practice, loose). Because they are vertically integrated, many of these companies, although their core business is not mining, are nevertheless involved in mining (to provide raw materials for their core operations or for energy to power these core operations). Moreover, with Chinas demand for almost all types of mineral, metal and hydrocarbon inputs now exceeding its domestic production, many State-owned enterprises are looking abroad for these resources. In this, they are being supported by the Chinese government, which is particularly uneasy about the countrys dependence, since 1993, on imported oil. State-owned companies have accounted for 80% of Chinese foreign direct investment, supported by soft loans from State banks. The countrys oil companies have been especially active, and deals exchanging infrastructure for oil have become a common business tool for them and for other Chinese State-owned companies seeking access to other commodities. This, of course, puts private-sector resource companies from other countries at a serious disadvantage.

South Africa and State Capitalism

South Africa is a long-standing State capitalism. The great bulk of key infrastructure, whether railways, ports, airports, electricity generation and transmission, water and sewage and broadcasting systems, is in the hands of wholly or predominantly State-owned companies. Moreover, the State is the biggest shareholder in national telecommunications giant Telkom with a 39.76% share, with the next biggest shareholder being the Public Investment Corporation which manages public-sector pension, provident, social security, development and guardian funds with 9.31%; the biggest private sector shareholder is Allan Gray Investment Council, with 8.82%. So, although Telkom is not, technically, State-owned, it is certainly State-dominated. In 2002, the government created the Petroleum, Oil and Gas Corporation of South Africa (PetroSA) as the countrys NOC. It explores for and exploits hydrocarbons both at home and abroad, and owns and operates the largest commercial gas-to-liquids refinery in the world at Mossel Bay on the countrys south coast. At home, the company operates the FAEM south coast gas fields and the Oribi and Oryx oilfields, while abroad it has exploration licenses in Equatorial Guinea and Namibia. Although a minnow by global standards, the companys official vision is to Be the leading African energy company. Further, in 2007, the South African government set up the African Exploration, Mining & Finance Corporation (AEMFC), under the Central Energy Fund (CEF), as a first step in the creation of a State-owned mining company. The company has since been awarded 27 exploration rights in South Africa and started the development of its first mine, a coal operation at Vlakfontein some 100 km east of Johannesburg, in February 2011.

What to Privatize and What to Not? What is privatization?

The transfer of ownership of property or businesses from a government to a privately owned entity.

Why SOEs are Privatize?

Raise revenues from privatization process Improved quality of product/ services. To reduce nepotism. To reduce political influence. Improvements in the level of efficiency in the production processes. Reduction in the debt burden of the government and fiscal deficit. Encourage competition, specially by abolishing the monopolies and promote integration of the domestic economy into the world economy Decrease the opportunities for misuse and corruption of public property by government officials and public sector managers.

Privatize or not
We are considering two SOE of Pakistan and take a rationale decision to privatize them or not. In case of Pakistan 51% to 70% share should be held by Government of Pakistan.

Pakistan Railway - Privatize it?

Pakistan Railways (reporting mark PR) is a national state-owned rail transport service of Pakistan, head-quartered in Lahore. It is administered by the federal government under the Ministry of Railways. PR provides an important mode of transportation throughout Pakistan. It is commonly referred to as the "life line of the country", by aiding in largescale movement of people and freight throughout Pakistan. Today, approximately 65 million passengers annually travel through Pakistan Railways while important items like petroleum products, wheat, coal, fertilizers, cement, sugar and thousands of other products are distributed through the institution. Pakistan Railways is purged of corrupt, dishonest and incompetent elements. Pakistan Railways is facing the worst loss in history and has suffered losses more than Rs 52 billion in the last three years. Pakistan Railways had 821 locomotives in 1948, it now has 528. The rest of the data on the Railways is equally depressing. The report says that only 140 locomotives out of the 528 are functional. In a report submitted to Railway Ministry, it has been disclosed that as many as 70 locomotives are awaiting spares at Pakistan Locomotive Factory, Risalpur since 2004.

Pakistan Ordnance Factories - Never Ever Privatize

Pakistan Ordnance Factories is the largest defense industrial complex under the ministry of defense production, producing conventional arms & ammo to international standards. POF Board headquarter is at Wah Cantt. Presently POF comprises of 14 ordnance factories and three commercial subsidiaries. Pakistan Ordnance Factories also specialize in the manufacture of commercial explosive, hunting ammunition and possess extensive facilities for the manufacture of brass, copper and aluminum ingots, extrusions and sections for non-military applications. A garments factory, which has the state of the art cloth cutting facilities and most modern stiching units, manufactures military uniforms and can also cater for the needs of the civil sector. In addition to meeting the demands of Pakistan Defense Forces, POF products are in service with over 40 countries, in Europe, Asia, the Middle East and the Americas. Ammunition and rifles have been exported to countries like Iraq and Afghanistan for their respective military establishments. POF should not be privatize because it creates a question mark in the security of Pakistan.