No. 442 November 2000
[Editor’s Note: This Jerusalem Letter/Viewpoints is based on Prof. Ne’eman’s presentation at a closed forum for experts on “Capital Market Reforms and the Privatization Process,” held on September 19, 2000, as part of the ongoing program by the Jerusalem Center and the Milken Institute to foster privatization in the Israeli economy.]
A number of factors are impeding the implementation of privatization in the Israeli economy. Here I will review those factors based on my own experience, both as someone who has represented investors who purchased government companies through privatization processes, and (from the other side of the fence) in my positions in the Ministry of Finance, when I had an opportunity to observe the governmental process from the inside.
Who Should Manage Privatization?
The main problem with privatization is due to a paradox that relates to the principle at the heart of the matter. We seek to privatize government companies since we assume that the government is the worst manager in the economy. Yet who is charged with the business of privatization? Not merely the worst manager in the economy, but an entire team of managers from almost every government ministry. In almost every case of privatization, someone in one of the ministries attempts to foil the plans. Thus, the very act of entrusting the act of privatization to elements in the government entails a profound paradox.
In 1977, Prime Minister Menachem Begin and Finance Minister Simcha Ehrlich correctly decided to transfer the privatization process to a businessman from the private sector — Israel Sacharov. While the director of the Government Companies Authority remained in his position, the negotiations concerning privatization of the Shipping Bank were managed by a businessman. The process took 48 hours from the moment of decision to the final agreement, and within two months the entire process had been completed. The appointment by the current prime minister of Yaron Jacobs, a man with business experience, to serve as director of the Government Companies Authority is definitely a positive step.
Lessons from the Past
Let us now review a number of examples from the past in order to illustrate some of the fundamental problems. One example in this context is the privatization of Shekem, a chain of retail outlets originally serving the military and other security personnel and their families. I was asked to represent the government as an attorney in this process. The major body impeding privatization in this case was the Ministry of Defense, which argued that privatization of the “mini-Shekem” stores would provide the controlling holder with the ability to discover the most preciously-guarded secrets of the defense system — information about the number of troops in the IDF. This obstacle delayed the process of privatization.
The privatization of Bezeq, Israel’s domestic telephone company, involved the Government Companies Authority, the Ministry of Justice, the Ministry of Communications, the Ministry of Defense, the Israel Lands Authority, the Ministry of the Environment, the Restrictive Trade Practices Commission, the Knesset Finance Committee (which is becoming not merely a political body but is also behaving as if it were a workers’ committee), the income tax authorities, and the attorney-general (within whose office different factions pulled in opposing directions). Each of these myriad groups is attempting to steer events according to its own interests. If privatization is to be successful, all these elements must be neutralized.
The privatization of Bezeq began in the early 1990s, and continues to this day, since Bezeq is still a government company and a monopoly. What were the reasons for the failure of this privatization? Firstly, the absence of a comprehensive and well-developed plan; combined with a policy approach ridden with u-turns and zigzags. The privatization process was accompanied by incessant wrangling, and suffered from the lack of a proper master plan or any long-term perspective on the dramatic technological changes seen over the past decade — forecasts that could have been obtained from any professional body active in the capital market. The future emergence of the Internet and cable-based communications were widely predicted, yet these developments were ignored.
Restrictions on Tenders
A major problem in the privatization of Bezeq relates to the right of the Ministry of Defense to disqualify candidates through notification from the director-general of the ministry, thus halting the privatization process at any moment. A further restriction prohibits a resident individual or company of a hostile nation to compete in the tender. The term “hostile nation” is loosely defined, including any nation that does not maintain diplomatic relations with Israel, or that is defined as hostile by the minister of defense. It is unclear, for example, whether Jordan is a “hostile nation.” The problem becomes even more complex if a competitor holds five percent or more of a corporation registered in a hostile nation. In such cases, the security authorities may demand the imposition of restrictions. This applies to international communications companies such as AT&T that have holdings in countries defined as hostile.
Yet the closure of the market to competitors goes further still. Government companies in other countries may not participate in acquiring a controlling share in Bezeq. Thus, such companies as Deutsche Telekom, the Spanish telephone company, British Telecom, the Dutch company KPN, and others find themselves disqualified from the outset. When the number of competitors is restricted, the price falls sharply. The State of Israel seems to have forgotten that, given the development of advanced communication technologies, Bezeq can no longer be considered the jewel in the crown.
“Golden Shares” for the State of Israel
When the first two issues of Bezeq shares were implemented, the state did not seek any “golden share” with special rights attached. Imagine a private or commercial body demanding shares with special rights after it had already implemented two issues of shares in a given company — the body would surely find itself in court facing charges of public deception. Yet when the State of Israel acts in this manner, it is a different story.
When we were working on one of the Bezeq share issues, I contacted the Government Companies Authority and asked whether it was intended that the state would be issued shares with special rights. The director of the Authority replied that this was unnecessary. Yet as early as 1992, the director-general of the Government Companies Authority, Zeev Refuah, stated that the Bezeq Law in Israel permits the state to do almost anything it pleases with Bezeq, at any time it chooses, including obliging the company to establish infrastructures and make investments.
The result of this situation was that members of the public acquired shares during the first issuance of Bezeq shares, and during trading on the stock exchange, based on the assumption that the state did not hold a “golden share,” and that there was no restriction on the sale or acquisition of shares. The price of the share was based on this assumption. It is common knowledge that if shares are subject to limitations on transfer, their value is negatively effected.
The Cable & Wireless Debacle
The tragic case of Cable & Wireless is a poor example for a country that claims to be eager to enter the world capital market. This communication company acquired shares in a series of deals on and off the stock exchange. During the acquisitions, there were no restrictions on the sale or acquisition of shares in Bezeq. When the state realized that Cable & Wireless had gained the right to appoint a director in Bezeq (based on the provision that a director could be appointed for each seven percent holding), a major offensive was launched by elements in the government, including ministers, who feared a loss of control of Bezeq. Israeli government ministers evidently consider that even after a company has been sold, they can continue to regard it as a government enterprise under their control.
Cable & Wireless was said to have begun a hostile takeover, and a well-orchestrated campaign was launched in the media by government figures with the goal of discrediting the company. In order to block the company, the Bezeq Law was amended, leading to the enactment of the Bezeq Order, Determination of a Vital Service Provided by Bezeq Israel Communications Company Ltd., 5757-1997. The use of legislation to impose restrictions on shares purchased in the past is incompatible with proper government in a democracy, and particularly in an economy that seeks to secure foreign capital investments and to expand its capital market.
It is totally unacceptable that primary and secondary legislation were used retroactively to allocate the State of Israel a golden share in Bezeq, thus imposing a restriction on control and holdings in Bezeq, to the effect that the Minister of Communications is now required to authorize the acquisition of additional holdings in the company.
This course of action in privatizing government companies is completely unacceptable, and provides an interesting lesson in the autocracy of public officials who attempt to seize control of assets that belong to all the residents of the state. Had investors been allowed to continue acquiring shares in Bezeq, the price would be much higher than it is now. The public would have benefited from this, and the privatization of government companies would have gathered momentum. I am sure that foreign companies, in the field of communications and in other fields, learned the lesson of the Cable & Wireless incident. The company itself, needless to say, abandoned its involvement in Israel at the first opportunity. At the time, this was the largest foreign cash investment in the State of Israel, and this incident undoubtedly served to discourage foreign investors from acquiring government companies in Israel.
Appointment of Directors
A further example of the policy u-turns typical of government officials is once again provided by Bezeq, though the same phenomenon may also be found elsewhere. As mentioned above, the articles of the privatized Bezeq company stated that each seven percent of shares allowed the appointment of a director — a sensible provision that enhances the value of the share. Yet after Cable & Wireless entered the picture, this approach, and the Bezeq articles, were suddenly amended to state that the majority holder (i.e., the state) appoints all the directors in Bezeq. This is a completely unreasonable condition, and the new demands reflect an incoherent and inconsistent policy.
The frequent changes in Israel’s privatization policy lead to a lack of confidence, destabilize the system, and deter foreign investors due to the risks inherent in acquiring government companies when ministers and officials refuse to relinquish their control.
State Land and Bezeq
A further example relating to Bezeq and other companies is the issue of land. The decision on this matter rests with the attorney-general, who is known to lack any experience in land deals and the capital market. In 1998, just before the previous decision to privatize Bezeq, it was suddenly recalled that land had been transferred from the state to Bezeq in 1984, and that the state still claimed rights to this land. I have examined the early forecasts for Bezeq, and it emerges that this matter was not even mentioned. Any private body that acted in this manner would almost certainly face criminal proceedings for concealing a substantive fact in a business forecast. The State of Israel, however, benefits from the immunity enjoyed by the attorney-general.
In passing, I would note that in a democracy such authority should rest with ministers, rather than with officials or attorneys-general. Be that as it may, the attorney-general’s support enabled the Israel Lands Authority to foil the privatization — a decision that caused tremendous damage to the Israeli economy. This problem will almost certainly continue to cast a shadow over privatization efforts and, even if it is resolved, the Ministry of Justice or the Ministry of the Environment, or some other ministry, will no doubt manage to find additional reasons to delay privatization. Government officials do not want to relinquish their power and influence, as I came to understand during my time at the Ministry of Finance.
The same is true in the case of Israel Chemical Industries. Although the state sold its control in the company, it maintained a share with sweeping powers that hampers the business activities of the concern. This is not a case that relates to maintaining vital national interests or protecting natural resources, yet this does not prevent the government bureaucracy from flexing its muscles. The underlying problem is the desire of ministers and civil servants with no business experience to control commercial companies.
In 1980, when the late Minister of Finance Yigal Hurvitz informed the government that he would be obliged to cut the budget, one of the ministers suggested that the government should print more money. When Hurvitz replied that he had no paper left to print the money, the other minister told him to buy some more, to which Hurvitz replied that he had no money left to buy the paper. The story illustrates once again the inexperience of those who are charged with making economic and commercial decisions.
If the government genuinely wishes to privatize companies, it should transfer all the relevant powers to the Government Companies Authority, particularly given that this body is currently headed by a businessman. Spreading power among a large number of bureaucrats will only prevent the continuation of privatization.