54114 Privatesector P U B L I C P O L I C Y F O R T H E Note No. 174 January 1999 Labor Redundancies and Privatization What should governments do? Sunita Kikeri When state-owned enterprises preparing for privatization have very high levels of redundant workers and when social safety nets and redundancy provisions in labor laws are inadequate or lacking, the political and social implications of layoffs mean that the government should be involved in the design and funding of special programs to deal with unemployment and labor unrest. This Note reviews the main elements of such programs--severance and retirement benefits, retraining and redeployment support, employee share ownership schemes, and, importantly, mechanisms to ensure labor consultation and participation. (Many of these components are supported in World Bank operations--see box 1.) In many countries these programs need to go hand-in-hand with reforms to expand private labor markets: removing obstacles to job creation, ending restrictions on hiring and firing, and eliminating taxes that raise the cost of labor. BOX 1 WORLD BANK SUPPORT FOR LABOR ADJUSTMENT IN PRIVATIZATION Since 1990 the World Bank has supported labor investment operations provided that such adjustment in privatization and enterprise restruc- financing results in improved productivity of the turing in about fifty operations around the world. sector and enterprise and that social mitigation The main elements of Bank support: measures are put in place (the first such Technical assistance to governments to help: operation was Brazil Railways, where the Bank Develop staff inventories and profiles. project financed half the costs of the severance Identify staffing needs. program). Develop severance and retirement packages. Poverty alleviation programs such as social Analyze labor market characteristics and funds to provide compensatory assistance, needs. advice and training, placement services, and Redeploy workers through active labor market credit for self-employment. Such funds are programs. typically targeted to the poor, but they have been Design employee share ownership schemes. used for state enterprise workers in cases of Establish consultative mechanisms. extreme economic distress or where large- Prepare communications programs. scale redundancies occur in concentrated areas Direct financing for severance payments in (as in the case of mining in Bolivia and Peru). The World Bank Group Finance, Private Sector, and Infrastructure Network Labor Redundancies and Privatization Selling state-owned enterprises with the labor in restructuring, instead making the policy de- force intact is not an option for firms and indus- cision to grant private investors full flexibility to tries that have large numbers of redundant work- select the workforce from the existing pool ac- ers or difficult labor relations at the time of cording to need, with the government assum- privatization.1 Attempts to do so on the grounds ing responsibility for dealing with residual that private investors both are better equipped workers, or to transfer all staff to the investor than the government to judge the level and kind but with the flexibility to make adjustments as of skills needed and have greater incentives to needed. Such an approach was used in Argen- minimize severance costs and adverse selection tina's Buenos Aires water concession, where the (where the best workers are the first to leave) concessionaire took on all 7,400 or so employees have proved risky. Where union opposition is and then reduced the workforce through a vol- high, private investors, wary of taking on the untary retirement program by nearly 50 percent political burden of carrying out large-scale lay- within six months after the start of operations. offs, are reluctant to bid and the process slows Severance benefits were financed jointly by the down. Moreover, when investors have to ab- new private company and the government. sorb large labor liabilities, they discount the sale price accordingly, leading to lower sale revenues Specific approaches to redundancies are bound and potential public allegations that assets are to vary from one country and enterprise to the being sold cheaply. Alternatively, they demand next, depending on local circumstances. But government subsidies to cover the cost of the redundancy programs typically include four liabilities, thus subverting one of the original main components. goals of privatization. Leaving large-scale down- sizing to new private owners may also create Severance and retirement benefits social problems, particularly where weak sev- erance laws and social safety nets reduce pro- Particularly in countries where the need to pla- tection for workers and where, in the absence cate labor is strong or labor legislation prohib- of alternative job opportunities, redundant work- its outright layoffs, governments have provided ers take months or even years to get new jobs. severance and early retirement incentives to encourage voluntary departures, the most com- In large, troubled enterprises, therefore, the gov- mon form of downsizing. The size of the ben- ernment has an important role to play in the efits varies considerably between countries and restructuring process. The extent and nature of between enterprises within a country, depending its role vary from case to case, however. In Ar- on the legal and contractual obligations and the gentina, for example, where surplus staff and strength of labor unions in negotiations. Pay- strong unions were a major source of inefficien- ments range from about eighteen months' sal- cies, the state-owned steel, railway, and energy ary (Brazil railways) to two and sometimes three firms undertook major employment cuts prior years' salary (Argentina, Bangladesh). to privatization. The railway company reduced employment by close to 80,000 in three years. Severance and retirement incentives buy labor Similarly, in Brazil more than 18,000 of the nearly support and allow privatization and its benefits 40,000 railway workers were retired or became to happen and, in the absence of unemploy- redundant before the systems were conces- ment insurance systems, mitigate the social im- sioned. Prior restructuring was undertaken not pact of layoffs. The financial and economic just to improve the prospects for sale but also returns are also high, with short payback peri- to overcome labor opposition and ensure that ods and increases in the marginal productivity the social consequences of layoffs were prop- of redundant staff redeployed to productive ac- erly addressed. In some cases, though, to mini- tivities elsewhere in the economy. But if poorly mize the risk of delays and to ensure that the designed, they can become costly and difficult right levels and mix of skills are retained, gov- to finance, and thus stall the process. In Paki- ernments have stayed away from a direct role stan, for example, an agreement with the unions resulted in a package equivalent to five months' Retraining and redeployment support pay for each year of service, while in Ghana and Tanzania the absence of overall guidelines Governments have often combined severance for the government sector resulted in extremely packages with retraining and redeployment generous severance packages negotiated at the support (counseling, job search assistance, enterprise level that neither the governments nor small business support) to help laid-off work- the firms could afford. If an overly generous ers reenter the labor market or become self- package is offered to all workers, there is the employed. Systematic evaluations are lacking added risk of adverse selection; in the rail and in developing countries, but anecdotal evidence steel industries in Argentina, for example, the shows that retraining programs in particular of- across-the-board offer led to the loss of key staff, ten founder because of timing delays, weak hurting the performance of the newly privatized institutional capacity, and low education lev- firms. els. In Bangladesh, Brazil, and India, for ex- ample, the demand for retraining was far lower To contain the risk of excessive payouts and than expected (with less than a 20 percent take- to minimize adverse selection, the best strat- up rate), and most surplus employees had left egy is to identify the activities and the workers their jobs well before the retraining programs to be separated and to target the severance became operational. But if properly designed, offer only to workers already identified as retraining can have important social and eco- redundant (through benchmarking studies, for nomic benefits by ensuring that workers with example) rather than to all employees. Tailor- several remaining years of productive life are ing the severance package to worker charac- equipped with the right skills to become gain- teristics (such as seniority or education) also fully employed elsewhere in the economy. helps induce the right self-selection and con- Better results can be achieved by ensuring that tain costs. A recent World Bank study of forty- retraining is demand-driven, not supply-driven one public sector retrenchments shows that (for example, by giving workers a choice be- moving away from standardized severance tween training and severance and building in packages linked to wage and past years of ser- a cost-sharing element), that it is targeted to vice to packages more closely linked to the those for whom it is most cost-effective, and future earnings potential of workers based on that nongovernmental and private institutions such characteristics can reduce costs by 20 are involved in the delivery of services. percent or more (Rama forthcoming). One way to redeploy redundant workers is to Voluntary departure programs, particularly early help them set up cooperatives or small busi- retirement, can accelerate pension liabilities and nesses to subcontract with the newly privatized aggravate the problems of already strained so- company for activities previously carried out by cial security systems, so it is important to syn- the state entity (for some types of jobs service chronize these programs with broader pension contracting improves performance incentives). reforms. Where enterprise pension funds are in- In Guinea, for example, the privatized water solvent, employees might be discouraged from management company (Société d'Exploitation taking early retirement because of fears that they des Eaux de Guinée, or SEEG) helped the 250 will not receive regular pension payments. As or so laid-off workers establish cooperatives to part of the privatization process, therefore, some provide such services as new connections, canal countries are looking at the option of creating maintenance, and landscaping. About twenty independent, privately managed pension funds small enterprises have been formed, all of which that would be capitalized through contributions subcontract with SEEG. In Argentina the priva- from the enterprise, employees, and government tized oil company entered into about 200 service (through sale of assets or employee stock op- contracts involving some 5,300 former employ- tion plans, for example) and allow payments to ees. But putting this approach into place and employees taking early retirement. ensuring that employees can compete effectively Labor Redundancies and Privatization with other service providers requires the tion on what happens to workers combined with provision of support services, including busi- the lack of involvement in the process exacer- ness incubators, training for business start-up, bates fears and opposition. As a matter of rou- access to initial working capital, and technical tine, efforts should be made to establish early support in preparing bids and contracts. Such dialogue with workers and unions to inform support should be temporary to ensure that com- them about the goals of privatization, the costs petition is not crowded out. In regions or towns and benefits, the timing and method of privati- where a state enterprise dominates the economy, zation, the social safety net being put in place, contracting, retraining, and job search assistance the regulatory arrangements being developed are not enough. Broader regional development to protect consumer welfare, and the incentive programs involving self-employment and enter- programs for employees, such as share owner- prise development support--as well as tempo- ship schemes. Such efforts have been particu- rary public works and subsidized private sector larly successful when combined with a broader employment programs--are important. public information campaign to ensure that the general public understands the costs of main- Employee share schemes taining inefficient enterprises and the benefits of privatization. Countries with strong and ac- To build labor support, many governments have tive labor unions, such as Argentina and South reserved shares (ranging anywhere from 3 to Africa, have gone a step further and involved 20 percent) for employees in privatized firms, labor in implementation as well. Such a partici- Viewpoint is an open often at discounted prices and with special finan- patory approach may slow the process, but in a forum intended to cing arrangements. Such programs have pro- highly politicized environment it may be cru- encourage dissemina- duced large financial gains for employees thanks cial in obtaining labor support and allowing tion of and debate on ideas, innovations, and to rapid share appreciation resulting from the privatization--and the broader economywide best practices for ex- investment and management changes imple- gains from privatization--to happen. panding the private mented by the new owners. In Bolivia, for sector. The views pub- lished are those of the example, employees in all the major transac- This Note is based on Sunita Kikeri, Privatization and Labor: What authors and should not tions realized capital gains of more than 80 per- Happens to Workers When Governments Divest? (World Bank Techni- be attributed to the cent in a matter of months. In addition to cal Paper 396, Washington, D.C., 1998). 1 World Bank or any of Governments have privatized many state enterprises with the labor its affiliated organiza- financial gains, ownership gives employees a force intact. Redundancy problems did not arise either because tions. Nor do any of the direct stake in the performance of the company increasing competition had led the firms to make prior labor adjust- conclusions represent and so has helped improve labor relations and ments or because private investors expecting new investments and official policy of the dynamic expansion were willing to take the existing labor force World Bank or of its labor productivity. Financing share ownership and deal with surpluses through natural attrition and early retire- Executive Directors schemes is the major concern in developing ment. Indeed, in a number of cases employment levels increased or the countries they countries. Chile successfully overcame this con- after privatization. In these cases workers have generally benefited represent. from significantly higher wages (with 40 to 60 percent increases), cern by allowing workers to use their end-of- improved training, and capital gains from share ownership schemes. To order additional service benefits to invest in the share scheme, See Narjess Boubakri and Jean-Claude Cosset, "Privatization in copies please call with the guarantee that the value of the shares Developing Countries" (Viewpoint 156), Ben A. Petrazzini, "Com- 202-458-1111 or contact petition in Telecoms--Implications for Universal Service and Em- Suzanne Smith, editor, would not fall below their entitled benefits at ployment" (Viewpoint 96), and William L. Megginson, Robert C. Room F11K-208, the time of retirement. As a result, in many of Nash, and Matthias van Randenborgh, "The Privatization Dividend" The World Bank, the enterprises more than 80 percent of employ- (Viewpoint 68). 1818 H Street, NW, Washington, D.C. 20433, ees participated in the program. or Internet address Reference ssmith7@worldbank.org. Consultation and participation Rama, Martin. Forthcoming. "Public Sector Downsizing: An Introduc- The series is also available on-line tion." World Bank Economic Review. (www.worldbank.org/ Often labor unions and workers are not opposed html/fpd/notes/). to the concept of privatization--many recog- Sunita Kikeri (skikeri@worldbank.org), Senior Printed on recycled nize that reforms are inevitable and that the time Private Sector Development Specialist, Private paper. for change has come. But the lack of informa- Sector Development Department