State-Owned Enterprises Essay

A state-owned enterprise (SOE) is a business owned or controlled by a national government. SOEs are a common instrument of government economic policy in both developed and developing countries, although concerns about their costs and performance relative to private firms have led to a worldwide privatization trend since the 1980s. Typically, SOEs have been prominent in transportation, communication, and energy production and distribution, and common in capital-intensive industries including mining and the manufacturing of chemicals, metals, machinery, and transportation equipment. In some countries, SOEs are also found in virtually any other sector of the economy, including banking and finance, trade, consumer industries, construction, and agriculture.

As stated above, an SOE is a business owned or controlled by a national government. SOEs differ from private firms in a variety of ways. They tend to have a variety of objectives, sometimes of a conflicting or contradictory nature. Making a profit is usually one stated objective, but may or may not be the primary one. SOEs are supposed to offer social returns, meaning special benefits to the state’s population, and be held accountable by the public through its elected or self-proclaimed representatives. At the same time, SOEs are generally expected to be financially viable and produce goods or services at prices related to their costs, and are thus different from ordinary government services and administration. Their business-like nature also differentiates them from state-owned producers in purely communist regimes without a legitimate private sector.

State ownership of an SOE may be complete or partial, and a company may be considered an SOE even when the government does not own a majority share of the company, as long as the state’s minority position is enough to make political intervention possible. From a legal point of view, an SOE may be classified as a government agency subject to general public law, a public corporation (a separate legal entity subject to special statute), a state company subject to private law, or a listed firm with shares owned fully or in part by the government. The three latter organizational forms imply an increasing degree of autonomy from political and bureaucratic interference, but in practice autonomy also tends to depend on a variety of other factors, and especially on the company’s financial status.

Historical Origins

The history of government-owned business operations goes back to antiquity, but SOEs as we know them today became widespread between the 1930s and the 1960s. Before that time, SOEs could be found in sectors with natural monopolies, meaning unlimited economies of scale (utilities, infrastructure), or in areas of strategic importance (heavy industry, weapons). With the collapse of international capitalism in the 1930s, however, state ownership and management of enterprises became increasingly popular as a political response to economic challenges. SOEs could eventually be found operating in a wide variety of economic activities, often because decision makers believed that state ownership would lead to more efficient and fair use of resources.

In industrialized countries, SOEs were seen as a solution to market failure and a way to promote longterm growth while limiting vulnerability to short-term business cycles. They were also intended as instruments of social engineering, with the hope of redistributing wealth and power, making business democratically accountable, securing employment, and improving industrial relations. In some cases, the creation of SOEs through nationalization also served to rescue mature industries, thus forestalling social unrest.

In the developing countries that became independent in the decolonization wave of the post–World War II era, SOEs were meant to serve several additional purposes. In general, SOEs were seen as instruments of nation building that were to promote economic growth, industrialization, national pride, and the exclusion of exploitative foreign interests. In many cases, SOEs were meant to engage in “state entrepreneurship” where a culture of private enterprise was missing. Nationalization could also represent a kind of “resource nationalism,” with the nationalization of foreign oil operations as one prominent example.

By the 1970s, many had begun to question the performance of SOEs relative to private firms. SOEs incurred heavy losses and burdened states that increasingly found themselves in fiscal difficulties following the oil crisis and the stagnation of the world economy. In response, governments across the globe took steps to reform or privatize large numbers of SOEs. In the 1980s, the United Kingdom and western Europe were early leaders in this process, later followed by Latin America and Asia. In the 1990s, former communist countries in central and eastern Europe became transitional economies intent on privatizing state holdings. By the turn of the millennium, thousands of small, medium, and large SOEs had been sold in part or in full to dispersed private citizens, financial institutions, or multinational corporations. Nevertheless, vast numbers of SOEs remain, and their significance continues to be considerable. This is especially true for the least-developed countries, despite consistent efforts by the World Bank and others to impose privatization programs as part of broader strategies of structural adjustment.

Pros And Cons Of Soes

A variety of arguments have been put forward in defense of SOEs. Many politicians and scholars have held that the ability to introduce other objectives than merely the maximization of profits is an important justification for state ownership. SOEs may be required to provide certain goods and services to all citizens without regard to place of residence or wealth, and to provide continued employment in struggling industries. They may be used to encourage the development of impoverished regions and to resist the influence of capitalist elites and foreign multinationals. SOEs allow government to influence the economy through directing credit and investment, financing efforts in new industries, and encouraging or substituting for private capital accumulation. They may to some extent facilitate macroeconomic planning and enable the government to use SOE investment as an anticyclical measure. SOEs may also be important to foster social cohesion and enhance political legitimacy, especially in developing countries where the state is weak and unstable. In these various ways, SOEs are believed to promote social justice, economic growth, and national integration.

In recent years, arguments illuminating the downsides of SOEs have attracted more attention. Many economists describe SOEs as inefficient and unproductive by design. They believe that some of the market failures SOEs are intended to correct can be solved more efficiently through contracting out or government regulation of private firms. At the same time, they suggest that “government failure” is far more pervasive and harmful than market failure.

SOEs are frequently subject to politicization, corruption, and rent-seeking behavior, and the assumption of a benevolent government allowing SOEs to operate at “arm’s length” is rarely justified. Critics insist that SOE managers lack incentives to innovate and cut costs, while the multiplicity of objectives causes accountability and responsiveness to be less than optimal. These problems are accentuated by the fact that many SOEs are monopolies, meaning that efficiency is difficult to measure. In general, SOEs are difficult to monitor, and few sanctions are available even when performance is obviously suboptimal— continued losses do not result in bankruptcy, and even nonperforming SOEs continue to have access to credit through state-owned banks or government guarantees. This “soft budget constraint” is often seen as the most important factor explaining the inferior financial performance of SOEs.

The notion that SOEs are suitable instruments of distribution and social justice has also been countered by some critics. If SOEs are inefficient and contribute to long-term distortions in the allocation of labor and capital, they will impede economic growth, crowd out private alternatives, and in practice require large subsidies from taxpayers and consumers to SOE managers and workers. Thus, they also contribute to government deficits and inflation while artificially raising SOE wages. Such high wages may create economic dualities in developing countries, where poverty is most prevalent outside the modern sector. In this view, the distributional effects of SOEs may be primarily to reward special constituencies and (in low-income countries) to create a small “state bourgeoisie.”

It is, of course, very difficult to determine how successful SOEs have been throughout history. The many different goals and purposes of these organizations make it inherently difficult to judge their performance or even decide how it should be judged. However, this has not discouraged observers from trying to assess SOEs from a variety of perspectives. The building consensus, based on hundreds of empirical studies, suggests that SOEs often have done poorly in terms of productivity and financial results, and that they have drained state budgets and national credit markets, with deleterious consequences for private businesses and the citizenry at large. Mainstream economists in particular tend to employ highly negative characterizations of SOEs, and politicians, too, seem to have reached a point of disillusionment. The next section provides a brief overview of the development paths of SOEs in some key countries to highlight the diversity of experiences with SOE as an instrument of economic policy.

SOE Trajectories

Western Europe has been remarkable both for its faith in SOEs in the 1930s to 1970s and for the high volume of privatization after 1980. Italy was an early leader in nationalization, prompted by the crisis of the 1930s to set up the massive, state-owned holding company IRI. Originally a temporary fix to rescue the banking system, IRI eventually became a permanent feature of Italy’s political economy. The holding company branched out into a variety of manufacturing sectors and served as a major instrument for industrial development in Italy after World War II. IRI at the height of its powers owned hundreds of companies, with the total number of employees in IRI holdings surpassing 500,000. As late as the 1980s, fixed investment in IRI companies exceeded the fixed investment in all private industry in Italy. IRI subsidiaries were involved in shipbuilding, steel, engineering, biomedical industry, biotechnology, aerospace, food processing, cement, telecom, the operation of toll roads, shipping, banking, and financial services. In 1953, IRI was joined by ENI, a holding company in the oil and gas sector, and in 1964 by EFIM, a third holding company with interests in the production of trains, helicopters, aluminum, and glass. Many of the subsidiaries of IRI and other holding groups were in fact competitive and productive firms, but over time it proved difficult to achieve financial self-reliance. By the early 1980s, the Italian government was transferring amounts equivalent to billions of dollars a year to the holding groups. The steel subholding Finsider struggled even after cutting the workforce by 50,000, and the government had to write off almost $800 million of automaker Alfa-Romeo’s debt. In the end, a program of privatization was implemented in the 1990s.

In the United Kingdom, the main drive toward SOE took place immediately after World War II, but it lasted in some respects until the election of Conservative prime minister Margaret Thatcher in 1979. Between 1946 and 1977, Labour governments pushed to nationalize coal mining, railroads, airlines, utilities, iron and steel manufacturing, and the building of automobiles, ships, and airplanes. The 1940s introduction of SOEs in coal, rail, and energy alone affected 2 million British workers. Unlike in Italy, however, government involvement in most manufacturing sectors and in banking remained limited. The relative productivity of British SOEs has been the subject of some debate, but the financial record was poor. In the 1980s, the Thatcher government spearheaded the worldwide drive toward privatization. The goals of the privatization program were to raise revenue, promote efficiency and competition, reduce government control of the economy, and develop the capital market by encouraging widespread ownership of stocks. This program was in general successful and popular, and offered evidence that the privatization process itself encouraged a positive change in organizational focus. By the time Labour returned to power in 1997, SOEs had ceased to be a factor in the British economy.

In France, some SOEs had been established in the 1930s, and more widespread nationalization followed World War II. Wartime collaboration with the German occupying forces and strong faith in collective solutions justified the takeover of airlines, large banks and insurance companies, the entire energy sector, as well as 20 percent of the manufacturing sector. A new wave followed in the early 1980s, following which SOEs existed in most sectors of the economy. As in other European countries, SOEs in banking, telecom, energy, and heavy industry were especially important, but the most impressive feature of state ownership was its near-ubiquity. The 1981–82 nationalization drive took 53 percent of corporate capital in France out of private hands. However, the election of a center-right government in 1986 led to an almost equally sudden reprivatization, with the sale of 22 major companies. At this point, key SOEs such as Renault, Air France, Credit Group Lyonnais, and the steel industry were experiencing severe problems and imposing great burdens on government budgets. By the late 1990s, even the Socialists had lost some of their faith in SOEs, and Prime Minister Lionel Jospin oversaw the privatization of France Télécom.

Since World War II, SOEs have played a comparatively modest role in the three remaining giants of industrial capitalism, that is, the United States, Germany, and Japan. In the liberal market economy of the United States, many of the tasks performed by SOEs elsewhere have been handled by regulatory regimes or public enterprises at a subnational (state or municipal) level. In the Federal Republic of Germany, state ownership and interference was to a considerable extent discredited by the Nazi regime. The public offerings of Volkswagen and VEBA in the 1960s were early predecessors to the much later drift toward privatization in other Western countries.

Asia

Japan, too, avoided extensive nationalization following World War II, despite a generally statist orientation. SOEs were largely limited to the so-called system of three public corporations and five governmental departments. This did, however, include important activities in transportation (railroads, aviation) and communication (telephone and telegraph systems), as well as monopolies in tobacco and alcohol. These SOEs tended to be overstaffed, yet they were notorious for providing poor customer service. A public commission established in 1981 suggested major reforms of Japanese SOE, and partial privatization began in the mid-1980s. The $40.6 billion third tranche offering of Nippon Telegraph & Telephone (NTT) in 1987 was the largest single security offering to date, and the partially privatized NTT rapidly emerged as the world’s second largest listed telecom company. Both NTT and the Japanese railroad system, unbundled into seven distinct corporations, showed improvements and used their newfound freedom to diversify into related business areas. NTT alone set up 85 new business entities in its two first years. However, the sell-off of NTT, the Japanese railroads, and other SOEs proceeded quite slowly, primarily because the stagnation of the Japanese economy had reduced the absorptive capacity of the stock market.

Elsewhere in Asia, many of the countries that became independent in the 1940s and 1950s had “legacy” SOEs that had been established by colonial powers. South Korea and Taiwan, for example, had SOEs in transportation, communication, energy, and other sectors created as colonial enterprises by the Japanese. However, these countries soon added to their existing holdings by creating new SOEs. In South Korea, there was an emphasis on heavy and chemical industry, which were seen as strategically important sectors where risk and capital needs were too great for private investors. The

Taiwanese government offered strong support for SOEs in oil, electricity, and steel in order to support export industries with raw materials and intermediate goods. In both countries, SOEs were used to encourage rapid, state-directed industrialization.

Although South Korea and Taiwan achieved phenomenal growth, many other Asian countries relied heavily on SOEs with much less success. In South Asia, SOEs mushroomed after independence, with state ownership common across virtually every sector of the economy in India and Pakistan. Indian SOEs were dominated by noneconomic objectives, often devoid of cost control, and in many cases so vast as to create significant diseconomies of scale. SOE performance was consequently very weak. Considering that in the 1980s, 22 of India’s 25 largest firms were SOEs, the negative effect on growth and development was substantial. Reform and privatization began in the 1990s. In Bangladesh, SOE sales began earlier, but as privatized firms continued to rely on the extremely lax banking practices of state banks, performance failed to improve. In fact, rent seekers were able to buy up SOEs with government money without any real commitment to pay debts or even taxes.

In Indonesia, state control of natural resources and strategic industries is required by the constitution. The oil revenue windfall in the 1970s turned many Indonesian SOEs into industrial giants, as oil revenues were deposited in state banks closely connected with state-owned industries. By the 1980s, Indonesia had more than 200 SOEs in sectors as diverse as banking, insurance, manufacturing, mining, agriculture, utilities, transportation, and trade, with a majority being monopolies. Since privatization of SOEs runs counter to Indonesian core values and national identity, a more modest approach of granting increased autonomy and exposing SOEs to competition has been the preferred and relatively successful approach of reformers since the mid-1980s. By contrast, the government of Malaysia has pursued a more aggressive privatization policy to divest itself of many of the more than 1,000 SOEs accumulated between 1957 and 1985. In Malaysia, the development of public enterprises has been linked with promoting the status of the Malay population (in the face of economic dominance by ethnic Chinese) since the 1969 race riots. Consequently, the privatization program also included strict restrictions on foreign and non-Malay ownership.

Since 1978, China has been through a process of liberalization leading from a system without private enterprise to a “socialist market economy.” A process of separating governing and business, offering greater autonomy and more incentives to SOEs and their managers, began in the 1980s. However, the positive effects of these changes proved to be temporary. In 1992, SOE losses and subsidies ate up 62 percent of state revenues. A new policy of partial privatization was developed, leading to insider buyouts of many small SOEs and public listing of larger firms. In 2001, public offerings of major oil companies, banks, and telecoms ensued, and since 2005 the Chinese government has been determined to further decrease the state’s holdings in large firms. However, the government still retains a controlling share in most companies listed on the stock exchanges, either directly or through state investment organizations known as “Legal Persons.” Outsiders, therefore, continue to question the independence, transparency, and quality of corporate governance in leading Chinese companies.

Latin America And Africa

In Latin America, the development of SOEs has been based on an “organic-statist” approach to political economy, emphasizing moral obligations and economic interdependence within the political framework of “presidential patrimonialism.” In Brazil, SOEs have been important in heavy industry, transportation, and utilities, and in such a large country, the economies of scale inherent in capital-intensive industries have allowed a modicum of success and many consistently profitable SOEs. However, the promotion of costly, import-substituting SOEs in Latin America in the 1970s also contributed to the grave debt crisis of the 1980s. Right-wing regimes in Chile and Argentina were pioneers of privatization already in the 1970s, and other Latin American countries have followed in their footsteps in the decades since (partly due to intense World Bank and International Monetary Fund [IMF] pressure). In many cases, these transactions took the form of debt-for-equity swaps, because SOEs carried most of the external debt. The immediate social cost of privatization (and liquidations) was often high, as in Mexico, where 400,000 SOE jobs were lost between 1983 and 1993. Latin America has arguably experienced the most radical privatization process of any market-economy region over the last 25 years. Mainstream economists tend to think of this process as successful and necessary, but the consequences of privatization have proved extremely unpopular in many Latin American countries.

African governments embraced SOE as a political and economic tool when independence came in the 1950s and 1960s. However, their poor performance and the accumulation of deficits and debts, combined with external pressure, resulted in 43 African countries having divestiture programs by 1992. Yet privatization in Africa is difficult because of a lack of capital markets, persistent economic troubles, and weak institutional frameworks. In Nigeria, the government embarked on a privatization program in the late 1980s, with the ambition of relieving the fiscal burden and encouraging private initiative in hydrocarbons, paper and pulp, sugar, and so forth. However, the sales have raised little revenue, and private entrepreneurship still leaves much to be desired. In general, SOEs remain pivotal and the private sector weak in most African countries.

Privatization: Progress And Pitfalls

Between the early 1980s and the early 21st century, governments around the world earned more than $1 trillion from the sales of SOE shares and assets. The global SOE share in GDP consequently dropped by an estimated one-half. In many cases, these sales were opportunistic, designed primarily to raise revenue or gather political support. In the worst cases, they were flagrant examples of corruption, allowing well-connected individuals access to significant assets at nominal costs. Outside pressure and a “bandwagon” effect also affected privatization programs. However, in most cases, privatization followed from an increasing concern with the performance of SOEs and a drastic devaluation of their merits since the mid-20th century. Governments found that the benefits of SOEs did not justify the costs.

Most scholars who study privatization agree that privatization “works,” in other words, it tends to improve efficiency, productivity, and returns. The best results have been achieved when privatization has been combined with other reforms, such as deregulation and increased competition. In some cases, privatization without other reforms and appropriate institutional safeguards may have disastrous consequences, especially in developing countries where the operating conditions for private enterprise can be dismal. Privatization can also lead to unemployment, poverty, social problems, and political protest. Hence, it is reasonable to expect that SOEs will continue to play an important role in many countries for years to come.

Bibliography:

  1. Alberto Cavaliere and Simona Scabrosetti, “Privatization and Efficiency: From Principals and Agents to Political Economy,” Journal of Economic Surveys (v.22/4, 2008);
  2. Reuel J. Khoza and Mohamed Adam, The Power of Governance: Enhancing the Performance of State-Owned Enterprises (Palgrave Macmillan, 2007);
  3. Megginson, The Financial Economics of Privatization (Oxford University Press, 2005);
  4. Organisation for Economic Co-operation and Development (OECD), Privatising State-Owned Enterprises (OECD, 2003);
  5. A. Toninelli, ed., The Rise and Fall of State-Owned Enterprise in the Western World (Cambridge University Press, 2000);
  6. Maria Vagliasindi, Governance Arrangements for State Owned Enterprises (World Bank, 2008);
  7. Qian Wang, T. J. Wong, and Lijun Xia, “State Ownership, the Institutional Environment, and Auditor Choice: Evidence from China,” Journal of Accounting and Economics (v.46/1, 2008);
  8. World Bank, Bureaucrats in Business (Oxford University Press, 1995);
  9. Yong Zhang, Large Chinese State-Owned Enterprises: Corporatization and Strategic Development (Palgrave Macmillan, 2008).

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