The secret to successful state-owned enterprises is how they're run

State-owned companies are often touted as necessary tools for development in emerging economies. This is because they can be directed by governments to achieve development ends. The model has been a success in some countries, but it’s been an epic failure in others.

The knee-jerk reaction to paralysis in state-owned enterprises is to call for privatisation. Business and Economy editor Andile Makholwa asked Steve Koch, Professor of Economics at the University of Pretoria, why governments need state-owned enterprises and what determines their success or failure.

Why do governments need state-owned companies?

In first year economics, we often consider an “ideal” world. The “real” world differs markedly from this “ideal”, and those differences create problems that potentially can be solved through government intervention. Those interventions include:

• the provision of safety and security;

• support for public health, education and research;

• the provision of water, sanitation, communications, energy and transportation infrastrcuture; and

• the development of regulations and enforcement agencies.

State-owned companies are not generally needed to provide goods. Rather, they are needed to provide the foundation for a well-functioning economy and a healthy, well-informed populace. State-owned companies operate in a wide range of sectors across all countries, although they are most common in emerging markets.

How can state-owned companies spur growth and development in emerging economies?

Recent research suggests that electricity infrastructure roll-out increases employment. Related to this, transport infrastructure expansion increases economic growth in the long-run and has relatively high rates of return in industrialising countries, although that effect might not be as strong as initially believed.

Thus, state-owned companies that provide the backbone of an economy can be expected to help spur economic growth and development.

But it is not clear that other types of state-owned companies can be expected to do the same. The share of state-owned companies among the top ten firms is 96% in China, 88% in the United Arab Emirates, 81% in Russia, and 59% in India. China and India are among the fastest-growing economies in the world.

That means it is tempting to conclude that state-owned enterprises can spur economic growth. But that conclusion is not supported by any empirical research, and ignores the fact that even China believes it is necessary to further reform its state-owned enterprises sector.

Where have they have been used successfully and where have they not?

State-owned companies can be found in every country in the world. Norway has, arguably, seen greater success than other countries, especially in Europe, while South Africa cannot point to the same levels of success. State ownership itself is not necessarily the problem.

Instead, success more often hinges on managerial skill and autonomy. In Norway the government operates through the board and treats all shareholders as equals.

Chinese state-owned enterprises have been spurred on by a variety of events, including increased autonomy and the impact of market forces.

Historically, governments have set up companies to develop industries where investors seem reluctant. Is that still important in today’s world?

Understanding the establishment and continuation of state-owned companies is more complex than wondering why investors might not favour them.

First, there are entrenched world leaders in some industries; in other words, investors may shy away from competing against that leader.

Second, industries require a host of both downstream and upstream counterparts (and skills) that often develop together. Investors may not have the resources to also develop these counterparts.

Third, political leaders may view certain companies as too important to fail. Such views create pressure on the fiscus, but also decrease investment risks.

Malaysia’s Proton is an interesting example. It was established in 1983 to increase the level of industrialisation in the economy, although Mitsubishi held a small stake. Its success hinged largely on industrial policies that made imports far more expensive than the local product. At the same time the manufacturer received millions in subsidies.

Although the company can point to some successes during its time, it was never in a position to compete with internationally produced cars because it was never expected to. Its future is therefore in doubt. But in 1993 the Malaysian government set up Perodua, another automobile manufacturing company, as a joint venture with Daihatsu. Their focus was to become a competitive manufacturer, and it is now the best-selling brand in the country.

Often, when state-owned companies are battling, there are calls for privatisation. What has been the experience of countries that have privatised?

A recent book on privatisation illuminates much of the recent history of privatisation: the good, the bad, and the ugly. For example, Russia’s privatisation program is believed to have led to increased economic inequality, as assets were stolen and agglomerated among a select few.

Privatisation in Mexico also fared poorly, partly because the proper regulatory structure was not in place to deal with companies inappropriately using their market power.

Thus, successful privatisation requires strong institutions.

Research also suggests that privatisation is good for productive efficiency, even if it does not always lead to improvements.

More generally, in addition to calls for privatisation (changing ownership), there are also calls for restructuring and changes in management. All of these feature in the private sector as well.

To oversimplify, the experiences associated with any of these changes have been mixed, both in the public sector and the private sector.

Thus, we end with another common statement in first-year economics:

It depends.

Steve Koch receives funding from the National Research Foundation, the World Health Organisation, and UK Aid.

Steve Koch, Professor of Economics, University of Pretoria

This article was originally published on The Conversation. Read the original article.