This is a continuation of my post, which was a verbatim reproduction of a private conversation with Joseph Edgar.
This topic about the government’s proper role in the workings of society is a critical one that has been taking place the world over for at least a few centuries now. The popularity of the view you hold has been responsible for the waves of privatization in recent decades. Free marketers often make it seem like it is the only logical choice but sober reflection from others suggests a more complicated picture. I would like to highlight some insights that have come out from this more nuanced discussion about the privatization of State Owned Enterprises (SOEs).
Much of the free marketers’ case against SOEs (And I admit that there is a lot of truth in it) is what is known in the economic literature as the principal-agent problem. Here the principals being the citizenry have elected bureaucrats (the agents) to manage SOEs in the principals’ best interest but the problem is linking the pay of public bureaucrats to the profitability of SOEs, is an incentive system that is notoriously difficult to design. Moreover, individual citizens are not incentivized to monitor the SOEs because the costs will be borne by them alone while the benefits will be shared by everybody (This is known as the free-rider problem). An associated problem is the soft-budget constraint problem: Being a part of the government, the argument goes, SOEs are often able to secure additional finances from the government if they make losses or are threatened with bankruptcy, which could lead to lax management.
Now it has been noticed that despite the threat of market discipline, these problems occur as well in large private sector companies to a significant extent.
Most large private sector companies are managed by hired managers because they have dispersed share ownership. If a private enterprise is run by hired managers and there are numerous shareholders owning only small fractions of the company, it will suffer from the same problems as state-owned enterprises. The hired managers (like their SOE counterparts) will also have no incentive to put in more than sub-optimal levels of effort (the principal-agent problem), while individual shareholders will not have enough incentive to monitor the hired managers just like with SOEs (the free-rider problem).
In addition, politically important, large private companies often get bail-outs from government (e.g in Nigeria, banks, electricity gencos/discos. Global examples include defense contractors, large companies in the finance, automotive and aerospace industries). In other words, there is the private company version of the soft budget constraint problem. To take the example of Nigerian banks, CBN is reputed to have spent over N3 trillion in 8 years between 2009 and 2017, in the wake of the Global Financial Crises of 2008 to stabilize the financial sector. Other global examples include Britain nationalizing some key firms in the 60s and 70s. They include Rolls Royce in 1971, British Steel in 1967, British Leyland in 1977, and British Aerospace also in 1977. Greece rescued about 43 bankrupt private sector firms between 1983 and 1987. In the 1980s, the US government under Ronald Reagan rescued carmaker, Chrysler. This one is especially ironic given that along with Margaret Thatcher, Reagan was the hardest pusher for liberalization/deregulation/privatization. In 1982, the Chilean government rescued the entire banking sector. This was another ironic one, in that this was the regime of General Augusto Pinochet, who came to power in 1973 via a bloody coup, in a bid to usher in free market capitalism, and in which the previous president, a Marxist by the name of Salvador Allende, committed suicide by gunshot.
Conversely SOEs are not totally immune to market forces. Many SOEs around the world have been shut down and their managers sacked because of bad performance. For example, during China’s market reform period between 1978 and 2006, lots of new entrepreneurs were allowed to compete against many SOEs and the SOEs that couldn’t compete were allowed to fail.
Furthermore, there are examples of first class SOEs so it is not inevitable that SOEs will be poorly run. Examples include Singapore Airlines, EMBRAER from Brazil, which is the third largest aircraft maker after Boeing and Airbus. Though it is privatized now, it achieved world class status under state ownership. Petrobras, the Brazilian state owned oil company is also world class. Quite a number of French companies that have become household names achieved world class status under government ownership, though now privatized. They include Renault, Alcatel, Elf Aquitaine, Thomson (electronics), Thales (defence electronics), Rhone-Poulenc (now part of pharmaceutical giant Sanofi-Aventis), Ursinor (Now part of Arcelor-Mittal, the largest steelmaker in the world). Locally, I would add NAFDAC under Dora Akunyuli was well run. Elsewhere on the African continent, Namibia is a country whose state enterprises are generally known to be operating at a profit.
Economic theory shows that there are circumstances under which public enterprises are superior to private-sector firms. This happens when a project has clear long-term viability but private capital refuses to get involved because the short term risks are large. An example is the internet described above (In the last post) and this is often the case when spawning new industries that are capital-intensive. A good current example would be the renewable energy industry, an area that China’s government is investing heavily. What these examples show is that SOEs have often been used to kick-start capitalism, not replace it. Resorting to SOEs to kick-start capitalism is an option more frequently used at earlier stages of development where capital markets are not well developed and therefore tend to be conservative.
SOEs can also be ideal when a natural monopoly exists. This refers to a situation where technology conditions dictate that having only one supplier is the most efficient way to serve the market. A good example of this in Nigeria is the Transmission sub-sector of the Power sector. Government retained ownership of Transmission while privatizing Generation and Distribution.
State-owned enterprises are also often a more practical solution than a system of subsidies and regulations for private-sector providers, especially in developing countries that lack tax and regulatory capabilities.
Privatization of natural monopolies or essential services will also fail if they are not subject to the right regulatory regime afterwards. When the SOEs concerned are natural monopolies, privatization without the appropriate regulatory capability on the part of the government may replace inefficient but (politically) restrained public monopolies with inefficient and unrestrained private monopolies.
The 1980s to the early 2000s saw a wave of privatization across Africa and the world at large, the results of which appear to have been mixed. No doubt there have been some stunning successes like the privatization of telecoms by Obasanjo. There have also been terrible failures, like privatization of our paper mills. On the world stage, privatization exercises with less than satisfactory results include the British rail privatization of 1993, in which the rail tracks had to be re-nationalized in 2002; The failed electricity deregulation of the state of California in the USA, which resulted in the infamous blackout of 2001. There is of course Russia, which is the poster child for privatization run amok. In a rushed privatization programme during the mid-90s, a corrupt group of businessmen with ties to the Russian mafia ended up acquiring about $100 billion worth of mainly oil and gas public resources for no more than $1 billion according to best estimates. I don’t want to make this document longer than it is already but there are enough examples on both sides to show that privatization is not a straightforward no-brainer.
Bibliography
- Chang, Ha-Joon. 2007 Bad Samaritans: The Guilty Secrets of Rich Nations and the Threat to Global Prosperity UK: Random House
- Mazzucato, Mariana 2013 The Entrepreneurial State: Debunking Public vs Private Sector Myths London: Anthem Press
- Sachs Jeffrey 2005 The End of Poverty: How We Can Make it Happen in our Life Time London: Penguin Books
