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Rethinking state ownership after COVID-19

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Sanitary workers wearing face masks following the COVID-19 outbreak are seen on Tiananmen Square before the closing session of the Chinese People's Political Consultative Conference (CPPCC) in Beijing, China, 27 May 2020 (Photo: Reuters/Thomas Peter).

In Brief

State ownership might be crucial for sectors that are vital for social stability. Over the last half century, the consensus among economists has been that state ownership is notorious for management inefficiency. Since the 1970s, there has been a wave of privatisation globally.

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But in recent years the percentage of state-owned enterprises (SOEs) in the Fortune Global 500 has risen to nearly a quarter. The increase in state capitalism over the last two decades in countries like Singapore, China, Brazil and Norway offers an opportunity to explore the nature of state ownership anew.

The necessity of containing a global pandemic also provides a backdrop to re-examine state ownership. Medical equipment that is in short supply globally — such as tests, masks and ventilators — and social distancing are crucial to combating COVID-19.

Countries with a state capitalist economy seem to be able to deal with both issues more effectively than those with free markets because the state can order an immediate shift in production to meet emergency needs. People in these countries also seem less likely to resist drastic social measures. This could be because they are accustomed to centralised control.

Producing and storing excessive quantities of medical supplies isn’t lucrative under normal circumstances. Companies must account for uncertainties in demand, incurring unpredictable inventory costs, quality maintenance and sales. But because the government can implement price controls during a disaster on humanitarian grounds, these costs might not be covered. In this situation, the market is likely to fail.

Some goods demand state intervention in unusual situations because they are critical to survival. These include medical supplies during a pandemic and shelter during wartime, as well as clean water, air and food. This category could be extended to include utilities such as electricity and services that ensure economic stability, including financial intermediation.

Until recent decades, state-owned utility companies managed the allocation of water, electricity and oil supplies around the world. Cross-border mergers and acquisitions were often blocked politically. Extra medical supplies were produced and reserved by militaries rather than hospitals.

The state can intervene against market failure in two ways. It can compel companies to shift production towards these urgent needs, disregarding costs and benefits to stakeholders in the private sector. It is socially justifiable to spend government tax incomes to address humanitarian issues.

State ownership is an alternative form of state intervention. In the fight against COVID-19, while all countries have centralised their efforts to some degree — for example, to increase the production of medical supplies — their approaches have been very different. In a free market system like that in the United States, the president can declare a state of emergency. This gives them greater executive authority, but can pose a risk if the president is unfit. In a state capitalist system like that in China, no extraordinary executive power is needed as the state is empowered to act as an economic agent — the shareholder.

Luckily, pandemics don’t happen frequently. But managing the trade-off for services concerning social and economic stability is a constant concern. In a free market system like the United States, banks are privately owned. In principle, shareholders are responsible for their profits and losses. But being thought of as ‘too-big-to-fail’ has caused severe moral hazards in many banks’ risk taking. In extreme situations such as the 2008 bailout, banks were protected from incurring losses without the requirement that they share profits.

In a state capitalist system like China, banks are mostly state-owned, meaning the state is responsible for both profits and losses. But a proper assessment of the economic cost of bailouts as opposed to that of state ownership is not straightforward. The former induces a moral hazard that can lead to risk taking, while the latter might lead to management inefficiencies such as under-taking risk. Both operate on a soft budget with tax revenue as the last resort. Intuitively, the comparison suggests a balance between state and private ownership might be best for this industry.

Beginning in the 1970s, the United Kingdom and many other countries privatised state-owned industries in response to a tide of neoliberalism. Once applauded as a success, this shift has recently become controversial for producing an array of new problems, such as a deterioration in railroad safety.

Assessing the financial underperformance of these sectors in the United Kingdom in the 1970s, economists and policymakers blamed state ownership for management inefficiency and fixed it through privatisation. But an alternative could have been to address the management issues through state ownership.

China offers a glimpse of what a viable alternative might look like. Recent studies have shown that, although CEOs in Chinese SOEs are evaluated according to political criteria, the economic performance of the firms they manage is sometimes a stronger predictor of their managerial and political promotion. The incentive for promotion aligns with shareholder wealth improvement. When the state acts as a shareholder, it adopts the modern separation between ownership and management. At the same time, with a controlling shareholder in place, this arrangement overcomes the free-riding issue that prevails with diverse ownership among small investors.

China and the United States are on opposite ends of the spectrum when it comes to state capitalism versus the free market. Scandinavian countries and other Asian countries like Singapore and South Korea are relatively more balanced. These countries also responded to COVID-19 more effectively than the United States.

The optimal performance of an economic system might require a balance between state and private ownership. This balance could be especially crucial for sectors that are vital to social stability.

Meijun Qian is Professor of Finance at the Research School of Finance, Actuarial Studies and Statistics, The Australian National University.

This article is part of an EAF special feature series on the novel coronavirus crisis and its impact.

One response to “Rethinking state ownership after COVID-19”

  1. When the national government owns industries at least the money that those industries produce from its sales of goods and services goes straight into the treasury. You also have lower administrative costs compared to private industries which are always shelling out so much money to its CEOs and upper management. For example, Social Security administrative costs in America are only 4% while if you privatize its, the administrative costs will keep going up and up because the people on Wall Street will keep siphon off the money to give themselves better wages, stock options, etc. In Argentina, where many business owners flee the country, the workers took over the businesses and discover that 30% of the companies’ expenses were spent on pampering the managers.

    In addition, private companies are always laying off people whether in good times or bad times thus putting a strain on goverment assistance programs or the companies are sending the jobs overseas or importing workers to replace the existing workers. In state own industries, this can’t happen because the workers will have a say in the matter.

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