fundamental gap in information between the principals and their agents. For example, when the hired manager says that she has done her best and that the poor performance is due to factors beyond her control, the principal will find it very difficult to prove that she is lying. The difficulty of the principal controlling the agent’s behaviour is known as the ‘principal-agent problem’ and the resulting costs (that is, the reduction in profits due to poor management) the ‘agency cost’. The principal-agent problem is at the centre of the neo-liberal argument against SOEs.
But this is not the only cause of inefficiency of state ownership of enterprises. Individual citizens, even if they theoretically own the public enterprises, do not have any incentives to take care of their properties (the enterprises in question) by adequately monitoring the hired managers. The problem is that any increase in profit resulting from the extra monitoring of the SOE managers by some citizens will be shared by every citizen, while only those citizens who do the monitoring pay the costs (e.g., time and energy spent in going through company accounts or alerting the relevant government agencies to any problems). As a result, everyone’s preferred course of action will be not to monitor the public enterprise managers at all and simply to ‘free-ride’ on the efforts of the others. But, if everyone free-rides, no one will monitor the managers and poor performance will be the outcome. The reader will immediately understand the ‘free-rider problem’ if he tries to recall how often he himself has monitored the performance of any of his country’s SOEs (of which he is one of the legal owners) – Amtrak, for example.
There is yet another argument against state-owned enterprises, known as 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. In this way, it is argued, enterprises can act as if the limits on their budgets are malleable, or ‘soft’, and get away with lax management. This theory of soft budget constraint was originally advanced by the famous Hungarian economist, Janos Kornai, to explain the behaviour of state-owned enterprises under communist central planning, but it can be applied to similar enterprises in capitalist economies too. Those ‘sick enterprises’ of India that never go bankrupt are the most frequently cited example of the soft budget constraint problem in relation to state-owned enterprises.[2]
So the case against state-owned enterprises, or public ownership, seems very powerful. The citizens, despite being the legal owners of public enterprises, have neither the ability nor the incentive to monitor their agents, who have been hired to run the enterprises. The agents (managers) do not maximize enterprise profits, while it is impossible for the principtals (citizens) to make them do so, because of the inherent deficiency in information they possess about the agents’ behaviour and the free-rider problem amongst the principals themselves. On top of this, state ownership makes it possible for enterprises to survive through political lobbying rather than through raising productivity.
But all three arguments against state ownership of enterprises actually apply to large private-sector firms as well. The principal-agent problem and the free-rider problem affect many large private-sector firms. Some large companies are still managed by their (majority) owners (e.g., BMW, Peugeot), but most of them 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 (the free-rider problem).
As for politically generated soft budget constraints, they are not confined to SOEs. If they are politically important (e.g., large employers or enterprises operating in politically sensitive industries, such as armaments or healthcare), private firms can also expect subsidies or even government bail-outs. Right after the Second World War, a lot of large private enterprises were nationalized in many European countries because they were not doing well. In the 1960s and the 1970s, the British industrial decline prompted both Labour and Conservative governments to nationalize key firms (Rolls Royce in 1971 under the Conservatives; British Steel in 1967, British Leyland in 1977, and British Aerospace in the same year under Labour). Or, to take another example, in Greece, 43 virtually bankrupt private-sector firms were nationalized between 1983 and 1987 when the economy was going through a difficult patch.[3] Conversely, state-owned enterprises are
Private firms know that they will be able to take advantage of soft budget constraints if they are important enough, and they are not shy about exploiting the opportunity to the full. As one foreign banker reportedly told the
Indeed, many state bail-outs of large private sector firms have been made by avowedly free-market governments. In the late 1970s, the bankrupt Swedish shipbuilding industry was rescued through nationalization by the country’s first right-wing government in 44 years, despite the fact that it had come to power with a pledge to reduce the size of the state. In the early 1980s, the troubled US car maker Chrysler was rescued by the Republican administration under Ronald Reagan, which was in the vanguard of neo-liberal market reforms at the time. Faced with the financial crisis in 1982, following its premature and poorly designed financial liberalization, the Chilean government rescued the entire banking sector with public money. This was General Pinochet’s government, which had seized power in a bloody
The neo-liberal case against state-owned enterprises is further undermined by the fact that there are numerous well-functioning SOEs in real life. Many of them are actually world-class firms. Let me tell you about some of the more important ones.
Singapore Airlines is one of the most highly regarded airlines in the world. Often voted the world’s favourite airline, it is efficient and friendly. Unlike most other carriers, it has never made a financial loss in its 35-year history.
The airline is a state-owned enterprise, 57% controlled by Temasek, the holding company whose sole shareholder is Singapore’s Ministry of Finance. Temasek Holdings owns controlling stakes* (usually the majority share) in a host of other highly efficient and profitable enterprises, called GLCs (government-linked companies). The GLCs do not just operate in the usual public ‘utility’ industries, such as telecommunications, power and transport. They also operate in areas that are owned by the private sector in most other countries, such as semiconductors, shipbuilding, engineering, shipping and banking.[5] The Singapore government also runs the so-called Statutory Boards that provide certain vital goods and services. Virtually all land in the country is publicly owned and around 85% of housing is provided by the Housing and Development Board. The Economic Development Board develops industrial estates, incubates new firms and provides business consulting services.
Singapore’s SOE sector is twice as big as that of Korea, when measured in terms of its contribution to national output.When measured in terms of its contribution to total national investment, it is nearly three times bigger.[6] Korea’s SOE sector is, in turn, about twice as large as that of Argentina and five times bigger than that of the Philippines, in terms of its share in national income.[7] Yet both Argentina and the Philippines are popularly believed to have failed because of an overextended state, while Korea and Singapore are often hailed as success stories of private-sector-driven economic development.
Korea also provides another dramatic example of a successful public enterprise in the form of the (now privatized) steel maker, POSCO (Pohang Iron and Steel Company).[8] The Korean government made an application to the World Bank in the late 1960s for a loan to build its first modern steel mill. The bank rejected it on the grounds that the project was not viable. Not an unreasonable decision. The country’s biggest export items at the time were fish, cheap apparel, wigs and plywood. Korea didn’t possess deposits of either of the two key raw materials – iron ore and coking coal. Furthermore, the Cold War meant it could not even import them from nearby communist China. They had to be brought all the way from Australia. And to cap it all, the Korean government proposed to run the venture as an SOE.What more perfect recipe for disaster? Yet within ten years of starting production in 1973 (the project was financed by Japanese banks), the company became
