Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism

one of the most efficient steel-producers on the planet and is now the world’s third largest.

Taiwan’s experience with state-owned enterprises has been eve more remarkable.[9] Taiwan’s official economic ideology is the so-called ‘Three People’s Principles’ of Dr Sun Yat-Sen, the founder of the Nationalist Party (Kuomintang) that engineered the Taiwanese economic miracle.[10] These principles dictate that the key industries should be owned by the state. Accordingly, Taiwan has had a very large SOE sector. Throughout the 1960s and the 1970s, it accounted for over 16% of national output. Little of it was privatized until 1996. Even after the ‘privatization’ of 18 (of many) state-owned enterprises in 1996, the Taiwanese government still retains a controlling stake in them (averaging 35.5%) and appoints 60% of the directors to their boardrooms. Taiwan’s strategy has been to let the private sector grow by creating a good economic environment (including, importantly, the supply of cheap, high-quality inputs by public enterprises) and not bothering about privatization very much.

In the past three decades of its economic ascendancy, China has used a strategy similar to that of Taiwan. All Chinese industrial enterprises had been owned by the state under Maoist communism. Now China’s SOE sector only accounts for around 40% of industrial output.[11] Over the past 30 years of economic reform, some smaller state-owned enterprises have been privatized under the slogan of zhuada fangxiao (grabbing the big, letting go of the small). But the fall in the share of state ownership has been mainly due to the growth of the private sector. The Chinese have also come up with a unique type of enterprise based on a hybrid form of ownership, called TVEs (township and village enterprises). These enterprises are formally owned by local authorities, but usually operate as if they were privately owned by powerful local political figures.

It is not only in East Asia that we can find good public enterprises. The economic successes of many European economies, such as Austria, Finland, France, Norway and Italy after the Second World War, were achieved with very large SOE sectors at least until the 1980s. In Finland and France especially, the SOE sector was at the forefront of technological modernization. In Finland, public enterprises led technological modernization in forestry, mining, steel, transport equipment, paper machinery and chemical industries.[12] The Finnish government gave up its controlling stake in only a few of these enterprises even after recent privatizations. In the case of France, the reader may be surprised to learn that many French household names, like Renault (automobiles), Alcatel (telecommunications equipment), St Gobain (glass and other building materials), Usinor (steel; merged into Arcelor, which is now part of Arcelor-Mittal, the biggest steel-maker in the world), Thomson (electronics), Thales (defence electronics), Elf Aquitaine (oil and gas), Rhone-Poulenc (pharmaceuticals; merged with the German company Hoechst to form Aventis, which is now part of Sanofi-Aventis), all used to be SOEs.[13] These firms led the country’s technological modernization and industrial development under state ownership until their privatization at various points between 1986 and 2000.[14]

Well-performing state-owned enterprises are also found in Latin America. The Brazilian state-owned oil company Petrobras is a world-class firm with leading-edge technologies. EMBRAER (Empresa Brasileira de Aeronautica), the Brazilian manufacturer of ‘regional jets’ (short-range jet planes), also became a world-class firm under state ownership. EMBRAER is now the world’s biggest producer of regional jets and the world’s third largest aircraft manufacturer of any kind, after Airbus and Boeing. It was privatized in 1994, but the Brazilian government still owns the ‘golden share’ (1% of the capital), which allows it to veto certain deals regarding military aircraft sales and technology transfers to foreign countries.[15]

If there are so many successful public enterprises, why do we rarely hear about them? It is partly because of the nature of reporting, whether journalistic or academic. Newspapers tend to report bad things – wars, natural disasters, epidemics, famines, crime, bankruptcy, etc. While it is natural and necessary for newspapers to focus on these events, the journalistic habit tends to present the public with the bleakest possible view of the world. In the case of SOEs, journalists and academics usually investigate them only when things go wrong – inefficiency, corruption or negligence.Well-performing SOEs attract relatively little attention in the same way that a peaceful and productive day in the life of a ‘model citizen’ is unlikely to make front-page news.

There is another, perhaps more important, reason for the paucity of positive information on state-owned enterprises. The rise of neo-liberalism during the past couple of decades has made state ownership so unpopular in the public mind that successful SOEs themselves want to underplay their connection with the state. Singapore Airlines does not advertise the fact that it is owned by the state. Renault, POSCO and EMBRAER – now all privatized – try to underplay, if not exactly hide, the fact that they became world-class firms under state ownership. Partial state ownership is practically hushed up. For example, few people know that the state (Land) government of Lower Saxony (Niedersachsen), with an 18.6% stake, is the largest shareholder in the German carmaker Volkswagen.

The unpopularity of state ownership, however, is not entirely, or even mainly, due to the power of neo- liberal ideology. There are many SOEs all over the world that are not performing well. My examples of high- performing SOEs are not meant to distract the reader’s attention away from the poorly performing ones. They are given to show that there is nothing ‘inevitable’ about poor performance by public enterprises and that improving their performance does not necessarily require privatization.

The case for state ownership

I have shown that all the reasons cited as causes of poor SOE performance apply also to large private- sector firms with dispersed ownership, if not always to the same degree. My examples also show that there are many public enterprises that do very well. But even that is not the whole story. Economic theory shows that there are circumstances under which public enterprises are superior to private-sector firms.

One such circumstance is where private-sector investors refuse to finance a venture despite its long-term viability because they think it is too risky. Precisely because money can move around quickly, capital markets have an inherent bias towards short-term gains and do not like risky, large-scale projects with long gestation periods. If the capital market is too cautious to finance a viable project (this is known as ‘capital market failure’ among economists), the state may do it by setting up an SOE.

Capital market failures are more pronounced in the earlier stages of development, when capital markets are underdeveloped and their conservatism greater. So, historically, countries have resorted to this option more frequently in the earlier stages of their development, as I mentioned in chapter 2. In the 18th century, under Frederick the Great (1740–86), Prussia set up a number of ‘model factories’ in industries like textiles (linen above all), metals, armaments, porcelain, silk and sugar refining.[16] Emulating Prussia, its role model, the Meiji Japanese state established state-owned model factories in a number of industries in the late 19th century. These included shipbuilding, steel, mining, textiles (cotton, wool and silk) and armaments.[17] The Japanese government privatized these enterprises soon after they were established, but some of them remained heavily subsidized even after privatization – especially the shipbuilding firms. The Korean steel maker POSCO is a more modern and more dramatic case of an SOE set up due to capital market failure. The general lesson is clear: public enterprises have often been set up in order to kick-start capitalism, not to supersede it, as it is commonly believed.

State-owned enterprises can also be ideal where there exists ‘natural monopoly’. This refers to the situation where technological conditions dictate that having only one supplier is the most efficient way to serve the market. Electricity, water, gas, railways and (landline) telephones are examples of natural monopoly. In these industries, the main cost of production is the building of the distribution network and, therefore, the unit cost of provision will go down if the number of customers that use the network serves is increased. In contrast, having multiple suppliers each with its own networks of, say, water pipes, increases the unit cost of supplying each household. Historically, such industries in the developed countries often started out with many small competing producers but were then consolidated into large regional or national monopolies (and then often nationalized).

When there is a natural monopoly, the producer can charge whatever it wants to, as consumers have no one else to turn to. But it is not just a matter of the producer ‘exploiting’ the consumer. This situation also generates a social loss that even the monopoly supplier cannot appropriate – known as ‘allocative deadweight loss’ in technical jargon.* In this case, it may be economically more efficient for the government to take over the activity in question and operate it itself, producing the socially optimal quantity.

The third reason for the government to set up state-owned enterprises is equity among citizens. For example, if left to private-sector firms, people living in remote areas may be denied access to vital services such as