Organizations in Economy and Society Lecture 14: Firms and The State Saul Estrin.

Organizations in Organizations in Economy and SocietyEconomy and Society

Lecture 14: Firms and The Lecture 14: Firms and The StateState

Saul EstrinSaul Estrin

Why Does The State Own Why Does The State Own Firms?Firms?

1.1. ““Market Failures”Market Failures”• Public good/externalitiesPublic good/externalities• ““natural monopolies”natural monopolies”• Failures of informationFailures of information

Note: Framework assumes state is “neutral” actor – Note: Framework assumes state is “neutral” actor – seeking to maximise social welfareseeking to maximise social welfare

e.g. e.g. AtkinsonAtkinson and Stiglitz, “Public and Stiglitz, “Public Economies”Economies”

Why Does The State Own Why Does The State Own Firms?Firms?

2. “Marxist View”2. “Marxist View”Social ownership of the means of Social ownership of the means of

production – to negate private production – to negate private ownership (exploitation) and to ownership (exploitation) and to facilitate socialist planningfacilitate socialist planning

Note: probably dominant current view. Derived on Note: probably dominant current view. Derived on approach of Buchanan, Tullock. Drives approach of Buchanan, Tullock. Drives perspective of World Bank/IMFperspective of World Bank/IMF

e.g. Gregory and Stuart,e.g. Gregory and Stuart,

“ “Comparing Economic Systems in the 21Comparing Economic Systems in the 21stst Century”Century”

Why Does The State Own Why Does The State Own Firms?Firms?

3. “Grabbing Hand”3. “Grabbing Hand”State as mechanism for appropriating rents State as mechanism for appropriating rents

from private agents. Rules of State from private agents. Rules of State formulated to maximise rent generation.formulated to maximise rent generation.

e.g. Shleifer and Vishny “The Grabbing e.g. Shleifer and Vishny “The Grabbing Hand”Hand”

Evidence on the Impact of the Evidence on the Impact of the State SectorState Sector

Size of State Sector (share of GDP) Size of State Sector (share of GDP) and economic Growthand economic Growth

i.i. Scully (1989)Scully (1989) – growth reduced as state – growth reduced as state share increases – rent seeking share increases – rent seeking explanation. In democracies, politicians explanation. In democracies, politicians redistribute income to groups that elect redistribute income to groups that elect them – leads to expansion of public them – leads to expansion of public sector, decline of private investment. In sector, decline of private investment. In non-democracies, ruling classes use non-democracies, ruling classes use state to extract rents.state to extract rents.

Evidence on the Impact of the Evidence on the Impact of the State SectorState Sector

ii.ii. Barro (1990)Barro (1990) – growth rate has – growth rate has inverted U-shape with respect to inverted U-shape with respect to government share, reaching a government share, reaching a maximum at around 20% GDPmaximum at around 20% GDP

Barro (1991)Barro (1991) – coefficient on – coefficient on government share in growth model government share in growth model is - 0.12 (0.03)is - 0.12 (0.03)

GDP = -4.262 + 0.115 PRIVSECT

(-1.36) (1.73)

Figure 1. GDP Growth and Private Sector Development

PrivatizationPrivatization

Size of State Owned Sector in 1989 Size of State Owned Sector in 1989 (%GDP)(%GDP)

OECD Economies – between 3 and 25% (US OECD Economies – between 3 and 25% (US to Austria). Average approximately 9% GDPto Austria). Average approximately 9% GDP

Developing economies – average Developing economies – average approximately 15% (Megginson, 2005)approximately 15% (Megginson, 2005)

Transition economies – 70% (Poland and Transition economies – 70% (Poland and Hungary) to 97% (Soviet Union, Hungary) to 97% (Soviet Union, Czechoslovakia)Czechoslovakia)

Privatization has reduced OECD average to Privatization has reduced OECD average to 5% and developing to 8%5% and developing to 8%

Private sector share in GDP and employment in Eastern Europe, 1991-2002

Sources: EBRD Transition Report 1999, 2003;

PrivatizationPrivatization

Scale of PrivatizationScale of Privatization $1.5 trillion revenues raised, 1990 – $1.5 trillion revenues raised, 1990 –

20002000 50% in Western Europe, 15% each in 50% in Western Europe, 15% each in

Latin America and AsiaLatin America and Asia Only 5% raised in transition economiesOnly 5% raised in transition economies 2% in Africa2% in Africa Associated with global wave of foreign Associated with global wave of foreign

direct investmentdirect investment

Reasons for PrivatizationReasons for Privatization

1.1. Problems with State OwnershipProblems with State Ownership Non – profit objectives Non – profit objectives (Estrin and Perotin, 1991)(Estrin and Perotin, 1991) Poor management incentives Poor management incentives (Vickers and Yarrow, (Vickers and Yarrow,

1985)1985) Soft budget constraints Soft budget constraints (Kornai, 1988)(Kornai, 1988)

2.2. Private Sector OwnershipPrivate Sector Ownership Constraints on managerial discretion – “superior Constraints on managerial discretion – “superior

governance” governance” (Megginson, 2005)(Megginson, 2005) External constraints – market for corporate control, External constraints – market for corporate control,

bancrupcy, managerial markets – Anglo – Saxon bancrupcy, managerial markets – Anglo – Saxon capital marketscapital markets

Internal Constraints – direct owner representation on Internal Constraints – direct owner representation on boards; German – Japanese governance systemsboards; German – Japanese governance systems

ImpliesImplies

Privately owned firms will be more Privately owned firms will be more efficient than state owned onesefficient than state owned ones

Additional Reasons for Additional Reasons for Privatization in Transition Privatization in Transition

EconomiesEconomies Revenues for the state Revenues for the state (Barr, 1993)(Barr, 1993) State ownership implies insider controlState ownership implies insider control High levels of inefficiency (labor High levels of inefficiency (labor

hoardinghoarding Rent-seeking behaviour e.g. tunellingRent-seeking behaviour e.g. tunelling Strong ideological reasons for rapid Strong ideological reasons for rapid

large scale privatization large scale privatization (Estrin, 2002)(Estrin, 2002)

Methods of PrivatizationMethods of Privatization

Developed economies and less Developed economies and less developed market economies developed market economies – auction or public tenderauction or public tender

Transition economiesTransition economies– Restitution, MEBO, “mass privatization”Restitution, MEBO, “mass privatization”

Mass privatization is forced distribution of Mass privatization is forced distribution of ownership shares to the population as a ownership shares to the population as a whole, either equally or disproportionably whole, either equally or disproportionably to managers and workersto managers and workers

Methods of PrivatizationMethods of Privatization

Mass privatization – dominant method in Mass privatization – dominant method in the majority of transition economiesthe majority of transition economies

Mass privatization chosen because legacy Mass privatization chosen because legacy of socialism was that private sector did not of socialism was that private sector did not have resources to purchase state owned have resources to purchase state owned firms quickly enough for reformers. firms quickly enough for reformers. Therefore had to sell to foreigners (FDI), Therefore had to sell to foreigners (FDI), mass privatize or waitmass privatize or wait

Measuring Effects of Measuring Effects of PrivatizationPrivatization

Compare “performance” of state Compare “performance” of state owned and private firms (e.g. owned and private firms (e.g. Boadman and Vining, 1989)Boadman and Vining, 1989)

Compare performance of state Compare performance of state owned firms over time as owned firms over time as privatization occursprivatization occurs

IssuesIssues Measuring performance – profitability Measuring performance – profitability

(ROE?), TFP, productivity.(ROE?), TFP, productivity. Controlling for other factors – demand, Controlling for other factors – demand,

location, quality of infrastructure etc.location, quality of infrastructure etc. Endogeneity – do privatized firms perform Endogeneity – do privatized firms perform

better because the governments select better because the governments select better firms for privatization?better firms for privatization?

How to define “private” and “state” How to define “private” and “state” ownership – 100%, 51% etc.ownership – 100%, 51% etc.

Role of ownership concentrationRole of ownership concentration Role of insider ownershipRole of insider ownership

Measuring PerformanceMeasuring Performance Most studies use Most studies use augmented production augmented production

functions functions to capture TFP.to capture TFP.

e.g. X = f(L,K,Z,O)e.g. X = f(L,K,Z,O)

Where X = value addedWhere X = value added L = employmentL = employment K = capitalK = capital Z = vector of other factors Z = vector of other factors

(demand, market structure etc.)(demand, market structure etc.) O = ownership (state, private etc.)O = ownership (state, private etc.)

Measuring PerformanceMeasuring Performance

X = f(L,K,Z,O)X = f(L,K,Z,O)

O is usually defined as a dummy O is usually defined as a dummy variable for state (100 or 50%) variable for state (100 or 50%) ownership. Sometimes quadratic in ownership. Sometimes quadratic in state shareholding.state shareholding.

Private ownership can be subdivided Private ownership can be subdivided into insider and outsider; insider into into insider and outsider; insider into workers and managers.workers and managers.

State Shareholding and Corporate Value

2

2.1

2.2

2.3

2.4

2.5

2.6

2.7

0 10 20 30 40 50 60 70 80

State Shareholding

Q

Findings from the Literature on Findings from the Literature on Effects of PrivatizationEffects of Privatization

1.1. Developed EconomiesDeveloped Economies– Private firms more efficient and profitable than Private firms more efficient and profitable than

state owned firms state owned firms (Megginson and Netter, 2001)(Megginson and Netter, 2001)– Privatization usually “works” e.g. privatized Privatization usually “works” e.g. privatized

firms more efficient, more profitable, stronger firms more efficient, more profitable, stronger financially and usually investing morefinancially and usually investing more

– Impact of privatization ambiguousImpact of privatization ambiguous– Governments usually under price shares in IPO’sGovernments usually under price shares in IPO’s– Governments often retain “golden shares”, with Governments often retain “golden shares”, with

not obvious effects on productivitynot obvious effects on productivity– Large privatization programme often helps to Large privatization programme often helps to

stimulate local financial sector, especially stock stimulate local financial sector, especially stock marketmarket

Findings from the Literature on Findings from the Literature on Effects of PrivatizationEffects of Privatization

2.2. Developing EconomiesDeveloping EconomiesResults more mixed.Results more mixed.– Strong positive effects noted in Megginson Strong positive effects noted in Megginson

and Netter survey. See also e.g and Netter survey. See also e.g La Porta La Porta et. et. al. al. on Mexicoon Mexico

– But impact depends on institutional But impact depends on institutional environment, and privatization does not work environment, and privatization does not work where this is weak. (Porter and Kirkpatrick, where this is weak. (Porter and Kirkpatrick, 2003)2003)

– Plane, 1997Plane, 1997: implementation of substantial : implementation of substantial privatization programme contributes to GDP privatization programme contributes to GDP growth. Effects strongest for privatization of growth. Effects strongest for privatization of industry or infrastructureindustry or infrastructure

– Kikeric and Kolo, 2005Kikeric and Kolo, 2005: privatization more : privatization more successful in competitive sectorssuccessful in competitive sectors

Findings from the Literature on Findings from the Literature on Effects of PrivatizationEffects of Privatization

3.3. Transition EconomiesTransition EconomiesDjankov and Murrell, 2002.Djankov and Murrell, 2002.– Impact often positive in early years in Central Impact often positive in early years in Central

EuropeEurope– Impact zero or even negative in former Soviet Impact zero or even negative in former Soviet

UnionUnion– Possible explanations:Possible explanations:

Too early for conclusions (many papers on which Too early for conclusions (many papers on which meta-analysis was undertaken were written in mid meta-analysis was undertaken were written in mid 90’s, using survey samples90’s, using survey samples

Central Europe privatized to “better owners” – Central Europe privatized to “better owners” – outsiders, foreigners, more concentrated outsiders, foreigners, more concentrated (“strategic”) owners.(“strategic”) owners.

Central Europe has better “institutions” than former Central Europe has better “institutions” than former Soviet UnionSoviet Union

ConclusionsConclusions

Pendulum has swung decisively away from Pendulum has swung decisively away from state to private ownership in developed, state to private ownership in developed, developing and especially transition developing and especially transition economies.economies.

Strong evidence privatization improves Strong evidence privatization improves company performance in developed company performance in developed economies. Results for latter two groups economies. Results for latter two groups depends on “institutional quality”depends on “institutional quality”

Points attention to relationship between Points attention to relationship between company performance and institutional company performance and institutional environmentenvironment