Organizations in Economy and Society

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

2. Why Does The State Own Firms? • “Market Failures” • Public good/externalities • “natural monopolies” • Failures of information Note: Framework assumes state is “neutral” actor – seeking to maximise social welfare e.g. Atkinsonand Stiglitz, “Public Economies”

3. Why Does The State Own Firms? 2. “Marxist View” Social ownership of the means of production – to negate private ownership (exploitation) and to facilitate socialist planning Note: probably dominant current view. Derived on approach of Buchanan, Tullock. Drives perspective of World Bank/IMF e.g. Gregory and Stuart, “Comparing Economic Systems in the 21st Century”

4. Why Does The State Own Firms? 3. “Grabbing Hand” State as mechanism for appropriating rents from private agents. Rules of State formulated to maximise rent generation. e.g. Shleifer and Vishny “The Grabbing Hand”

5. Evidence on the Impact of the State Sector • Size of State Sector (share of GDP) and economic Growth • Scully (1989) – growth reduced as state share increases – rent seeking explanation. In democracies, politicians redistribute income to groups that elect them – leads to expansion of public sector, decline of private investment. In non-democracies, ruling classes use state to extract rents.

6. Evidence on the Impact of the State Sector ii. Barro (1990) – growth rate has inverted U-shape with respect to government share, reaching a maximum at around 20% GDP Barro (1991) – coefficient on government share in growth model is - 0.12 (0.03)

7. GDP = -4.262 + 0.115 PRIVSECT (-1.36) (1.73) Figure 1. GDP Growth and Private Sector Development

8. Privatization • Size of State Owned Sector in 1989 (%GDP) • OECD Economies – between 3 and 25% (US to Austria). Average approximately 9% GDP • Developing economies – average approximately 15% (Megginson, 2005) • Transition economies – 70% (Poland and Hungary) to 97% (Soviet Union, Czechoslovakia) • Privatization has reduced OECD average to 5% and developing to 8%

9. Private sector share in GDP and employment in Eastern Europe, 1991-2002 Sources: EBRD Transition Report 1999, 2003;

10. Privatization • Scale of Privatization • $1.5 trillion revenues raised, 1990 – 2000 • 50% in Western Europe, 15% each in Latin America and Asia • Only 5% raised in transition economies • 2% in Africa • Associated with global wave of foreign direct investment

11. Reasons for Privatization • Problems with State Ownership • Non – profit objectives (Estrin and Perotin, 1991) • Poor management incentives (Vickers and Yarrow, 1985) • Soft budget constraints (Kornai, 1988) • Private Sector Ownership • Constraints on managerial discretion – “superior governance” (Megginson, 2005) • External constraints – market for corporate control, bancrupcy, managerial markets – Anglo – Saxon capital markets • Internal Constraints – direct owner representation on boards; German – Japanese governance systems

12. Implies Privately owned firms will be more efficient than state owned ones

13. Additional Reasons for Privatization in Transition Economies • Revenues for the state (Barr, 1993) • State ownership implies insider control • High levels of inefficiency (labor hoarding • Rent-seeking behaviour e.g. tunelling • Strong ideological reasons for rapid large scale privatization (Estrin, 2002)

14. Methods of Privatization • Developed economies and less developed market economies • auction or public tender • Transition economies • Restitution, MEBO, “mass privatization” Mass privatization is forced distribution of ownership shares to the population as a whole, either equally or disproportionably to managers and workers

15. Methods of Privatization • Mass privatization – dominant method in the majority of transition economies • Mass privatization chosen because legacy of socialism was that private sector did not have resources to purchase state owned firms quickly enough for reformers. Therefore had to sell to foreigners (FDI), mass privatize or wait

16. Measuring Effects of Privatization • Compare “performance” of state owned and private firms (e.g. Boadman and Vining, 1989) • Compare performance of state owned firms over time as privatization occurs

17. Issues • Measuring performance – profitability (ROE?), TFP, productivity. • Controlling for other factors – demand, location, quality of infrastructure etc. • Endogeneity – do privatized firms perform better because the governments select better firms for privatization? • How to define “private” and “state” ownership – 100%, 51% etc. • Role of ownership concentration • Role of insider ownership

18. Measuring Performance • Most studies use augmented production functions to capture TFP. e.g. X = f(L,K,Z,O) Where X = value added L = employment K = capital Z = vector of other factors (demand, market structure etc.) O = ownership (state, private etc.)

19. Measuring Performance X = f(L,K,Z,O) O is usually defined as a dummy variable for state (100 or 50%) ownership. Sometimes quadratic in state shareholding. Private ownership can be subdivided into insider and outsider; insider into workers and managers.

21. Findings from the Literature on Effects of Privatization • Developed Economies • Private firms more efficient and profitable than state owned firms (Megginson and Netter, 2001) • Privatization usually “works” e.g. privatized firms more efficient, more profitable, stronger financially and usually investing more • Impact of privatization ambiguous • Governments usually under price shares in IPO’s • Governments often retain “golden shares”, with not obvious effects on productivity • Large privatization programme often helps to stimulate local financial sector, especially stock market

22. Findings from the Literature on Effects of Privatization • Developing Economies Results more mixed. • Strong positive effects noted in Megginson and Netter survey. See also e.g La Porta et. al. on Mexico • But impact depends on institutional environment, and privatization does not work where this is weak. (Porter and Kirkpatrick, 2003) • Plane, 1997: implementation of substantial privatization programme contributes to GDP growth. Effects strongest for privatization of industry or infrastructure • Kikeric and Kolo, 2005: privatization more successful in competitive sectors

23. Findings from the Literature on Effects of Privatization • Transition Economies Djankov and Murrell, 2002. • Impact often positive in early years in Central Europe • Impact zero or even negative in former Soviet Union • Possible explanations: • Too early for conclusions (many papers on which meta-analysis was undertaken were written in mid 90’s, using survey samples • Central Europe privatized to “better owners” – outsiders, foreigners, more concentrated (“strategic”) owners. • Central Europe has better “institutions” than former Soviet Union

24. Conclusions • Pendulum has swung decisively away from state to private ownership in developed, developing and especially transition economies. • Strong evidence privatization improves company performance in developed economies. Results for latter two groups depends on “institutional quality” • Points attention to relationship between company performance and institutional environment