Future Reform of State-Owned Enterprises in emerging markets

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One of the greatest challenges facing emerging markets like China and Vietnam is what to do about State-Owned Enterprises, or nationally owned industries.  There are 145,000 of them in China alone. They generate 35% of China’s GDP and 43% of profits.

Many of them survive only with large government subsidies, which distort national markets. They may enjoy lower tax rates than privately owned competitors.

They often rely on huge bank loans at preferential rates of interest, crowding out other borrowers, discouraging investment and adding to government liabilities. So what should be done?

40% of Vietnam’s GDP is state-owned enterprises, yet they employ less than 10% of the labour force.

These enterprises are responsible for a very high proportion of non-performing loans, and are one of the reasons why many banks in these nations are so vulnerable to economic shocks.

The great fear is that if government subsidies are suddenly withdrawn, many of these enterprises will cease to trade, leaving banks carrying huge amounts of unpaid debt, which in turn could trigger collapse of banks, flight of investors, collapse of the currency and a severe new economic crisis.

Mass privatisations in 1980s and 1990s

Before 1990, every corporation in Communist nations was by definition state-owned.  In the 1990s, huge numbers of state-owned enterprises were privatized in countries like Russia, often very rapidly, creating huge wealth for a privileged few who had access to the capital to buy them.  

It was a painful process in Russia. Many state-owned manufacturing giants were extremely inefficient and unable to compete in a global market.  Steel mills closed.  Car factories closed.  Across Russia today you can see the scars on the landscape from vast, crumbling industrial sites that are totally deserted.

A similar wave of large-scale privatisations had already taken place in countries like the UK and the US in the 1980s, usually by publicly listing on Stock Exchanges, allowing millions of small shareholders to participate in the restructuring.

The process was also traumatic in Britain – led by Margaret Thatcher, pitting riot police and soldiers against violent opposition by unionized workers. 

The end result was rapid economic growth, but in areas where most of the population had previously worked for state-owned companies, unemployment soared and there was severe hardship.

Conflicts of interest in government leaders

In most nations, state-owned enterprises are run by people closely linked to government leaders, friends, family, business associates.  

In many case, government leaders sit on the boards of state-owned corporations.  By definition, state-owned enterprises are run by the state for the benefit of the population as a whole, so government has a great responsibility to see that they are properly managed.  

Conflicts of interest are often created by such involvement of government leaders and their wider circle: people may stand to lose significant income and status if a state-owned enterprise is sold off.

Future of State-owned enterprises

So what should governments do? The critical issue is usually speed / timing.  Another issue is national security – ensuring continuity of vital services such as power generation, water, sanitation, ports, airports, telecommunications and so on.

We can expect slow change in countries like China, where government leaders are prepared to sacrifice some longer term economic growth to reduce risks of short term instability and pain.

Steps to gradual change

While every country is different, here are some principles that have worked. Each action needs to be balanced carefully with other actions, according to the national situation, and carried out in stages.

1) Open up competition
- deregulate to allow privately owned competitors to develop, with investment from outside the country if appropriate.

2) Restrict diversification of state-owned enterprises
    - in some nations like Vietnam, SOEs have taken advantage of loans on advantageous terms to invest in areas outside their core competence – for example investing in real estate as a utility company.  This makes the process of privatization even more complex and distorts markets still further.

3) Recapitalise banks where necessary so that they are better able to survive losses on non-performing loans from SOEs.

4) Withdraw state subsidies over a period of years, as clearly laid out in government policy commitments.

5) Sell off non-critical SOEs, if necessary in pieces eg real estate first, then telecom company.

* What do YOU think about State-Owned Enterprises? What should be done?  Do comment below.

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