introduction examples views on state capitalism overvie · private investors and under new...

IntroductionThe extent of state ownership

Views on State CapitalismHistory

Nationalization and privatization cycles

The New State Capitalism (1)State ownership: Extent, history, dynamics, reasons

Carsten Sprenger

Higher School of Economics Moscow

Februrary 2017 / CES Lectures, Munich

Carsten Sprenger Lecture 1




ExamplesOverview

Some stories (1)

May, 2007: Brazilian JBS acquired Colorado-based Swift &Company (beef processing) for $1.4 billion; September,2009: it acquires Pilgrim’s Pride, another US meatprocessing firm for $2.8 billion. The biggest shareholder ofJBS is the Brazilian National Development Bank (BNDES).July, 2010: IPO of Agricultural Bank of China (ABC) inShanghai and Hong Kong. Previously, it was a "policybank" lending primarily according to instructions by theCommunist Party. In 2008, it had 25% non-performingloans. Before the IPO, the Chinese government bailed itout, cleaned up the balance sheet, improved corporategovernance. The IPO raised $22 billion for 15% of thebank’s capital.





ExamplesOverview

Some stories (2)

December, 2004: Acquisition of Yuganskneftegaz, themain productive asset of the Russian oil giant Yukos byRosneft. Yukos was bankrupt due to allegations of taxfraud by the Russian tax authorities. This was preceded bythe arrests of the two major shareholders and founders ofthe company, Platon Lebedev and Mikhail Khodorkovsky in2003. Rosneft, before the acquisition a rather smallstate-owned oil company, launched an IPO raising $10.7billion in 2006. It was the world’s fifth-largest IPO at thetime and the largest ever for a Russian company.





ExamplesOverview

The New State Capitalism (1)

Clearly, all three stories are about state capitalism.The new feature is that the state works hand in hand withprivate investors and under new governancearrangements. Previously, governments mostly held 100%stakes.The Economist (Jan 21, 2012) reports that 8 of the 15largest IPOs between 2005 and 2012 were sales ofminority equity positions in state-owned companies.Musacchio and Lazzarini, 2014 count that SOEs accountfor 20% of stock market capitalization in Italy, 30% inGreece, 40% in Russia and 60% in China.





ExamplesOverview

The New State Capitalism (2)

Musacchio and Lazzarini, 2014 define state capitalism aswidespread influence of the government in the economy,either by owning majority or minority equity positions incompanies or by providing subsidized credit and/or otherprivileges to private companies.





ExamplesOverview

Overview of this lecture

1 The current extent of state ownership around the world2 Views on state capitalism

Incentives of governments to control firmsThe industrial policy view (the helping hand)The social viewThe political view (the grabbing hand)

Governance problems (agency view)3 The history of state ownership, nationalization and

privatization4 Nationalization and privatization cycles (Model of Chang et

al., 2016)





ExamplesOverview

Overview of the next two lectures

Lecture 2: Theoretical insights on state ownershipLecture 3: Empirical studies on the comparison betweenstate-owned and private firms, privatization; the politicaleconomy and the international dimension of stateownership.





DefinitionsSIEs among the World’s largest companies

The extent of state ownership

(This section follows broadly Christiansen and Kim, 2014.)






Some definitions

State-invested enterprise (SIE)a corporation in which the State is the ultimate beneficiaryowner, on a consolidated basis, of at least 10% of the votingstock (or equivalent, if the corporation is not a joint stockcompany).

State-owned enterprise (SOE)includes (1) corporate entities entirely ownedby the State; (2) joint stock companies orpartnerships in which the State (on aconsolidated basis) owns more than 50% ofthe voting rights; and (3) corporate entities inwhich the State has a degree of control that isequivalent to majority ownership.

Partially SOE (PSOE)includes corporate entitieswhere the state controls atleast 10% but less than50% of the voting stock (orhas an equivalent degreeof control).






The extent of state ownership (1)

Christiansen and Kim, 2014 from the OECD computed theshare of SIEs in the world’s largest 2000 companies fromthe Forbes listForbes ranks companies according to an average of theirvaluation, sales, profit and asset value.Only public (=listed) companies are ranked.There are 282 SIEs, of which 50 are SOEs in the businessyear 2012-13.Among the top 25 SOEs, there are 13 Chinese, 3 Russian,2 Brazilian companies, and 3 from OECD countries.






The largest 25 SOEs in 2012-13 (US$ billion)

(Forbes 2000, Christiansen and Kim, 2014)

2) ENI is 30% state-owned, but the Italian government is entitled to appoint the majority of board members.






The largest 25 SOEs in 2012-13 (US$ billion),continued







It may seem that state control over commercial enterprisesis mostly a phenomenon in emerging markets, notablyChina.In countries with more developed capital markets, andtherefore more ownership dispersion, control over acompany can often be ensured by holding much less than50% of the shares.The 10% criterion (consistent with the definition of FDI ininternational investment statistics) assumes that investorsdo not hold more than 10% of the shares in a companyunless they have strategic intent.Thus, next we look at the largest PSOEs (with the state asa minority investor).






The largest 25 PSOEs in 2012-13 (US$ billion)

(Forbes 2000, Christiansen and Kim, 2014)






The largest 25 PSOEs in 2012-13 (US$ billion),continued







The list of the largest PSOEs contains predominantlycompanies from OECD countries.Both the tables of SOEs and PSOEs reveal that in 22 ofthe largest 100 pubic companies, the State has a dominantor significant influence.The smaller the companies the smaller is the likelihood ofstate ownership.





Incentives of governments to control firmsGovernance problems

Views on State Capitalism: Incentives ofgovernments to control firms and

Governance Problems

(This section follows broadly Musacchio and Lazzarini, 2014, Ch. 1 and 3.)






The industrial policy view (the helping hand)

State investment as a way to overcome market failures:in capital markets (financial constraints),investments with large externalities ("big push" to promotecoordinated, complementary investments), in particular inconjunction with underdeveloped capital markets,externalities in the discovery of new technologies (Rodrik,2004, proposes temporary financial incentives for newproducts).

More generally, under this view the government shouldpromote development beyond what is possible under freemarkets.This does, however, give no indication whether SOEs areneeded to fulfill such a role of the government.






The social view

SOEs may have social objectives that sometimes conflictwith profitability.This is sometimes also called the double bottom line.Examples: keep excess employment, open unprofitableplants in poor areas, offer services below market prices oreven below costs.Hart et al., 1997: Profit maximization might causeexcessive emphasis on cost reduction at the expense ofquality.






The political view (the grabbing hand)

SOEs are inefficient because politician use them for theirpersonal or political benefit (rent-seeking).Top managers are appointed according to politicalconnectedness, not by merit.Also, managers of SOEs face low pressure since theyknow that they will be bailed out if they drive their firms tobankruptcy (soft budget constraint).






Governance problems of SOEs (the agency view)

Lack of incentives for managers since incentive contractsand monitoring are more difficult to put in place.Performance measures often go beyond profits and shareprices, but might be contradicting each other.Monitoring: multiple principals (government, ministry,state-owned holding company, population, employees?)Boards are often populated by politicians, but whomonitors the monitors?






Governance problems (2)

As mentioned before, SOEs are often insulated frombankruptcy and takeovers. Example: Russian statecorporations Rosatom, Rostec, Rosnano are exemptedfrom bankruptcy by law. Such exemptions might be implicitin many cases.Lack of separation of regulatory and ownership functionsof the governmentExample: Rosatom, the Russian state holding for nuclearpower, is authorized to issue regulations for the sector ofnuclear energy, to give licenses for the fabrication,transport and storage of nuclear material etc.





Late XIX / early XX centuryInterwar periodPost-war nationalizations1970-80sPrivatization

The history of state ownership,nationalization and privatization from the

late XIX to the XXI century

(This section follows broadly Musacchio and Lazzarini, 2014, Ch. 2.)






Late XIX / early XX century

Late XIX century: Governments tried to to cure marketfailure, often linked to natural monopolies.Governments provided public goods such as mail, waterand sewage, and, later on, electricity, telephone andrailways.In many cases, the government first gave out concessionsto private companies, sometimes combined with subsidiesand guarantees.When companies failed the government often ended uptaking them over.






Late XIX / early XX century

For example, Bavaria, Saxony and Prussia nationnalizedmost of the private railways between 1879 and 1885.This increased the share of state-owned railway miles from56 to 82%.Thus, governments acted often as insurers against failure.In the instable interwar period and with the slowdown ofthe Great Depression, governments bailed out many ofthese services, essentially nationalizing them.






Interwar period (1)

UK: BP (1914), BBC (1926), created the Central ElectricityBoard (1927)France 1936-37: aircraft, armament factories, airlines(merged into the government-owned Air France), mergedfive railroad companies under the control of the newrailway holding company SNCF.Italy: Italian Institute for Industrial Reconstructions (IRI),founded during the bailout of the two largest Italian banksin 1933, which had a number of industrial holdings.These assets could not easily sold back to the privatesector, IRI became a permanent institution in 1937 andwould hold about 20% of all Italian corporations on the eveof World War II.






Interwar period (2)

Bailing out ailing industries: Europe, Latin America, Africa.Total nationalization in Russia and the Soviet Union.






Germany, Late 1930s and during the war

The Nazi government integrated important Germanindustries, such as steel, under the umbrella of a largeholding company, the Reichswerke Hermann Göring,created in 1937.Reichswerke took over about 300 firms in occupiedterritories (coal, iron, steel, weapons, river and railtransport).Founding of Volkswagenwerke due to Hitler’s idea toproduce a "people’s car" on a massive scale.






Post-war nationalizations

A new round of nationalizations in France under Charlesde Gaulle: major banks (Banque de France, SociétéGénérale, Crédit Lyonnais, among others), 36 insurancecompanies, coal firms, Renault, increased voting power inAir France, created a holding (Électricité et Gaz de France)to control Électricité de France and Gaz de France, twohuge utility companies.France also introduced the system of economic planning.UK: Coal industry (1947), transport (rail, buses, ports) andelectricity (1948), gas (1949), steel (1951), often creatingholding companies to control smaller firms.Spain, Austria, Eastern European countries(Czechoslovakia, Poland, Yugoslavia, Hungary, Romania,Bulgaria).






Main motivation of governments

Solution to coordination problems and market failuresTool to overcome the difficulties of regulating certainnatural monopolies.Later, government influence extended into new sectors:nuclear power, oil, mining, aerospace.






A new wave of nationalization in the 1970-80s (1)

UK: underperforming water-distribution and manufacturingindustries, among them Rolls-Royce and British Leyland(Jaguar) in 2974; British Aerospace and BritishShipbuilders (1977).Austria: ÖIAG (Österreichische Bundes- undIndustriebeteiligungen) expanded into steel, nonferrousmetals, chemicals, among others, partly by bailing outprivate firms.






A new wave of nationalization in the 1970-80s (2)

France: The government of Mitterand nationalized mostbanks and their industrial holdings, increased stake inCompagnie Génerale d’Électricité (the electricity andnuclear power conglomerate), CIT-Alcatel (telecom),aluminium, steel, chemicals, aircraft.Norway: Norsk Hydro, aluminium, oil refining, createdseveral state-owned banks.






Developing countries

Nationalizations after WWII, peak between 1970 and 1975Latin America: mostly bailouts, Asia and Africa:nationalization of former colonial companies.Oil shocks in the 1970s led to more nationalizations in theoil industry(e.g., Algeria, Iran, Venezuela)






The peak of state ownership

In 1980, the average output of SOEs to GDP reachedabove 7% in developed economies, almost 12% innon-socialist developing countries, close to 90% in EasternEurope.Governments started realizing inefficiencies and tookvarious approaches to reforming SOEs:

Training (schools of public administration for managers ofSOEs and public officials)Improved managerial incentives (France: the "contract plan"specified social, production, quantity and quality objectives,financial indicators) but the performance targets were hardto measure and subject to changing economic and politicalcircumstances, and managers tried to set "soft" targets.Limited corporatization (boards, some financial anddecision-making autonomy).






The decline of state ownership

The oil price shocks led to higher inflation, but prices ofgoods and services produced by SOEs were oftencontrolled by the government. SOEs converted into majorloss-makers.Inflation led also the Fed to increase interest rates.Together with the default of Mexico on its debt in 1982, thisworsened refinancing conditions for developing country’sSOEs considerably. (SOEs were holding large liabilities inforeign currency.)Governments started considering not only structuralreforms of the state sector but also privatization.






The decline of state ownership

Other factors that led to the decline:Swing of voters towards conservative parties (e.g., France,UK)IMF and Worldbank included privatization into conditionalityfor their loansAcademic research on the underperformance of SOEs






Privatization

UK under Margaret Thatcher: Large-scale privatizationprogram.For example, the successful British Telecom IPO in 1984.France under prime minister Jacques Chirac: privatized 22large firms in 15 months between 1986 and 1988.The privatization trend quickly spread internationally.Since 2000: more partial privatizations without transferringcontrol.






Privatization revenues, 1977-2008

PO = public offering, PS = private sale






"Reluctant privatization"

Bortolotti and Faccio, 2009 compute ultimateshareholdings of governments in publicly tradedcompanies that went through some privatization until theend of 1996 (public offering (share issue privatization) orprivate sales).The authors show that governments of OECD countriesoften held back minority and sometimes majority shares inprivatized companies.Governments used also devices to enhance their votingpower for given ownership stake, e.g., pyramids, dual classshares, special voting rights (golden shares).As a result, governments controlled on average 37% ofvoting rights directly, but their ultimate control stakes wason average 52%.






Political factors in privatization

Bortolotti and Faccio, 2009 further construct a matchingsample for the 141 privatized firms that they found.Matching firms should be also publicly traded, not have amajority government stake, come from the same countryand industry, with similar market capitalization in 1996.Two of the political variables that reduces residual stateownership are

a larger decentralization (states or provinces have authorityover taxation, government spending, regulation), anda higher disproportionality between seats and votes (e.g,majoritarian electoral systems).






Features of the new SIEs

The government often holds less than 100%, even minoritystakes.Companies are often listed, have professionalmanagement, board of directors, sometimes withindependent members.State-owned holding companies (pyramids)Internationalization (partly through sovereign wealth funds)





Nationalization and privatization in Resource industriesThe Model of Chang, Hevia and Loayza


(This section focuses mostly on natural resource sectors and presents themodel of Chang et al., 2016.)






Drivers of nationalization in the resource industries

Extractive industries seem to be more prone tonationalization due to high sunk costs (they require largeinvestments at early stages before production can start).Guriev et al., 2011 study nationalization episodes in the oilindustry between 1960 and 2006.They find that nationalization occurs more often when oilprices are high and in countries with weak politicalinstitutions.






Stylized facts on the occurrence of nationalization andprivatization

Chang et al., 2016 start from four observations thatmotivate their model of nationalization and privatizationcycles;

1 Nationalizations and privatizations are recurrentphenomena, and come often in waves simultaneously inseveral countries.

2 Privatization - nationalization cycles tend to occur moreoften in natural resources and utilities sectors.

3 Nationalization of natural resource industries tend to occurwhen the corresponding commodity prices are high.

4 Privatization leads to higher productivity but also largerinequality, and nationalization is more likely when inequalityrises excessively.






The Model of Chang et al., 2016 (1)

emphasizes a basic tradeoff between equality andefficiency.Private ownership provides more incentives for effort, whileunder state ownership the government cannot crediblycommit not to equalize incomes ex-post. But equalityimplies ex-ante a choice of minimal effort by the workers(moral hazard).The model allows to study the effect of external variables,such as the commodity price, the tax regime and financialconstraints, on the choice of private vs. national regime.As external and domestic conditions fluctuate, cycles ofprivatization and nationalization emerge.






The Model of Chang et al., 2016 (2)

increasing and concave production function F = F (L),where L is laborcommodity price p (dollars)We consider in some detail the static version of the model,and discuss briefly additional results from the dynamicversion.






Workers (1)

N workers, indexed by iLabor supply (productivity) li is a random variable whosedistribution depends on worker i ’s effort, ai . Labor supply isobservable, but effort is not.Specifically, li can take two values, lH or lL < lH . Theprobability of high productivity is increasing and concave ineffort: Pr(li = lH |a) = π(a), where π′(a) > 0, π′′(a) < 0.Given effort, the realization of li is i.i.d. across workers.L =

∑Ni=1 li .






Workers (2)

Each worker faces a labor market with a wage schedule{y∗H , y∗L}, where y∗H and y∗L are the payments to a workerwith high and low labor productivity, respectively.Total income of a worker with productivity li is y∗i + T ,where T is a lump-sum transfer.Denote the utility of income by u(c) and the cost of effortby φ(a).Assume u′ > 0 > u′′, φ(0) = φ′(0) = 0, φ′ > 0, and φ′′ > 0for all a > 0.






Workers (3)

Given the wage schedule, {y∗H , y∗L}, workers choose a ≥ 0to maximize expected utility

π(a)u(y∗H + T ) + (1− π(a))u(y∗L + T )− φ(a)

First-order necessary condition is

π′(a)[u(y∗H + T )− u(y∗L + T )]− φ′(a) = 0

a > 0 if and only if y∗H > y∗LThe FOC implies that effort increases in the wagedifferential.






State ownership (1)

Assumptions:1 The government is benevolent. It maximizes an equally

weighted sum of the (domestic) workers’ utility.2 The government chooses a wage schedule and taxes after

effort has been exerted and productivity is observed.Given the probability π (and assuming without loss ofgenerality that T = 0), the planner chooses yH and yL tomaximize the sum of workers’ utilities

N[πu(yH) + (1− π)u(yL)]

subject to the feasibility constraint

N[πyH + (1− π)yL] = pF (N(πlH + (1− π)lL))






State ownership (2)

The optimal allocation implies u′(yH) = u′(yL) or,equivalently, yH = yL.Workers, anticipating this outcome, choose optimally theminimum effort, aS = 0.Aggregate labor is LS = N[π(0)lH + (1− π(0))lL].In sum, under state ownership, the government equalizesconsumption across agents, and effort, labor, and outputfall to their smallest possible values.






Private ownership (1)

Firms operate in competitive markets. There is acontinuum of firms of measure 1.Firms pay two taxes, a dividend tax 0 ≤ τ < 1 and a salestax 0 ≤ θ < 1. Receipts from these taxes are rebatedlump-sum to the workers.Given a market wage schedule {y∗H , y∗L} and thecommodity price p, firms choose the number of workers nand a suggested effort level a to maximize expectedprofits...







max{p(1−θ)F (n[π(a)lH+(1−π(a))lL])−n[π(a)yH+(1−π(a))yL]}(1−τ)

subject to

u(yH + T )− u(yL + T )− γ(a) = 0 (IC)π(a)u(yH + T ) + (1− π(a))u(yL + T )− φ(a) ≤ U∗ (IR)

where γ(a) = φ′(a)/π′(a) and U∗ is the reservation utility that aworker can get in the market, given by

U∗ = π(a∗)u(y∗H + T ) + (1− π(a∗))u(y∗L + T )− φ(a∗)







Let η(1− τ) and λ(1− τ) denote the Lagrange multiplierson the IC and IR constraints, respectively.The FOC w.r.t. n is

p(1− θ)F ′(n`(a))`(a) = π(a)yH + (1− π(a))yL

where `(a) = π(a)lH + (1− π(a))lL is the expected laborsupply given effort a.







FOCs w.r.t. yH and yL:n

u′(yH + T )= λ+

η

π(a)and

nu′(yL + T )

= λ− η

1− π(a)Assume (counterfactually) that η were zero, i.e. the ICconstraint did not bind. In that case,u′(yH + T ) = u′(yL + T ), or yH = yL. (This would be thecheapest way to pay workers their outside option of U∗.)The need to provide incentives for effort creates a wedgebetween yH and yL, which is costly to the firm.The FOC w.r.t. a, using the IC constraint, reads

nπ′(a)[p(1− θ)F ′(n`(a))(lH − lL)(yH − yL)] = ηγ′(a)







Lemma 1: Both constraints need to bind in the optimum(λ > 0 and η >0) and the optimal contract is monotone,that is, yH > yL.Industry equilibrium: Since all firms are equal, inequilibrium n = N and {a, yH , yL} = {a∗, y∗H , y∗L}. Thegovernment budget constraint is

TN = τ{p(1−θ)F (N`(a∗))−N[π(a∗)y∗H+(1−π(a∗))y∗

L ]}+θpF (N`(a∗))

We have now a system of six equations – the IC constraint,FOCs w.r.t. n, yH , yL, a and the government budgetconstraint that determine the six endogenous variables{y∗H , y∗L ,a∗,T ∗, λ, η}.







Proposition: Under private ownership, workers exertpositive effort and the high productivity workers are paidmore than the low productivity ones. The optimal contractinduces consumption inequality and imperfect risk sharing.However, in the private regime, some of the profits areappropriated by private owners; this is a cost if the welfareof owners is not part of the national welfare function (e.g., ifthey are foreigners).A 100% dividend tax τ (when θ = 0) leads to theconstrained-efficient solution (it is similar to stateownership) with yH = yL. Thus, τ < 1 is assumed.Further results are obtained from numerical simulations(specific functional forms and parameter values).






Optimal regime choice (1)






Optimal regime choice (2)

At high commodity prices (p > p∗), state ownership ispreferred (income equality becomes more important).High prices substitute for the low productivity.How does the choice of regime depend on parameters?

Cost of effort φ(a) = ϕa2/2Parameters governing the probability of successπ(a) = 1− δe−νa

Change in relative productivity lH/lL, keeping averageproductivity πlH + (1− π)lL constantTaxes τ and θ.






The dynamic model

Regime change entails a one-time benefit (privatization) orcost (nationalization).Commodity price follows a stochastic process resulting in alognormal distribution/Results can be obtained about the length of ownershipregimes (e.g., depending on the volatility of the priceprocess).






Optimal regime choice in the dynamic model






Relation to stylized facts

1 Cyclical nature of privatization and nationalization. Given acommon factor (commodity price), such cycles are likely toinvolve multiple countries.

2 Assumptions are typical for natural resource sectors.3 Reproduce the higher likelihood of nationalization when

resource prices are high.4 Nationalization occurs in the model when inequality across

workers becomes relatively more important and profits ofprivate firms are highest.






Policy conclusions

Institutional improvements may help eliminatingprivatization - nationalization cycles, to the extent that suchreforms enhance the ability of the government to commit inadvance to a certain redistributive policy.An implicit assumption underlying this theory is that, in aprivatized regime, workers cannot pool wage income riskswith each other. Fostering the development of financialmarkets could help.


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