State-Owned Enterprises: The Domestic Costs

In Western capitalist societies, state-owned enterprises (SOEs) are typically created for two reasons.  The primary situation in which we see investment in existing enterprises or creation of new enterprises is when the government or economy is in crisis, such as in wartime or during a major economic crisis.  Most of these “crisis investments” are unwound after the crisis has passed.  In the U.S., examples of such investments include the wartime companies such as the War Finance Corp. and Defense Homes Corp., Depression-era companies (some of which still remain) such as the FDIC, Tennessee Valley Authority, Commodity Credit Corp., and the Financial Crisis investments in AIG, Citigroup, and GM.

The second category of investment concerns the creation of enterprises that are designed to perform important societal functions, but lack private investment and/or would benefit from a more efficient and politically insulated form.  SOEs may provide for more efficient production of important services because of economies of scale, efficient pricing, and higher levels of investment and innovation.  U.S. SOEs created under this justification include the U.S. Postal Service; Amtrak; Space Communications Satellite Corp. 

These investments can take a number of forms, including:

  • Minority owner in a private corporation (Citigroup)
  • Controlling owner in a private corporation (Fannie Mae)
  • Mixed-ownership government corporation (FDIC; Amtrak)
  • Wholly-owned government corporation (TVA, OPIC)

Although not directly owned by the government, there are also private corporations that have been created or backed by governments and are deemed essential to regulation and may have implicit ongoing federal support (e.g., public-private partnerships, and Fannie/Freddie pre-conservatorship).

This is the positive side of SOEs: they achieve important societal goals that may not be achieved by the private sector.  A recent Economist magazine report on China’s SOEs reminds us of the negative side of SOE activity; many of these concerns apply equally well to U.S. and other Western SOEs. Here are a couple of the domestic costs that reduce the effectiveness of SOEs:

  1. Taxpayers often lose; corrupted officials often win.  The report states that:

An independent Chinese study has found that if all the government’s grants and hidden subsidies were taken away, the SOEs would lose money. They pay hardly any dividends back to the government. Instead much of the wealth has ended up enriching SOEs’ chiefs and political patrons.

2.   SOEs cannibalize smaller home-market firms.  Again from the Economist:

SOEs damage small and medium-sized Chinese enterprises, which are starved of money. This deprives China of the bamboo capitalists whose drive and innovation is needed more than ever now that economic growth is slowing.

Not only do these concerns apply to SOEs, but they apply to all situations in which the government invests in or provides subsidies to private enterprise.  Are you listening, JobsOhio?


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