During the 20th century the economic importance of the state
grew all over the world. In developed
countries central government spending accounted
for less than 10 percent of gross
domestic product (GDP) in the early 1900s,
but by the 1990s that share had grown to nearly 50 percent
in many of those countries (Figure 11.1;
Data Table 3 ). Among the
major historical factors contributing to this government
expansion were the Russian Revolution of 1917 and the Great
Depression of the 1930s. But the data suggest that this
expansion continues even today: over the past 35 years the
share of government spending in the GDP of developed countries
countries the economic role of government
grew dramatically in the second half of the 20th century,
after the end of colonialism and in pursuit of such development
goals as industrialization
and social equity. In many of these countries the state
was striving to mobilize resources and direct them toward
growth, rather than just to stabilize the
economy, as in most developed countries. Until the 1980s
the pattern of state-dominated development- which included
centralized planning and state control of the economy- was
widely followed. Still, the share of government spending
in the GDP of developing countries is less than half that
in developed countries (see Figure 11.1
and Data Table 3). Does this
mean that a growing share of government spending in GDP
should be seen as a sign of development?
Government budgets in developing countries are not only
proportionately smaller, but they are also structured differently.
In developed countries more than half of government spending
is devoted to social services, including pensions, unemployment
insurance, social security, and other transfer
payments. In developing countries much less
government spending goes for social services and much more
is used to subsidize commercial (that is, selling goods
and services) state-owned enterprises. Unlike other state-owned
enterprises that provide free public services (for example,
schools and health clinics), these state-owned enterprises
could also be run for profit by private firms. Governments,
however, sometimes prefer to keep them under their direct
control. The share of commercial state enterprises in GDP
and in gross
domestic investment tends to be higher in
poorer countries (Figure 11.2).
Is a high share of state enterprises a
problem? Is it good or bad for the economic
growth and development of
developing countries? Those who want
to preserve extensive state enterprises
- Only government is capable of providing
sufficient investment for technical
modernization of major
- Only direct government control over
certain enterprises can prevent
socially unacceptable high prices for
basic goods and services such as
energy, housing, and transportation.
- Only government ownership of the
biggest enterprises can help avoid
On the other hand, experience from many countries shows
that state enterprises are normally less efficient
than private firms. One of the main reasons is that state
enterprise managers have little or no incentive to pursue
profitability for their enterprises. Easy access to government
subsidies and government- guaranteed loans effectively remove
the threat of bankruptcy as a check on inefficiency. Besides,
it is often hard to run state enterprises at a profit because
governments tend to keep state enterprises' selling prices
artificially low, and because rules often do not allow these
enterprises to lay off excess employees.
In countries where the share of state
enterprises is high, their typically low
efficiency can hinder economic growth.
In addition, governments have to cover
the financial losses of these inefficient
enterprises. To meet the resulting budget
deficits, governments often have to
either print more money and thus cause
inflation, or borrow and build up their
domestic or foreign debt. In both cases
national economies are destabilized and
growth opportunities are lost.
Given all that, is it ever preferable to
keep enterprises under government ownership?
What is the ideal size and
composition of a country's public sector?
And can there be any general answers to
these questions independent of ideological
In fact, it is increasingly recognized that
state intervention is justified only where
markets fail. There are five basic situations,
called market failures, where the
private sector tends to underproduce or
overproduce certain goods and services:
- Underproduction of public goods
such as defense, law and order,
roads, and environmental
- Underproduction of goods and services
with positive externalities (for
example, public health and education)
and overproduction of goods
and services with negative externalities
(for example, cigarettes).
- Overpricing and underproduction
by natural monopolies, for example
by electric and water utilities.
- Insufficient supply of social services
such as pensions or medical and
- Insufficient information available to
some parties affected by market
processes (for example, information
about the quality of food products
and medicines available to consumers
whose health is at risk).
These five situations call for some kind of government
intervention. But even where markets clearly fail, government
provision of undersupplied goods and services is not necessarily
the best option. We have already discussed the reasons for
the typically low efficiency of state enterprise management.
Add to that the possibility of corruption among bureaucrats
and you get what came to be called "government failure".
Increased awareness of this problem explains why some governments
of developed countries are searching for alternatives to
state ownership, such as new methods of regulation or government
funding for private provision of public goods. A notable
example of such an alternative solution to both market and
government failures is provided by the new phenomenon of
public funding for private prisons in the United States1.
By privatizing all the enterprises
that can be successfully run by private firms, governments
can often make national economies more efficient, on the
one hand, and free their budgets from the burden of subsidizing
loss-making enterprises, on the other. As a result they
are able to focus on tasks that cannot be handed over to
markets, such as building human
capital and providing for human development
(see chapter 1). For example,
according to some estimates, shifting budget funds from
state enterprise subsidies to public health care would have
allowed central governments to increase their health spending
by about four times in Mexico and five times in India. Alternatively,
Mexico's central government could have increased its education
spending by 50 percent, and India's by 550 percent.
If governments are to shift
away from supplying marketable goods and services, there
must be active private sectors that are ready to take up
these activities. In some cases reducing the economic prominence
of state enterprises is even possible without extensive
privatization, mainly by means of market
liberalization that leads to accelerated
growth of the private sector. That was the case in the Republic
of Korea in the 1970s and 1980s, and in China in the 1980s
and 1990s. But more often, particularly where public sectors
are much larger than private sectors and so absorb a lot
of scarce national resources, special privatization programs
Since the 1980s many developing
and some developed countries have adopted privatization
programs. You can attempt to judge their scale by examining
data on government proceeds from privatization in Data Table
3. Note that these data depend not only on the scale of
privatization but also on its methods. Selling state enterprises
to outside owners normally brings more revenue than selling
them to enterprise managers and employees, while voucher
privatization (such as in Russia in 1991-93) brings no revenue
The most impressive privatization
process is currently under way in former socialist countries.
Their transition to market-oriented economies requires unprecedented
mass privatization of formerly dominant state enterprises.
For the different starting points and speeds of privatization
in this group of countries, see Figure
11.3. Among other regions of the developing world, privatization
programs have accelerated in Latin America and Southeast
Asia, while in Sub-Saharan Africa the process is less pronounced.
Unfortunately, in some transition
countries- particularly those suffering from transitional
economic crises- market reforms have resulted in neglect
of the state's vital functions, such as law and order or
critical social services. Important programs in education
and health, for instance, have been cut along with or even
instead of cutting subsidies to money-losing enterprises.
Such policies not only damage people's welfare, they also
erode the foundations of further national development.
Many experts argue that,
although state-dominated development has failed, so would
"stateless" development. Think about it: why are an effective
state and viable private sector both important for development?
1 Prisons were traditionally state-owned "enterprises"
because they "produce" such public goods as obedience to the
law and public safety.