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Should Bureaucrats Be Businessmen?

June 23, 2011

Loup Brefort

This article was published in NIN weekly magazine on Jun 23, 2011

Governments' view of the economy can often be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. This quote – attributed to Ronald Reagan – came to mind when I started thinking about what makes an economy fly or stagnate and, in particular, about the role of the state in running commercially-oriented companies.

Governments are most of the time lousy entrepreneurs. History has shown that private ownership is a crucial source of efficiency and incentives to innovate, and that state-owned enterprises are rarely, if ever, leaders in their field. In addition, companies owned by the state often capture disproportionate share of credit, squeezing out private sector borrowing. Many survive by charging rent-seeking tariffs when they hold a monopoly power; or by letting the assets they operate run down when their lack of productivity and controlled tariffs does not allow them to invest, thus ultimately offering poor service to their captive consumers for years until they have to go back to the state to beg for resources for capital investment; or by absorbing large amounts of public funds that could be better spent on the type of infrastructure that, for the time being, does not attract private capital or on basic social services, such as education or health.  Still, it is often proving very hard to “let go”, for instance through privatization of the state enterprise itself, or by forcing it to compete on a level playing field with private firms. This requires the elimination of barriers to entry and often of the multiple bureaucratic regulatory impediments that offer protection to the state firm against private competitors, although they are often cloaked in the argument of consumer protection, or that of the interest of society at large.

Bureaucrats perform poorly in business not because they are incompetent (many, indeed, are not) but because they face contradictory goals and perverse incentives that can distract and discourage even very able and dedicated public servants. The problem is not the people but the system. When assets are publicly owned, the public manager has relatively weak incentives to make investments that reduce costs or innovate, and the state has many incentives to use the firm as an instrument to pursue objectives that often have nothing to do with sound economics. For example, the revolution in telecommunications brought to light huge benefits of private ownership of phone companies from the perspective of creation and adoption of new technologies. In industries where innovation is crucial, the case for government provision is extremely far-fetched.

And yet, despite universal consensus that governments perform less well than the private sector, state-owned companies still account for a significant share of economies. Serbia is no exception.

There may be several reasons why it often proves so hard to “let go” of public enterprises. One may be economic “jingoism” that, in some societies, is still very much ingrained in the psyche of many that look to state enterprises to proudly “carry the flag”, whatever the real cost to the consumers or to the economy. A good example was, for decades, the support and emotional attachment of many to national airline companies, in spite of the fact that they absorbed very significant subsidies ultimately paid for by many taxpayers that would never fly in them. It is questionable whether the consumers of air travel are less well served by private companies offering convenient services at much reduced prices, although indeed they do not advertize the national flag on the fuselage of their planes. And I bet society can derive as much national pride in a successful private enterprise. Ask the Finns about Nokia, for instance?

A second reason may lie in the resistance of powerful interest groups, particularly when – often contrary to objective evidence – they seem able to convince society that they fight their corporatist battles for the benefit of all. The first such constituency is often that of the employees of the state enterprise and their unions. Indeed, privatization usually reduces labor benefits and increases anxiety about possible lay-offs since state enterprises are very often grossly overstaffed. Strangely enough, while in many countries the workers of public companies are among the most shielded ones, they often manage to elicit sympathy for the maintenance of their privileged status from far more disenfranchised groups in society. Another group which often has vested interests in the status quo is the network of suppliers of goods and services to public companies. Because productivity and profitability may not be the primary drivers of state owned firms, a number may have developed over the years cozy commercial relationships that are not always based on excellence - providing the best product for the lowest price, that they do not want to see disrupted or jeopardized if they had to face the kind of competitive pressure they would have to face if they had to deal with a private firm.

Finally, worldwide research has found that many bureaucrats and sometimes political parties also use public companies to pursue their own agenda: be it as a source of patronage, influence or funding.

However, the crucial point here is not to protect the interest of a few tens of thousands, but that of millions. Better and cheaper service is in the interest of the whole society. It leads to the creation of greater wealth and saves scarce resources that can be invested – by individuals and the state – in other priorities. Acting in the name of the public interest, it is the responsibility of government to change the political economy, so as to secure a broad enough constituency for reform. This is an effort well worth rallying the support of all those that wish the citizens of Serbia the future they aspire to.  Fly, double-headed eagle, fly!!