Is a growing share

of government

spending a reliable

indicator of

development?

61

11

During the 20th century the economicimportance of the state grew all over theworld. In developed countries centralgovernment spending accounted for lessthan 10 percent of gross domesticproduct (GDP) in the early 1900s, butby the 1990s that share had grown tonearly 50 percent in many of thosecountries (Figure 11.1; Data Table 3 ).Among the major historical factors con-tributing to this government expansionwere the Russian Revolution of 1917and the Great Depression of the 1930s.But the data suggest that this expansioncontinues even today: over the past 35years the share of government spendingin the GDP of developed countriesroughly doubled.

In developing countries the economicrole of government grew dramatically inthe second half of the 20th century, afterthe end of colonialism and in pursuit ofsuch development goals as industrial-ization and social equity. In many ofthese countries the state was striving tomobilize resources and direct themtoward rapid economic growth, ratherthan just to stabilize the economy, as inmost developed countries. Until the1980s the pattern of state-dominateddevelopmentwhich included central-ized planning and state control of the

economywas widely followed. Still,the share of government spending in theGDP of developing countries is less thanhalf that in developed countries (seeFigure 11.1 and Data Table 3). Does thismean that a growing share of govern-ment spending in GDP should be seenas a sign of development?

The Dilemma of Public-PrivateOwnership

Government budgets in developing coun-tries are not only proportionately smaller,but they are also structured differently. Indeveloped countries more than half ofgovernment spending is devoted to socialservices, including pensions, unemploy-ment insurance, social security, and othertransfer payments. In developing coun-tries much less government spending goesfor social services and much more is usedto subsidize commercial (that is, sellinggoods and services) state-owned enter-prises. Unlike other state-owned enter-prises that provide free public services (forexample, schools and health clinics), thesestate-owned enterprises could also be runfor profit by private firms. Governments,however, sometimes prefer to keep themunder their direct control. The share ofcommercial state enterprises in GDP and

Public and Private Enterprises:Finding the Right Mix

BEYOND ECONOMIC GROWTH

62

in gross domestic investment tends tobe higher in poorer countries (Figure11.2).

Is a high share of state enterprises aproblem? Is it good or bad for the eco-nomic growth and development ofdeveloping countries? Those who wantto preserve extensive state enterprisesargue that:

Only government is capable of pro-viding sufficient investment for tech-nical modernization of majornational industries.

Only direct government control overcertain enterprises can preventsocially unacceptable high prices forbasic goods and services such asenergy, housing, and transportation.

Only government ownership of thebiggest enterprises can help avoidmass unemployment.

On the other hand, experience frommany countries shows that state enter-prises are normally less efficient thanprivate firms. One of the main reasons isthat state enterprise managers have littleor no incentive to pursue profitabilityfor their enterprises. Easy access to gov-ernment subsidies and government-guar-anteed loans effectively remove thethreat of bankruptcy as a check on inef-ficiency. Besides, it is often hard to runstate enterprises at a profit because gov-ernments tend to keep state enterprisesselling prices artificially low, and becauserules often do not allow these enterprisesto lay off excess employees.

Figure 11.1 Central government expenditure as a percentage of GDP, 1995

China

India

Mexico

Chile

Russia

Turkey

United States

Japan

Germany

United Kingdom

Sweden

France

Netherlands

0 10 20 30 40 50 60

Developing countries Transition economies Developed countries

9.4%

16.1%

16.8%

19.2%

22.2%

22.8%

22.9%

23.8%

33.8%

41.8%

45.0%

46.4%

50.8%

UnitedKingdom

$$ $

11 PUBLIC AND PRIVATE ENTERPRISE: FINDING THE RIGHT MIX

When should

governments

intervene in

economic

activities?

63

In countries where the share of stateenterprises is high, their typically lowefficiency can hinder economic growth.In addition, governments have to coverthe financial losses of these inefficiententerprises. To meet the resulting budgetdeficits, governments often have toeither print more money and thus causeinflation, or borrow and build up theirdomestic or foreign debt. In both casesnational economies are destabilized andgrowth opportunities are lost.

Given all that, is it ever preferable tokeep enterprises under government own-ership? What is the ideal size and com-

position of a countrys public sector?And can there be any general answers tothese questions independent of ideologi-cal beliefs?

In fact, it is increasingly recognized thatstate intervention is justified only wheremarkets fail. There are five basic situa-tions, called market failures, where theprivate sector tends to underproduce oroverproduce certain goods and services:

Underproduction of public goodssuch as defense, law and order,roads, and environmentalprotection.

Underproduction of goods and ser-vices with positive externalities (forexample, public health and educa-tion) and overproduction of goodsand services with negative externali-ties (for example, cigarettes).

Overpricing and underproductionby natural monopolies, for exampleby electric and water utilities.

Insufficient supply of social servicessuch as pensions or medical andunemployment insurance.

Insufficient information available tosome parties affected by marketprocesses (for example, informationabout the quality of food productsand medicines available to con-sumers whose health is at risk).

These five situations call for some kind ofgovernment intervention. But even wheremarkets clearly fail, government provision

0

5

10

15

20

25

30

Low-income

countries

GDP GDI

14%

28%

9%

17%

8%

13%

Middle-income

countries

High-income

countries

$ $

Figure 11.2 State-owned enterprises share of GDP and gross domestic investment (GDI), 198691

BEYOND ECONOMIC GROWTH

64

of undersupplied goods and services is notnecessarily the best option. We havealready discussed the reasons for the typi-cally low efficiency of state enterprisemanagement. Add to that the possibilityof corruption among bureaucrats and youget what came to be called governmentfailure. Increased awareness of this prob-lem explains why some governments ofdeveloped countries are searching foralternatives to state ownership, such asnew methods of regulation or governmentfunding for private provision of publicgoods. A notable example of such an alter-native solution to both market and gov-ernment failures is provided by the newphenomenon of public funding for pri-vate prisons in the United States.1

Is There a Trend towardPrivatization?

By privatizing all the enterprises that canbe successfully run by private firms, gov-ernments can often make nationaleconomies more efficient, on the onehand, and free their budgets from theburden of subsidizing loss-making enter-prises, on the other. As a result they areable to focus on tasks that cannot behanded over to markets, such as buildinghuman capital and providing forhuman development (see chapter 1). Forexample, according to some estimates,shifting budget funds from state enter-prise subsidies to public health carewould have allowed central governments

to increase their health spending byabout four times in Mexico and fivetimes in India. Alternatively, Mexicoscentral government could have increasedits education spending by 50 percent,and Indias by 550 percent.

If governments are to shift away fromsupplying marketable goods and ser-vices, there must be active private sectorsthat are ready to take up these activities.In some cases reducing the economicprominence of state enterprises is evenpossible without extensive privatization,mainly by means of market liberaliza-tion that leads to accelerated growth ofthe private sector. That was the case inthe Republic of Korea in the 1970s and1980s, and in China in the 1980s and1990s. But more often, particularlywhere public sectors are much largerthan private sectors and so absorb a lotof scarce national resources, special pri-vatization programs are needed.

Since the 1980s many developing andsome developed countries have adoptedprivatization programs. You can attemptto judge their scale by examining data ongovernment proceeds from privatizationin Data Table 3. Note that these datadepend not only on the scale of privatiza-tion but also on its methods. Selling stateenterprises to outside owners normallybrings more revenue than selling them toenterprise managers and employees, whilevoucher privatization (such as in Russia in199193) brings no revenue at all.

11 PUBLIC AND PRIVATE ENTERPRISE: FINDING THE RIGHT MIX

65

The most impressive privatizationprocess is currently under way in formersocialist countries. Their transition tomarket-oriented economies requiresunprecedented mass privatization of for-merly dominant state enterprises. For

the different starting points and speedsof privatization in this group of coun-tries, see Figure 11.3. Among otherregions of the developing world, privati-zation programs have accelerated inLatin America and Southeast Asia, whilein Sub-Saharan Africa the process is lesspronounced.

Unfortunately, in some transitioncountriesparticularly those sufferingfrom transitional economic crisesmarket reforms have resulted in neglectof the states vital functions, such as lawand order or critical social services.Important programs in education andhealth, for instance, have been cut alongwith or even instead of cutting subsidiesto money-losing enterprises. Such poli-cies not only damage peoples welfare,they also erode the foundations of fur-ther national development.

Many experts argue that, although state-dominated development has failed, sowould stateless development. Thinkabout it: why are an effective state andviable private sector both important fordevelopment?

Note

1. Prisons were traditionally state-owned enter-

prises because they produce such public goods

as obedience to the law and public safety.

Figure 11.3 Private sector outputas a share of GDP,1990 and 1995

Belarus

Turkmanistan

Tajikistan

Kazakhstan

Azerbajan

Uzbekistan

Georgia

Moldova

Bulgaria

Ukraine

Romania

Slovenia

Kyrgyz Republic

Macedonia, FYR

Armenia

Croatia

Mongolia

Lithuania

Latvia

Poland

Russia

Slovak Republic

Albania

Hungary

Estonia

Czech Republic

0

Percent

10 20 30 40 50 60 70 80

1990 1995

$ $