The role of State-Owned Enterprises (SOEs) is critical in the delivery of essential services to citizens, developing new industries and infrastructure thereby ensuring economic growth. However, many challenges often beset SOEs from delivering upon this key mandate. This policy brief examines the critical role and challenges by SOEs to uplift the lives of citizens and contribute to investment opportunities.
Well-managed, efficient and profitable State-Owned Enterprises (SOEs) that deliver on their developmental mandates are crucial for African countries to achieve inclusive economic development, lift growth levels and expand infrastructure.
In many developing and developed countries SOEs, have in spite of good intentions, generally been less efficient than private firms (Heath and Norman 2004; Feigenbaum 1982; Ferner 1988; Stiglitz 1994). This trend has been bucked in some of the successful East Asian developmental states and Scandinavian democratic welfare states (Wade 1990; World Bank 1993; Chang 1994; Evans 1995; UNCTAD 2007; Gumede 2019). Although forming a significant part of the economies of African countries, with inputs such as electricity, public transport and telecommunications being dominated by SOEs, their performance has generally disappointed.
In post-colonial Africa, many SOEs have struggled to reach many of their key developmental mandates (UNECA 2000; UNCTAD 2007; Gumede 2014; Beegle, Christiaensen, Dabalen and Gaddis 2016). These include poor implementation, lack of skills transfer, inability to generate new technology, and fostering new industries not present before or underdeveloped before. SOEs have often failed to play the catalyst role in broader industrialisation. They have struggled to upscale Africa’s sprawling informal sector, expand SMMEs or beneficiate commodities. This means they have not played their proper role in boosting economic growth, infrastructure development and poverty reduction.
In many countries, the poor performance of SOEs has now become a significant obstacle to economic growth, service delivery and job creation itself – rather than a producer of these (UNECA 2000; UNCTAD 2007; Gumede 2015). Many SOEs continue to depend heavily on state subsidies to operate, which means they are a high fiscal burden. In spite of state subsidies, SOEs are often unproductive, the quality of investments and decisions are poor.
Some are badly managed, loss-making, and regularly incur wasteful expenditures. Many more have not succeeded as viable businesses. Few are financially sustainable. Yet more have become mired in corruption, cronyism and pork-barrelling. Many have failed to deliver effective public services, meeting the transformation needs of society – skills transfer, job creation, and playing the catalyst role in broader industrial development, creating new competitive industries and lifting economic growth (UNECA 2000; UNCTAD 2007; Gumede 2015).
The rationale for SOEs
SOEs play a key role in the post-Second World War industrialisation strategy of many industrial, developing and African countries (Lewin 1982; Stiglitz 1989, 1994; Ramanadham 1991; Heath and Norman 2004). Governments have established SOEs to overcome market failures or to provide essential public goods, such as electricity provisions or telecommunications that are too costly for the private sector to roll out (and too difficult to establish competitive markets).
Many African countries lack significant or well-developed domestic private sectors, foreign investors and markets, and skills, yet have vast infrastructure, technology and public service deficits.
They were used to provide public services in sectors such as education, health and security, which would be too expensive for the private sector to do so. It has been used to create employment, develop technical training for the wider economy and incubate new technology.
Many countries have used SOEs to expand the key infrastructure industries such as rail, air, sea transport, telecommunications, water and nuclear energy. SOEs are also used to achieve redistribution goals – to provide the same services for the same price across the country, by subsidising prices of products in poorer areas.
They were also used to create new industries and supported infant ones, whether through providing subsidised inputs, services and finance, or preferential procurement to local companies. SOEs are used to diversify a country’s industrial output, support the incubation of newly identified manufacturing industries and to beneficiate raw materials.
In some countries, strategic industries were prioritised as in the national interest and security – and therefore put in national hands. But SOEs are also used to boost macro-economic strategies – either used to meet specific fiscal targets or for counter-cyclical spending during downturns to “smooth out the business cycle”.
They could also be used to augment country macro-economic strategies (Stiglitz 1989, 1994) for example: to pursue counter-cyclical spending during economic downturns (Heath and Norman 2004, p.11; Ramanadham 1991, pp. 76-81; Lewin 1982, p.53-58). During recessions, SOEs, for example, could be used to “smooth out the business cycle”, by creating, maintaining or soaking up jobs (Heath and Norman 2004, p.11; Ramanadham 1991, pp. 76-81; Lewin 1982, p.53-58).
SOEs may be used to boost industrialisation by investing in newly identified sectors where there is no current capacity, identified as priorities in a country’s industrial or national development policy, or give preferential procurement opportunities to firms as part of encouraging new domestic companies (Heath and Norman 2004, p.11; Ramanadham 1991, pp. 76-81; Lewin 1982, p.53-58; Stiglitz 1989, 1994).
SOEs can also provide subsidised goods and public services to, and invest in poorer communities and regions, as either part of a redistribution strategy. SOEs are also often established to reduce negative externalities (Heath and Norman 2004, p.11; Ramanadham 1991, pp. 76-81; Lewin 1982, p.53-58; Stiglitz 1989, 1994). The state could with greater certainty pursue risky investments, but could also better lead and coordinate industrial ‘game-changing’ new projects, which may be innovative but are often risky. State ownership has also often been preferred in industries where the risk of catastrophic environmental damage is high, such as nuclear energy.
Since the global and Eurozone financial crises, many developed and developing countries have bailed out private companies and overnight turned them effectively into SOEs. Furthermore, in the post-global and Eurozone financial crises many countries, particularly developing countries have increasingly relied on SOEs to reboot their economies.
Why SOEs struggle to achieve their developmental mandates
The first problem is one of ideological rigidity, in that many African and developing country governments wrongly believe that only the state, either through government departments, agencies and SOEs can deliver on broader development, jobs and public services. Many others in multilateral organisations argue, again wrongly, that only the market or business can deliver development.
Of course, the most pragmatic solution to lift growth, meet transformation and development objectives is for a pragmatic partnership between the private sector and the state, with the state leading, where it is too costly for the private sector, and the private sector taking the lead in effective competitive markets where there are well-established private actors, and where it be a waste of public resources for the state to be a market player.
SOEs are often not run as businesses. African SOEs are in many instances manages as if they are part of the public sector – with all its inefficiencies. The organisational culture of many SOEs mimics that of the wider public sector – which makes it almost impossible to lift the organisational performances of most SOEs. Employment in the public sector is generally protected, and ineffective employees and managers are not often fired.
Alarmingly, many African leaders, governments and civil society organisations believe that somehow SOEs do not need to be as effective as businesses as private companies because they focus on social, development or service delivery goals. Yet, because SOEs use scarce public finance, and often runs a monopoly, the premium on them to be better managed is, in fact, higher than for private companies.
Many African SOEs only focused on social or public service goals, without expecting returns on state capital or economic value add, has in most cases led to poor SOE performance. The best SOEs “maximise returns on state capital”, where return on state capital should be defined along the lines of providing “economic value adds (EVA)”, which should be measured as SOEs earning more than “cost of debt and equity capital” (Stewart III 1991).
But because SOEs often do not have market competitors, or are protected from competition through regulation, allows for what is called the “soft budget constraint” problem, whereby government would bailout out firms in trouble. SOE executives and managers are often not under pressure to run firms financially prudently.
SOE executives and managers have generally little incentives to run the firms under their control efficiently. Since the state is often not concentrating on making a profit, governments would often bail out struggling SOEs, whereas in the private sector, companies face the prospect of takeovers, and executives and managers sacked if companies do not make a profit.
For another, some African governments, leaders and civil society organisations argue that even if SOEs are failing financially because they are creating employment, deliver some level of public services, however erratic, they should be propped up with public funds.
But government ownership of SOEs is often abused by politicians and SOEs executives and managers to use the firms for personal enrichment, rather than development objectives. But the allocation of SOEs resources could also be politically motivated, rather than for business or development reasons. Politicians could encourage SOEs to go for unproductive projects, but which favour their supporters, region or even ethnic group, but which distorts, undermines productivity and efficiencies.
Such negatively politically motivated SOE investing is different from the more positive actions which are in the broader public interest, for example, correcting market failures, investing in neglected regions, increasing employment or to overcome negative externalities, such as projects with possibilities of causing environmental harm.
The developmental mandates of SOEs are often politically defined and are often unclear, multiple and contested (Ferner 1988). The lack of clarity, multiple developmental mandates and contested objectives of an SOE makes it very difficult to evaluate the performance of the company. The “ambiguity of objectives provides the managers (of SOEs) further discretion to pursue their own interests” (Stiglitz et al 1989, p.32).
It is difficult to measure the true effectiveness of SOEs, because of the lack of competition. In the private sector, competition normally not only provides the benchmark for how good companies are doing, but also provides the incentives for managers to perform better. In private firms, the profit objectives offer a central standard for how firms are doing as all managers aim to make their companies profitable in similar economic environments (Heath and Norman 2004).
But SOEs often also have the problem of multiple principals also (Freeman 1984; Stiglitz 1989). In some countries, SOEs are accountable to different ministries. In other countries SOEs are either accountable to a single department, a holding company or a number of different departments. While the SOE may be accountable to the single department or holding company, they may also be accountable to a board. The multiple reporting structures for SOEs are often confusing and make it difficult to hold them accountable.
For another, units within government departments to which SOEs report to are often understaffed, lack skills and resources. They, therefore, cannot effectively hold SOEs accountable. African regulatory auditing agencies can often only report irregularities in SOEs audits to parliaments, but lack the enforcement power to hold entities accountable. But African parliaments often also do not hold SOEs accountable for poor performance. Some governments – to curtail corruption do annual internal lifestyle and ethics audits of SOE boards, executives and staff (Kaganova 2011).
Recommendations for Positioning SOEs to Deliver on their Developmental Mandates
In order to deal with the issue of multiple social objectives, African governments should clearly determine or provide a scorecard for SOEs showing how various developmental objectives should be balanced, evaluated, and how they should be prioritised.
African SOEs must be compelled to provide a ‘reasonable return’ (Heath and Norman 2004, p.11) on investment, which include financial and social objects, deliver the public goods efficiently and manage such organisations’ accountably (Ramanadham 1991, pp. 76-81; Lewin 1982, p.53-58).
African SOEs should move to a system of using economic value add as the key performance indicator for their SOEs. SOEs should be expected to be as efficient as comparable business in the private sector, be a good employer, a democratic corporate citizen showing social corporate responsibility (Mako, and Zhang 2004).
African governments must bring more transparency into the operations of SOEs – to make it as transparent as listed companies. The media, civil society and communities must monitor the performance of SOEs – and protest strongly if they do not deliver on financial, developmental and corporate citizen objectives.
Awards of tenders, sales and transactions must be publicly released. SOEs must conduct regular public surveys of consumers, stakeholders and communities who rate their services. They should release the results publicly. The public ratings should form part of the performance management of SOEs.
Parliaments must get better in holding SOEs accountable. In South Africa amendments to the Public Audit Act gave the Auditor General more power to ensure accountability in the public sector, including SOEs. The amendments provide the Auditor-General with the power to refer material irregularities to appropriate authorities to investigate as well as the power to recover money lost as a result of such irregularities. This mechanism could be something other African governments should consider.
It is difficult to measure the true effectiveness of SOEs, because of the lack of competition. In the private sector competition normally not only provides the benchmark for how good companies are doing, but also provides the incentives for managers to perform better. In private firms, the profit objectives offer a central standard for how firms are doing as all managers aim to make their companies profitable in similar economic environments (Heath and Norman 2004).
To improve the effectiveness of SOEs, many governments have moved to beef up corporate governance, construct specific laws, regulations and oversight institutions to govern SOE behaviour, and hold them accountable. Furthermore, there has been an emphasis on strengthening the power of SOE boards, appointing board members and executives on merit, rather than based on politics or patronage, and hold them strictly accountable for performance on clear developmental, financial and operational efficiency mandates.
Successful SOEs are transparent in their operations, reasonably less corrupt and accountable to the shareholder, the public and stakeholders. They have professional boards and management consisting of experts. The boards of directors include both public and private sector individuals. They are transparently appointed. They are appointed on merit. African governments must have a professional board, executive and staff appointments to SOEs. They should make appointments on merit, balancing merit with redistribution, affirmative action and equity considerations.
African governments must consider performing annual internal lifestyle and ethics audits of SOE boards, executives and staff – to tackle corruption, which undermines the ability of SOEs to achieve their developmental mandates.
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*This policy brief was presented at the African Network on Corporate Governance of State-Owned Enterprises In Le Meridien, Mauritius on 08 – 09 November 2018.