How not to run a business: examples of poor SOE performance

By Paul Walker 28/05/2013

In a previous posting I noted that

By the late 1970s-early 1980s the sceptical minority was becoming larger, the mood was turning against government ownership [of firms] among both politicians and economists.

One of the motivating forces for politicians and economists rethinking their position on state-owned enterprises was a history of under performance by these firms worldwide. Some of the more extreme cases of poor SOE performance that have been publicised include:

McDonald (1991) outlines the case of the Hindustan Fertiliser Corporation in Haldia, West Bengal, India. By 1991 the firm had been operating for twelve years and employed twelve hundred workers. Yet up to that time the enterprise had not produced a single kilogram of fertiliser for sale!

The Economist (Economist 1994) details similar experiences in Italy: “[o]ne example was a rolling mill at Bagnoli near Naples built by Italy’s state-owned steel company ILVA. Designed to create jobs in a depressed area where the Christian Democrats were strong, the plant, which took nearly a decade to complete, was never used. In Sardinia, another area of high unemployment, politicians made ENI, a state chemicals and energy conglomerate, refit a coal mine, only to leave the miners idle but on the payroll”.

In France, the near-bankruptcy of then state-owned bank Credit Lyonnais is another example. In 1997 the French finance minister Dominique Strauss-Kahn admitted that the bank had probably lost around Ffr100 billion (around US$17 billion). The bank had to be bailed out three times in the 1990s. The total cost to the French taxpayer of the whole debacle has been estimated at between US$20 and US$30 billion. See the Economist (1997) for more on the affair.

With regard to the experience of the steel industry in the United Kingdom, Aylen (1988: 2) writes that in “1980/1 the [British Steel] Corporation made a total loss of pounds 1 billion on a turnover of just under pounds 3 billion, earning a place for a while in the Guinness Book of Records. [ … ] By 1980 British Steel was fundamentally uncompetitive, with cost per tonne almost a third above those of West German producers, and by rights should not have survived”. About coal, Vickers and Yarrow (1988: 331) could write, “[i]n recent years, mostly as a consequence of the combination of overinvestment in new capacity and the relatively slow rate of closure of inefficient collieries, the NCB [National Coal Board]’s continued viability has depended upon large injections of Government finance. In 1983-1984, for example, operating losses were covered by subsidies, known as deficit grants, amounting to pounds 875 million.”. During a House of Commons debate on nationalisation, denationalisation and renationalisation in 1991 the then Financial Secretary to the Treasury, Francis Maude, said of the British experience with nationalised industries: “I do not wish to dwell on the record of nationalised industries in Britain. It is a sad and depressing saga in our nation’s life. We all remember the British Steel Corporation, with its losses of £1 million every day of the year. We all remember British Telecom being in the Guinness Book of Records for the largest loss ever. We all remember the sloppy standards, the waiting lists for telephones, the ever-rising prices, the dingy tale of failure, the contempt for the customer, the craven management and the political interference”. (Maude 1991).

The World Bank (World Bank 1995: 33-35) notes that in “Turkey, Turkiye Taskorumu Kurmu, a state-owned coal mining company, lost the equivalent of about $6.4 billion between 1986 and 1990. Losses in 1992 worked out to about $12,000 per worker, six times the average national income. Yet health and safety condition in the mine were so poor that a miners’ life expectancy was forty-six years, eleven years below the national average. [ … ] In the Philippines, the performance of the National Power Corporation steadily deteriorated from 1985 until the early 1990s. In 1990 the capital region alone lost an estimated $2.4 billion in economic output due to power outages. By 1992-93, electricity was shut off about seven hours a day in many parts of the country. In Bangladesh, in 1992 the state sugar milling monopoly had twice as many office workers as it needed, or about 8,000 extra employees. [ … ] Meanwhile, sugar cost twice as much on the open market in Bangladesh as it did internationally. In Tanzania, the state-owned Morogoro shoe factory, built in the 1970s with a World Bank loan, never manufactured more than about 4 percent of its supposed annual capacity”.

Kikeri, Nellis and Shirley (1992: 2) state that “[o]f particular concern to governments is the burden that loss-making SOEs place on hard-pressed public budgets. SOE losses as a percentage of gross domestic product (GDP) reached 9 percent in Argentina and Poland in 1989; through the 1980s about half of Tanzania’s 350 SOEs persistently ran losses that has to be covered from public funds; in Ghana from 1985 to 1989 the annual outflow from government to fourteen core SOEs averaged 2 percent of GDP; and in China about 30 percent of SOEs were loss-making in 1991. The losses have important consequences: Mexico’s minister of finance has noted that a fraction of the $10 billion in losses incurred by the state-owned steel complex would have been enough to bring potable water, sewerage, hospitals, and educational facilities to an entire region of the country (Aspe 1991)”.

0 Responses to “How not to run a business: examples of poor SOE performance”

  • Pigs, India and Mexicans with cellphones.

    Hmm…why are you mentioning this at this time?

  • Bad companies are run badly, politicians sometimes make bad decisions and/or waste money to claim that they’re doing something.

    And the data that allows you to claim this as a representative sample of all SOEs ever is where? Or the evidence that no private business has ever been run badly?

    Ross is right to ask – who or what purpose does this post serve?

  • Try reading what I actually wrote. First, as to a purpose: “One of the motivating forces for politicians and economists rethinking their position on state-owned enterprises was a history of under performance by these firms worldwide.” In other words, examples like these forced even politicians to rethink their position on SOEs. This relates to what I wrote in a previous posting as why there was a change in attitude towards SOEs around 1980, as I note above. Second, at no point did I say this was a “representative sample”, if fact what I actually wrote was “Some of the more extreme cases”. These examples are extreme, but that is the point. They are so extreme that even badly run private companies would fail long before they got to the point that these SOEs got to. Things only got this bad because these firms were SOEs. I mean, just how how many private companies could stay in business for 12 years, with 1200 workers and not produce anything!!! The McDonald article goes on to say “Two consultants, Uhde from Germany and Toyo Engineering from Japan, recommended that the plant be scrapped and a new factory built on the site. New Delhi has preferred to keep it “running” instead of admitting that it was a huge mistake and facing the wrath of public-sector unions.” Private companies are just in a position to keep such factories “running”.

  • I assume there’s supposed to be a “not” in that last sentence.

    Private companies are free to ignore the social cost that their creative destruction imposes on the people they employ and sell products to. Companies aren’t democracies. Whereas an elected government is supposed to keep a lid on starvation etc. Lots of people have compared govt-run businesses’ financial balance sheets to private businesses – what I’d find interesting is a comparison between running makework businesses to maintain fullish employment vs laying people off and letting social welfare mop up. There are measures you could use to track the loss of social capital that high long term unemployment causes.

  • You are right about the missing “not” in the last sentence. There was one in my head if not my fingers! The long term comparison is easy, without “creative destruction” economies die and the outcome for everybody is worse. Economies that growth and thus improve the lot of their members are those that change and innovate. They are economies where entrepreneurs are looking for new products and new ways of making and using old products. Without this dynamic process productivity declines, innovation declines and ultimately so does the society.

  • Now let me think…

    What fraction of NZs (private sector) finance companies dipped into their shareholder funds recently ? Further, we don’t have to look at obscure offshore nations rife with corruption to find a few examples.

    Oh I see! Its economically efficient. You’re right, the mafia have run economically efficient businesses for centuries.

  • Paul, I know the hypothesis about creative destruction, but this is a science blog. I’d be really interested in posts that discussed the evidence for the claims rather than rolled out anecdotes. Like any field in which people have strong vested interests, economics is vulnerable to capture by ideology. I think anyone writing on this subject needs to work harder than, say, the vaccination articles on this site to demonstrate that what they say is backed by good data rather than political assumptions.

  • The point of the posting, as I said in the posting and already in the comments was “One of the motivating forces for politicians and economists rethinking their position on state-owned enterprises was a history of under performance by these firms worldwide.” In other words, examples like these forced even politicians to rethink their position on SOEs. This relates to what I wrote in a previous posting as why there was a change in attitude towards SOEs around 1980, as I note above.” The kinds of examples in the posting were the sort of examples that were being discussed at the time and thus that were influencing policy at the time. As I note in a previous posting “A number of commentators have argued that the early privatisation programmes weren’t so much the result of the deliberate implementation of a preplanned strategy founded on a well developed theoretical base, but rather were ad hoc policies developed in practice, evolving over time, with the theory catching up later.” So there was not theory at the time to consider. The theory really didn’t turn up till around 1990. As to empirical work that started in a serious way in the 1980s. An early survey of this work is George Yarrow (1986). ‘Privatization in Theory and Practice’, Economic Policy, 2 April: 324-77. Of the empirical studies (many of which were based on US data) Yarrow ranks them in terms of being pro/neutral/anti public ownership. On this ranking 15 anti, 6 pro, 4 neutral and 1 pro/neutral. Of those only 18 where published pre 1980. So the empirical evidence available pre 1980 when the privatisation programmes started wasn’t great. And that evidence wasn’t exactly public knowledge, it was known only to those economists working in the area. And there were few of them. Thus politicians were influenced by casual empiricism. The British experience noted in the post was of course important for the Thatcher government.

  • Are you arguing that the whole Friedman/Hayek/Chicago School of Economics thing wasn’t a factor in the SOE privatisations of the 80s around the world? That it was anecdotes (Prebble used to tell a story about a train falling off the dock, and divers asking the railways guys which one they want salvaged) rather than a worldwide political shift in favour of small government? That seems bold.

  • Yes and no. My feeling is that you are right there was a shift towards small government at that time. The question is just how influential the “Friedman/Hayek/Chicago School of Economics” (BTW Hayek disagreed with the Chicago school on may issues, so they aren’t really a single block. You still see this today in the different positions the Austrians and the Chicago school take on many issues. See “Vienna & Chicago, Friends or Foes?: A Tale of Two Schools of Free-Market Economics” by Mark Skousen for general discussion.) really were. As I have noted before,

    “A number of commentators have argued that the early privatisation programmes weren’t so much the result of the deliberate implementation of a preplanned strategy founded on a well developed theoretical base, but rather were ad hoc policies developed in practice, evolving over time, with the theory catching up later. This argument is commonly made with respect to the Thatcher governments privatisation programme in the United Kingdom. Bortolotti and Siniscalco (2004: 5) state that, “[c]uriously, the United Kingdom embarked on the first large-scale privatization programme in the late 1970s largely on faith, as the main privatization theories were not yet developed”. Pirie (1988: 9-10) notes, “[i]t is highly significant that the election manifesto which the Conservatives put forward under Mrs Thatcher in 1979 referred to the sale of only the shipbuilding and aerospace industries and the National Freight Corporation. The fact that dozens of pieces of privatization have been successfully implemented indicates that the British government developed the techniques in practice. Privatization in Britain was not the end-result of an ideological victory in the world of ideas; it was something which was so successful in practice that the government did more of it.” Arguing in a similar vein Veljanovski (1989: vii) writes, “[t]he remarkable thing about the whole [privatisation] process is that it was unpredictable, and it followed no coherent over-arching strategy. Privatisation evolved, each sale was self-contained and each pattern of disposing of assets, from the legal requirements to the terms of sale, was ad hoc.” In a review of the Thatcher government’s economic policies Samuel Brittan (Brittan 1989: 6) goes so far as to argue that privatisation became an important policy plank for the Conservative government simply because it was easier to carry out than other policies: “[ … ] privatization was hardly mentioned in the 1979 Conservative manifesto, except for shipbuilding, aerospace and National Freight. But it became a major thread when it was found easier to carry out than many other Conservative aspirations.”

    In addition, Kay and Thompson (1986) lay the charge that privatisation in the United Kingdom lacked any clear rationale. They summed up their view in the title of their paper “Privatisation: A Policy in Search of a Rationale”. They argue that “[ … ] the reality behind the apparent multiplicity of objectives [of privatisation in the United Kingdom] is not that the policy has a rather sophisticated rationale, but rather that it is lacking any clear analysis of purpose or effects; and hence any objective which seems achievable is seized as justification.” (Kay and Thompson 1986: 19).

    So I’m not sure there was a well thought out privatisation plan, based on any economic theory – Austrian or Chicago – pre the 1979 UK election. That’s not to say both groups would not have supported privatisation, they did but I’m not sure they had that much influence at the beginning. Over time they had more influence via think tanks like the IEA in London.

  • Just to add my two cents – I read this post as an economic history post, indicating many of the specific events that occurred that saw a growing acceptance of public choice literature as we came into the 1970s.

    I find this sort of stuff useful – it isn’t really supposed to be the “entire argument” but rather a snapshot of events that were important at a point in time. No matter how much we like to pretend, hypotheses and the decision to invest in investigating them will be based on events that capture the imagination of the time – rather than a direct recognition of what exists as “objective truth”.

    Looking at it this way makes everyone commenting right in a sense, and it appeals to my own wish that I’d actually finished my history degree instead of just skipping the last few papers to do more economics more quickly 😉

  • Yeah Matt. Part economic history, part political history, part, “Just what the hell were they doing?”! history. These kinds of examples I would argue were more significant at the time as far as policy thinking was concerned than the academic literature.