The global financial crisis of 2008-2009 has prompted many industrialized states worldwide to increase their stakes in private corporations. This wave of partial nationalizations has come amidst full scale expropriations in developing countries such as Venezuela, Bolivia, and Ecuador. Does this signal a return of “state capitalism”? If so, what should we expect of the state-owned enterprises (SOEs) that spring back into economic life? Should we be afraid that this return to state capitalism will bring back the practices of the large, inefficient SOEs that countries privatized during the 1980s and 1990s?

From a look at the popular press one certainly gets the impression that there is a return of “state capitalism,” as if state intervention in industrial activity actually went away for a significant period of time. Moreover, many observers of the recent wave of nationalizations and government-backed bank capitalizations are afraid that a return to the wasteful state-owned enterprises of the past is imminent. In this essay we propose two alternative views. First, we stress the resilience of state-owned enterprises, which have been around for more than one hundred years in the world’s capitalist economies. In fact, state interventions similar to those of today were seen in the pre-World War I period, an era known by some economic historians as “the first big wave of globalization.” Second, we argue that there is no reason to believe that the SOEs of the twenty-first century will be as inefficient as those of the 1970s and 1980s. The world has changed much since former British Prime Minister Margaret Thatcher first began implementing large scale privatizations. In fact, we document some cases of present-day competitive SOEs and explain some of the conditions that made them efficient, even in comparison to their private counterparts. We do not argue that all SOEs are efficient or that it is optimal to have government ownership of banks and other companies. What we aim to show is that the return of state capitalism is likely to be different this time since, we believe, the environment is different and many SOEs have learned the lessons of the past.

State Intervention and Ownership before the Great Depression

One big myth about state ownership of large corporations is that state intervention in the corporate world was a by-product of the Great Depression. This myth assumes that before 1929, and especially before 1914, the world of corporate finance was relatively free of any state intervention. But how do those claims fare with regard to the historical evidence? What did state intervention look like before World War I?

First, state intervention in economic activity was ubiquitous prior to World War I in places as varied as Victorian Britain, republican Brazil, and Bismarckian Germany. Across countries and industries, governments sought to provide incentives for wary investors to purchase securities in everything from banks to railways and other infrastructure endeavors. While in 1840 around 80 percent of railway tracks worldwide were in private hands, by 1910 states owned nearly 60 percent of a much larger network of total operating railway tracks. Obviously, this does not imply that state-owned railways were better run than their private counterparts (often they were not), but it does remind us that state-owned enterprises and capitalism co-existed long before the Great Depression.

Perhaps the most important fact that we should highlight here is that governments all around the world had a very active role in promoting private companies that provided public goods (e.g., docks, canals, utilities, etc.) through state guarantees. How did these guarantees work? The story is rather simple. Often, governments subsidized interest payments on bond issues. If you were a bondholder in one of these guaranteed companies, you would get your interest payments of, say, 6 percent per year, no matter what happened to the company. In a way, the government was providing an insurance policy for the creditors of the company. If the enterprises had windfall profits, then the government had the right to take most of the excess profit or at least split it with the company. Additionally, the companies receiving subsidies all around the world were subject to closer monitoring and to more stringent financial reporting requirements. These contracts were not only common in continental Europe, but also in England, Australia, Canada, South Africa, India, and all across Latin America.

Government ownership of utilities increased rapidly in continental Europe in the first few decades of the twentieth century. Robert Millward, a professor of economic history at the University of Manchester, has demonstrated in his research that, in the nineteenth century, western European municipal and state governments were owners of utilities companies before socialist parties even existed. In fact, before the Great Depression, most governments in continental Europe owned large utilities and had equity in large commercial banks.



Today, many observers are afraid that bank nationalizations and the subsidies that auto industries are receiving (e.g., General Motors) may bring down globalization. But before World War I government subsidies in the form of state guarantees for investors were not incompatible with globalization. Government guarantees or financial support for companies in trouble before 1930 was not what brought down globalization at the beginning of the twentieth century. What brought down globalization in the 1920s and 1930s was, first, the disruption in international capital flows caused by World War I and, subsequently, the wave of retaliatory increases in trade barriers after the United States passed the Smoot-Hawley Tariff Act in 1930.

The Rise of State Capitalism

Even if different forms of state ownership and subsidies arose before the Great Depression, most observers would say that the actual rise of state capitalism took place after World War II. A wave of nationalizations took place in continental Europe in the 1940s, in the United Kingdom in 1946, in India after independence in 1947, and in Latin America in the 1940s. Yet what is truly different about the post-World War II period is that state-owned enterprises operated in domestic markets that were largely closed to the outside world.

In Europe and Japan, governments took a more interventionist (dirigiste) approach during and after the post-World War II reconstruction period. In this context, governments relied on SOEs as a way to better achieve the targets set out in the Marshall Plan—a program with American foreign aid designed to reconstruct Europe after the war—and in the targets that governments themselves set out later on in five- or six-year economic plans. Instead of promoting competition, many governments allowed SOEs to act as monopolies or be part of oligopolies that minimized competition to access scarce resources such as imported coal, iron, and steel during a time when countries did not have enough foreign exchange to finance all of these imports. For example, in France, in the 1950s and 1960s, oil markets were controlled by the French Company of Petroleum (CFP) and Elf-Erap (a 70 percent state-owned company). In England, after WWII, the National Coal Board and British Gas were in charge of controlling the market for energy until the British National Oil Corporation was created in 1975.

In developing countries, the leading doctrine for economic development at the time, known as import-substitution industrialization, called for the establishment of trade barriers that would allow for the protection of “infant” industrial enterprises. These countries believed that the domestic production of industrial goods was the path to prosperity, and in those sectors considered strategic for development or for national security or lacking local private interest to invest, public companies were the preferred policy instrument. Companies engaged in the production of steel, chemicals, and electricity, among other sectors, were created or appropriated by the state. The time was ripe for states to delve into entrepreneurial activities, and countries in Europe, Latin America, Africa, and India most willingly did so.

The economic regime of state ownership of industry and trade protectionism soon degenerated. This is the period when SOEs in many countries became large, inefficient monsters with complacent managers. Governments expanded their domain into light industrial sectors without economies of scale that could justify crowding out private investors. State-owned enterprises were used as de facto unemployment insurance entities, hiring workers way in excess of their productive needs. Labor unions became entrenched, powerful political interest groups. Subsidies were granted without much regard for the net present value of the government outlays, and corruption became widespread. As documented by John Waterbury, formerly a professor of politics and international affairs at Princeton University, countries as culturally diverse as Egypt, India, Mexico, and Turkey all fell into the same pit.

Not facing market competition, state-owned enterprises sunk deeper and deeper in mediocrity and waste. Since most countries around the world engaged in some form of economic planning, they set production targets for SOEs that managers usually had little incentive to exceed. As a result, entrepreneurial spirit dried out. With outside scrutiny of these companies from shareholders or angry creditors absent, corruption broke loose. The calls for reform eventually arose, first most strongly manifested in the conservative government of Margaret Thatcher in the United Kingdom and then throughout the industrialized and the developing worlds.

Under Thatcherism (and the general drive for skinnier governments in the 1980s and early 1990s), the world turned against state-owned enterprises. The wave of privatizations of these two decades were many times motivated by a real desire to reduce inefficiencies, improve public services, and reduce government subsidies to inefficient companies. After privatization, governments were in a better position to show fiscal surpluses and to maintain macroeconomic stability.



Yet not all governments privatized all companies, either because of nationalistic reasons or because privatization of some strategic sectors did not go well with their development strategies in the 1990s. For example, petroleum, the strategic commodity par excellence, remained in state hands in most countries. Governments all around the world kept control of companies in other sectors. For instance, in Italy and Mexico, government-owned companies Enel and CFE still control power generation. In the United States and India, respectively, Amtrak and Indian Railways operate passenger and freight railways.

Lessons from SOEs in the 1990s and Early 2000s

Surviving in the 1990s posed renewed challenges for these companies. Trade protectionism mostly went away as countries all around the world joined the General Agreement on Trade and Tariffs (GATT) and, subsequently, the World Trade Organization (WTO). Massive subsidies disappeared, especially in countries for which assistance from the World Bank or the International Monetary Fund came with the condition of lowering government expenditures and balancing the budget. Moreover, new employment opportunities for successful managers of state-owned enterprises opened up in the private sector, and SOEs became more dependent on stock and bond markets to raise capital.

Ironically, adversity in the business environment proved beneficial for public enterprises. Diminished government protection exposed inefficient management. Similarly, the very threat of privatization opened up a new era of accountability. Now, governments had to justify very carefully why they refused to privatize a company. Upon choosing to retain state control, they faced greater public scrutiny. A “new public management” approach emerged, calling for the adoption of private sector practices by government bureaucrats.

Other elements of the contemporary world strengthened SOE corporate governance. As financial markets developed, SOEs turned to private investors to raise funds to finance the expansion of their operations at home and abroad. Thus, SOEs started to issue bonds in international markets or to privatize part of their shares by selling them in their domestic stock markets or directly in the New York Stock Exchange, using American Depository Receipts (ADRs). Furthermore, as the wave of democratizations worldwide changed the political landscape in which SOEs were doing businesses, the pressures to perform came not only from competitors or investors, but from voters as well.

In short, the management of state-owned companies has fundamentally changed in the last two decades. This change occurred somewhat surreptitiously. Today, the vanguard of SOEs may not necessarily be as efficient as the leaders of the private sector, but they are certainly competitive. Among the new features that stand out are the following: (1) emission of shares in stock exchanges, with the dual purpose of raising capital and subjecting management to the daily evaluation of the stock prices; (2) independent auditors and members of the Board of Directors; (3) credible restrictions on the transfer of subsidies from the government; (4) recruitment of personnel at top world universities; and (5) incentive schemes for managerial pay.

Perhaps the most notable change in the practice of state-owned enterprises is the fact that corporate governance has changed significantly in the last decade and a half. Many SOEs have changed their charters to improve internal governance, include outside directors on their boards, provide incentives to managers for good performance, and professionalize management. This drive to improve governance internally has been partly promoted by the need that SOEs had to tap financial markets to obtain capital in the late 1990s and the first decade of the twenty-first century. For instance, many SOEs in developed and developing countries listed on the New York Stock Exchange and other exchanges when they privatized part of their shares (e.g., Gazprom in Russia, Petrobras in Brazil, Enel in Italy, Endesa, SA in Spain). Additionally, other governments that preferred to keep ownership of large companies allowed SOEs to obtain funds from stock markets through bond issues.

The end result has been a significant improvement in corporate governance and financial reporting and control. In the first place, companies that privatized part of their shares through issues of stock had to induce investors to buy shares by self-imposing limits on the capacity the government had to extract resources from the company. In order to do that, management was professionalized, outside directors were invited to the boards to monitor the company, and financial reporting was improved. Listing on a stock exchange, either to sell shares or bonds, forced companies to comply with high accounting standards, to report financial statements quarterly, and to hire auditor companies like PricewaterhouseCoopers, Ernst & Young, and KPMG. With the monitoring of shareholders, the oversight of stock exchange regulators (like the Securities and Exchange Commission), and the hiring of auditing companies, it became harder for the managers of SOEs to steal profits or to follow fraudulent accounting practices—not impossible, but much harder.



The “Good” SOEs of the Twenty-First Century

We describe briefly three instances of SOEs that have reached high levels of performance: Indian Railways, Petrobras, and Statoil. They hail from countries as culturally varied as India, Brazil, and Norway, respectively. The first one provides a service (transportation), while the other two perform heavy industrial activities. They all share, however, a commitment from the state to adopt a proper institutional framework that allows them to succeed in a globalized world. We believe that these firms can set an example for other SOEs to adopt in the years to come.

Indian Railways, the entity in charge of operating the railway network of India, is the largest nonmilitary employer in the world after Wal-Mart and is under direct control of the Ministry of Railways. In 2001, the company was on the brink of bankruptcy after it failed to make its dividend payment to the government (i.e., the payment it has to make every year for the capital the government has invested in it). Today, Indian Railways is a profitable company with a cash surplus—after paying operational costs—of US$20 billion and net earnings—after paying the government dividend and subtracting money for depreciation—higher than those of many of the Fortune 500 companies in the United States. How did they do it?

The key was to increase the rate at which they used their existing assets. They ran longer and faster trains by buying more powerful locomotives and changing wagon design to carry more cargo. Moreover, they changed the rates they charged to commodity exporters as a way to take advantage of the fact that some of them could not substitute railways for road or plane transportation (e.g., exporters of iron ore). The company is profitable now without having to fire employees. Since India is a country with strong political opposition to privatization, there were many constraints in turning around the company (it was hard to fire people or to increase the rates charged to passengers traveling by rail). What motivated the minister of railways and the special officer in charge of Indian Railways to produce good results? The future employment opportunities for both -- whether as elected officials or private sector employment -- depended upon their success at Indian Railways. In India, managerial talent is so scarce that private companies may induce capable managers from SOEs to join their executive ranks.

Meanwhile, Petrobras, Brazil’s state-owned oil company, is a renowned leader in deepwater exploration and production. In fact, Petrobras has held the world record for water-depth production, a remarkable feat for any company, public or private. Moreover, Petrobras has devoted vast amounts of resources to the development of renewable energy, primarily in the form of sugar-based ethanol. Interestingly, until the early 1990s, the company suffered from many of the problems typical of SOEs of the time. In 1997, however, the Brazilian government opened the domestic oil industry to international competition and allowed Petrobras to sell shares in stock markets as long as the government controlled 51 percent of the voting stock. The result was a more accountable company that has been successfully expanding internationally and developing world-class technologies.

Within Brazil, Petrobras is considered one of the companies with the best corporate governance practices. For instance, it complies with General Accepted Accounting Principles (GAAP) because it is listed in the New York Stock Exchange. Petrobras has a board of 5 to 9 directors with terms of one year with the possibility of reelection (to prevent entrenched directors from promoting their interests unless they are viewed as respecting the interests of shareholders). Preferred shareholders (holders of nonvoting shares) are allowed to elect one of the board members. The company also has decreased the level of corruption by forcing directors to disclose all of the company deals in which they are involved and by asking them to reveal detailed information about how they may benefit from the transaction. Directors cannot take part in votes to decide whether to do deals with companies in which they have a 10 percent stake or more.

Statoil is Norway’s state-owned oil company (today named StatoilHydro, after its 2007 merger with the oil and gas segment of Norsk Hydro). It is a major global player in offshore petroleum exploration and production, having developed its expertise upon operating for years in the treacherous waters of the North Sea. Today, the company has expanded internationally and operates not only in the Norwegian continental shelf, but also in West Africa, the Gulf of Mexico, and off the coast of Brazil. It owns two refineries—one in Norway and one in Denmark—and its gasoline retail activities span across Scandinavia and the Baltic States.



Statoil was founded in 1972, and its operations were generally regarded as acceptable in the following decades. Nevertheless, concerns that the company was falling behind in the international oil industry, especially at a time when the Norwegian oil fields were declining, led the Norwegian Parliament to authorize that shares in the Oslo and New York Stock Exchanges be issued in 2001. The increased accountability provided by stock prices, which rise or decrease in value according to the performance of the firm, are believed by industry experts to have contributed to Statoil’s becoming a world leader in technological capacity. Today, Statoil is at the forefront of deepwater exploration and production and carbon capture and sequestration, two technologies deemed as critical for the future of the industry.

The Challenges that Lie Ahead

The discussion above underscores two main points. First, state intervention in industrial activity has been an ever-present element of capitalist economies for more than a hundred years. Thus, the recent rise of state ownership of enterprises is unlikely to represent a chasm in modern capitalism. Second, the state-owned enterprises of the upcoming years can learn much from the highly performing public companies of today in order to avoid falling into the gross inefficiencies of the 1970s and 1980s. Yet, two main challenges lie ahead for national governments to resolve successfully.

First, we note that despite all the institutional advances in SOE management over the last few years, the temptation for politicians with predatory or imperialistic tendencies to exert influence over large public enterprises will not disappear. State enterprises, especially those in strategic sectors such as energy, represent formidable tools for state leaders to seek geopolitical gains. While this possibility is not restricted to the public sector—in fact, private firms are also susceptible to political influence—SOEs do provide a more direct mechanism of control.

Second, as SOEs improve their operations, many of them are expanding internationally. Yet, it is still unclear how states will react to having foreign public enterprises enter their territories for commercial endeavors. Some believe that state-owned multinational companies will be received more favorably than private ones, but this need not be the case, and the recent clash between Petrobras and the Bolivian government is a good example. The manner in which these issues are resolved, however, will be revealed only when broader questions of democratic consolidation across countries and transparency in government operations are answered.