State Owned Returns

Originally published in the Informanté newspaper on Thursday, 6 July, 2017.

During Trustco’s Results Presentation keynote, Dr Quinton van Rooyen revealed a very telling statistic about the Namibian economy – namely that 58% of the net worth of the top 30 companies reporting public financial information in Namibia is owned by government. Furthermore, analysis of his figures showed that whereas foreign companies and Namibian companies generally give a return on equity of 18% and 21%, State-Owned Entities only managed a return of 2% - of which 97.6% was contributed by Namdeb and MTC! 

When we consider that government itself constitutes about 30% of the economy on its own, these figures reveal that through state owned-enterprises, government itself thus has effective control of a much larger segment of Namibia’s GDP than can be easily seen. Thus, when the nation is in a recession, it seems like government itself should have the capability to kick-start the economy itself – after all, it is in direct control of a large part of it. Why then are we having a recession? And if government cannot leverage optimal returns from the SOE’s, why do they exist?

Well, state-owned enterprises form as a result of a failure of the free market due to natural monopolies. A monopoly exists when a specific business is the only supplier of a particular commodity. As a result, if a business is a monopoly, it seeks to maximize profit – but as a monopoly, it can SET the price of the commodity, as it is the only supplier. In a competitive market, other suppliers would compete, and drive prices down to the marginal, or per-unit, cost of the commodity, but when no competitors exist, the monopoly will increase prices to maximize profit.

A natural monopoly arises when a business requires high fixed costs to start-up, and has unique resources that can only be acquired once – such as a port at sea, etc. Natural monopolies, then, mostly arise due to infrastructure. After all, once a road network or power distribution network is built, it is much easier for those owning the networks to expand, and conversely, prevent any competitors from springing up. Hence, when such a natural monopoly is created, it is in government’s interest to own it, as government can then ensure that it is run for the people. Or at least, that’s what they intend.

Unfortunately, state-owned enterprises fall victim to what is known as the principal-agent problem. The principal-agent problem develops when a principal (investor/owner) creates an environment in which its agent’s (managers/officers) incentives don’t align with its own. Where in a private company, investors demand profits, and align its employee’s incentives to reward them for increasing profit, either via increased sales or greater efficiency by reducing costs, now the government usually wants to run the monopoly to serve the most people. Unfortunately, governments are used to run government – and set up their incentives in the same way they’re used to.

For any government, its greatest incentive is to remain in power – to provide whatever promises and services is needed to ensure they retain the trust and, more importantly, the votes of the public. Government funds itself via tax revenues – which they can raise because the people demanded this or that and they need to fund it. When such incentive structures are replicated in a monopoly, however, you start to see a problem. With incentives designed to stay in power, there is no incentive to remain efficient, to provide returns for the people. For the first few years, the SOE is run at prices much closer to marginal cost, but without incentives to stay there, soon the incentives to stay in power take hold. 

Above-average salary increases are granted, with perks to keep staff loyal. This increases costs, but no matter – the SOE is a monopoly and can adjust prices. They are still, after all, cheap. Yet a few years down the line, these price increases can no longer be tolerated – the people complain. The principal demands that prices be kept down, and the agents have no choice but to comply. To sustain their incentive structures, corners are cut. Efficiency drops, and pretty soon all the returns that had to go to the people, are now going to those managing the SOE. 

That is how the return on equity of a state-owned enterprise ends up in the doldrums. When we take a look at our own State-Owned Enterprises, is this not exactly what we see? The solution is simple – fix the principal agent problem. Ensure that the incentives of the managers and officers of state-owned enterprises don’t reward staying in their positions, but rather that they are rewarded for efficiency and service delivery. 

If government finds this difficult, it should consult the private sector for guidance – after all, these are the companies that know how to align employee incentives for above-average performance. In the private sector, there is no qualms about firing employees who do not contribute to performance. It might be a painful adjustment for those managing state-owned enterprises, but it is what we as a public not only expects from them, but what we require from them.

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