The state is back in business

The state is back in business
By Clare Nuttall in Glasgow November 11, 2020

The coronavirus (COVID-19) pandemic that struck the world this year has resulted in an increase in the role of the state as governments were forced to step in with emergency stimulus packages, support for people and companies whose incomes were hit by the spring lockdowns and a ramping up of funding for healthcare. 

The latest annual Transition Report from the European Bank for Reconstruction and Development (EBRD), titled “The state strikes back”, shows that the pandemic has encouraged people to see an increased role for the state in a more positive light. 45% of people in the post-communist states now favour higher levels of state ownership, says the EBRD’s chief economist, Beata Javorcik, in an interview with bne IntelliNews. Moreover, people who come of age during an epidemic are more likely to support public ownership and to be suspicious of the market economy. 

The more positive view of an increase in the state’s role in the economy is not purely a product of the coronavirus pandemic, however. This year’s public health crisis accelerated but did not create the phenomenon. 

“When the EBRD published its first Transition Report back in 1994, the prevailing consensus was that lower levels of state ownership helped to create more dynamic and prosperous economies … Today, there is a sense that the state is striking back,” says the report. 

“And that was true even before the arrival of COVID-19. In advanced economies, more firms were nationalised than privatised in the early years of the 21st century, while economies where state ownership is widespread, such as China and Singapore, have experienced exceptional rates of economic growth. Household surveys reveal significant and rising support for the expansion of state ownership, perhaps as a reflection of rising inequality and the scars of the global financial crisis of 2008-09.”

This could see a reversal of trends over the past decades. State employment declined in both advanced economies and emerging markets, and even faster in the EBRD region, from 45% in the mid-1990s to 24% in the mid-2010s a change attributed both to privatisation and more vibrant entrepreneurial activity. 

However, since the international economic crisis, state employment has been increasing in many lower income economies. In around one third of the EBRD region, the public sector share of employment rose between 2015 and 2018, especially in four Eurasian countries, Armenia, Georgia, Kazakhstan and Mongolia. 

Despite decades of privatisations, “state-owned enterprises continue to play an important role in the EBRD regions, providing almost half of all public-sector employment”, concentrated in the energy, utilities and transport sectors, according to the report. 

A question of governance 

The role of state-owned enterprises as a stabilising force for example, providing employment during downturns and in disadvantaged regions was clear in spring 2020, when state-owned enterprise (SOE) employees were less likely to have their pay cut when lockdowns brought a halt to much economic activity. 

However, Javorcik warns in an interview with bne IntelliNews that an expansion of the state role in the economy in countries with poor governance “is a dangerous thing” because many SOEs are very poorly governed. 

“In almost half of the counties where we operate, the same ministry is running the state-owned enterprise and regulating the sector; in one fifth it’s the state-owned enterprise itself that has the regulatory power. In the vast majority of countries there are no rules against state-owned enterprises receiving support from the state that would give them an advantage, for example getting subsided inputs like energy, water or land, getting preferential financing, preferential tax treatment or soft budget constraints. They may be transacting with other state-owned enterprises not on commercial terms, and that means that the playing field may be tilted against the private sector,” Javorcik explains. 

As for the EBRD’s role, Javorcik believes the shift back towards greater state involvement in the economy means the bank “will be needed more than ever” as the issue of governance becomes more important now with the crisis and with growing support for state intervention. “We can help countries improve the regulatory framework of state-owned enterprises, help with running state-owned enterprises in terms of structure of the board.”

Asked whether the increase in the state’s role in the economy will be a permanent change that will persist post-pandemic, Javorcik says this will again depend on the level of governance. “In countries that are poorly governed, when the state takes over an enterprise this is an opportunity to give jobs to political supporters, to friends, so there is a danger that vested interests will be created that will prevent subsequent privatisation. The state-owned enterprise may stay in the same hands for a long time.” 

Banks in state hands 

Well before the start of the pandemic, state-owned banks had been growing in importance across the EBRD region since the mid-2000s, during which time they have expanded their assets almost twice as fast as private banks. 

Belarus, Russia and Ukraine are among the emerging market economies where state banks own more than half of all banking assets. In Russia, state banks owned more than 60% of all banking assets in 2016-18. State ownership is relatively low in Central and Southeast Europe, where most banks were privatised in the early 1990s, though there too there has been an increase in state ownership of the sector in certain countries recently. 

“The banking sector is perhaps the area where the state has struck back most clearly in recent years,” wrote Javorcik in the report. 

This has turned state banks into “major competitors to the private sector”, not least, says the EBRD, “because many have less stringent lending standards, lower net interest rate margins and a higher tolerance of non-performing loans.”

During a crisis, state banks’ willingness to assume risks can help soften the impact of economic shocks. However, the companies that borrow from the state financial sector tend to be less innovative and show weaker productivity growth, says the EBRD, partly because state-owned banks can be more susceptible to political interference in their lending decisions.

Javorcik gives the example of Turkey though similar actions have been observed in numerous other countries where research quoted in the report has shown crediting directed in response to local election battles. State banks, says the report, have been pumping credit into provinces where elections are closely contested and the mayor represents the ruling party. Conversely, state banks have been shown to be withholding credit in areas where the mayor is from the opposition. 

Systematically adjusting lending in response to local elections is problematic on two counts, as outlined by Javorcik. First, it is an abuse of political power. Second, it leads to inefficiency, because the banks are issuing loans to the wrong firms, which often leads to high default rates later on and foregoing economic growth. 

The green future 

Decisions made now as governments are looking to the post-crisis recovery are critical, wrote Javorcik in the foreword to the report. 

“The economies of the EBRD regions stand at a crossroads, with decisions on policies and institutions that are taken now potentially determining their paths for decades to come. The current period of crisis and upheaval triggered by the global pandemic represents a valuable opportunity to lay the foundations for a wealthier, fairer and greener future,” wrote Javorcik.

The EBRD calls on countries in the region to “build the transition to a green economy into their post-COVID-19 recovery plans, prioritise industries and firms with a zero-carbon future, and not prop up “zombie firms that will struggle in the green economy”. 

Unfortunately, finds the report, “EBRD economies are falling behind in the enforcement of policies that help reduce carbon emissions, in the wake of the 2015 Paris Agreement.” What has been achieved is a reduction in CO2 emissions by 12% over the period 1997-2016 relative to the levels that would otherwise have been seen. However, while they have set targets, the report says these are “not sufficiently ambitious”, and they are lagging on enforcement. 

The report explores the role state-owned energy companies can play in the green transition in the region, and whether and how they can be used directly to support the transition to a green economy. 

“The fact that in many of our countries the state-owned enterprises play quite a big role in the energy sector is an opportunity to use them to deal with stranded assets,” comments Javorcik. 

However, achieving this will require action by governments. “It is clear … that if state ownership is to become a climate policy tool, policy action is required on the part of state enterprise owners – national governments,” says the report. 

While private sector “ingenuity, investment and entrepreneurship” is needed for a successful green transition, “a strong state – encompassing sound public policy, strong state institutions and determined political leadership – is needed to channel private-sector dynamism in the right direction”, says the report. Specifically, states need to “incentivise companies and consumers to think green, promote clean investment and remove barriers preventing a smooth transition to the low-carbon economy of the future”.

There are fears the green transition will be particularly painful in parts of the region that still rely heavily on coal for power generation and where the coal industry is the main employer. Javorcik points out that in Poland, more than 1% of employment is in the coal sector, directly and indirectly. 

Outlining the EBRD’s approach, she says: “We want to protect workers, not jobs. We want to take care of people… but we can’t try to keep the structure of the economy. The world has changed and the world will be changing as carbon prices go up.” 

Changed perceptions 

According to Javorcik the pandemic has changed perceptions of climate change in the bank’s region of operations. The EBRD ran a survey in August asking respondents whether they had become more concerned about climate change as a result of COVID-19. 

“The result was striking,” Javorcik tells bne IntelliNews. “COVID-19 is changing perceptions.”

Over half of the respondents in Turkey said yes, as did more than 40% in Greece and Egypt and one third in Poland. Javorcik hones in on the impact of the crisis on young people from the Eastern Europe region, whose international mobility has abruptly been curtailed (and may be further restricted by Brexit). 

“Young people will be paying off the debt of COVID-19, young people will be dealing with the consequences of climate change. If they stay [in Central and Eastern Europe] and become more politically active they have a chance of changing the political discourse. Growing awareness of climate change combined with the activation of young people could lead changes.”