The Development of State Capitalism in Europe

Introduction In the recent history and the current global financial crisis governments have nationalised banks in the Western world. They did this because the banks had too many debts and if the banks would go bankrupt it would create social unrest, political instability and economic problems because people will lose confidence in the monetary system. In other words, these organizations were “too big to fail” and the governments had to step in to solve market failure.

State capitalism is the widespread influence of the government in the economy, either by owning majority or minority equity positions in companies or through the provision of subsidized credit and/or other privileges to private companies. There are two different forms of state capitalism: through majority control (state-controlled SOE’s) or in a more hybrid fashion through minority investments by development banks, pension funds, or the government itself.

The difference of state involvement in Western and Eastern Europe If we look at table 1 we see a list of the number of State owned enterprises. If we compare the countries from Western Europe to the countries from Eastern Europe we see a significant difference Eg. the number of SOE’s in the countries and the percentage of government minority positions in SOE’s. The countries listed are all part of the OECD. The mission of the Organisation for Economic Co-operation and Development (OECD) is to promote policies that will improve the economic and social well-being of people around the world.

Poland has 1189 SOE’s, while the Netherlands only has 44 SOE’s. Although the government in Poland has in 58% of the SEO’s a minority position, the total volume of SEO’s is still very high. In the Netherlands this percentage is 36%, but the total volume of SEO’s is 44. The reason that for example Poland and Czech Republic have the most absolute numbers of SOE’s can be found in the history of the former socialist countries. This is because the state still retains a share, even a very small one, was well as enterprises under the supervision of both central and regional governments.

Because Poland is a bigger country than the Netherlands we can better look at the output from the SOE’s in the GDP from the country. In Poland the output from the SOE’s to GPD is 28% and in the Netherlands this is 15%.

If we look at table 3 we see the development of state capitalism in Europe we see that the shares and other equity held by the government as percentage of GDP raised in the Netherlands from 8% in 2004 to 17% in 2008. In Poland this percentage went up from 18% to 28%. The financial crisis had a huge impact in the Netherlands, in particularly on the banking system. The Dutch government was forced to nationalise banks otherwise the banks would go bankrupt. This explains (partly) the higher equity held by the government as a percentage of GDP.

Negative effects of state involvement in commercial activities Because of the influence of the state in a company, the company can pursue non-commercial objectives and not only maximization of profit. Non-commercial objectives can be job creation, regional development and income redistribution. This can lead to non-efficient business activities with eventually possible debts.

There is also a risk that decision makers in SOE’s may approve bad investments and use public funds to cover losses or desperately go on with projects that are doomed to fail (non-commercial objectives). When the state is involved in the company, indirectly politics are also playing a role. When this is the case, there is always the possibility that there will be corruption. The government can provide capital to companies and ask for political support in return. We see the above effects take place for example in France and Poland. These countries are huge beneficiaries of the European agricultural funds.

Because they get huge amounts of money, they lack to innovate, they have almost no competitors and eventually there productivity will go down. And then they need more funds, so it is bad for economic development in Europe. Also the food prices will go up if Europe goes on with subsidising all agriculture sectors in the West.

Because the law of diminishing returns says that if natural resources, technology and Capital stays on the same level, but the population will grow, there will be an increasing numbers of farmers. With those conditions, the agriculture productivity will decrease. Thomas R. Malthus (1798) also supports this vision with the following claims: population grows at a geometric ratio and when the population will grow and the agricultural productivity is diminishing, there will be a shortage of food.

Reasons for state involvement in commercial activities There are reasons for State involvement in commercial activities. The most common are natural monopoly, capital market failure, equity and externalities. Natural monopoly applies to a situation in which the technical requirements of an industry or economies of scale are such that only one supplier may profitably exist (railways lines, water and electricity distribution). But, when a natural monopoly exists, the supplier is able to extract high monopoly profits by charging high prices. Under such circumstances, there is a strong need for a SOE to be set up and controlled to prevent abuse of such a natural monopoly.

Capital market failure, where private sector investors are unable or unwilling to finance projects that might have high returns in the long run but carry high risks in the short term. Recent events have reversed this trend in the banking sector. The current inability of some banks in Europe (and the U.S.) to raise finance in capital markets has required the State to take large ownership stakes in the key banks.

The rationale for state investment in enterprise arising from externalities needs to be looked in to on a case by case basis. For example, there may be a case for State provision of a next generation broadband network to cater for the bandwidth needs of industries in the future as it could yield significant positive externalities for the wider economy and support the development of new products and services, innovation and regional development.

Profit-seeking firms in industries that provide basic goods and services may refuse to serve less desirable customers, such as people living in poverty or those living in more remote regions. State involvement may be justified if the provision of the good or service is desirable on a universal basis in order to support equality, regional development and other economic and social goals. Examples include the provision of water, postal services, public transport and basic broadband.

References http://www.oecd.org/general/listofoecdmembercountries-ratificationoftheconventionontheoecd.htm http://www.keepeek.com/Digital-Asset-Management/oecd/governance/corporate-governance-of-state-owned-enterprises_9789264009431-en

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