The Public Sector - An Uncertain Future

By: Dr. Sam Vaknin
 

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What is : big, hated, outdated and indispensable ? Answer : the Public Sector.

Everyone likes to complain about the deterioration of services provided by the Government and about how it obstructs the development of the Private Sector.

The Public Sector is composed of two elements :

PUBLIC UTILITIES - giant monopolies which supply electricity, water, sewage, communication services (PTT) and even banking. To qualify as public sector - these enterprises have to be owned by the state.

LOCAL AUTHORITIES - Municipal, regional and state authorities. The Federal Republic of Germany is made of 16 LANDER. Each LAND has its own government and even Parliament. Each LAND collects taxes from its citizens and has its own fiscal budget. The same is true for the USA with more than 50 STATES and three levels of taxation : Federal, State and municipal.

Some analysts include the Government and its activities in the Public Sector as well.

The Public Sector has a very bad image in the West nowadays. It is fashionable to deride and devalue it. Everyone - including the American Democrat President, Bill Clinton - is against "Big Government". The former British Prime Minister, Margaret Thatcher, started all this with her Privatisation policies. She sold many British state owned firms to the public and broke the power of the trade unions. Her efforts were so successful that they were copied and emulated throughout the world.

Yet, even after one decade of privatizing the public sector, the figures are still alarming. We measure the involvement of the public sector in the national economy as a percentage of the Gross Domestic Product (GDP). In the European Union it accounts for 42% to 59% of the GDP.

That means that the public sector consumes between 42 and 59 Dollars of every 100 Dollars produced by the national economy. In Japan and the USA the corresponding number is 35%.

The public sector used to be 8% of GDP in the USA in 1920. It used to be 24% of GDP in Japan in 1955 - when the GDP was 12% of the current one. This means that the public sector in Japan grew by 400% in real terms in 40 years !

Singapore and Hong Kong are not in much better shape with 19%.

But what is wrong with having a large public sector ?

To answer this question, let us review three historical "accidents".

In 1946 Germany was divided into West and East. Both parts had an identical economic starting point. Yet, 44 years later - West Germany was producing 6 times as much as East Germany, per capita.

In 1953 Korea was divided into South and North. Both parts had an identical economic starting point. Yet, 44 years later South Korea produces 40 (!) times more than its Northern neighbour.

Needless to mention the difference between these initially identical twins : one had an enormous public sector with central economic planning (East Germany and North Korea) - the other has a well developed private sector (West Germany and South Korea).

During the 1980s, British Telecom and British Steel - two state owned firms - were handed over to private hands. Their productivity now outstrips the output of state owned utilities by a factor of 6 (per employee).

The West has developed a few methods of coping with this unwelcome situation :

Privatization

There are three forms of passing the ownership of a state enterprise - or the control of it - to private hands :

(a) The sale of the control of the business to private investors. The latter purchase an amount of shares of the privatized firm which is sufficient to ensure their control of its operations (a controlling stake or "nucleus"). The rest of the shares are sold to the same investors at higher prices in the future, as the performance of the firm is considerably improved under the new management. Alternatively, the rest of the shares are sold in various stock exchanges at prices reflecting a premium attributable to the introduction of new management and new capital to the firm. Privatization in the USA is typically carried out in this way.

Some critics of this method say that it is inequitable. The enterprise belongs to the citizens of the country. When its value is determined by a group of bureaucrats in the Ministry of Finance (even if they are assisted by outside experts, the final decision at what price to sell is theirs) - there is room for big mistakes or even for corruption. This way, a select, tiny group of well-connected businessmen (or former managers of the firm, who led it to its sorry state) will buy the privatized firm at a fraction of its true value and thus deprive the people of what is rightfully theirs.

A second approach was devised and implemented (mainly in Great Britain) to try and overcome these objections.

(b) The sale of the control of the enterprise to the wide public by offering (=selling) its shares in the local stock exchange. Another way is to give each and every citizen a warrant which carries the right to purchase shares in privatized firms (Poland, Russia, Czechoslovakia).

This way the public wealth is equally accessible to anyone who wishes to share in it.

The disadvantage : this is not real privatization - the firm passes from one public hand to the other. The true control of the firm will remain in the hands of its old managers, who will continue doing the same as long as they can.

(c) The third approach - adopted by Israel and France - is undoubtedly the worst. It includes the sale of the operations and management of the firm to a select group of investors at a value determined by bureaucrats at the government. But through special arrangements - commonly known as "golden shares" - the state maintains its grip over the prices at which the products
of the firm are sold, its labour policies, its political affiliation and so on. This is usually done under the pretext that the firm utilizes "national natural resources" or that its continued operations are a matter of national security or social interest.

De - Regulation

Governments are doing their citizens a much better service when they de-regulate.

This also has three forms to it :

(a) Divestiture - the breaking up of big state owned or even private firms which are monopolistic in nature, into smaller regional and / or operational units. These units will compete among themselves in the same markets. The usual result : lower prices, better service, more technological innovation. Famous cases : the breaking up of the telecommunications (privately owned) giant AT&T into small regional phone operators ("Baby Bells") in 1984.
Shortly Japan will follow suit with the breaking up of NTT, another (private) telecommunications behemoth.

(b) The easing or cancelling of regulations which inhibit or prohibit domestic competition.
A famous example : lately, the Cable TV operators in the USA were allowed to compete in the telecommunications markets. They were permitted to transfer phone calls over their infrastructure of lines and modems. This will make them formidable competitors to the local phone companies. The end result for the end user : lower prices, better service.

(c) Adopting free trade policies is a way of de-regulating the markets. When custom tariffs are reduced and other, non-tariff, trade barriers are lowered - this fosters foreign competition.
Economic research and theory demonstrate the benefits of free trade :
more efficient allocation of resources, lower prices, better products and services, faster economic cycles resulting in technological innovation.
 

Securitization
 

In the West, the provider of credits takes some risk that the credits will not be paid back. These risks associated with credits are called "assets", in banking lingo.

When a person buys real estate property in the West he takes a loan ("mortgage") to finance part of his purchase cost.
His loan is packaged together with other loans and sold to the public in the form of a bond.
The terms and conditions of the bond (maturity, interest payable, etc.) accurately reflect the terms and conditions of the assets (=credits, loans) underlying the bond.

The same is done with car loans and with many other forms of credits yielding regular streams of income to the creditor. This way, the creditor spreads his risks among many bondholders.

This process is called "securitization" - the transformation of financial assets (=credits) into securities which are sold in the stock exchanges to the wide public.

The public sector - and especially public utilities which have a stable stream of income - can sell their future income to the markets. This is done by issuing bonds to the public and selling them through the stock exchange. Another way is to sell these bonds directly to institutional investors, such as pension funds.

The bonds are paid back from income generated by the sale of electricity, water, etc. to the public - or by income generated by specific projects which is pledged to the bondholders.

Hidden Assets

The public sector possesses many assets which are either intangible or cannot be presented in ordinary accounting books. These assets can be put to productive use and generate income.

Examples abound :

Railroad companies own the land in which their railways run. They can lease these strips of land to various users : store-owners, cable TV companies, phone operators.

Electricity utilities have the exclusive rights to use the air through which their physical lines go. These rights can be leased to would-be users. For instance : cable TV companies can run their cables and piggyback on the lines of the electricity company.

Arguably the most well-known case is that of airwaves. The USA government is selling the rights to use the airwaves (radio frequencies) for cellular communication in special tenders conducted once every few months. The revenues from the sale of these intangible assets amount to billions of USD.

Innovative supply and demand patterns

The public sector is developing innovative patterns of supplying its products and services - and of generating demand for them. A well-known example : everyone in North America can produce electricity in his home and in his spare time. He can use wind energy or even the energy in his muscles to produce electricity. The electricity companies are obliged to purchase the electricity thus generated from the small producers at a fixed price. This way, they secure diversified sources of supply and plow back a part of its income to the community.