Introduction

          In 1979, Margaret Thatcher began one of the largest wealth transfers in history. In response to decades of post-war stagnation, the “Iron Lady” started her ten-year campaign to privatize large swaths of the British government and its state-owned companies. Thatcher transferred dozens of state assets to the British populace during her tenure, amounting to $150B in modern-day value. Before the privatization wave, whether directly or indirectly, only 7% of British households owned shares in companies through pensions. By the end, over 25% of households had a direct stake in the success of the country's most valuable businesses. Consumer prices across competitive industries such as telecommunications, industrials, banking, and electricity fell 25-50% in the following decade.  Initially, employment fell due to the State’s overemployment, but rising labor productivity and market growth led to rapid hiring as firms now prioritized shareholder value creation. 


What followed was 25 years of mass privatization sweeping the world. In Latin America, Mexico and Chile led the way with the banking, telecommunication, industrial, and even social security assets transitioning into the hands of the people. Western Europe, North America, and Australia followed suit and proceeded to sell off some of the largest companies to increase efficiency and growth. As the USSR dissolved, Eastern Europe quickly transitioned its central command economies to free-flowing marketplaces, resulting in two decades of record growth. All told, over 100 countries transferred $3.3 trillion of assets from the government to the open market. 


While many expected this privatization trend to continue, it halted in the early 2000s. Today, history has reversed its course and rewound much of its progress. In many developing economies, the State is working its way back into the economy and state-owned enterprises (SOEs) now account for 1/5th of global revenues, comparable to 1980s levels. 


Economic and political forces are starting to expose the fragility of this trend. As global indebtedness continues to rise, governments are staring at their fiscal balance sheets with little to no idea how they will afford their debt. Many developing economies now spend 20% of their tax revenues just on paying their public debt interest costs. This will only increase as much of the sovereign debt reaches maturity and rolls into a new rate environment. A record amount of public debt is being raised on behalf of or being funneled into state-owned enterprises. On top of the current fiscal challenges, political pressure is increasing from large development finance institutions. Groups such as the IMF seek to diminish the State’s involvement in the global economy specifically within competitive markets where 70% of all state companies operate. It is clear that transparency and better governance are needed to crack down on political corruption, which in turn, hinders growth, innovation, and better outcomes for the general population. 


The world finds itself at an important crossroads as the State continues to tighten its grip on the global economy with every opportunity. Government officials entrench themselves after emergencies such as COVID-19 to justify further State intervention. At every turn, we have looked to the State as the solution. As Peter Drucker wrote in 1969, we have again become “hypnotized by the government” and see “no limits to its abilities.” 


But, the hypnosis is beginning to wear off. The changing tides have led us to create The Imperium Project. Imperium is exploring the world of the “State Economy” in an effort to assist all stakeholders by introducing engaged capital, better transparency, stronger governance, and fairer markets. We look to history as evidence of the effectiveness of private enterprise and equity-based incentives. The future of developing markets is unlikely to be driven by governments but rather by private enterprise through entrepreneurship, open and fair markets, and engaged capital. We are creating a firm to be at the center of this transformation.

 Many believe the State’s role in economic activity has been diminishing over time. Much like Fukuyama’s “End of History,” which argued that the natural political end state had been found in liberal democracy, many economists believed the natural economic end state had been found in the free and open market. This is not the case. Rather, the State’s economic sphere has ebbed and flowed since the earliest civilizations. 


Rewinding the clock 2,500 years ago, the Roman Republic offloaded modern-day government services to the private sector, including tax collection and military defense. However, it employed state companies in the food and agricultural sectors. China’s “golden era” of 200 BC - 200 AD was a prime example of a government letting the market speak for itself. 


Classical economics argues that state-owned enterprises should be utilized in sectors of national security importance or natural monopolies such as infrastructure and utilities. For certain resource-rich nations their SOEs are the first line of defense in protecting against foreign actors taking legal and commercial control of their most valuable natural resources. For countries such as Saudi Arabia, where their state oil company, Saudi Aramco, accounts for ~35% of the government’s budget, these governments cannot afford to lose control. 


Not all state-owned companies are poorly run, nor is the inverse true in that all private companies are well run. But, incentives matter, and on average, the incentives of equity ownership drive efficiency, profitability, and growth more efficiently than any other corporate structure created so far. Equity creates alignment in both directions. Management is held accountable for mistakes and is rewarded for success. Well-designed governance in conjunction with equitization leads to accountability for management, boards, and shareholders alike. 


In many SOEs, this structure simply does not exist. Instead of equity value, political reelection becomes the main measure of success for management. This results in ineffective leaders retaining their positions throughout decades of poor performance, capital misallocation, and no value being delivered to the broader public. Moreover, political timelines (often measured in 4-6 year election cycles) are drastically different from the longer-term timeframes that well-run businesses must operate under. 


Overemployment is the standard in most SOEs with sales per employee averaging 1/6th of their private peers. If a politician can claim to provide jobs, regardless of the legitimacy or efficacy of the jobs, then they will command more political support. Most people assume SOEs underpay their employees, but in many countries SOEs pay an average of 20% more in average wages compared to their private counterparts:

Source: World Bank

Private and state-owned companies fundamentally differ in their objectives. While a majority of private companies strive to maximize their long-term shareholder value through growth and profitability, there may be other goals for their state-owned counterparts. This fundamental difference raises a crucial question: how can private, commercial entities effectively compete with firms that access subsidization and endless government funding to sustain their operations?

The use of below-cost pricing and unfair capital funding can create an environment that inevitably drives out private competition. A live example of this phenomenon is unfolding in China, where foreign direct investment has reached a 30-year low. In many other countries, SOEs have first offer rights on any new business licenses required to operate in regulated markets. Governments throughout history have witnessed this damaging effect and chosen to reform the State’s role through privatization.

The first country to employ wide-scale privatization was Chile under the Pinochet regime. While a controversial figure due to his rise to power, Pinochet’s economic reforms allowed Chile to become the fastest-growing and most prosperous nation in South America. Through privatization, most notably Chilean social security, the economy quickly outgrew its neighbors. By 2000, the Chilean GDP per capita was 40% higher than the average South American country after starting out as one of the poorer South American countries.


After World War II, a decimated Europe relied on nationalization and State intervention to jumpstart growth. The state took over many industrial sectors to rebuild. Banking and financial services were either partially nationalized or heavily subsidized, and loans were guaranteed by governments to encourage lending to households and businesses. However, as the years progressed, this temporary State support became a permanent structure. Government officials became apprehensive about letting go of State companies out of fear that they may lose political backing. 


As economies struggled and governments ran into fiscal imbalances, many European leaders elected or were forced to divest assets. In Spain, the State’s ownership of economic output decreased by 99% from 1983 to 1999 and prices fell across the economy as regulations lifted and private competition flourished. A majority of the funds received by the government from sales were used to close the fiscal deficit. The French PM, Jacques Chirac, launched a privatization campaign in 1986 and sold off 30 companies and created five million new shareholders in the country through stock purchases during privatization. Chirac’s plan of selling over 50 companies was never achieved and today, many French companies are still partially state owned.


During the 1960s, Mexico’s government nationalized 1,100 companies which led to SOE subsidization equal to 13% of the country’s GDP. The IMF announced in 1985 that Mexico was close to defaulting on the IMF lending facility. Finding itself in a tough fiscal position, Mexico’s president, Carlos Salinas de Gortari, sold 85% of the Mexican state assets to private owners equating to 20% of global privatization value in the 1990s. 


The most well-known privatization chapter was the Russian and Eastern European efforts after the collapse of the Soviet Union. As early as 1987, Gorbachev moved some agricultural and production assets into the hands of the people as part of the Perestroika reformation. As the USSR dissolved, the privatization race began. In just a few years, 15,000 Russian companies were pushed into the private market in one of the most significant wealth transfers in history. All 150 million of the Russian people were granted the right to purchase shares for five cents. Company management teams were quick to acquire as many shares as possible to maintain control. Many companies were auctioned for a fraction of their intrinsic value due to the lack of transparency, trustworthy financials, and the government’s pressure to reform the economy as quickly as possible. Unfortunately, Russia’s program fell short in many places. While firms were privatized, they were rarely depoliticized which led to very little actual change in the State’s economic role. Secondly, the Russian program led to the centralization of share ownership by wealthy politicians and businessmen as they went around buying up vouchers from citizens who didn’t know the true worth of the vouchers.

After 30 years of privatization efforts around the world, the State’s economic ownership bottomed in the early 2000s, with only 5-7% of the global economy being managed by SOEs. Free-market capitalists around the world rejoiced and claimed victory. Economic growth globally was strong without State involvement.


Even with free markets creating strong economic growth, the world’s governments have quietly moved back into the economy. As of 2018, State-owned enterprises grew back to accounting for 15-20% of global revenues. This percentage has undoubtedly grown since the start of the Covid-19 pandemic, though no relevant public data sets are available. Much of this increase is due to the rapid rise of the Chinese economy and the growth of state-owned banks, industrial firms, and energy companies. The general trend of increased State presence holds true across developing economies where SOE market share has tripled in the last two decades. The State itself is the largest economic actor in many emerging markets. 

Source: World Bank

Today, 76,000 companies globally have at least 10% state ownership and SOEs represent 1/4th of the largest enterprises in the world. The actual number could be significantly larger given the obfuscation of state involvement via indirect ownership, local ownership, and other factors in funding structures.  The degree of State involvement varies around the world. In Vietnam, a majority of economic activity is managed by SOEs across every sector. Across the Balkans, the State manages more than a fifth of all production. 

Source: World Bank

Source: World Bank

Many SOEs in emerging economies are financial drags on their governments. Larger SOEs tend to be highly profitable (i.e. Saudi Aramco, Kazatomprom, NorNickel) as their scale leads to domestic monopolistic pricing power. The rest of the SOE market does not have the same luxury. Recent IMF studies show that 40+% of the SOEs in Africa reported negative profitability and many are insolvent. The IMF estimates that over 30% of all SOEs globally are unprofitable and require ongoing government funding, mostly through debt, to stay afloat. This lack of cash generation combined with a rise in government services globally has forced governments to borrow more than they can afford. 


Africa as a whole is in a dangerous situation. The continent’s governments are now spending an average of 15% of their tax revenues on servicing public debt and sovereign indebtedness is at all-time highs as rates - both base rates and spreads - rise. Nearly $35B of Africa’s sovereign debt comes due in the next five years which, in turn, will force redemption or refinancing at higher rates. The fiscal math stops working when this debt rolls into higher rates. Most African nations have less than two years of currency reserves at current deficit levels. 


A growing portion of this public debt raised over the last decade has been funneled into SOEs to keep them solvent. Below is a 20-year view of SOEs' share of government debt shown as a percentage of the region’s GDP. African governments have tripled their funding for SOEs to keep them running and Central Asian countries 4x’ed their funding:

The World Bank data unfortunately ends in 2020. It is safe to assume that SOE funding grew since 2020 as many SOEs continue to operate unprofitably and overall State funding stayed elevated as many economies entered economic recessions. This increase in total SOE funding combined with higher rates since 2022 has a serious fiscal impact. 


When reading recent World Bank Group publications such as the Business of the State and The Other Government, it is clear that international development organizations are increasing their pressure on governments to revert much of the nationalization that happened over the last 20 years. Development finance institutions (DFIs) such as the IMF have witnessed their monetary funding go into governments and quickly disappear into SOEs with little oversight, financial controls, or transparency. Half of the world’s SOEs do not report employment data to show the total employment base, average wages, or employee productivity levels. Financial disclosures are also becoming rarer with less than half of countries regularly reporting fiscal transfers and outstanding debt within SOEs. How can anyone govern enterprises that don’t transparently disclose their employment figures, let alone overall financial health? 

Source: Bloomberg

Capital markets are not always appropriate measures of productive capital. What about real, productive investment in emerging economies? Unfortunately, it's a similar story in many regions. Foreign direct investment into many developing regions has flatlined or fallen for 15 years.