Why should there be international rules governing State-owned enterprises?

31 October 2014

The subject that I have been following the most closely during these last few years in the frenetic international negotiating activities in which the US is currently engaged is the extent to which state-owned enterprises (SOEs) will be subject to international trading rules when they engage in commercial competition. In many countries, state ownership plays a major role in the national economy and often a dominant role in specific sectors. In cases where these SOEs are engaged in commerce, their presence can easily make a mockery of international trade agreements.

Governments have been engaging in business for centuries, if not millennia. An early motivation for state ownership was raising revenue – for example, on the sale of salt or tobacco. That motivation, with the exception perhaps of gambling – i.e. state lotteries – and in some instances the sale of alcohol, has substantially eroded.

What remains are two general categories of activity. With respect to one of these, public services, trade negotiators are not concerned. This involves, for instance, the provision of basic health and education, local public transportation, and sometimes utilities.

Then there are state-owned companies that engage in commercial competition. This second category may have arisen out of a need at one time to provide a service that the private sector was not fulfilling. This motive presumably gave rise to postal saving accounts and to some extent state-owned airlines, for example – although national pride may have often been a factor in the latter.

However, today there are often areas in which state-owned companies compete for business which the private sector can and does provide, such as with express delivery. There are also other motives for state ownership being in competition with the private sector. A state may wish to control its natural resources through direct ownership rather than through regulation and taxation. With respect to manufacturing and the provision of some services, the state may simply wish to develop a part of its economy for industrial policy purposes and state investment in the form of ownership it deems necessary.

Overall, state ownership is a phenomenon that is not disappearing. It represents a substantial part of major economies such as China and Russia, but is also present significantly in many other countries. All countries have some state-owned commercial enterprises. Some governments are moving actively to diminish the number of their state-owned enterprises. In Vietnam, the number of SOEs has shrunk by some 90 percent over the last decade, with these accounting for an increasingly smaller part of the Vietnamese economy.

International trading rules are not going to dictate whether a country chooses to have state ownership in a commercial enterprise or not. What then are the concerns? For the home government, the primary question is one of efficiency, specifically whether state ownership the best way to organise its own economy.

The OECD has done much work on this subject, and it is not an aspect of state ownership that trade negotiators seek to address in binding rules, or directly at all. But in the current consensus view of many governments – such as those engaged in the 12-country Trans-Pacific Partnership (TPP) negotiations or in the US-EU Transatlantic Trade and Investment Partnership (TTIP) negotiations – some rules of the game are required when state enterprises are engaged in commercial competition.

Why? This is because under trade agreements, while governments have entered into numerous obligations with respect to international trade and investment, state-owned enterprises may frustrate the fulfilment of these commitments. Two of the cornerstone commitments of all WTO members are providing national treatment – treatment no less favourable for foreign business than for its domestic businesses, with some exceptions – and a stipulated degree of access to its market, specifically by binding tariffs at a level above which they cannot be raised.

But lowering market barriers at the border does not mean that a market is really available, for example, if there is a domestic state-owned company dominant in that market as either a buyer or a seller. It may or may not be seeking to return a profit to its state owner. It may be influenced by policy objectives of its owner, such as by maintaining employment where its plants are now located, or placing new plants in depressed regions, or supporting other state enterprises. There are also less noble purposes – rewarding political allies, for example. Motive really does not matter to trade negotiations; it is trade- and investment-distorting effects with which these negotiators are concerned.

One concern is that a government agency that is both promoting domestic “champions” and regulating the market will be at a minimum conflicted, and favour the state enterprise over foreign-owned companies competing with it. Another is that a state-owned enterprise will not buy or sell on the basis of commercial considerations – that is, it will not act like a private competitor. This would distort the market. There is also a concern that state-owned companies may not be transparent with respect to ownership, control, or other activities, in a manner that securities markets usually require of commercial competitors.

The most difficult area, but one of concern, is that of subsidies to state-owned enterprises. Given that the state owners provide capital, loans, grants, and other valuable inputs to their progeny, the effect may be the same in commercial competition for private companies as playing against a sports team that is given repeated doses of steroids: usually not healthy for the recipient in the long term, but harmful to private competitors in the present.

Alan Wolff is a member of the E15 expert group on Trade and Innovation. He is Chairman of the National Foreign Trade Council (NFTC) in Washington, D.C. and Senior Counsel at McKenna Long & Aldridge LLP. He also acts as Co-Chair of the Innovation Policy Forum of the Science Technology and Economic Policy Board of the National Academies Washington, D.C.