REVIEW #7: Fighting Fire with Fire: Employing Regulation against Government

After the dissolution of communism in Eastern Europe, most state-held property was transferred to private ownership. That effectively ended the ownership of means of production by the state and destroyed the foundations on which communism stood. While privatization varied in time and scope in different countries, the basic idea was to never return to state-owned bakeries, petrol stations, or restaurants.


While some companies remained state-owned, in the spirit of privatization, it seemed just a matter of time until all state-owned enterprises (SOEs) were private. Remaining holdouts (energy companies, railways, and other “strategic assets”) it was thought by some, would be privatized later. That in fact was the agenda of some governments for at least a couple decades.

However, the political climate changed and the enthusiasm for privatization died down. The 2008 financial crisis, geopolitical tensions, and other macro factors have slowed down SOE privatization. In some CEE countries, the trend has even reversed. Estonia nationalized its railways in 2007 and Lithuania bought out private investors in its energy companies. Far from being on a transition to privatization, it seems that SOEs are here to stay for a long time.

This puts free marketeers in a peculiar position. Our best solution is, of course, to privatize SOEs. But if privatization is out of the political agenda, what is the second-best solution? Make SOEs adhere to the same set of rules as private companies, lose the privileges they have, or be run like private businesses?

State-Owned Enterprises – A Recurring Headache

The fundamental problem is that the state retains ownership of the means of production – just like in the Soviet times. However, some more dangerous problems loom when the state retains ownership of large companies. Lost revenue, industry politicization, handing out well-paying jobs to party loyalists, sub-optimal pricing, cross subsidization – all are a reason for concern.

It is equally dangerous if SOEs go on the offensive to expand their operations. First, it is not unfathomable that during the times of uncertainty SOEs can be better-placed to invest or expand into new sectors of economy compared to private investors. Bureaucratic burdens, taxation, and regulation all create large obstacles for private businesses. But SOEs can easily bear them or avoid them. When government creates rules and must abide by them, it is not unusual for governments to change the rules so SOEs can proceed. It is called “corruption” if such favors are handed to private companies, but “public interest” if SOEs are involved.

Second, we should not forget that rich SOEs could attract high-quality people or outcompete private sector for talent. Capable managers tasked with increasing the value of SOEs see no qualms in expanding SOE operations. Pair talent with deep pockets and flexible rules, and SOEs can truly push private companies out of the market.

If SOEs are here to stay, we need some sort of regulatory response that limits their expansion and mitigates the damage they cause. But we also need a casus belli to show that expanding SOEs are a problem, one that can be tackled with regulation.

Of course, free marketeers have an abundance of arguments against SOEs per se. However, in the changing political climate, they would not suffice. Liberal arguments and evidence are very powerful for people who subscribe to or sympathize with liberal ideology. But if a new political consensus sees no problem with the government owning the means of production, those arguments would not do.

So, let us re-explore the notion of government failure and regulatory capture. After all, if governments justify intervention into markets because markets are imperfect, could we not adopt similar arguments in relation to SOEs? If regulatory capture is possible (and even the critics of liberalism agree that it is), would SOEs not be guilty of that as well? Would it not be something that governments should address?

Regulatory Capture, Government Failure

Because the government is the agency that sets up and enforces regulations, it has the ability to create an uneven regulatory playing field. As critics of capitalism like to point out, it can happen even without the involvement (or existence) of SOEs. Private enterprises are also susceptible to engaging in regulatory capture, attempts to subvert regulation to favor certain enterprises or business models.

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