Reinventing State Capitalism

Aldo Musacchio, Sergio G. Lazzarini

• Publisher: Harvard University Press
• Year: 2014
• ISBN:
  9780674419599
• Topic: Business
• Subtopic: Government & Business
• Index: Business

The wave of liberalization that swept world markets in the 1980s and 90s altered the ways that governments manage their economies. Reinventing State Capitalism analyzes the rise of new species of state capitalism in which governments interact with private investors either as majority or minority shareholders in publicly-traded corporations or as financial backers of purely private firms (the so-called "national champions"). Focusing on a detailed quantitative assessment of Brazil's economic performance from 1976 to 2009, Aldo Musacchio and Sergio Lazzarini examine how these models of state capitalism influence corporate investment and performance.According to one model, the state acts as a majority investor, granting the state-owned enterprise (SOE) financial autonomy and allowing professional management. This form, the authors argue, has reduced many agency problems commonly faced by state ownership. According to another hybrid model, the state uses sovereign wealth funds, holding companies, and development banks to acquire a small share of equity ownership in a corporation, thereby potentially alleviating capital constraints and leveraging latent capabilities.Both models have benefits and costs. Yet neither model has entirely eliminated the temptation of governments to intervene in the operation of natural resource industries and other large strategic enterprises. Nevertheless, the longstanding debate over whether private ownership is superior or inferior to state capitalism has become irrelevant, Musacchio and Lazzarini conclude. Private ownership is now mingled with state capital on a global scale.

1

Introduction

New Varieties of State Capitalism

In May 2007, the relatively unknown Brazilian firm JBS acquired Colorado-based Swift & Company for $1.4 billion and suddenly became the largest beef processing company in the world. Two years later, in September 2009, JBS made another surprising move by acquiring Pilgrim’s Pride, an iconic American meat processing firm, for $2.8 billion. Where had a rather unknown Brazilian firm gotten the funds to finance such acquisitions? The answer was simple. The Brazilian National Development Bank (known in Portuguese as BNDES) had singled out JBS as a “national champion” and provided funding to make it a dominant player in the global beef and poultry market. Thanks to its $4 billion investments in JBS, BNDES eventually controlled 30.4 percent of the firm’s shares, becoming its largest minority shareholder and, in turn, a minority shareholder of both Swift and Pilgrim’s Pride.¹ These transactions, like many others conducted by governments and development banks around the world, raised interesting questions. Should governments use development banks, such as BNDES, to support firms? Should governments support firms by becoming minority shareholders? What are the implications of such investments for firms and for countries as a whole?

In July 2010, while the JBS story was unfolding in Brazil, a consortium of investment banks on the other side of the world launched the initial public offering (IPO) of Agricultural Bank of China (ABC) on the Shanghai and Hong Kong stock exchanges. ABC had traditionally been a “policy bank”—that is, a bank that lent according to the interests of leaders of the Chinese Communist Party. As a result, by 2008, over 25 percent of its loans were nonperforming. To fix ABC before the IPO, the government bailed out the bank, cleaned up its balance sheet, and revamped its processes and governance.

Investor interest was enormous. This was the largest IPO in the world at the time; it raised almost $22 billion for shares—15 percent of the firm’s capital—and the bank’s share value rose to almost 30 percent above the issuing price in a couple of months. Yet it was not clear if the investors who bought the shares knew what they were getting into. Were they misguided? Could the Chinese government be trusted as a majority investor?

In both cases, investors were faced with something that was clearly state capitalism, but was clearly not the state capitalism they were used to. In this book, we study the rise of these new forms of state capitalism in which the state works hand in hand with private investors in novel governance arrangements. We define state capitalism as the widespread influence of the government in the economy, either by owning majority or minority equity positions in companies or by providing subsidized credit and/or other privileges to private companies. The new varieties of state capitalism differ from the more traditional model in which governments own and manage state-owned enterprises (SOEs)² as extensions of the public bureaucracy. We refer to this traditional model as Leviathan as an entrepreneur.

We identify two new models of state capitalism that go beyond the Leviathan as an entrepreneur model. In the Leviathan as a majority investor model, as in the example of Agricultural Bank of China, the state is still the controlling shareholder, but SOEs have distinct governance traits that allow for the participation of private investors. In the Leviathan as a minority investor model, state capitalism adopts a more hybrid form in which the state relinquishes control of its enterprises to private investors but remains present through minority equity investments by pension funds, sovereign wealth funds, and the government itself. In the latter model, we also include the provision of loans to private firms by development banks and other state-owned financial institutions. In our view, then, the rise of national champions such as JBS, whose expansion was based on subsidized capital from its home government, is a manifestation of the Leviathan as a minority investor model.³

The examples of Agricultural Bank of China and JBS are by no means curious exceptions. By some calculations, firms under government control account for one-fifth of the world’s total stock market capitalization.⁴ In Italy, for example, SOEs listed on the stock exchange (both majority- and minority-owned by the government) account for over 20 percent of stock market capitalization. In Greece, this figure is 30 percent, while in the Netherlands and Sweden it is closer to 5 percent (OECD 2005, 35). In large markets, such as Russia and Brazil, companies controlled by the government or in which the government has a significant stake dominate trading, and they account for between 30 and 40 percent of market capitalization. In China, companies in which the government is a controlling shareholder account for over 60 percent of stock market capitalization.⁵ Furthermore, in our analysis of SOEs in myriad emerging countries (see Chapter 2), the Leviathan as a minority investor model is prevalent and covers almost half the companies in which the government has equity (the rest being majority-owned SOEs).

Thus it is very likely, then, that global investors will have to at least consider SOEs as potential investment targets. In fact, nine of the fifteen largest IPOs in the world between 2005 and 2012 were sales of minority equity positions by SOEs, most of them from developing countries.⁶ One of the reasons why investors do not mind buying these securities is that governments share rents with them, which has often led to high returns. For instance, according to a report from Morgan Stanley, the stock returns of publicly traded SOEs from Europe, the Middle East, Africa, and Latin America between 2001 and 2012 “generated superior returns vs. [the] benchmark [indices].”⁷

Moreover, the firms that we study are by no means small. SOEs are typically among the largest publicly traded firms in the stock markets of developing countries. In fact, some large SOEs have also become some of the most profitable firms in the world. The number of SOEs among the one hundred largest companies in the Fortune Global 500 list, which ranks companies by revenues, went from eleven in 2005 to twenty-five in 2010. In 2005, there were no SOEs among the top ten, but by 2010, there were four—Japan Post Holdings, Sinopec and China National Petroleum (two of China’s national oil companies), and State Grid (a Chinese utility).⁸

Still, many observers view the rise of new forms of state capitalism with apprehension. Political analyst Ian Bremmer characterizes state capitalism as “a system in which the state functions as the leading economic actor and uses markets primarily for political gain” (Bremmer 2010, 5). A Harvard Business School summit of founders and CEOs of some of the world’s top companies identified state capitalism and its support for national champions among the ten most important threats to market capitalism (Bower et al. 2011). Managers of private firms often complain when they find their competitors heavily supported or subsidized by local governments.

Although not all investors and policy makers feel such apprehension (Amatori et al. 2011), for many the concerns stem from the large theoretical and empirical literature showing that, on average, SOEs are less efficient than their private counterparts (see for a review Megginson and Netter 2001).⁹ In this literature there are three broad explanations for the inefficiency of state ownership (Yeyati et al. 2004). According to the agency view, SOEs are inefficient because their managers lack high-powered incentives and proper monitoring, either from boards of directors or from the market, or simply because managers were poorly selected in the first place (La Porta and López-de-Silanes 1999; Boardman and Vining 1989; Vickers and Yarrow 1988; Dharwadkar et al. 2000). According to the social view, SOEs have social objectives that sometimes conflict with profitability. For example, they may be charged with maximizing employment or opening unprofitable plants in poor areas (Shirley and Nellis 1991; Bai and Xu 2005). According to the political view, the sources of inefficiency lie in the fact that politicians use SOEs for their personal benefit or to benefit politically connected capitalists. Additionally, managers of large SOEs commonly face low pressure to perform because they know the government will bail them out if they drive their firms to bankruptcy (Vickers and Yarrow 1988; Kornai 1979; Shleifer and Vishny 1998; Boycko et al. 1996). State participation would therefore entail a “grabbing hand” detrimental to economic efficiency.¹⁰

In contrast, defenders of the industrial policy view see state investment as a way to promote development beyond what is possible under free markets. In this view, governments should help firms develop new capabilities, either by reducing capital constraints (Yeyati et al. 2004; Cameron 1961; Gerschenkron 1962), by reducing the costs of research and development, or by coordinating resources and firms to pursue new projects with high spillovers (Rodrik 2007; Amsden 2001; Evans 1995). According to this view, the creation of new capabilities in the local economy requires the “helping hand” of the government to mitigate all sorts of market failure.

Our book is not about whether one view is right and the others wrong; nor is it a test of whether private firms are more efficient than SOEs. This book is about understanding (a) how the world ended up with new forms of state capitalism and (b) the circumstances in which these new forms overcome some of the problems highlighted by the literature and solve a host of market failures that thwart development. Although each chapter proposes and tests explicit hypotheses related to different views of the role of SOEs, the book as a whole is about the nuances of state intervention and the conditions that make such intervention either more or less effective.¹¹

Furthermore, we are not trying to argue that privatization is not a desirable policy. We think, nonetheless, that the pushback against full-fledged privatization in large developed and developing markets makes the study of the new forms of state capitalism relevant. That is, even if the new forms of state ownership we study are a second-best solution from the point of view of economic efficiency, they are a solution that is often politically acceptable. In emerging markets, governments have encountered strong political opposition to sweeping programs of privatization. Shirley (2005) shows that, in Latin America, the popular rejection of privatization increased between the 1990s and the early 2000s. In BRIC countries, privatization programs have almost stopped in Brazil and India and have been proceeding at a gradual pace in China and Russia, with those governments now preferring to privatize only a small share of equity in their large SOEs.

Finally, we also do not claim that the new varieties of state capitalism are universally better than the previous varieties. We explicitly warn that the new varieties also have limits when it comes to taming the government’s temptation to intervene politically in a firm. In the model in which Leviathan is a majority investor, for instance, the government is still a controlling shareholder, and, absent checks and balances, it may be drawn to intervene in strategic sectors such as energy, mining, and utilities. In the model in which Leviathan is a minority shareholder, equity investments or loan disbursements may actually benefit politically connected capitalists rather than financially constrained firms.

The Reinvention of State Capitalism

How have the new forms of state capitalism evolved over the years? For some observers, the rise of state capitalism to the forefront of global markets is a consequence of the global financial crisis that started in 2008. Bremmer (2010), for instance, sees that crisis as a shock that led to an alarming reemergence of state capitalism. Part of the concern comes from the fact that, even in a liberal economy such as the United States, the crisis led the government to bail out firms such as General Motors and AIG, a large insurance group, becoming a minority shareholder of the former and a majority shareholder of the latter. As the examples of Agricultural Bank of China and JBS illustrate, however, state capitalism was alive and kicking—and even expanding—before the crisis (Amatori et al. 2011; Bortolotti and Faccio 2009). Firms owned and operated by the government were privatized en masse in the 1980s, 1990s, and early 2000s, but state ownership and influence in those firms continued.

State capitalism peaked in the middle of the 1970s when European governments nationalized firms in large numbers. Around the same time, governments in developing countries either nationalized firms or created (and then owned) tens or hundreds of new ones. As a consequence, by the end of the 1970s, SOE output to GDP reached 10 percent in mixed economies and close to 16 percent in developing countries.

Then, between the 1970s and the turn of the twenty-first century, governments transformed the way in which they owned and managed firms. In the 1980s, governments and multilateral agencies experimented with reforms in SOEs to try to reduce the financial hardship both SOEs and governments themselves were facing. Officials tried corporate governance reforms, performance contracts for firms and managers, and training programs for SOE executives (Shirley 1999; Gómez-Ibañez 2007).

Yet these attempts were futile, and the political cost of privatization started to look small compared to the losses afflicting SOEs. For instance, as a consequence of the oil shocks of the 1970s and the liquidity crunch of the early 1980s, SOEs from all around the world ran average losses equivalent to 2 percent of GDP, reaching 4 percent in developing countries (World Bank 1996). SOE losses were then translated into national budget deficits, and those deficits exploded once interest rates spiked in the United States in 1979 and once debt markets were closed for developing countries after Mexico’s 1982 debt default (Frieden 1991). Ultimately, as a consequence of those macroeconomic shocks and the fall of the socialist bloc, governments ended up privatizing thousands of firms (Megginson 2005), opening up their economies to foreign trade, and gradually dismantling capital controls.

Stil...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Dedication
• Contents
• 1. Introduction: New Varieties of State Capitalism
• Part I: The Reinvention of State Capitalism around the World
• Part II: Leviathan as an Entrepreneur and Majority Investor
• Part III: Leviathan as a Minority Investor
• Notes
• Bibliography
• Acknowledgments
• Index