THE LEGATUM PROSPERITY INDEX™ 2021

Creating the Pathways from Poverty to Prosperity

Enterprise Conditions Spotlights: How limiting state-owned enterprises can stimulate competition

Enterprise Conditions have improved in all regions of the world over the past decade, with Eastern Europe seeing the most progress since 2011. In particular, the region has made extraordinary progress in improving Domestic Market Contestability, which captures the extent to which markets are open to new participants. Thirteen of the region’s 23 nations have recorded improvements since 2011, with Armenia experiencing the greatest improvement anywhere in the world, rising from 119th to 59th.

Enterprise Conditions have improved in all regions of the world over the past decade, with Eastern Europe seeing the most progress since 2011. In particular, the region has made extraordinary progress in improving Domestic Market Contestability, which captures the extent to which markets are open to new participants. Thirteen of the region’s 23 nations have recorded improvements since 2011, with Armenia experiencing the greatest improvement anywhere in the world, rising from 119th to 59th.

These improvements exemplify how cultivating a competitive market is key to establishing open economies, and represent an extraordinary achievement for a region dominated by communism just three decades ago. However, competitive markets are not yet a universal feature of the region’s economies. Hungary saw the greatest deterioration in Domestic Market Contestability in Eastern Europe over the past decade, falling from 28th in 2011 to 64th in 2021. One reason for the limited competitiveness of Hungary’s economy is the presence of a high number of state-owned enterprises (SOEs), with a recent study identifying more than 350 active within the country.

Though SOEs often play a formative role in early economic development, their continued presence in large concentrations can deter investment in the sectors in which they are active, as private sector entities struggle to match the resources and influence of their state-owned counterparts. Despite successive waves of privatisation, many governments continue to own and operate enterprises — notably in key sectors of the economy such as energy — creating potent protected monopolies that can discourage enterprise and competition and distort access to both supply chains and credit. Accordingly, SOEs can act as a constraint on economic growth as they limit the development of private sector enterprise, as well as constituting significant fiscal liabilities for governments responsible for keeping them operating, even at a loss.

Despite this, evidence suggests that the SOEs are becoming a more — rather than less — prevalent feature of the global economy. Over the past decade, the share of SOE assets among the world’s 2,000 largest firms doubled to 20%. This is a challenge common to emerging or post-transition economies, where SOEs are a particularly dominant feature of the economy. Such entities typically comprise around 25% of publicly listed companies within emerging markets, compared to around only 4% in developed economies

Perhaps the most notable example of a country that has reduced the number of SOEs is Colombia. Successive governments reduced the number of active SOEs by 58 during the decade between 1988 and 1998, as part of a wave of privatisations that formed part of the country’s so-called apertura.

Whilst the levels of state ownership remain relatively high in Colombia, their distortive impact has been successfully minimized. The country’s remaining 70 SOEs are subject to legislation passed in 2009 under which any persons or enterprises affecting market functions were rendered fully subject to competition law. This means, in practice, that SOEs are expected to find financing through commercial markets, and not given preferential treatment over private enterprises. Indeed, for the most part, the legal framework has established a relatively level playing field between SOEs and private enterprise and has functioned successfully.

Limiting the distortive impact of SOEs is essential to developing an open national economy, by creating the conditions in which enterprise can grow and flourish. Though SOEs can perform important public service functions in many developing nations, such roles should not limit competition and deter investment. By removing non-essential SOEs and by ensuring that those that remain are subject to effective oversight, leaders can ensure that they do not become an obstacle on the pathway to prosperity.

Did you know?

Around one-third of all state-owned enterprises (SOEs) in Latin America and the Caribbean report average annual losses. Keeping such enterprises operating requires governments to approve fiscal transfers equating to between 0.3% and 1% of GDP. Meanwhile, the liabilities that the region’s SOEs accumulate can reach up to 20% of GDP, effectively making them too big to fail.