State-owned enterprises: Why the state should (mostly) get out of business
The challenges associated with our state-owned entities (SOEs) have been on the national agenda for several years now. Having long been touted by government as critical levers of a developmental state, our SOEs are now ignominiously associated with state capture, corruption, mismanagement and annual bailouts from an exhausted fiscus. The largest state-owned company, Eskom, has limited our economic growth for over a decade, and emerged as the country’s biggest fiscal risk over the last several years.
For the first time in a long time, the government appears willing to take an objective look at the SOE portfolio. This was the message out of the January ANC NEC lekgotla, which was reinforced in the President’s state of the nation address, as well as a recent tweet by the Minister of Finance.
My focus here is primarily on the large, commercial SOCs in Schedule 2 of the PFMA, such as Eskom, Transnet, SAA, Telkom and Denel. [SOCs to facilitate national ownership of mineral resources requires a separate discussion.]
Whether you think government should retain these SOCs depends in large part on one’s ideological position.
For the purpose of this discussion, let’s assume that we live in a dynamic, market-based economy in which most companies are privately owned, unless the state has a very good reason to interject itself. In the same way that we get on fine without state-owned retail banks, supermarkets, clothing stores, carmakers, consumer electronics makers and so on – because private companies produce those goods sufficiently – let’s put the burden of the proof on the state to convince us it should be in business in a particular sector.
In other words, we tacitly accept that business is not the state’s core business – rather it is rule-setting and regulation – barring exceptional cases.
Now I’m willing to accept the Presidential Review Committee’s argument, made way back in 2012, that some industries are natural monopolies – such as water provision, electric grid management – that should be owned by the state. The problem is when the state gets greedy, which ours has.
By all means, own and operate the national electrical grid, a national strategic asset. But why must electricity generation be a monopoly? Businesses are ready and willing to build power stations, backed by domestic and foreign investment, without encumbering the state’s balance sheet and threatening our sovereign credit rating.
The answer is ideology and vested interests. Factions inside the ANC love the idea of big state-owned companies because it provides direct control over the economy, and politically useful opportunities for patronage (executive appointments) and party funding (from businesses in their supply chains). COSATU loves the idea of big state-owned companies because it can use its leverage over the ANC to ensure they are overstaffed, pay salaries de-linked from productivity and never retrench workers no matter how unsustainable this is for the companies (and for us).
This has resulted in the tail, (SOCs) wagging the dog (the economy). Where SOCs were supposed to be enablers of growth, instead they are obstacles. Eskom has limited growth since load shedding entered our lives in 2008 because its inability to guarantee electricity has limited investment in new industrial capacity. While Eskom’s mismanagement has hogged the headlines, Transnet may be having a similarly baleful effect.
Treasury’s call for reform of network industries including electricity and logistics, is based in part on a 2016 paper by Treasury and the World Bank which found that issues of access, cost and reliability in our ports and rail – owned and operated by Transnet – undermine our export competitiveness.
South African exporters need to overcome the natural fact of our geography (we are distant from key export markets) as well as the man-made fact that, because of Transnet, it costs more to export a container from South Africa than high-income OECD countries and key comparator countries such as Malaysia, Thailand and India. Treasury referred to a fruit industry study which found that 54% of the export value of one citrus exporter went to logistics costs.
This is a clear obstacle to export growth, which is a critical driver of development.
Before we conclude with some specific recommendations on key SOCs, its worth looking at the biggest issues with the state in business.
Conflict with core role as regulator. Many of the things the state wants to achieve through direct ownership can be achieved through regulation. For example, the state’s stake in Telkom has not prevented us having high data prices. These are more a function of a weak ICASA, a highly concentrated telecommunications sector and the inordinately long delay in allocating new spectrum. The state’s incoherence is further evidenced by it awarding the transversal cellphone service contract for government to Vodacom in 2016, not to partially state-owned Telkom. In energy, tens of billions of rands worth of renewable IPP investment has been delayed for several years as the state prevaricated between managing energy policy and protecting Eskom. All of this indicates that the state would be better served focusing its limited capacity on effective regulation rather than being both a player and referee and doing both poorly.
Moral hazard. Eskom has bungled its Medupi and Kusile construction to the tune of R290bn in project overruns which citizens have to pay for, through steep tariff increases, taxes to fund support from the fiscus, or pension funds. Earlier this month it was reported that the Post Office underestimated the cost to distribute social grants and is now experiencing financial problems. When private companies get big strategic bets wrong, investors lose money, managers get fired. More competitive companies often swoop in to buy out or take over from their less effective rivals. When SOCs get it wrong, managers shrug their shoulders, knowing that we the public will just have to foot the bill.
Temptation of patronage and corruption. Political parties always need money to pursue reelection. Big SOCs with big procurement budgets present a temptation. Brazilian politicians weren’t able to avoid this temptation, as the Lava Jato (Car wash) scandal showed how politicians across the spectrum sold access to Petrobras contracts to fill party and personal coffers. Sound familiar? Our focus on former President Zuma obscures the structural problem presented by big SOCs in developing countries such as ours with immature established norms protecting public resources. It’s astonishing how little is made of the fact that the ANC’s investment vehicle profited from Eskom even as the economy and citizens continue to suffer. This is before even addressing the patronage which has seen unqualified but connected individuals continually appointed to SOC boards and management.
Tendency to extract rather than invest. Businesses need regular reinvestment to remain competitive. Governments, especially in developing countries, usually have more demand for spending than money to spend, and spending decisions are overly politicised in most governments. A country which highlights these dynamics is Venezuela. Despite having the world’s largest proven reserves, its economy is dysfunctional and its production capacity has repeatedly fallen as government raids the industry to fund social programs, but does not invest in maintaining and increasing production capacity. Governments are happy to raid the barn, but are reluctant to plan the maize. We’ve witnessed this ourselves as Eskom, Transnet and SAA have all suffered from long-term underinvestment.
Disciplined governments can avoid these pitfalls. Especially in mature democracies with strong norms on transparency and accountability, political competition. Norway’s responsible stewardship of oil resources for industrialization, diversification and citizens’ wellbeing is a notable example. We are not Norway. (See highly questionable sale of our strategic fuel stocks by the CEF, an SOC.)
So where does this leave us?
Electricity generation should be opened to competition. Management of the national grid should belong to an independent SOC which buys power from various sources including Eskom. Transnet’s port and rail operations deserve major scrutiny. Both behemoths should right size staff numbers over say, two years. The remaining Telkom stake should be sold and the proceeds used to reduce public debt.
Private sector participation should be sought for all but the most sensitive cases – such as water provision and arms production – for expertise, capital, discipline and transparency. This worked well in Telkom which, from once being dubbed ‘Hellkom’ for its hellish, monopoly-culture service to its customers, now acts and competes like a real company for the most part.
A conversation for another day is the process of Telkom’s privatization, through which a politically connected few got lucrative shares, among other problems. We need to be vigilant that future privatizations do not emulate the Russian process which was largely hijacked by oligarchs, detailed rivetingly in the book Red Notice, by Bill Browder.
One of the many unfortunate consequences of the mismanagement of our SOCs, is that Eskom and Transnet could have become national champions and preferred infrastructure development partners to African countries. Instead, China assumed that role. Lastly, SAA. Maybe I’m nostalgic over my days in university in the US when, excited to return home to South Africa during breaks, the SAA departure lounge at JFK felt like home. Or maybe I’m just not willing to cede real and symbolic control of the African skies to Ethiopian Airlines and Kenya Airways. I do think SAA, slimmed down and run well, can serve an important role of ensuring international connectivity (favoring the interests of South African travelers), promoting our tourism offerings and maintaining South Africa as a regional hub. By all means though, bring in a private sector partner if that’s what it takes to keep our flag flying the skies.