state-owned enterprises

This chapter starts with a brief discussion of the rationale for state ownership, before presenting a snapshot of what a typical state enterprise in the EBRD regions looks like today. Thirty years after the start of the transition process, such enterprises continue to play an important role in the manufacturing sectors of lower-income economies. However, in many other economies in the EBRD regions they have more or less disappeared from competitive sectors such as manufacturing. These days, state enterprises tend to be more concentrated in network industries (such as utilities), natural monopolies (such as the railway sector) and commodities.

There is a large body of literature comparing the performance of state-owned enterprises and similar private firms and raising concerns about inefficiencies at state enterprises. Such enterprises have often been found to employ too many workers relative to their output, with privatisation typically being found to improve firms’ performance.1 Similar trends have been observed for state-owned banks (see Chapter 3).

State enterprises’ low levels of productivity and profitability may, to some extent, reflect the non-financial objectives of such entities, which go beyond the maximisation of profits and include things like the provision of subsidised services, support for economic activity in disadvantaged regions or in the face of economic and technological shocks, or the protection of the environment. These are all discussed in this chapter. State ownership is often also considered to be important in sectors of strategic interest, such as defence.

The inefficiencies of state enterprises also reflect weak governance, with recent studies finding that the performance gap between state and private enterprises tends to be narrower in economies with better governance and well-defined institutional arrangements.2 The last section of this chapter provides in-depth analysis of the governance of state enterprises. Drawing on a comprehensive new review of the country-level legal frameworks governing state enterprises in the EBRD regions, as well as firm-level practices and lessons from the EBRD’s work with state-owned clients, that section makes practical recommendations with a view to improving state enterprises’ governance.

In the context of natural monopolies (industries with infinite economies of scale, such as water supply and sewerage), the initial cost of building the necessary infrastructure may be so large that private firms are reluctant to enter the market or unable to achieve efficiencies of scale. Many of these are also network industries (as in the case of the transmission and distribution of electricity). These sectors require fixed infrastructure and a high degree of standardisation in order to serve customers efficiently. At the same time, providing network services (such as train services or access to broadband) in sparsely populated areas may not be profitable from the service provider’s perspective, but may be crucial for regional development and ensuring equality of opportunity among citizens. State intervention is also necessary where markets fail to internalise externalities such as pollution.

State ownership can also be used to lean against rising regional disparities by providing employment in areas that have been affected by adverse economic or technological shocks, or where private-sector employment is scarce, preventing a vicious circle of rising unemployment, emigration and further economic decline.

Each of these policy alternatives involves costs and trade-offs. State-owned enterprises face unique governance challenges as a result of the multitude of objectives that they may have to pursue at the behest of the state, with those objectives often lacking clear definition. The state is typically able to maintain a tight grip on its state-owned enterprises – often doing so with multiple hands. However, lines of influence and accountability may be complex and blurred owing to the complexity of governments’ administrative structures, with numerous government ministries and agencies exerting influence simultaneously. State support may be extensive, but not transparent, and politicians may interfere with state enterprises’ appointments and operations. This may result in soft budget constraints, ineffective supervisory boards, weak management and poor performance. While these issues have been documented extensively in previous studies, the second half of this chapter revisits the question of state enterprises’ corporate governance, drawing on a comprehensive new review of the country-level legal frameworks governing state enterprises in the EBRD regions.

Alternative solutions involving the private provision of services under a public service obligation require a certain level of administrative capacity in order to set up such schemes and monitor their implementation. The same is true of targeted means-tested benefits providing support for the poorest households in society, as well as social safety nets aimed at tackling the adverse effects of economic and technological shocks at both household and regional level.

State-owned enterprises are typically larger than private firms, with the private sector being dominated by small companies: over a third of state enterprises in the EBRD regions have more than 100 employees, while 45 per cent of private firms have 10 employees or fewer (see Chart 2.3). A similar pattern can be observed in advanced economies. As discussed in the following sections, a single state enterprise (such as a railway company, a coal-mining firm or an oil company) can employ tens of thousands of people and dominate the labour market of an entire municipality, city or region.

Over the past 30 years, the European Union has encouraged the vertical unbundling of incumbent national railway companies, calling for (i) the establishment of separate providers responsible for passenger and freight transport and infrastructure, (ii) regulated access to the track for third parties, and (iii) policies to support competition. Such unbundling is intended to increase the transparency of the government support provided to railways. It also aims to boost competition between the railways and other modes of transport (although railways’ market shares have not generally increased following such reforms, and have declined in some cases).7 In the western hemisphere, meanwhile, reforms have focused on ensuring horizontal competition between vertically integrated private railway companies combining infrastructure, freight and passenger transport, with such companies often operating parallel services on routes with strong demand. In Japan, the privatisation of Japan National Railways has resulted in a system where passenger rail services are provided by vertically integrated regional companies. While the state-owned freight operator has access to their tracks, private freight companies can only enter the market by building their own infrastructure.8 Many countries in the EBRD regions (including most EU member states, some of the Western Balkans, Kazakhstan and Russia) have unbundled their state-owned railways into passenger, freight and infrastructure companies under the EU blueprint.

Railway companies, which are still overwhelmingly state-owned in the EBRD regions, remain very large employers. Indeed, a single company can account for up to 1.5 per cent of national employment (with more than 260,000 people working for Ukrainian Railways, for example; see Chart 2.6). At the same time, unbundling often involves substantial job losses. In Serbia, for instance, 42 per cent of railway jobs were lost as a result of such reforms.9

Railway companies in the EBRD regions remain highly dependent on government subsidies (as do their counterparts in most advanced economies). Monopoly companies, in particular, often benefit from a range of direct and indirect subsidies (such as reduced fuel prices or tax breaks), which are often negotiated retrospectively. The writing-off of debts to banks and other state-owned enterprises supplying services (such as electricity companies) remains common. For example, Greece’s infrastructure management company and train operator benefited from debt cancellations totalling 7 per cent of GDP in 2011. And in 2016, prior to its unbundling, Serbian Railways had its debt to the state-owned electricity provider written off, with that debt totalling 0.1 per cent of GDP. By 2019, however, Serbian Railway Infrastructure, one of its unbundled successors, was again one of the largest debtors to the state electricity company.

Such subsidies typically aim to ensure the universal provision of affordable railway services. Information collected by the European Commission as part of its Rail Market Monitoring Survey reveals that few advanced European economies are able to recover all costs through passenger fares. This only tends to be the case in densely populated countries where rail networks are used intensively (such as Luxembourg and the Netherlands; see Chart 2.7). In sharp contrast, the EBRD regions are generally characterised by relatively low population density, low levels of network utilisation, and thus low recovery rates, resulting in a continued need for large subsidies. In some economies in central and south-eastern Europe, only about a fifth of costs are recovered through passenger fares.

Private competition remains limited in the EBRD regions’ railway sectors. Where private operators exist, they tend to concentrate on the most frequently used and profitable lines, or on freight transport. Operating on less profitable and less frequently used routes, on the other hand, requires government subsidies or cross-subsidisation using the fares charged on other routes. In France, for instance, a group of regional lines account for 15 per cent of costs, but only 2 per cent of total users, and a similar pattern can be observed in the United Kingdom.10

While rail services are, in general, primarily used by the more highly educated and the better off, people with lower levels of education and income may be more likely to use regional routes. Indeed, they may often have few alternative travel options if such routes are cut. Where other options exist, commuting by rail tends to be more environmentally friendly than commuting by car.

State ownership is just one way of providing an affordable service with universal coverage. As an alternative, universal provision can also be ensured by giving subsidies to private providers operating under public service obligations, and low-income households can be given targeted means-tested benefits to cover the cost of rail travel or utilities. However, these alternative approaches rely on the public sector having sufficient implementation capacity and entail their own costs. For example, ensuring universal provision through public service obligations requires clearly defined geographical areas, the careful calibration of payments, and the regulation and monitoring of providers.

As a result, utility prices are often set below the level that is required to recover costs. This leads to excessive consumption of energy with adverse environmental effects (see Chapter 4), and economic gains accrue primarily to the rich, who consume more electricity, gas and water. At the same time, however, increases in utility prices would have a disproportionate impact on the livelihoods of low income households unless such increases were offset by targeted means-tested benefits.

In countries with stronger economic institutions, state-owned utilities have the potential to be transparent and well-run. Indeed, a number of advanced economies have recently seen a wave of utility companies returning to municipal ownership (as witnessed, for instance, in the French water sector, the German energy services industry and the Norwegian waste collection sector) with the aim of increasing accountability.11

In contrast, in countries with weaker economic institutions, subsidies tend to be larger and less transparent where utilities are provided by state-owned companies.12 Large, non-transparent utility subsidies tend to go hand in hand with weak social safety nets, particularly in Central Asia and parts of the Western Balkans, suggesting that the two approaches are substitutes. Many EBRD economies with more limited administrative capacity have used price controls and utility subsidies as part of their economic response to the Covid-19 pandemic on account of their ease of implementation, despite such measures being a fairly imprecise way of channelling support to the individuals who need it most (see Chapter 1).

In countries with weaker economic institutions, well-defined private-sector participation may help to clarify contractual relationships between governments and service providers and increase the transparency of state support for municipally owned companies. By way of example, Box 2.2 discusses Romania’s experience of introducing private-sector participation in the area of district heating.

In many countries, regional and municipal governments have stepped in to bridge this digital divide, offering affordable high-speed internet services in small towns and rural areas where low population density renders investment unprofitable for private telecommunication companies. Meanwhile, in the United Kingdom’s 2019 general election, the Labour Party manifesto even went as far as promising to provide free universal broadband through a partially nationalised British Telecom.

State intervention to ensure the universal provision of affordable broadband services has taken many different forms. Most EU countries use an operator subsidy model, whereby the state subsidises a network provider with the aim of establishing or upgrading the country’s network, extending coverage to areas with low population density. In contrast, some regions (including parts of Croatia, Latvia and Lithuania) have a fully public network model, whereby a public authority builds and owns the network and may provide services directly. In some cases, new municipal and inter-municipal partnerships have been set up to provide broadband services, with significant financial support coming from the central government. In Germany, for example, this model is used in more than 200 rural municipalities. In other economies, the state builds the network and remains its ultimate owner, but leases it to a private network operator on the condition that service providers enjoy fair and non-discriminatory open access.13

In South Korea, meanwhile, universal service obligations were crucial to ensure the construction of broadband infrastructure in rural areas following the privatisation of Korea Telecom, with state support covering half of all investment costs through a matching fund. In contrast, the universal service obligation framework in Uzbekistan does not currently guarantee the provision of services at affordable rates for all consumers.14

Thus, there are various different models that can successfully be used to ensure the universal provision of broadband services, ranging from full state ownership to no state ownership, but they all tend to require state intervention in one form or another.

Governments can use a range of tools to address rising regional disparities. These include direct fiscal transfers to support disadvantaged regions, investment in infrastructure, and incentive schemes (such as tax breaks) that encourage companies to locate themselves in particular regions. At the same time, measures aimed at improving the local business environment can help to attract domestic and foreign private investment.16

The distribution of state employment across regions can have a significant impact on the location of private-sector activity. The effects of such relocation are likely to be larger where the relocated jobs are more highly skilled and where spending by employees and procurement by public bodies will generate greater demand for goods and services supplied by the private sector. Those effects can, in turn, be further enhanced by improvements to the business environment and transport links.17

Against that background, this section looks at whether state-owned enterprises can help to support economic activity in disadvantaged regions. That analysis examines the spatial distribution of state enterprises using the latest round of Enterprise Surveys, which were conducted in 2018-20 by the EBRD, the European Investment Bank (EIB) and the World Bank Group and covered more than 25,000 randomly selected firms across the EBRD regions.

Disaggregated data on employment by type of ownership and sector for 380 Polish powiats (roughly equivalent to UK counties) allows for more detailed analysis of the spatial distribution of state employment (see Box 2.3). That analysis shows that the regions with higher unemployment in northern, eastern and south western Poland are also the ones with higher percentages of state employment (see Chart 2.10). Moreover, regression analysis can be used to link state employment (as a percentage of total employment) to the unemployment rate (unemployment as a percentage of the labour force) and various county-level characteristics (such as the sectoral composition of employment, the ratio of the working-age population to the total population, population density and NUTS 2-level regional fixed effects). That analysis reveals that a 1 percentage point increase in the county-level unemployment rate is associated with a 0.5 percentage point increase in state employment as a percentage of total employment. That relationship is not by construction to the extent that the two ratios have different denominators.

In regions with fewer private-sector employers, state employment (be it in public administration, education or healthcare, or in municipal utility companies, railway companies or post offices) becomes relatively more important as a source of local employment. In this sense, public-sector employment acts as an automatic stabiliser when regions experience adverse economic or technological shocks. Similarly, state-owned banks tend to be more important lenders in rural areas (see Chapter 3). Evidence from the latest round of the Life in Transition Survey confirms these findings. Residents of rural areas are more likely to work for a state enterprise or another public entity, even when taking into account individual characteristics such as their age, education or sector of employment.

In August 2020, the EBRD and the ifo Institute (an economic think-tank) conducted a representative survey of 40,000 adults in 14 countries (Belarus, Egypt, France, Germany, Greece, Hungary, Italy, the Netherlands, Poland, Serbia, Spain, Sweden, Turkey and Ukraine) in order to track the impact that the Covid-19 crisis was having on people in the EBRD regions. As many as 72 per cent of respondents in the EBRD regions reported being personally impacted by the economic crisis, compared with 41 per cent in advanced economies. The burden of the crisis in terms of job losses, furlough arrangements, unpaid leave, reduced hours and pay cuts is being borne disproportionately by younger people and those with lower levels of education and income.

People employed by private-sector firms are significantly more likely to have been negatively affected by the crisis than employees of state enterprises or other public-sector entities. Those differences remain statistically significant when account is taken of various individual characteristics.

Furthermore, Google searches relating to unemployment and benefits have increased less in economies where state enterprises account for a larger percentage of employment (see Chart 2.13).

Over time, public-sector employees also appear to be able to accumulate larger savings buffers. Evidence from the latest edition of the Global Findex Database suggests that the percentage of respondents who say they can come up with emergency funds (equivalent to 5 per cent of gross national income per capita) over the next month is higher in countries with larger public sectors (see Chart 2.14). The more stable income streams that are associated with public-sector jobs may enhance an individual’s ability to save, and this effect appears to outweigh the smaller need for precautionary savings among individuals with more stable sources of income. Individual-level evidence from the Life in Transition Survey confirms that people who are employed in the public sector are more likely to be able to come up with emergency funds than similar individuals (in terms of educational background, level of risk aversion and other characteristics) who work in the private sector, although the differences are smaller when household income is taken into account.

Thus far, state enterprises have not been used as an explicit environmental policy tool in the EBRD regions. A new review of the legal frameworks that govern state enterprises across the economies of the EBRD regions reveals that only 15 per cent of countries have legal frameworks that refer to board responsibilities relating to environmental and social objectives (and in some cases, those responsibilities are only applicable to listed companies).

Evidence from the Enterprise Surveys also suggests that while state enterprises are more likely to monitor emissions and have emissions-related targets, they are no more likely to engage in green investment than similar private firms. They are, for example, significantly less likely to invest in the upgrading of machinery, even when taking into account firms’ sector, size and other characteristics. State enterprises also tend to consume more electricity, and more energy, per unit of output.

Detailed analysis of investment proposals submitted to the EBRD since 2010 corroborates these findings, suggesting that state-owned enterprises are no more likely to pursue environmental and social objectives than private-sector firms – and in many cases, less likely (see Box 2.5). It is clear, therefore, that if state ownership is to become a climate policy tool, policy action is required on the part of state enterprises’ owners – national governments.

Coal still accounts for more than a third of global electricity generation and remains the second-largest fuel in the global energy mix after oil and the second-most-traded bulk commodity after iron ore.26 In the EBRD regions, coal accounts for more than 80 per cent of electricity generation in Kosovo, Mongolia and Poland (see Chart 2.17). In countries which are both large consumers and large producers of coal (such as Kazakhstan, Poland and Turkey), coal is regarded as being important for energy security. Moreover, some countries in the EBRD regions (such as Mongolia and Russia) are major coal exporters.

Despite being a major polluter, the coal sector continues to receive large subsidies in many countries. When account is taken of subsidies relating to tax treatment, as well as damage to public health and the environment, total subsidies can exceed 30 per cent of GDP (see Chart 2.18).

State enterprises can play an important role in the winding-down of sunset industries, where privatising firms may be difficult. In most EU member states, there has already been a clear shift away from coal as a result of the implementation of stricter emission standards, the rising price of emissions under the EU Emissions Trading System (EU ETS; see Chapter 4), and growing competition from renewables and, in some cases, natural gas. Meeting national decarbonisation targets in 2030 will require 80 per cent of coal power capacity to be retired – with the higher quality bituminous coal and anthracite produced in Kazakhstan, Poland and Ukraine (which is also used in industrial processes) being less affected, given the challenges of phasing out coal in processes such as steel making.27 In addition, an increasing number of banks and institutional investors are placing restrictions on investment in coal.28

The fact that the Western Balkans countries and Ukraine are members of Europe’s Energy Community means that they are legally obliged to implement adapted versions of the EU’s energy and environmental legislation. While those economies’ implementation of environmental standards is not as advanced as it is in the EU, a number of existing mines have been closed, and plans to build new lignite plants have been cancelled, as these will cease to be profitable as soon as the EU’s Emissions Trading System is introduced.

As a result, the private sector is moving out of coal and other sunset industries, where state ownership often dominates. Thus, the state is left with the task of winding down large “stranded” assets and managing the decline in employment. Globally, companies with no state ownership own 14 per cent of operational coal power capacity, but account for only 3 per cent of the coal power investment pipeline.29 Today, the coal sector is predominantly state-owned in most of central and south-eastern Europe. At the same time, significant private involvement in the coal sector can still be found in economies where environmental regulations remain less stringent, making operations more profitable (including countries such as Kazakhstan, Mongolia, Russia and Turkey).

The coal sector has traditionally been an important employer, both directly and indirectly, accounting for up to 2.5 per cent of total employment in economies such as Bosnia and Herzegovina and Kosovo. Furthermore, employment in the coal sector is also highly concentrated: it accounts for between 10 and 20 per cent of total employment in south-eastern Bulgaria and the region of Western Macedonia in Greece (see also Box 2.3 on employment in the mining industry in Polish counties).

Active state policies can help to deal with the legacy of coal mining. In the Netherlands, for instance, state-owned mines were successfully turned into a diversified petrochemicals multinational in the 1970s. In Germany, meanwhile, public-sector jobs are being created at new agencies in coal-mining areas in the east of the country to compensate for concentrated job losses. Against that background, Chapter 4 looks at the EBRD’s “just transition initiative” in the EBRD regions.

At the same time, some NOCs are highly indebted. Their long-term liabilities can be as high as 49 per cent of GDP in the EBRD regions (see Chart 2.20). NOC debt can take various different forms, such as corporate bonds, loans from banks, oil-backed loans from other NOCs or traders (as in the case of KazMunayGas, Kazakhstan’s state-owned oil and gas company), or loans from a government entity. While their debts may not formally be guaranteed by the government, they are likely to be considered “too big to fail”.32 Indeed, several NOCs have received large government bailouts in recent years. The bailout of KazMunayGas in 2015 (which had a total value equivalent to 2.2 per cent of Kazakhstan’s GDP) had no bearing on the country’s credit rating, consistent with pre-existing market perceptions of implicit state support for national oil companies.

Almost two-thirds of NOCs exhibit “weak” to “failing” performance in the area of public transparency, as measured by the Resource Governance Index. Disclosure is weakest in countries with weaker country-level governance and in the areas of employment and spending.33 Transparency and accountability can be increased through initiatives such as the Extractive Industries Transparency Initiative (EITI), which seeks to strengthen the disclosure of information about transactions throughout the extractive industry value chain – from the awarding of extraction rights to the transferring of revenues to the government – as well as information about how transactions benefit the public. This is important, as NOCs’ choices in respect of the management of climate-related financial risks have a significant bearing on their countries’ economic resilience and levels of ambition under the Paris Agreement.34

There have been a few examples of NOCs proactively integrating climate policy in their operations – for instance, through green procurement regulations and the mitigation of upstream emissions. This is often driven by commercial imperatives (including access to carbon finance), particularly where companies have minority private shareholdings. Meanwhile, NOCs in countries as diverse as Colombia, Nigeria and Saudi Arabia have turned their attention to investment in renewable energy. NOCs could further leverage their experience of managing complicated projects in cooperation with international partners in order to help foster the transition to a green economy. However, NOCs’ strong reliance on fossil fuel rents (the difference between the international price of oil and gas and the cost of production) may make them reluctant supporters of alternative sources of energy.35

This section presents detailed analysis of state enterprises’ governance, examining the existing governance frameworks in the EBRD regions and highlighting areas for improvement (see also the Structural Reform section). This analysis draws on a comprehensive new review of the country-level legal frameworks that govern state-owned enterprises in 36 economies in the EBRD regions. It is complemented by an in-depth examination of state enterprises’ compliance with corporate governance rules, drawing on a review of the corporate governance disclosures of more than 100 state enterprises in 23 economies in the EBRD regions. Lastly, this section looks specifically at the lessons that have been learnt from the EBRD’s work with state enterprises.

Weak or ad hoc budgetary governance creates fiscal risks and cycles of dependence between state enterprises and governments: state-owned enterprises are used to provide subsidies, but they incur losses, accumulate debt and need to be bailed out.37 Subsidies and grants to state enterprises can be observed in almost all EBRD economies (being subject to EU rules on state aid in EU member states). What is more, such subsidies are typically calculated after losses have been incurred. Determining the level of subsidies in advance on the basis of objective measures capturing public service obligations (for instance, per end-user of the service) could strengthen accountability and increase incentives to improve the operational efficiency of state enterprises. Subsidised or targeted loans to state enterprises are slightly less common – and where they are used, they tend to be channelled through state-owned banks or development banks (see Chapter 3). Tax exemptions and tax benefits are rare, being observed in only 22 per cent of the economies in the EBRD regions. The majority of the economies in the EBRD regions do not normally allow state guarantees to be provided, although more than 65 per cent allow exceptions subject to parliamentary legislation or government approval.

Even in the economies where a centralised ownership function exists, that entity often lacks the powers that are necessary to adequately scrutinise state enterprises. In 36 per cent of economies ownership is exercised by means of a dual model, whereby responsibilities are shared between two authorities, such as the line ministry and the government, or the line ministry and the ministry of finance. The remaining economies operate a decentralised model, whereby multiple authorities (mainly line ministries) supervise state enterprises in their own respective areas of competence. In practice, state-owned enterprises are heavily influenced by line ministries. Indeed, in almost half of all economies in the EBRD regions, line ministries hold shares in at least some – and in some cases, all – state-owned enterprises. Moreover, firm-level analysis confirms that most key state enterprises are owned by line ministries. Municipal or regional authorities, ministries of finance and economic affairs, national holding companies or funds, other state enterprises and the cabinet or parliament can also play a role when it comes to exercising ownership functions.

In line with the low-risk, low-return model discussed earlier in the chapter, the management of state enterprises often focuses mainly on compliance. State enterprises are often governed by very detailed legal frameworks, with only limited autonomy to make decisions. Indeed, they can often be thought of as operating in an environment where “everything is prohibited unless it is explicitly allowed”, as opposed to “everything is allowed unless it is explicitly prohibited”.

State enterprises also conduct very little risk analysis. Their strategies are rarely assessed from a risk perspective, with specific risks and mitigating measures not generally being set out in budgets. Most state enterprises reviewed in the study have no risk department, so there is no organisational framework for acting on external risk analysis, and more than 50 per cent of the economies in the EBRD regions do not impose any risk-related reporting requirements. Those that do only require the disclosure of general risk factors in the context of annual reports, rather than obliging state enterprises to report on the way that they deal with the risks they face in their operations.

Fiscal risks need to be managed by making state support more transparent and requiring analysis of the key risks faced by state companies. Transfers to state enterprises (in relation to public service obligations, for instance) should be based on concrete formulae. And state enterprises’ budgets should include sensitivity analysis, using a variety of macroeconomic and operational scenarios and stress tests to inform estimates of contingent liabilities for the government (particularly in the context of large capital projects). More generally, governments need to track the financial performance of state-owned enterprises, both with and without government transfers, and perform risk analysis in respect of such enterprises’ liabilities (including adverse scenarios involving declines in output prices or increases in input prices).38

As a result of the expansion of social services, the public sector has become the dominant employer in many of those economies.39 While state-owned enterprises only account for around 17 per cent of total state employment in the economies of the southern and eastern Mediterranean, compared with an average of 44 per cent in the EBRD regions as a whole, over-employment in state-owned enterprises has, nonetheless, been widely documented.

Macroeconomic difficulties resulting from falling oil prices, high levels of government debt, weak private investment and inefficiencies at state-owned enterprises triggered a wave of market liberalisation, deregulation and privatisation in the late 1980s and the 1990s. While that privatisation process generated significant revenue in some countries (such as Egypt, Morocco and Tunisia), it also encountered administrative challenges and popular resistance, culminating in demonstrations and strikes. Institutions’ weaknesses created space for widespread corruption, and people with political connections benefited disproportionately from privatisation.40

Today, state enterprises in the southern and eastern Mediterranean continue to play a major role in primary sectors (such as phosphate mining), certain branches of manufacturing (such as chemicals, but also consumer goods), finance and real estate. Some have monopoly rights in sectors that could otherwise be competitive, often operating using regulated tariffs – as is the case, for instance, in the cereal, olive oil, meat and sugar sectors in Tunisia.41

State enterprises and the broader public sector remain important elements of the social contract in those economies, being viewed as a source of jobs, part of the social safety net and a vehicle for public investment. When the state enterprise sector was downsized in Egypt, it resulted in the culling of unproductive but relatively well-paid employment, but was not accompanied by sufficient strengthening of the social safety net or job creation in the private sector. That was arguably one of the factors that contributed to the unrest seen in 2011.42

State-owned enterprises remain important providers of subsidised services. In Egypt, for instance, the military has historically used state-owned enterprises to build affordable housing for the country’s security forces, and that mandate has recently been expanded to include the provision of social housing more generally. In Morocco, meanwhile, the national electricity company has implemented a 15-year electrification programme, and the national highway construction company has been busy building new rural roads.43 However, compensation for such non-financial objectives does not tend to be transparent and is typically only regulated in a few sectors. In some cases, such payments constitute a significant drag on countries’ budgets.44

The governance challenges discussed in this chapter are a significant issue in the southern and eastern Mediterranean. With the exception of Egypt, which has set out broad objectives governing state ownership, no country in the region has a state ownership policy. Most of the region’s economies have complex decentralised ownership arrangements, with managerial responsibilities being undertaken primarily by line ministries. Jordan, the West Bank and Gaza, and Morocco have elements of a dual system, with the ministry of finance playing a key role, while in Egypt, Tunisia and Lebanon there is some limited coordination by central bodies. In many cases, entities exercising ownership responsibilities also have regulatory powers or are responsible for sectoral policies, although in some cases independent regulators have been set up (notably in the telecommunication, transport and electricity sectors) with the aim of introducing competition in previously monopolised markets.

The boards of state-owned enterprises only have strategic responsibilities in half of the region’s economies. Moreover, there are limited regulatory requirements ensuring that boards have an appropriate composition. Most countries have rules requiring the publication of information on state enterprises’ ownership, their performance (in the form of annual reports, for example) and the regulatory arrangements governing things like state assistance. However, such rules are not always followed in practice – neither by the companies themselves nor by regulators. Even if information is collected, it is not generally aggregated or made easily accessible to the public, thereby reducing transparency and accountability.

District heating services are relatively costly and can account for a significant percentage of a household’s income during the heating season, making the removal of heating subsidies politically difficult. Indeed, the results of the latest round of the Life in Transition Survey indicate that around 30 per cent of households in the EBRD regions’ poorest income decile are unable to afford adequate heating of their home. This could help to explain why district heating is more likely to be state-owned than other utilities.

At the same time, investment needs in the area of district heating are particularly large in the EBRD regions following years of under-investment. Those economies’ distribution systems were not designed for individual metering or user control, making the introduction of consumption-based billing costly and difficult. In addition, many secondary cities in the EBRD regions have falling populations and industries that are in decline. In the past, for instance, industrial plants were often major consumers of heat, surrounded by residential neighbourhoods. In such circumstances, heating networks and production facilities may need to be re-scaled and re-routed, as oversized systems are unable to operate economically.

Tariffs are typically set below cost-recovery levels to ensure universal access. Thus, while the poor spend a larger percentage of their income on utilities, larger percentages of subsidies accrue to richer households who consume more energy. Under-pricing also results in excess consumption of heating and under-investment in energy-efficient buildings, with adverse implications for the environment.

From a service provider’s perspective, municipal subsidies often lack predictability. In Romania, for instance, municipal subsidies are common in the district heating sector, while the water sector only receives investment grants. At the same time, however, the revenue stream is often uncertain, hindering long-term investment planning and encouraging utility companies to spend time lobbying city authorities rather than focusing on providing a high-quality service for users.

Many district heating utilities in the EBRD regions are effectively in a downward spiral of managed decline. Those downward spirals typically start with a heating utility struggling with a legacy of under investment and poor maintenance, which results in heating being provided at unpredictable temperatures. As dissatisfied customers disconnect, revenues fall and unit costs increase as the distribution network becomes oversized, exacerbating under-investment and further undermining the quality of the service. In many cases, this results in the service being withdrawn entirely. In Romania, for example, the total number of district heating systems has fallen from 315 in 1989 to just 43 today.

Most remaining district heating utilities struggle with their cash flow, despite public subsidies. They often accumulate debts to their energy suppliers, unpaid tax bills or other forms of debt and end up receiving government bailouts. Such soft budget constraints – which are prevalent in the district heating sector, but not the water sector – hamper the planning of investment, as well as the management of government budgets. Over time, they may also foster an implicit acceptance of the notion that state enterprises do not need to honour contractual agreements.

It is not impossible for state-owned district heating utilities to be financially sound and well-run, with positive examples typically being found in countries with mature commercial and governance frameworks, such as the Nordic countries. In countries with weaker public governance frameworks, well-defined private-sector participation in the form of public-private partnerships or management contracts may help to clarify contractual arrangements, achieve an arm’s-length relationship between the utility’s management and local authorities and do away with soft budget constraints. The district heating utility in the Romanian city of Iaşi experienced most of the challenges described above, including a persistent failure to pay key suppliers. When it filed for bankruptcy in April 2012, the city signed a 20-year concession contract with a private operator, Dalkia Termo Iaşi. District heating remains subsidised and significant investment is still needed, but transfers from the city budget have become predictable. The accumulation of debt has slowed and the disconnection rate has fallen, reflecting improvements in the quality of service – a major step towards breaking the vicious circle of persistent underfunding and a shrinking customer base.

Much of that employment is in public services, including public administration, education, healthcare, social work, utilities (water supply, sewerage and waste, as well as electricity, gas and steam), transport and storage. The public sector also accounts for around three-fifths of all employment in the mining sector, which primarily involves the extraction of coal. While mining only accounts for around 1 per cent of total employment in Poland, that employment is highly concentrated. In the southern regions of Sląskie and Małopolskie, for example, it accounts for 3 per cent of total employment, and 85 per cent of the mining employment in those regions is in the public sector.

Almost half of all state employment in Poland is in entities that are run or owned by local governments (see Chart 2.3.1), including most public-sector employment in the areas of education, healthcare, social work, water supply, sewerage and waste. In contrast, state employment in sectors such as mining, agriculture and manufacturing is overwhelmingly in entities that are owned or run by the central government.

State employment tends to be higher in disadvantaged regions, where unemployment rates are higher (for instance, in northern, eastern and parts of south-western Poland). Indeed, the public sector’s share of employment is, on average, 3 percentage points higher in counties with unemployment rates of around 20 per cent (the 90th percentile of the distribution of unemployment across counties) relative to counties where unemployment is around 6 per cent (the 10th percentile). Those differences are even more pronounced when account is taken of other county-level characteristics, such as demographics, the sectoral composition of the economy or regional effects. Overall, a 1 percentage point increase in a county’s unemployment rate is associated with a 0.5 percentage point increase in the public sector’s share of employment.

That relationship is driven by the fact that the public sector accounts for a larger percentage of total employment in “non-business services” such as public administration, education or healthcare. In counties with less private-sector employment, post offices, train stations, municipal utility companies, hospitals and schools become more important as local sources of employment. Thus, public-sector employment is able to act as an automatic stabiliser in regions that experience adverse technological and economic shocks.

Those respondents were asked whether responsibility for providing people with work should fall primarily to the state, be shared between the state and the private sector, or fall primarily to the private sector, or whether it does not matter as long as jobs are available. Around 46 per cent of respondents across those nine economies believe that the state should have primary responsibility for providing jobs.

Views vary substantially within individual countries. While only about 37 per cent of those living in capital cities think that the state should have primary responsibility for providing jobs, that rises to around 49 per cent in rural areas (with the difference between the two being statistically significant). Support for state-led job creation in rural areas is particularly strong in Albania, Bosnia and Herzegovina, North Macedonia and Romania, with shares of between 54 and 66 per cent. Regression analysis taking account of various individual-level characteristics (such as age or gender) confirms that people living outside capital cities are more likely to think that the state should have primary responsibility for job creation.46 People living in rural areas are also more likely to think that the state should have primary responsibility for providing education and medical services, building roads and organising the collection of waste.

People in poorer regions are also more likely to think that the state should have primary responsibility for job creation – both when looking at regional GDP per capita and when data on the intensity of night-time lights (which are available at a more disaggregated level) are used instead. That effect remains statistically significant when controlling for a range of household-level characteristics and the country of residence.

That effect could be driven by the fact that there are fewer alternative (private) employment opportunities in disadvantaged areas, as well as demand for the state to get involved in the local economy to help it catch up with the country’s more prosperous regions. Personal exposure to public-sector jobs may also play a role, since (as shown in Chapter 1) people in rural areas are more likely to work in the public sector.

As noted elsewhere in this chapter, the direct provision of employment is just one of various ways that the state can support disadvantaged regions. In line with that, demand for state-led job creation in rural areas appears to be lower in EU member states, which benefit from EU structural and cohesion funds earmarked for low-income regions within countries. Conversely, the percentage of respondents who favour increased state spending on regional economic development is significantly higher in the Western Balkans economies (at an average of 64 per cent) than it is in the EU member states in the sample (where it averages 53 per cent).

This analysis looks at the expected characteristics of an investment project when it is first reviewed by the EBRD’s investment committee. Such snapshots, taken before in-depth due diligence has been conducted, are a good indicator of the client’s initial interest in the various ESG objectives (as distinct from the final features of the project, which are a product of joint work by the EBRD project team and the client). For instance, at the concept stage, environmental elements are expected, on average, to account for 20 per cent of the funding invested, compared with an average of 39 per cent when projects are finally agreed. The analysis also takes account of various project-level characteristics, including the country, the industry, the expected amount of financing and a measure of the commercial risk involved in the transaction.

Third, state enterprises also appear to be less likely to want to engage with environmental issues, particularly in the energy and financial sectors. In the area of municipal infrastructure, on the other hand, state-owned companies are significantly more likely to explore green issues.

In conclusion, therefore, there is little evidence that state ownership necessarily makes enterprises more likely to target policy objectives in the area of the green economy or develop local supply chains and skills. State-owned companies are no more likely than private companies to actively engage in these areas (and in some instances, they are less likely to do so). Using state enterprises as an ESG policy tool will therefore require more action on the part of their owners – national governments.

That strategy stipulates that state ownership of enterprises is only appropriate for (i) natural monopolies, (ii) the provision of essential infrastructure services or public services that are not commercially viable, and (iii) areas of strategic interest such as defence and other specific industries (including precious metals and nuclear power plants). Other enterprises should be earmarked for either privatisation, liquidation or conversion into government agencies.

State-owned firms are also expected to set out their commercial and non-commercial objectives (in their company charters and annual business plans, for example). This is expected to lead to increased transparency when it comes to the provision of government subsidies, which are widely used to compensate state enterprises for delivering on their non-commercial objectives.

The strategy also aims to reduce conflicts of interest by separating the state’s ownership and regulatory functions by 2023, since it is often the case that government bodies both own and regulate state firms. At present, Uzbekistan’s Cabinet of Ministers is the central decision-making body as regards state enterprises. It represents state interests at annual meetings, decides on restructuring and privatisation, appoints the members of supervisory boards, and approves the appointment of senior managers. The strategy essentially intends to transfer those powers to a stronger State Assets Management Agency, adopting a more decentralised approach to state ownership. In order to create a level playing field, state unitary enterprises – which are not subject to bankruptcy procedures – will be converted into either joint-stock companies or limited liability companies.

Currently, supervisory boards often consist of civil servants representing the various government bodies that regulate the relevant sectors. The strategy aims to improve state firms’ overall governance structures, with an objective of having independent members make up at least 30 per cent of state enterprises’ supervisory boards by 2025, as well as establishing audit, appointment and remuneration committees, and introducing appropriate risk management and internal control systems. Moreover, civil servants will no longer be able to serve as the chief executives of state firms.

The strategy also aims to introduce transparency and disclosure obligations for state enterprises. While many state firms have websites, these typically contain little information. State enterprises will be required to publish their company charters, their organisational structures, quarterly business plans, annual financial reports (with the aim of reporting in line with the International Financial Reporting Standards (IFRS) by 2024), risk reports and information on large transactions with affiliates, as well as details of the CVs and remuneration of supervisory and executive board members. The website of the State Assets Management Agency will, in turn, provide annual reports on the performance of state enterprises.

This disclosure system was established in response to concerns that public institutions were inefficiently managed and insufficiently accountable, gave excessive bonuses to executives and lacked transparency when it came to major appointments. By 2018, there were 42 separate items that were subject to disclosure requirements, including standard financial information, the minutes of company boards’ weekly meetings, information on purchases of gifts with a value above the recommended threshold, international business travel, the hiring of retired staff, and recommendations by the Board of Audit and Inspection. Moreover, this information is highly disaggregated (making it possible, for example, to trace the corporate credit card usage of individual employees). ALIO also provides comprehensive information on procurement contracts and suppliers, including details of the duration and value of each contract, the contracting entity, the contract type (direct selection or competitive selection, for instance), the purpose of the contract, and the law that governs it. The Ministry of the Economy and Finance, which is responsible for overseeing the ALIO system, can issue penalties for failing to disclose information correctly. Meanwhile, the public disclosure of organisations’ environmental performance is managed separately by the Ministry of the Environment.

Public satisfaction with state institutions has increased strongly following the establishment of ALIO, indicating that the initiative has been a success (see Chart 2.7.1).

Connections are complex in nature and have a strong network dimension. Connections between politicians, political parties and firms are typically assessed on a binary basis, involving a judgement as to whether two entities or people are connected or not. However, where a firm or individual is located in a network will affect how privileges are acquired and, potentially, the scale of those privileges. Although networks are ubiquitous in social and economic life, their role in providing access to assets, markets, finance, public contracts and other resources has been difficult to document thus far.

The analysis in this box demonstrates a novel way of measuring complex connections, using a detailed dataset (PEPData) which contains publicly available information assembled by major commercial providers of business intelligence on politically exposed persons (PEPs) in each country, the connections among them, and links between PEPs and political parties and firms.51 In order to identify links between firms and PEPs, that information has been combined with data taken from Bureau van Dijk’s Orbis database, which provides information on firms’ ownership and shareholders, as well as financial and balance sheet information.

Networks differ substantially depending on the relevant country’s political system and associated institutions (see, for example, the network maps for Russia and Romania in Chart 2.8.1). The nodes in those network maps are firms (either private or state-owned), individuals, political parties and politicians; the links between them denote their connections. Russia’s network has relatively few political parties, but many state-owned and private companies. Further analysis shows that state enterprises – unlike politicians and other individuals – consistently occupy strategic or central positions in that network.

Romania’s network has a rather different composition and shape, being characterised by a multiplicity of political parties and their associated clusters. In addition, state and private firms are both less likely to occupy central locations than politicians and political parties.

As regards political systems, democracies consistently have far more integrated networks. In countries with weaker democratic institutions, the formation of networks is often impeded so as to ensure that the political sphere – and thus potential opposition – is fragmented. As a result, power tends to be concentrated in clusters, and network connections mostly run to and from those clusters.52

What are the consequences of these networks of connections? Connected firms, including state-owned ones, are unequivocally larger than non-connected firms, whether in terms of revenue or employment. This difference tends to be even greater if they have a more central position in the network. Although connections may provide access to cheap finance or preferential contracts, and may even increase market power, they may also dilute incentives to invest and raise productivity. Indeed, when looking at firms’ performance, as measured by the return on the assets or capital employed, connected firms perform relatively poorly. This is true of both state-owned and private firms, and the finding holds when a binary approach is used instead of one where network features are included. This effect is even stronger when looking specifically at the firms with the most connections. Where firms have large numbers of connections – including a connection with a politician – their return on capital is around 85 per cent lower than that of a non-connected firm. In this case, the difference is substantially smaller if it is measured on a binary basis that does not take account of network features.

Such networks of connections have proven to be highly resilient, despite major changes to the political and economic regimes of transition countries in recent decades. State-owned enterprises continue to occupy prominent positions in most networks, with a high degree of centrality but poor performance. When combined with the presence of newer – but highly potent – politically connected private firms, this raises concerns not only about productive inefficiencies, but also, more generally, about inequality and the integrity of political and institutional frameworks.