State Owned Enterprise (SOE)
A business association where the country's central or state government assumes business operations through a full, majority, or minority ownership stake.
A state-owned enterprise, also known as a government-owned enterprise, is a business association where the country's central or state government assumes business operations through a full, majority, or minority ownership stake.
Since state-owned firms operate as normal companies (public or private companies), they are legal entities, which implies that the enterprise's assets are separate from the assets held by the government.
Generally, state-owned firms are set up to conduct business operations of commercial nature. However, since certain business activities require very high capital requirements at lower investment returns, these activities are carried out by government organizations.
The government, in such cases, assumes full or partial ownership of such organizations. Typically, SOEs are set up to conduct activities such as improving the country's railways, extracting oil and natural gas, and improving the city's transportation facilities.
Moreover, state-owned enterprises do not justbusiness for commercial purposes but also sell physical resources and raw materials to other trading firms and companies in the country.
However, the structure of state-owned firms should be distinct from that of publicly listed companies that government organizations partially own, as these companies are purely public firms that, by chance, have government entities as one of their shareholders.
The concept of SOE exists in almost all countries worldwide but is most popular in countries like the United States, China, India, New Zealand, and Russia.
Some of the most famous state-owned firms around the world are Federal National Mortgage Association (US), China National Petroleum Corporation (China), Oil and Natural Gas Corporation (ONGC, India), and Australia Post (Australia).
Reasons to set up State-Owned Enterprises
Government-owned firms undertake several commercial business activities that require very high capital, which private firms alone cannot take up. As a result, state-owned enterprises, with the help of other firms, indulge in such activities.
The main reasons for setting up a government-owned firm are as follows:
1. Political Factors
Several government-owned firms are set up in rural and remote areas of a city to promote infrastructure development and instill employment opportunities in the locality.
This leads to an increase in the taxable income of the government that they derive from the possible employment generated in these rural areas.
Furthermore, state-owned firms are also set up to boost the process of providing good quality services to the public. Along with the support of private firms, SOEs can improve the efficiency and effectiveness of services provided.
SOEs can also be set up in a country to reduce fiscal stress because the expenses of many state-owned enterprises are not accounted for in the state/central budget.
2. Monopolies in the market
Since state-owned firms provide services of significant importance, many of these firms own ain the market as they can achieve while providing the services to the public.
State-owned firms undertake business activities that require high capital and must go through high regulatory requirements. As a result, these firms take up activities of significant interest to the public, for example, the construction of railways.
Generally, the government doesn't want these kinds of activities to be controlled by private firms because these activities are significant for developing infrastructure in theand thus hold monopolies in such industries.
3. Existence of Infant Industries
Many state-owned firms are set up to promote infant industries, which are considered economically desirable. Government-owned firms promote these industries because private firms do not set them up alone.
To set up an infant industry, capital from private sector firms alone will not be sufficient. As a result, the government sets up organizations that tend to provide a helping hand by promoting these industries that are crucial to the development of the economy.
However, it is extremely difficult for government organizations to classify infant industries.
Advantages of State-Owned Enterprises
The advantages of setting up a state-owned enterprise are as follows:
1. Improving the efficiency of Public Services
Government-owned enterprises are set up to provide services crucial to protect the public interest. For example, the railway system, radio and television, and postal services.
Promoting such activities through private sector investments can reduce the efficiency of those services, as the goal of all private firms is to maximize their profits, which might harm the provision of such public services.
As a result, providing these services through state-owned firms helps ensure the provision of better services to the people, as it is believed that these business operations stay more efficient and safer in the hands of government firms.
2. Restricted Use of Valuable Resources
Resources of significant importance, such as oil and natural gas, nuclear energy, and other minerals like coal, stay safer in the hands of government agencies.
If these resources are under the control of the government, individual use of these resources remains prohibited. This helps to ensure that the resources are well-spent and are used most efficiently to promote the interests of the public.
3. Boosts Development in Remote Areas
Government-owned enterprises aim to provide services in all parts of their localities. As a result, this ensures faster industrialization of the economy.
Moreover, these firms have a higher reach, which helps them provide services in remote areas. Thus, development in countries becomes faster, and this is most useful in developing countries, where private firms do not have a significant impact.
4. Increases Employment Opportunities
SOEs play an important role in countries with high unemployment rates as these firms tend to increase employment opportunities in the economy.
Government-owned firms tend to provide easy and fair wages along with several perks and benefits, which help solve the unemployment problem in the economy.
5. Ensures Fair Trade Practices Within the Economy
The presence of government-owned enterprises helps ensure fair trade practices. In addition, due to better control, it discourages the exchange of harmful substances like narcotics.
6. Control over the Banking Operations
The control of the government over the banking operations helps to ensure financial stability in the economy.
Furthermore, issuingnotes is crucial to maintain inflation and other economic factors. As a result, government ownership in these activities helps promote public interest and look after the economy.
Disadvantages of State-Owned Enterprises
Although the existence of state-owned firms is crucial to the development of the economy, there are several drawbacks to such firms. The disadvantages of government-owned enterprises are as follows:
1. Management Constraints
State-owned firms can sometimes be inefficient in providing services to the public. Since these firms are run by employees who get paid in the form of a salary, it is extremely difficult to check their accountability.
Moreover, due to the chain of command that these firms are expected to comply with, decision-making in government-owned firms can be very time-consuming, reducing the efficiency of services provided.
2. Inefficient use of capital
Since these firms are under the control of the government, acquiring sufficient capital for funding business activities can rarely be a problem for government-owned enterprises.
However, due to the easy access to capital, it is more likely that funds invested in these firms are lying idle or are not invested efficiently, resulting in a wastage of capital.
This issue is often referred to as the watering of capital and is most commonly seen in state-owned firms.
3. Tedious Decision-Making Process
A lack of quick decision-making often characterizes government-owned enterprises. As mentioned above, opinions have to go through a hierarchy chain in SOEs.
This result is a heavy loss of time and leads to slow and inefficient decision-making. In addition, state-owned firms face the issue of red tape, which makes implementing ideas difficult.
4. Higher Tax Burden
Since state-owned firms operate intending to provide services to the public, some firms sometimes fail to even produce a break-even revenue for themselves.
As a result, due to the incentive to make higher profits, public interest has to be sacrificed by these firms, and thus, the losses incurred by these firms are met by the excess tax burden borne by the general public.
5. Lack of Focus on Developing Area
Due to inefficient decision-making, certain economic factors, at times, are ignored. Because of those reasons, SOEs do not set up industries in remote areas.
As a result of the heavy emphasis on already developed regions, remote developing areas are ignored, which leads to poor industrialization in the economy.
Profit Recognition in State-Owned Enterprises
Although state-owned firms operate as normal firms, and the primary goal of all these government-owned enterprises is to make profits and maximize their's wealth, only some firms make profits and often end up incurring losses.
For example, all government-owned firms in Sri Lanka have reported losses worth $15 billion in the past 15 years. However, these firms have continued to exist. The Sri Lankan government prioritized 55 firms as 'strategically important firms' out of the 527 SOEs in the country.
Despite placing a significant burden on public finances, these government-owned firms continue to exist as they provide key services critical to developing infrastructure in society.
As a result, despite operating at significant losses and not generating enough revenue, the government continues to fund these organizations as they provide services of key importance and significance to the country's development.
However, certain state-owned firms operate at losses and are shut down by the government, as these firms might not be necessary to the country's development.
Moreover, in many cases, state-owned firms are considered unfeasible investments as they incur a high amount of losses that the government may be unable to deal with.
Due to the lack of positive returns, these firms do not display signs of growth, and the complexity in the management structure leads to the delivery of poor quality services to the public.
Are State-Owned Firms Pivotal to Economic Development?
Government-owned firms, especially in developing countries like India, are paramount and the backbone of economic development. It can inject tremendousand operated wisely.
However, it can't be said that all kinds of SOEs are essential in the economy, as most generate losses, making investing more funds in these kinds of firms unattractive.
Therefore, the success of state-owned enterprises can never be guaranteed. For example, the operations of certain SOEs in Norway display commendable performance; however, many government-owned firms in South Africa needed to taste the success more.
Government control is one of many problems that tend to affect the efficiency of these firms. The success of these firms is majorly based on the level of managerial skills the employees possess and the level of autonomy available to the workers.
Since the structure of the government-owned firms creates barriers for them to grow, a decentralized working environment, where decisions do not have to travel the chain of command, can prove beneficial for these organizations.
Due to a decentralized working environment, it will be easy for employees to make day-to-day decisions without consulting their supervisors. This will facilitate quick decision-making within the organization, which might improve the services provided.
A government-owned enterprise is thus a global concept. It exists in all kinds of countries, but the success of these organizations purely depends on the employees' skills and the structure followed by these organizations.
These firms play an essential role in performing activities of significant nature, such as resource extraction, which cannot be done by the private sector alone (without the aid provided by the government).
However, if not appropriately managed, state-owned firms can create several hardships for the government due to the large amounts of funds invested and corruption in all kinds of societies.
But if put to good use, government-owned enterprises, along with support from private firms and individuals, can spur economic growth and thereby develop infrastructure to the extent that the country's status can move from a developing to a developed nation.
Researched and authored by Mehul Taparia | LinkedIn
Reviewed and edited by Parul Gupta | LinkedIn
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