What Determines the Extent of Public Ownership?

Abstract

There is a great deal of variation in the extent of state ownership of enterprises across countries and despite the growing consensus over the benefits of privatization many countries continue to maintain large public sectors. Currently, there are two prominent theories that purport to explain the extent of public ownership. Both are based on incomplete contracting between the government and private firms, but they take different perspectives on the nature of imperfections and different implications about the impact of country characteristics on the size of the public sector. One perspective emphasizes the role of state ownership as a means of resolving contracting problems when the government wants to get the firms to perform certain tasks. The other points to public enterprises as a substitute for private ones that are driven out when the risk of opportunistic changes in regulatory and tax policies is high. This paper develops a model that puts these two theories into a common framework and identifies the conditions under which the effects of each dominate. The model is tested with a cross-country panel dataset. The results show that deficiencies in commitment and greater political pressure for control of employment are associated with larger public enterprise sectors. We also find that a higher opportunity cost of public funds tends to reduce the extent of state ownership except when commitment capability and pressure for employment control are low. These findings have interesting implications for the pattern of state ownership across countries and for the timing of nationalizations and privatizations.

Keywords: Public vs. Private Ownership, Incomplete Contracts, Commitment, Institutions

JEL Classification: L32, L33, L5, H11