How Much State Ownership, and Why?

There is increased evidence from official development institutions and private economists around the world documenting the linkage between more rapid—and stable—economic growth on the one hand, and sound financial systems on the other.

Despite numerous privatizations over the past decade, publicly owned banks and other state-owned financial institutions still serve the majority of individuals in developing countries, according to presentations by the World Bank. State-owned financial enterprises are less prevalent in developed economies, with very few exceptions, such as Germany and, to a lesser extent, the United States, with its large government-sponsored entities supporting residential home ownership that have implicit government backing, according to the International Monetary Fund. Public ownership of these financial institutions and others has been rationalized on several grounds:

  • To counter the power of strong private sector banks or to promote the development of home-grown banks in the early stages of an economy’s history—the so-called infant industry rationale. Both arguments helped justify the formation of the First and Second National Banks of the United States in the early 1800s, for example.
  • To ensure that economic growth is consistent with national objectives. This is a clear rationale for socialist economies, but even in private economies there is a view that governments have better knowledge of socially beneficial investment opportunities than private banks.
  • To ensure that underserved groups or sectors, such as agriculture and small businesses, receive credit.
  • To respond to financial crises, which have hit developed and developing countries alike. In some of these cases, government ownership is temporary, but in some cases it lasts for significant periods. Among government officials around the world there is support for some government ownership of financial institutions based on one or more of these rationales. Economists generally, however, are skeptical of all these rationales except for the last one.

With rare exceptions, public sector banks have performed poorly by conventional financial measures, such as returns on equity or assets, the extent of nonperforming loans, and expense levels, according to James Hanson. In principle, these banks may fare better if their broader social missions are taken into account (for example, when they finance roads or sewers), because the benefits to the entire economy may exceed those to the specific borrower. But in practice these banks tend to extend much if not most of their credit to large borrowers, which suggests that social returns are not larger than private gains.

 

Executive Editor

 Ms Anna Sullivan

Ms Anna Sullivan