State v Business. Partners or Rivals
Editorial
The functions of the state in market economy to a certain extent are focused on three aspects: social security, the regulation of rules of market processes and active involvement in business in the role of investor. The experience of developed countries shows that in order to achieve real efficient economic development greater attention should be paid to solving precisely the first two tasks.
Economist Oraz Zhandosov believes that the less the state is directly involved in competitive sectors of the economy, as long as they do not raise systemic obstacles for the work of private business, the better it is for the country. Otherwise it is quite obvious that corruption may result. “The state is an abstract master. As such, it is hard for the state to control a manager who is faced with a choice between immediate corrupt practices and long-term interests. On the other hand, the manager cannot draft a long-term development strategy for a particular state-run company because as soon as there is a change of government, or even of a minister responsible for the sector, the company’s manager may also be replaced,” Mr Zhandosov says. If we look at the management of major companies which serve as an example of the state’s involvement in business, Mr Zhandosov goes on, most of them are either mining companies or natural resources monopolies. “Both of these examples are far from the common understanding of normal business. The entire business of mining companies is based on the fact that there are simply no problems with demand for raw materials in the world. Moreover, mining companies do not face the problem of efficient management because the market does not exert pressure on them,” Mr Zhandosov said.
Some economists believe that state support for business and the economy in general is becoming increasingly more substantial now. As early as three years ago, President Nursultan Nazarbayev criticised national companies and major holding companies which in addition to their main business had non-core activities which were ‘monopolising’ the economy. Many of them created their own consultancy, insurance and financial subsidiaries. Some of them had their own media outlets, trade houses and leisure centres. It is fair to say that this also concerned major private holding companies and banks. As a result of their monopolisation of certain sectors of the economy, there was practically no room for developing small and medium-sized businesses and promoting healthy competition. Since then the situation has not changed.
In theory, the existence of state-run companies is prompted by the necessity to develop those sectors of the economy where private business is not capable of doing this. However, in reality state-run companies do not want to develop sectors with low profitability and high labour content.
Without a rival
Let us recall that in the past three years the Kazakh economy has been developing in a situation of high inflow of foreign investment and petrodollars and large volumes of foreign borrowing by the real and banking sectors, which posed a latent threat to financial stability. The US subprime mortgage crisis clearly showed this. When the global situation changed, Kazakh banks faced liquidity shortages and this, above all, hurt the construction and real sectors. Our economy is still based on raw materials; the bulk of foreign investment is channelled into the extractive sector, while non-extractive exports remains at a low level and the potential of diversifying and modernising the economy has not yet been realised.
At the same time, in order to speed up the diversification of the economy, Kazakhstan has set up development institutions and social and entrepreneurial corporations which should combine the efforts of business and the state in a path of rapid growth. It is expected that playing the role of business partner, the state will be better placed to understand business’s demands and quicker to react to them. As an idea this scheme is very impressive, but its implementation is stumbling into corruption, bureaucracy and other obstacles. For example, in order to develop the economy and social stability, measures should be taken to strengthen small and medium-sized businesses which should form the long-delayed middle class. The main problem this sector is facing now is the high price of financial resources, because medium-sized enterprises cannot afford bank loans.
With the aim of providing them with affordable funds as part of the Kazyna Sustainable Development Fund, the Small Entrepreneurship Development Fund was set up which has since been transformed into the Damu Entrepreneurship Development Fund. The principles of supporting small and medium-sized enterprises were also changed. It was decided that Damu’s funds would be deposits in commercial banks, which in turn would make loans to entrepreneurs. However, no-one has abolished the middleman’s margin, so the average interest rate on loans for small and medium-sized enterprises is as high as 18% now, whereas the fund directly funded them at an annual rate of 10-15%.
“At the moment, businessmen have told me, they have not yet sensed the support from this fund. Although Damu’s funds are in high demand now on the assumption that this institution will work properly, which means it will issue small loans at low interest. In reality, entrepreneurs are now suffering because the development institution which should develop small and medium-sized businesses has stopped allocating funds, although there are many companies that need real help from this fund,” says Lyubov Khudova, the chair of the board of the Association of Light Industry Enterprises of Kazakhstan.
In general, articles by and interviews with entrepreneurs in the media show their disappointment with the work of the development institutions. Instead of creating a platform for developing business through implementing infrastructure projects, Kazyna is busy with commercial projects, competing against the private sector. “Development institutions are mainly investing funds in successful commercial projects. For example, the Development Bank of Kazakhstan’s BRK-Leasing subsidiary will fully fund a project to expand the export potential of a successful company, Textiline Kazakhstan,” Mrs Khudova says. Another company in Shymkent, she continues, will receive Kazyna funds to fulfil a project to produce geotextiles. “In the meantime, the country’s only carpet combine with a 70-year-long history is dying in Almaty. As for deep processing, we have the Kargaly Woollen Combine that has everything necessary to produce fabric. It is facing bankruptcy now, whereas it supported a whole town in Soviet times. The combine is dying, so the village of Kargaly is decaying,” she complained.
Perhaps, after the expected restructuring of Kazyna’s investment portfolio and the privatisation of the fund, the situation will improve. The new head of the Kazyna Fund, Arman Dunayev, has said that projects in priority sectors will account for 75% of Kazyna’ investment portfolio by 2010, while commercially viable projects only 25%.
Liabilities of the national economy
Due to a weak legislative base that regulates the responsibility of top managers of government agencies and state-run companies, the efficiency of managing financial resources of development institutions and national companies leaves a lot to be desired. For example, the Samruk holding company for managing state-owned assets had free funds worth 28.2 billion tenge in 2007. Let us recall that this structure was set up to unite isolated state-owned assets to pursue a single (and to be more precise, more efficient) investment policy and purchasing strategy. Because of the failure to use funds fully, Kazakhstan is losing the possibility for additional growth of the economy.
“We should get down to funding a project only after it has demonstrated full readiness for practical application. Under the current rules for allocating funds, budget money is distributed every month without real conditions and without establishing whether the recipients are ready to use it. We accept submissions as fact when the facilities that receive funding have not even carried out feasibility studies, acquired plots of lands and so on,” says the chair of the Audit Committee for Monitoring the Fulfilment of the Central Budget, Omarkhan Oksikbayev.
Since the spending of budget funds was not monitored, companies often deposited them in commercial banks or channelled them into buying government securities and repo operations. For instance, 52 billion tenge was deposited in banks as at 1 January 2008. At the time, the Nuclear Technology Park and the National Innovation Fund had deposited 1.2 billion tenge in Valyut-Transit Bank, which was never recovered after the bank’s bankruptcy. It is clear that in this situation the relevant agencies should have carried out stricter monitoring and assessment of the efficiency of state-run structures. Now, in order to boost the efficiency of the spending of budget funds, the government intends to adopt a three-year planning of the central budget from 2009. Government officials believe that in this approach government money will aim to produce positive results.
The Audit Committee also raises the alarm over the rapid growth of the total foreign debt. This is not just an issue concerning the commercial banks. National companies and development institutions also abused state participation in their capital, obtaining cheap loans and enjoying high credit ratings. “The Kazakhstan Temir Zholy national railway company has been borrowing a lot of money, mainly taking short-term loans which were refinanced by other loans. We used to say that such uncontrolled borrowing might in the end lead to certain force majeure situations. Today, by the way, this has already happened, if only because all the institutions of Kazakhstan have attracted mostly short-term loans. Why have commercial banks ended up in this situation? They wildly obtained short-term syndicated loans abroad – with a maturity of no more than five years, often for a year with an extension for another year – to issue loans and refinanced old loans with new ones and they believed that this process would last indefinitely,” Mr Oksikbayev says. Since development institutions and national companies are owned by the state, the responsibility for their debts will largely be placed on the country’s budget and state-run assets.
Business and government
In general, if we look at the experience of other countries we can perfectly see that direct state involvement in business does not improve but on the contrary worsens the economic indicators of a country.
We can provide the example of Ireland, which has made a huge jump in its development over the past 15 yeas, reducing the state’s involvement in GDP and increasing the share of private business. As a result, local entrepreneurs received the possibility of self-funding and started to develop rapidly. Ireland was declared an offshore zone with tax, customs and other incentives to develop information technologies and the electronics sector. Some 10 years later, this small country occupied a leading position in Europe in terms of electronics exports. Having optimised its state policy, Ireland has managed to outperform Britain in terms of economic development and living standards. The booming Irish economy is facing shortages of specialists, although previously young people could not find jobs in the country and left to work abroad.
The other side of the coin is Russia, where state involvement in business is continuing to grow. The state now accounts for 55% of all property in the country. “I believe that the state is not capable of efficiently running commercial activities. Business, in keeping with market laws, should be concentrated in the private sector. I do not see any advantages in concentrating property designed for commercial use in the hands of government agencies. Moreover, this is one of the greatest sources of government corruption, which has grown on an enormous scale in Russia,” Abel Aganbegyan, Professor of Russia’s Academy of Economy, argues. Failing to fulfil its direct functions of regulating business and creating favourable socio-economic conditions, the state is trying to run commercial activities independently through federal, regional and municipal bodies.
By creating state-run commercial organisations aimed not at fulfilling government functions but making a profit, the government is violating market laws. Clearly, such organisations have privileged, often monopolistic, positions and this seriously hurts the country’s socio-economic development.
If we consider economic development growth rates in Russia and Kazakhstan by sector, we can note that the state-run commercial sector has the worst growth and the highest number of insolvent organisations which are pulling the country’s economy down. The private sector is developing faster and working much more efficiently, including in terms of raising budget revenue for the government.
Main characters
If we abstract and imagine that the state is a large company, then the country’s government will be top management while the population represents low-level personnel. The top manager is a key figure in any company; he is the one who improves its profitability and competitiveness. However, this does not mean that the top manager should do all the work. His main aim is to optimise all business processes and organise his business in such a way that he does not always have to be in the office and do everything himself. This can be achieved by using the potential and brains of his subordinates. For example, the boss is not a specialist in information technologies but his company employs a systems administrator who is a professional in his sphere and can develop the programmes that his bosses need. This is the solution to the problem.
If a company is facing a crisis and failing to cope with problems, this means that its management is failing in its function of managing efficiently. And the issue is often not so much a lack of professionalism of the managers as their distrust of their subordinates. If top management had hired and promoted a professional risk manager in due time, it would have definitely avoided many troubles now.
Mr Zhandosov believes that the state can play the following roles in the economy, based on private ownership, market pricing and competitive goods and services:
The first is the role of regulator, i.e. a body that sets rules for market players (producers and consumers) and monitors their observance.
The second is the role of supplier of social services. “In this case we mean services that cannot be provided by the private sector due to the specifics of their production and consumption. For example, this concerns the reconstruction and construction of roads in sparsely-populated countries or rural areas. It is clear that in densely-populated countries roads between major agglomerations can be a matter of private entrepreneurship,” Mr Zhandosov explains. Another example is secondary education. In many countries, he said, economists and the public are maintaining a consensus – secondary education should be provided by the state.
And, finally, the third role is when the state directly takes part in business as an investor and a kind of manager because it appoints specific people to posts.
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