The Small Island Developing States conference held earlier this month included the launch of the Asian Development Bank's latest state-owned enterprise (SOE) benchmarking study, Finding Balance: Benchmarking the Performance of SOEs in Island Countries. The study compares the performance of SOEs in nine island countries (Fiji, Samoa, Solomon Islands, Marshall Islands, PNG, Tonga, Jamaica, Mauritius and Cape Verde) over a 10-year period, and measures their impact on economic growth. The results are sobering.

Over the 2002-2012 period, none of the SOE portfolios generated a sufficient return to cover their initial capital costs. Why is this important? Because when SOEs perform poorly, the economy as a whole suffers.

SOEs in island economies are often the sole providers of core infrastructure services (power, water, transport), so when these are of poor quality and insufficient reach, private businesses cannot develop and become competitive. By absorbing large amounts of scarce capital on which they provide very low returns, crowding out the private sector, and diverting public funds that could otherwise be invested in such high-yielding social sectors as health and education, SOEs act as a drag on economic growth.

The study shows that low SOE returns are not unique to the Pacific (nor island economies), and are common throughout the developing and developed world. Chronic SOE underperformance highlights a fundamental flaw in the model: it is not an effective long-term ownership structure. While the SOE model attempts to replicate private ownership demands and dynamics, it never truly replaces the market disciplines that private firms face. As long as SOEs remain under majority public ownership, politicians will avoid commercial decisions with potential short-term political costs.

Policy makers around the world are aware of SOEs' persistent deficiencies, fiscal costs and negative impact on growth and poverty alleviation. Consequently, efforts to reform SOEs have been ongoing for decades. However, SOE reform requires strong political commitment and this study demonstrates that this is extremely difficult to sustain over prolonged periods. Involving the private sector through public–private partnerships and privatisation is a much more effective way to sustain improved SOE performance and service delivery. Competition for investment capital means that the private sector will always have stronger performance incentives than the public sector. These incentives should be harnessed to support public service delivery. 

Governments engaging in SOE reform are therefore asking three key questions:

  1. What is the appropriate role of the state in the economy?
  2. Does the government need to own and manage state assets to deliver public services?
  3. Can these services be contracted to private sector providers? 

This is the debate all governments with large SOE sectors should be having, regardless of the size of their economy. Within the Pacific in recent years, progress has been made to reduce the size of SOE portfolios and place them on a more commercial footing. The experience of the Solomon Islands is notable, where the SOE portfolio has gone from generating an average return of -14% on equity between 2002-2009 to 10% from 2010-2012. It is now the best performing portfolio of the benchmarking sample, having liquidated underperforming SOEs, established public-private partnerships and restructured its largest SOEs so that they can operate on fully commercial terms.

The experience of the Solomon Islands demonstrates that SOE reform is possible, but requires sustained political commitment to strengthen the underlying SOE legislation, resist the temptation to directly interfere in the business of the SOEs, and allow greater private sector participation in delivering the goods and services traditionally provided by government owned corporations. These reforms are also underway in a number of Pacific countries, and with increased public awareness of the rationale for and benefits of the reforms, it is hoped that the necessary political support can be garnered to see them implemented.