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Rebalancing the State’s Balance Sheet

By A. Michael Spence, William R. Berkley Professor in Economics & Business

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It is important that more attention is now paid to public liabilities – not only growing sovereign debt, but also larger, non-debt liabilities embedded in social-insurance programs.

Until recently, relatively little attention was paid to states’ balance sheets. Measurement and reporting were neglected. Even today, states’ liabilities receive considerable attention, while their asset sides receive significantly less.

In an earlier era, states owned substantial industrial assets. This “commanding heights of the economy” model was rejected largely because it seriously under-performed, especially when state-owned sectors were protected from competition (as was the norm). Efficiency declined. But, more important, the absence of entry and exit by firms, a key ingredient of innovation, caused dynamism to suffer and losses to grow over time.

The model’s shortcomings led to privatization in many developed and developing countries. In Europe, privatization was viewed as a key step in the integration process. The theory, in Europe and elsewhere, was that states could not be impartial owners of industrial assets. Through regulation, public procurement, and hidden subsidies, they would favor their own assets.

Of course, state ownership is not the only way to impede efficiency and dynamism. Regulations in a range of countries, from Japan to Italy, create sectors that are sheltered from competition, with detrimental effects on productivity. This pattern is particularly pronounced in the non-tradable sectors (which account for two-thirds of the economy), where the discipline of foreign competition is absent by definition. Even here, foreign-based domestic competitors could improve performance.

Read full article as published in Project Syndicate.