Accounting Magnitudes

Taxes and royalties. This heading deals with the following indicators (throughout this section, the superscript P refers to the public enterprise sector, the superscript F to the private sector, and the subscript t to a year):

The indicators are:¹³

Later in this section, it will be indicated how the comparison of TAXI PRF ratios (tax payments as a proportion of accounting profit) may lead to imputation of an implicit tax subsidy to the public enterprise sector.

Tax categories (subscript i) whose coefficients one might wish to scrutinize under this heading include (i) direct taxes (comprising company/corporation income taxes, excess profits tax, payroll taxes, land and real estate taxes, licenses); (ii) taxes on domestically consumed goods and services other than import duties, sales and excise taxes, which are excluded here—first, because the same or larger amounts could be collected from final consumers if the commodities were imported in finished form and, second, because their point of collection is arbitrary (import duties could be collected from private importers and included in prices charged to public enterprises, and excises could be collected from private retailers, in both of which cases public enterprise tax payments would be correspondingly lower for institutional reasons having nothing to do with operating efficiency); and (iii) export taxes and royalties on natural resource-based exports.

Increase in arrears of government payments for goods and services supplied by public enterprise. (Decrease =—.) This item, denoted $$AR{R}_t^P$$, could also be classified with public enterprise sector loans to government (subsection, “Lending to government by nonfinancial public enterprises,” below). One can define several ratios as indicators of the public enterprise sector’s exposure under conditions of Fiscal stringency. For example, $$AR{R}_t^P\text{/}DE{F}_t$$ denotes the proportion of the year t government deficit financed by increased arrears to public enterprises; and $$AR{R}_t^P\text{/}SA{L}_t^P$$ represents the proportion of sales to government not compensated by timely payment, compared with the analogous ratio for the private sector, $$AR{R}_t^F\text{/}SA{L}_t^F$$.

Payments of return on investment. The key items here are:

The point of departure in analyzing such payments is to compare them with the value of the investment on which they are earned. The obvious criterion value for the nominal return is unity plus the year’s inflation rate, times the difference between the annualized social opportunity cost of the public capital employed by the public enterprise sector and its direct tax payments (tax payments are subtracted, because social opportunity cost, based on the social discount rate used in benefit-cost analysis of public investments, is computed gross of these whereas interest and dividend payments, of course, exclude them).

The objection may be interposed here that determination of the appropriate discount rate by which to compute social opportunity cost of use of public resources is subject to a considerable margin of uncertainty, and arguments are advanced for widely differing values. On the other hand, the consensus of modern social opportunity cost theorists is that the low rate of social time preference by virtue of which society collectively sets aside a much greater proportion of available resources to benefit future generations than the average citizen would agree to independently is not an appropriate discount rate for government expenditure.

The vast majority of estimates focusing on returns available from application of public capital to expenditure opportunities available at the margin yield values ranging from 10 percent to 20 percent in real terms (net of inflation). Since few public enterprises in mixed economies yield anything approaching such returns to their governments on commercial operations alone, the thrust of public enterprise evaluation against the criterion value in question is clear and a few percentage points of uncertainty in the social discount rate do not alter the conclusion that the public enterprise sector in most countries enjoys a hefty capital subsidy.¹⁴

The ideal measure of the capital stock to which the social discount rate is applied for purposes of calculating annualized opportunity cost is the net present value of the stream of social benefits obtainable from the assets in question under conditions of “normal” efficiency. Historical cost, even when inflated as a proxy for replacement cost, is only a rough index of this ideal measure, which treats all past investment as a sunk cost. There is much to be said for it in theory, but its estimation across the public enterprise sector as a whole poses insuperable problems. A more practicable candidate for denominator in the rate of return calculation, notwithstanding the major computational effort involved, is the constant-price value of the public enterprise sector’s capital stock computed according to the methodology outlined in Appendix II. As noted in the subsection on the “Comparison of Adjusted Parameters with Criterion Values,” above, for use in the present context, capital stock is computed gross of working capital (mean level during the period in question) and net of construction in progress or investment still in a start-up phase.

Specifically with regard to government equity investment, it could be argued that the criterion value for comparison with return on investment should include an element of compensation for the risk and uncertainty associated therewith. Opposing this would be the consideration that, particularly in the current inflationary environment, an equity investor expects part of his return by way of capital appreciation; hence, not even the most demanding finance minister would call for dividend payments corresponding to the full opportunity cost of government’s equity.

This argument does not apply to loan capital. However, nominal financial charges that governments impose on their public enterprises are almost invariably below the social discount rate plus inflation, owing in large part to a widespread conception that one accelerates development by charging entities that carry out socially “desirable” activities less than they would have to pay to borrow on the open market, particularly considering the risk premium that the market would have to collect from many of the activities in question. Thus, direct loans to public enterprises from government treasuries, as well as loans from government-controlled development banks and other financial intermediaries, more often than not carry nominal interest rates that are below the inflation rate and, hence, are negative in real terms.¹⁵

In most developing countries this picture is not confined to government-run credit facilities, since government regulation of the private financial sector holds nominal interest rates in the formal money market below levels that would prevail under competition, which one would expect to compensate for inflation and risk while approximating the real social opportunity cost of capital.

Flows to developing countries from public credit institutions likewise contain subsidy elements ranging up to and even exceeding 90 percent in the case of long-term (up to 50-year), low-interest (below 1 percent or even zero) loans when service obligations are discounted by anticipated export price inflation plus a real capital opportunity cost of 10 percent or more. Such institutions generally require that portion of their assistance destined for commercial-type activities of public enterprises to be on-lent by the host government on “economic” terms, but the outcome of a bargaining process in which most recipient governments (and, of course, the participating enterprises) strive to keep the on-lending terms relatively soft is normally an effective interest rate well below the social discount rate.

Flows from private foreign lenders usually carry terms much closer to the domestic opportunity cost of capital, however, even in this case, the following caveats apply: (1) such loans, particularly the subcategory of supplier credits, sometimes carry a hidden subsidy in the form of source government guarantees that soften the terms of repayment; (2) a portion of the true financing cost is sometimes hidden in inflated prices of capital equipment acquired under other than international competitive bidding arrangements; and (3) it is in this category that one most frequently encounters nonfungible transfers, altering the cost calculus as described in Appendix II. (Asset purchase costs are deducted from the value of capital stock, and annual interest and dividend payments are added to the product of the social discount rate times the residual capital stock.)

In conclusion, there is no mixed economy whose public enterprise sector would not display a substantial shortfall against the proposed criterion value.

Perusal of budgets and investment programs over a number of years in several countries reveals that early optimism about the proportion of these that could be financed out of cash returns on government’s investment in public enterprises has faded. Today it is the rare national treasury that finances more than a trivial proportion of its investment budget from this source, other than via dividend payments more appropriately classified as royalties on natural resource-based output.

This suggests, as a second indicator with respect to cash returns on government investment in public enterprises, a comparison between actual outturn of $$IN{T}_t^P+DI{V}_t^P$$ and planned or budgeted values, $$IN{T}_t^{P*}+DI{V}_t^{P*}$$, suitably inflated to current prices. The latter figures may be available in summary form in annual budget and/or multiyear plan documents.

A related concept that applies to loan investment only is a comparison between the outturn of $$IN{T}_t^P$$ and the sum of products of loan balances outstanding times the respective contractual interest rates. Any discrepancy represents default of interest owed to government by the public enterprise sector.

Regardless of how far interest and dividend payments to government fall below the social opportunity cost criterion value, it may still make sense to examine a time series of the proportion that government is recovering in cash out of the annualized cost of its investment in the public enterprise sector. A marked trend upward or downward might be considered significant with respect to the authorities’ diligence or lack thereof in imposing financial discipline on the sector.

It is worth repeating here that the present conceptual framework stops short of prescribing remedies for shortcomings in public enterprise performance, and specifically with regard to payments of return on investment, it does not advise that every government should as fast as possible reorganize its public enterprise sector to cover the full opportunity cost of past investment. Depending on factors specific to a given country, it may well be that social goals would best be served by, in effect, writing off much or all past investment in public enterprise while stiffening the criteria for approval of new investment proposals. Indeed many countries, both developing and industrial, are at one or another stage of implementing such a policy, and many are being supported in that direction by their international creditors. It is nevertheless the paper’s thesis that evaluation of sectoral performance hitherto is a valid if not exclusive criterion for assessing the sector’s likely contribution to achievement of macroeconomic policy objectives in future, and that measurement of current returns on past investment is a major component of such evaluation.

Redemption of capital. Under this heading, the following terms are defined:

The second of these terms represents a comparatively rare phenomenon, as the movement is overwhelmingly in the opposite direction—government increasing its equity (or providing outright grants in lieu of equity) either to assist in expansion or to cover operating deficits. Where an enterprise’s cash flow would permit it to redeem shares without prejudice to financing its own socially beneficial expansion, most governments are inclined to channel the surplus into their own debt instruments or to tax it away via royalties, excess profits tax, etc.

Two indicators suggest themselves with respect to amortization of loan capital: first, a comparison of outturn with contractual obligations—payment arrears being represented by a negative result, $$AM{R}_t^P-AM{R}_t^{P*}<0$$—suggests problems of cash flow, lax financial discipline, and the like. Second, the presence of significant discrepancies between $$AM{R}_t^P$$ and depreciation allowances on account of the facilities financed by the public loans in question indicates either financing of medium-to long-term investments with excessively short-term capital or, conversely, a preferential arrangement that gives the borrowing enterprises financial leeway to increase investment out of cash flow or incur operating deficits. Either finding suggests an irregularity with respect to conventional standards; however, either practice may also be justified under special circumstances.

Lending to government by nonfinancial public enterprises. It is appropriate here to distinguish between medium- and long-term lending on the one hand, and purchases of treasury bills and other short-term instruments on the other hand as a component of normal liquidity management. To be sure, to any given program of medium-term and long-term lending mandated by government there will always be a corresponding equivalent rate of increase in purchase of short-term instruments, maintained over an adequate period of time.

Lending to government, denoted by $$LN{D}_t^P$$, suggests no special indicator other than the fact that a significant positive value means one of two things: either (1) certain components of the sector, from which we exclude financial institutions for purposes of this heading, are in a cash surplus position that enables them to help finance other government programs, or else (2) fiscal stringency has led government, after exhausting the resources of the financial sector, to compel public enterprises to buy its bonds or otherwise lend to it against their commercial interest.

Case (1) may raise a question as to whether government should not be appropriating the surplus through special levies in lieu of indebting itself with the public enterprise sector. Alternatively, it may be a matter of particularly creditworthy enterprises, such as petroleum producers, mining concerns, or electric power and telecommunications companies, borrowing abroad in excess of the residual of their investment needs less internal cash flow; here, it often makes economic sense for the enterprise to go ahead and borrow as much as it can, meanwhile investing the surplus in general government obligations.

Implicit Transfers

Two items deserve mention under implicit financial transfers from the public enterprise sector to government.

Expenses and revenue losses arising from pursuit of noncommercial objectives. $$EX{P}_{i,t}^P$$ denotes the expense or revenue loss incurred by the public enterprise sector in year t as a result of pursuing, by government directive (explicit or implied), a given noncommercial objective, represented by the subscript i (see list on page 45 which is amplified in Appendix I).

A host of methodological issues arise in measuring the financial burden of pursuing noncommercial objectives. How to estimate prices that would have prevailed in the absence of inflation control measures? How to measure optimum food stocks from a commercial viewpoint, as opposed to stocks held on government directive to ensure an extra margin of security? What are the extra costs of a crash industrialization program initiated by government, as compared with the baseline investment program that the pre-existing public enterprise sector would have carried out in accordance with commercial objectives? What are the real differences in costs between operating in less developed regions benefiting from government preference and operating in locations that would be chosen on the basis of commercial criteria?

Moreover, there may be honest disagreement as to whether pursuit of a given objective does, in fact, impose a financial burden on a public enterprise. What, for example, is the cost of localizing a management position (assuming as the baseline alternative that a foreigner would have occupied the post in any private facility established in lieu of the public initiative)? Nominal emoluments are normally far lower. Who would be bold enough to quantify the offsetting loss of revenue incurred as a result of the local manager’s allegedly inferior experience, skills, market contacts, etc.?

A standard approach to estimating EXP^p would be first to ask enterprise managers for documentary evidence concerning regulatory controls imposed on them, on the one hand, and, on the other hand, instructions received with respect to positive acts of resource allocation. The next step would be to sift through accounts to net out the impact of controls and instructions that the managers claimed had affected adversely their operating results. Such netting out involves not only subtracting costs and revenues attributable to the relevant measures, but also considering the disposition of the incremental operating surplus that would be generated by their cancellation.

For example, fiscal transfers identified above—tax payments or returns on government investment—might well increase. Alternatively, if the effect of the netting out is to reduce a pre-existing deficit rather than create or increase an operating surplus, an assumption is required, preferably buttressed by advice of management, as to what source(s) of deficit financing would most likely be released.

The exercise cannot, however, stop at documented measures of control. Enterprise managers may well attribute a portion of any losses to oral instructions, to decisions of their own in pursuit of general policy guidelines, or perhaps merely to their own supposition as to what course of action would be most in the public interest. These attributions must be verified with government officials, who will often counter that the enterprise managers are merely covering up for bad business decisions or inept management. Ultimately some exercise of the analyst’s judgment cannot be avoided.

A few countries have progressed in government-public enterprise relations to the point where, within the framework of a periodic (annual or multiannual) agreement,¹⁶ government acknowledges responsibility for covering a certain level of losses which the enterprise anticipates incurring in pursuing noncommercial objectives. Even where this approach is adopted, however, the authorities who negotiate such arrangements on government’s behalf may not be free to acknowledge the noneconomic motivations underlying certain instructions—for example, using an enterprise’s payroll as an instrument of political patronage, as distinct from the broader goal of curbing unemployment in society at large—so that the analyst may be obliged to augment the estimates of the financial burden. Still, under the pressure of negotiations leading to the agreement the parties normally gather much data that are useful in the analysis.

Introducing the EXP^P term into the fiscal balance does not trigger an offsetting entry in the reverse flow from government to the public enterprise sector, although the sector may already be receiving sufficient cash or implicit tax subsidies to cover the sum of its EXP^ps.

Below-market supply of goods and services to government. $$LO{S}_t^P$$ (“LOS” stands for “loss”) symbolizes a positive difference (if any) between the fair market or opportunity cost value of goods and services that the public enterprise sector supplies to government in year t, and what government actually pays for them. Having excluded the fair market or opportunity cost value of transactions from fiscal impact, one is obliged to enter this discrepancy as a flow from the sector. The criterion value is, of course, zero; any positive value of LOS^p is tantamount to imposition of an extralegal tax.

The reverse flow embodied in the accordance of preference to public enterprises in government procurement may be more common, however, cases of cereals marketing agencies supplying foodstuffs to civil servants below purchase and handling cost are numerous.

Accounting Magnitudes

Explicit financial flows from government to the public enterprise sector are grouped under three headings: (1) purchase of equity, (2) debt transactions including return on loans (from the public enterprise sector to government), and (3) unrequited transfers (grants and subsidies). Flows analogous to those in the subsection, “Financial Flows from the Public Enterprise Sector to Government,” carry the same notation, except that the superscript “G” denotes payments by, or changes in the financial assets of, government.

Purchase of equity (denoted by $$EQ{I}_t^G$$). Two indicators are of interest here: first, debt/equity ratios for the public enterprise sector as a whole, various categories of enterprises, and the sector’s current investment program or individual segments of it. Public enterprises and their individual projects are frequently undercapitalized, as governments strive to carry out ambitious investments with a minimum commitment of budget resources. Prudent debt/equity ratios differ sectorally and among categories of activities within a sector. Once a mean criterion value has been determined for the set of activities currently under implementation, divergence of $$EQ{I}_t^G$$ from that value (almost invariably in a downward direction) increases the probability of future claims on the budget and the money market, unanticipated in the activities’ initial planning, to forestall bankruptcy.

The second indicator pertains to the allocation of government transfers to public enterprises among equity, outright grants, and loans. Indiscriminate inflation of equity (or loan capital) on the occasion of every bailout operation enlarges the capital base against which returns are compared and may eventually create a misleading picture of low social profitability if the transfers merely served to compensate for pursuit of noncommercial objectives or were required during an atypical period of inferior management.

Debt transactions. Three items may be identified here.

$$LN{D}_t^G$$ denotes lending by government to the public enterprise sector. Relevant indicators are analogous to those under purchase of equity. In addition it is of interest to distinguish insofar as possible between external loans on-lent directly to public enterprises and all other government lending to the public enterprise sector. The first is a wash transaction with respect to its impact on the near-term fiscal balance, even though gross magnitudes are correspondingly enlarged and a government liability is created subject to some degree of probability that the exchequer will be called upon to make it good. (This latter point applies also to direct borrowings of public enterprises which are guaranteed by government, otherwise treated here as a monetary parameter under “The Monetary Impact of the Public Enterprise Sector” below.)

$$TA{R}_t^G$$ denotes increase (decrease = –) in arrears of tax payments from the public enterprise sector to government. It enters into the fiscal balance equation only insofar as the corresponding liability has been included in the TAX^p expressions of the subsection “Financial Flows from the Public Enterprise Sector to Government,” above, but even if it does not appear in the equation, it should be recorded as a memorandum item. A criterion value would be either zero or the ratio of increase in arrears to annual tax liabilities of a comparable segment of the private sector. An unfavorable comparison against the criterion value would cast the public enterprise sector in a burdensome light vis-à-vis the public finances.

$$AM{R}_t^G$$ denotes amortization of government borrowings from the nonfinancial public enterprise sector. In some countries, it comprises redemption of government securities held by nonfinancial public enterprises; in other countries, redemption of public enterprise loans to government follows a more ad hoc pattern (i.e., government pays when, and only when, decision makers perceive the marginal social utility of doing so to be no less than that of any alternative expenditure). if amortization lags behind contractual schedules, the public enterprise sector is being penalized all the more for its close lies to government.

Interest on government borrowings (denoted by $$IN{T}_t^G$$). Here one looks to see whether government is complying with its loan service obligations and what opportunity cost (by virtue of low—in real terms, typically negative—interest rates) government imposes on the public enterprise sector through compulsory borrowings.

Unrequited transfers (grants and subsidies) (denoted by $$SU{B}_t^G$$). This is a residual category grouping all transfers in cash or kind that do not qualify as payments for goods and services rendered, purchases of equity, or changes in liabilities. Given the heterogeneous nature of the animal, a varied set of analytical questions arises: what proportion, if any, of the transfers can be regarded as compensation for expenses and revenue losses incurred in pursuit of government-imposed noncommercial objectives? What rationale has been applied in allocating transfers to a given set of enterprises between $$SU{B}_t^G$$ and $$EQ{I}_t^G$$? In the preceding discussion of the latter component, reservations were expressed about the practice of loading transfers for extraneous purposes onto equity. The converse also applies—namely, that treating as “manna from heaven” what is essentially equity capital understates the asset value on which a positive real return should be earned.

It is, however, the implicit subsidy component of unrequited transfers that deserves the bulk of our analytical attention and to which the paper now turns.

Implicit Subsidies

Three items are identified here, of which the first two are tax subsidies. The first of these constitutes an implicit tax on the population that becomes an implicit subsidy to the public enterprise sector, because government allows the sector to retain it in lieu of handing it over to the treasury. The second implicit subsidy arises when government exempts public enterprises from taxation or levies lower taxes on them than on comparable units in the private sector. Finally, the third implicit subsidy arises because, as already noted, the public enterprise sector enjoys the use of public capital at a price well below its social opportunity cost.

Tax subsidies. The first entry under this heading is $$SB{T}_{1,t}^G$$ = implicit tax revenue retained by public enterprises, comprising payments to them by their customers—Final consumers or other producers—which, as a result of some governmental policy or act of commission or omission, exceed baseline levels. The baseline here consists of revenues that would enable a public enterprise operating at a “normal” level of efficiency to cover exactly the opportunity cost of its capital—that is, to earn a “normal” profit only. Conversely, revenues—provided they are facilitated by governmental action—that enable such a public enterprise to incur a smaller deficit than would otherwise be the case, or even to earn normal profit or better, are treated as implicit tax receipts.

The justification for this is that the present paper focuses on payments in excess of economic cost that are extracted from the public via exercise of governmental power and are devoted to a governmental objective—namely, strengthening the financial position of public enterprises. Formally, if not politically, government could just as well have mandated the payments in question and directed the enterprises to remit the proceeds to it as conventional indirect tax revenue.

Implicit tax revenues are generated principally by two categories of government policy, the first normally pursued via acts of commission while the second may be associated with either acts of commission or omission. The first category consists of protection of enterprises against foreign and/or domestic competition, the second involves lax control over prices of natural monopolies.

For enterprises producing tradable goods and services, the baseline or zero-implicit-tax case holds where selling prices of output equal unit costs of inputs (which may be protected or taxed well above border price levels) plus unit value added (in the enterprises) reflecting a unit domestic resource cost (DRC) of earning or saving foreign exchange—units of local currency expended on local factor services consumed in producing one dollar of value added at border prices—equal to the shadow exchange rate.

In the case of nontradables, it is appropriate to distinguish goods and services whose production and distribution permit competition and the so-called natural monopolies. With the former, the baseline case corresponds to free competition, ensuring “normal” profits to firms operating at an efficiency level determined, by whatever means are available, to be “average” for the economy in question. Accepting the scope that public utility regulation allows for overinvestment and inefficient operation, the baseline case for natural monopolies is defined as a set of average prices such that production and consumption end up at approximately the level determined by the intersection between the demand curve and an average total cost curve considered by the regulatory authority to reflect reasonable efficiency. Determining such baseline prices is, of course, a standard task for regulatory entities, who have to judge what constitutes reasonable utilization of labor, capital, and purchased inputs to obtain a given level of output. Earning a level of average revenue that meets these criteria does not rule out the use of marginal cost pricing at the margin, since enterprises may still engage in sufficient inframarginal price discrimination to avoid losses or supernormal profits.

Once baseline prices are determined, the implicit tax revenue is given by the area of the rectangle defined by the intersection of the actual price line and the demand curve, and the horizontal line through the baseline price. Graphically, the implicit revenue, which then becomes an implicit subsidy to the public enterprise sector, equals the area bounded by p_aABp_b in Figure 1.

View Full Size

—Collection of Implicit Tax Revenue by Public Enterprises

Explanation: The baseline situation is defined as the establishment, by the regulatory authority, of an average selling price that enables the enterprise to cover the social opportunity cost of all factors, which includes earning a “normal” profit. In the actual situation shown, the regulatory authority is permitting the enterprise to charge a higher average selling price and thus to earn “supernormal” profit. The shaded area represents the implicit tax collected by the enterprise.

• Download Figure
• Download figure as PowerPoint slide

View Full Size

Explanation: By levying an indirect tax equivalent to p_a-p_b on imports of the good or service in question, or through quantitative restrictions limiting the quantum of imports, the government has brought about an actual domestic selling price of pa. As in Part I, the shaded area represents the implicit tax thereby levied on behalf of the public enterprise.

• Download Figure
• Download figure as PowerPoint slide

The second tax subsidy applicable here, which we term a “conventional” tax subsidy, is $$SB{T}_{2,t}^G$$, representing the value of any preferential lax treatment accorded to public enterprises. In some countries, varying proportions of the sector enjoy exemption from company tax, import duties, and/or other indirect taxes, or lower tax rates compared with the private sector as a whole. As in the computation of implicit tax revenue, it is necessary first to determine a baseline against which to measure the degree of preference involved.

This exercise is subject to two major complications. First, remaining within a partial equilibrium framework, the tax treatment of private companies often varies according to size, economic sector, and other characteristics. One might seek to establish the effective tax rates applied to the majority of private enterprises or to those enterprises accounting for the major share of the base for a given tax. Or one might calculate a mean yield from the application of a particular tax to private sector earnings or transactions.

Second, as one moves into a general equilibrium framework, it becomes necessary to take account of the fact that removal of tax subsidies from public enterprises would reduce the pressure on other points of the tax system, including taxation of private companies (another effect, assuming continuous behavioral functions, would be to stimulate supplemental expenditure). Thus, the baseline company tax against which the implicit subsidies should be measured is, in fact, lower than any that might be computed on the basis of de jure or de facto tax rates.

Any discrepancy between actual taxes paid by a public enterprise and the baseline, however determined, would then be considered an implicit subsidy from government to the enterprise (and would, of course, have to be balanced by expansion of enterprise direct tax payments as a corresponding entry under reverse flows).

It goes without saying that before computing conventional tax subsidies in the case of natural resource-based sectors, any portion of rents which is captured in the form of direct taxes rather than royalties and the like must be deducted from direct tax payments and treated as an implicit royalty.

The capital subsidy to public enterprise. This implicit subsidy, labeled $$SB{C}_t^G$$, is essentially the difference between the criterion value for payment of returns on public investment and actual payments to government on account of interest and dividends, which was elaborated in the subsection “Payments of return on investment.” As indicated in that discussion, most public enterprises enjoy a substantial subsidy on account of their use of the services of public capital; frequently, it exceeds the total of all other annual operating costs.

The approach followed here and in the subsection “Payments of return on investment” takes the history of government and financial sector capital infusions at face value and looks at the adequacy of the returns they are currently generating as compared with the social opportunity costs of those infusions.

An alternative approach, focusing exclusively on the capital stock’s present earning power, would seek to provide a normative basis for evaluating the macroeconomic performance of the public enterprise sector’s current management. The implicit subsidy calculated in this case measures the shortfall between what the sector is actually earning on its invested capital and what the analysts consider to be its true earning power, with due allowance made for the low or zero productivity of misguided past investment. In other words, with this approach, one seeks to avoid saddling current enterprise management with the responsibility for earning a return consonant with the social opportunity cost of capital on past losses in excess of reasonable startup costs, as well as on politically and socially motivated expenditures of the past. Clearly, the process of netting out such expenditures is subject to a wide margin of uncertainty; but in some of the more blatant cases, reasonable observers might agree on the order of magnitude of the invested capital to be written down.

The question arises as to how adjustment of the “subsidy” entry in Table 1 to incorporate the implicit capital subsidy or attribution of a portion of before-tax profit to implicit tax revenue in the case of monopoly pricing would affect the national income aggregates discussed in “Summary Accounts of the Public Enterprise Sector.”It turns out that these changes do not affect sectoral GDP at market prices, in the first case because introduction of a capital subsidy increases the financing charges/operating surplus pari passu, in the second case because treatment of part of profit/operating surplus as implicit indirect tax revenue merely shifts the sum in question from one component of value added/GDP to the other.

On the other hand, modification of either the subsidy or the indirect tax component affects the transition from market prices to factor incomes—upward adjustment of subsidies increasing GDP at factor cost and higher (implicit) indirect tax revenue decreasing it.

Adding a time dimension to analysis of the capital subsidy received by the public enterprise sector puts its importance, and the corresponding implicit fiscal burden on government, in even bolder relief. The discussion in this paper has hitherto been restricted to flows and stocks pertaining to a particular discrete period, typically one year, during which it is desired to evaluate the public enterprise sector’s performance. However, the provision of public capital to enterprises is customarily a contractual arrangement in which government either binds itself explicitly to accept a specific rate of return over a period of years, sometimes indefinitely, or else renounces any entitlement to a specific return (case of equity capital) and, in many cases, by precedent as well as by current policy, signals to enterprise management that, far from expecting a financial return in the foreseeable future, it will be relieved if the enterprise can survive without periodic operating subsidies.

In either of these cases one can define the present value of an implicit stream of future subsidy payments to which government is committing itself, contractually or de facto. The stream consists of annual differences between the social opportunity cost of capital, as defined in “Payments of return on investment” above, and the interest payments stipulated in the loan agreement, or the expected flow of dividends in the case of equity capital. The social discount rate is applied to calculate present value. The ratio of present values of (1) the subsidy stream and (2) the disbursement stream of the loan or equity investment constitutes the grant element of the instrument in question. A new paper tabulates this grant element on varying assumptions about loan terms, and shows that explicit interest subsidies in Korea’s direct official lending (not only to public enterprises) during the 1970s accounted for a minimum of half the central government budget deficit.¹⁷