Summary of WP/92/79
“Private Sector Development in State-Dominated Economies” by Aasim M. Husain
A rapid expansion of the private sector is widely considered to be a key element in the economic transformation of Central and Eastern Europe. Although these economies have undertaken significant reforms, state-owned enterprises continue to produce a significant share of output. Because state-owned enterprises are not subject to bankruptcy and the resulting loss of future profit opportunities, they tend to overemploy nontraded factors of production, such as labor.
This paper analyzes the effect of state-owned enterprises on equilibrium levels of input employment and output of private firms. Use of a significant share of inputs by state-owned enterprises causes the market-clearing input price to rise. As a result, private firms’ profit margins are reduced, and the equilibrium number of firms in the industry, as well as each firm’s output, declines.
The framework developed in the paper allows for an interesting analysis of the impact of policy changes. Whereas policies that result in a reduction of the number of state-owned enterprises--such as those that “harden” enterprises’ budget constraints --have a negative impact on industrial production in the short run, the market price of inputs declines, and the profitability of private firms increases. This induces more firms to enter the industry, and, in the long run, total output increases.
If financial policies can be designed to bring about a sustained depreciation of the real exchange rate or improve the efficiency of credit markets, the implementation of such policies improves the competitiveness of all firms and leads to an increase in output in the short run. In the long run, however, the resulting rise in factor prices may induce firms to exit the industry and could result in a decline in total production.