An Overview of the Historical Use of Public

An Overview of the Historical Use of Public Enterprise The Development of Public Enterprise January 14 th

Crown Corporations n n They existed prior to Confederation The first was the public works board of 1841, to build the canal system in Upper Canada Also used for the administration of harbors The first major Crown was the CNR in 1918 n Formed after the collapse of three railways

Crown Corps n 1930 s saw more n n 1932 CBC 1934 Bank of Canada, Canada Wheat Board 1937 Trans. Canada Airlines (Air Canada) Provinces were also involved early n n Ontario Hydro 1906 Telephones in the 1910 s in most provinces

WW II and Post War Era n n 28 wartime Crown Corporations established employing some 230, 000 people or more than one sixth of the entire manufacturing workforce. At the end of the war some were sold to private investors, some were dismantled and the government retained ownership of some. By the beginning of the 1950 s there were only around 30 federal crown corporations In 1952 the government passed the FAA which was to regulate the financial affairs of the Crown corporations and there relations with the federal government.

Crowns n Canadian Nationalism saw another wave in the 1960 s n n Canada Council, National Arts Center, Canadian Film Development Corporation National Film Board There was another wave in the 1970 s n 50 Crowns created in the Trudeau era for job creation , economic stabilization and nationalism n Petro Canada, Export Development Corporation, Cape Bretton Development Corporation etc.

Crowns n Provinces got heavily involved in the 1970 s n n n Province building was facilitated by Crowns Sask and Quebec were the most active but others were also involved Quebec was aimed a building a nation Sask had two eras in 1940 and 1970 s, one was utility based the other was resource based. A reasonable return for resource ownership All provinces use them for a variety of policy purposes

Federalism was a factor n n n Federalism changing from the old centralized version of the war years and immediate war years to one in which the provinces began to challenge Ottawa. Provinces were not happy with Ottawa imposing its priorities on them PE appeared attractive to governments with concerns about jobs, regional economic diversification, and export promotion.

Federalism n n n Job creation and economic stabilization were the reason the federal government created the Cape Breton Development Crorporation Provincial governments were equally aggressive “Province-building” was the response to uneven development due to the nature of the market. Provincial government wanted to ensure that the province realized an appropriate return form its ownership of natural resources All provincial government established development corporations to attract industry to their jurisdiction.

Public enterprise n First and Second Generation Public Enterprise created since 1945 n First Generation: created passively and actively n n Passive: industries in decline, prevent the collapse of economy after the war Active : Nationalization of the “commanding heights” some of it was punative dealing with wartime collaborators

Public Enterprise n Five Basic Reason for the First Generation of Public Enterprise n n n 1) socialist economic policy 2) social and consumer interest 3) salvage uncompetitive businesses 4) punitive nationalizations of wartime collaborators 5) promotion of advanced technology Only two and five guidelines

Public enterprise n With strong Keynsian policy, public enterprise declined because of: n n n New emphasis on direct expenditure Direct stimulus through monetary and fiscal policy But by late 1960 s and early 1970 s, a second generation emerged with participation in viable rather than failing businesses

Public Enterprise n Why? Two reasons n Contradiction in the pattern of national economic growth n n Structural unemployment, regional unemployment, and sectoral under investment Changing International Political Economy n n EU, multinational corporations, need for equity finance to deal with external competition Reassert control of the economy.

State Intervention in Canada n Government always plays a role in the economy n n n Transportation infrastructure Intervention came in the form of outright construction and the bailout of bankrupt firms Canada’s role as a producer of staples, distorted economic structures n n Created rigidity and over-investment in transportation infrastructure Canadian economy subject to violent shifts in international economy

State Intervention in Canada n n n Canada has lots of resources, but great distances thus transportation is crucial As a colony, Canada also lacked a strong free enterprise spirit and accepted state intervention As a late industrializing nation Capital accumulates too slowly thus state involvement was necessary

State Intervention in Canada also has a problem with dependent industrialization n n We lag behind the US due to staples economy American aggressiveness lead to “defensive expansionism” The role of the state was a challenge to the US Need for state interaction based on economic stimulus and territorial integration. Provinces joined in with cheap power and telephones and rural electrification

State Intervention in Canada n n Some have argued that Canada was a public enterprise nation This is how we built the nation Canadian business have been quick to press for government intervention and assistance in economic ventures All explanations rely on some geopolitical explanation for the large role of the state n Geography, climate, small populations, insulation against American interests all point to “defensive expansionism.

Economic Development and State Intervention n What explains public enterprise in areas of production n n Petro-Canada, Aircraft Manufacturing, etc Three Factors n 1) trade dependent with weak manufacturing n n n Relied on import substitution 2) reliance on imported production processes 3) federal system of government with uneven regional development

Public enterprise n n n Not all market failure have resulted in public enterprise Each country and province has a calculus of instrument choice but some regularities exist Found in similar sectors: n postal service; railway; telecommunications; gas; electricity; airlines

Public enterprises n n Ownership of the residual interest in state enterprises is compulsory for taxpayers and is non-transferable Ownership by government means interest is typically very heterogeneous. n n Governments represent different groups with very different and often conflicting interests in the enterprises. By contrast, owners of private enterprises typically have a single homogeneous interest, the value of the firms and hence their equity. Government is no ordinary owner. Governments can and typically do – use their regulatory and taxing powers to extend special privileges to their own enterprises. This is a common feature of SOE’s they are given special privileges and have non-commercial obligations placed upon them.

Public Enterprises n Mixed objectives: Multiple principles n They are typically asked to meet non-commercial as well as commercial objectives. The list of non-commercial objectives is very divers 1. 2. 3. 4. 5. redistributing income subsidising particular regions and sectors earning foreign exchange generating employment increasing the probability that the government in power will be re-elected.

Multiple Objectives n Some have only commercial objectives, but most face conflicting or multiple objectives. n n A focus on commercial objectives are either not implemented or do not persist. Statutory objectives: n n n Few PEs are given only commercial objectives when they are established. Most PEs are established with vague or conflicting objectives. Mixed objectives and weak taxpayer interest in commercial performance give management, and their political masters, considerable scope to be responsive to groups with a politically active interest in the operation of the enterprise.

Public Enterprise n Ongoing intervention in SOE management n n n More than objectives is the influence of legislative intervention Ministers have powerful format powers such as to appoint and remove board members, to give direction of a general character to management and to approve significant financial commitments. There also significant informal powers?

Evidence on Public Enterprise Behaviour n n Evidence suggest that PEs place considerable weight on non-commercial objectives. Studies of production, pricing, employment and investment decisions of PEs suggest that they are responsive to groups with a politically active interest in the operation of the enterprise. n Consumers, suppliers, employees have more power than taxpayers.

Special Privileges: The Problem of Commitment There are may special privileges extended to public enterprise Protection from competition Under priced natural resources Tax exemptions Lower financing costs and or sales preferences from government

Special Privileges n Special advantages may not give public enterprise a competitive advantage n n Because of the special burden imposed by non-commercial objectives. The fact that PEs have to meet costly non-commercial objectives is likely to be the reason that they are extended special privileges in the first place. Governments may also choose to extend privileges or benefits to private firms faced with collapse a government can extend privileges to private enterprises and regulated private enterprise is often the practical alternative to public ownership.

Why Choose Public Enterprise n 1. Four reasons why legislators might prefer SOEs over subsidised or regulated private providers. It may in some cases be difficult to define or reach any agreement on the exact nature of non-commercial objectives. n n Non-commercial objectives may become clearer over time, of they may evolve over time, and legislators know that it will be easier to interfere in the affairs of public enterprise than private enterprise.

Why Choose Public Enterprise 2) The redistribution achieved by a PE through pricing, purchasing, production, employment and investment decisions is typically less transparent than it would be with either subsidy or regulation n SOEs transfer is less transparent 3) Private enterprise will weaken the position of the residual claimant relative to other groups with an interest in the enterprise. n private firms will want to return to shareholders as much of the benefits generated by the special privileges as then can and do as little to meet non-commercial objectives as they can get away with. SOEs can reduce agency costs?

Why Choose Public enterprise 4) The commitment problem: n Private enterprise is much more adversely affected by the political uncertainty surrounding the durability of special privileges for at least two reasons. n n A state-owned enterprise is likely to be seen as a more legitimate recipient of special privileges, as least in part because of the perception that the benefits will not simply be captured by private shareholders. This in turn will reduce the risk that special privileges will be short-lived.

The State as Investor Ken Rasmussen Part 2 January 14 th, 2004

The State as Investor n n When and why does the state become an investor Public private partnerships is not new n Federal government has equity in 400 companies n Governments are often involved in firms, through the provision of loans, grants for r and d n But equity is something altogether different n n Ownership shares confer rights Equity allows more participation in the share sales Equity confers the right to benefit from the distribution of assets in the event of liquidation equity confers the right to share in profits distributed through dividend payments upon the decision of the Board of Directors

The State as Investor n n Equity can be a highly discretionary instrument of policy if government capital is directed towards specific sectors, categories of firms and or individual companies. European governments have sought to use investment to redeploy factor’s of production, to enhance competitiveness, and promote winners Ottawa, has used equity investment in a reactive manner -- a problem solving devices Que. and Alberta, have had a positive investment strategy n used portfolio investment both to generate revenues and to serve the goal of regional economic development

Purposes served by investment Return on Investment n Sometimes the government is purely interested in making money Security n Government acts as an investment banker n n n Minority equity is used to provide insurance to creditors This is particularly so in the small business sector FBDB, SOC- -- lender of last resort Acquire good or Service n The subsidiary investment of a wholly owned crown corporation

Purpose served by investment n Incentives n n n Strategy n n n New capital can serve as a spur to the enterprise Government can use equity to induce a private investor by sharing the risk Sometimes, the government has an overt strategy of economic development. Defensive expansion of Telsat is a case in point Problem solving n n Frequently government is drawn into share ownership by default Sometimes plans go screwy and government must take up the slack.

Towards and Investment Strategy n The Canadian Development Investment Corporation (CDIC) n n n instrument created to hold the government’s equity investments It was also created out of the governments disillusionment with CDC CDIC would hold the government’s investment in CDC until it was a favourable time to sell. CDIC quickly moved from a numbered holding company holding CDC shares to a Crown Corporation following cabinet investments instructions to a holding company with $12 billion in investments

CDIC n n n n First President was Maurice Strong, who wanted to move away from reactive investment CDIC was incorporated under the Canadian Business Corporations ACTS in May of 1982. Its broad objective was to “assist in the creation of development of business, resources, properties and industries of Canada. Would invest in any business likely to benefit Canada. No private body could hold shares in CDIC. Yet CDIC was neither an instrument of policy nor for targeting new investments nor for privatising government investments. CDIC was used principally to rationalise state-owned enterprise in crises so as to avert their financial collapse and to divert political pressure by showing a new “business like” management.

Provincial State as Investor n n Provincial investment strategies 3 factories favour a more active role for government as an investor n n n economic opportunity ie windfall profits from resource industries. intergovernmental conflict of interest ie federal taxation, pricing or regulation policy that harm a provincial treasury strong political leadership

Alberta n Windfall profits brought two concerns n n n an investment strategy that would optimise the use of these funds. overcome the vulnerability of a regional economy that would be tied to the fortunes of a volatile commodity Created the Alberta Heritage Savings and Trust Fund n n n The strategy was based on the gov’t commitment to free enterprise It was designed to reduce dependence on oil and gas The government could have simply used the revenue to reduce the level of taxation, but chose to become an investor

Alberta n Could invest in: n n n n (1) capital projects that would provide long-term economic or social benefits, but not profits (2) loans to other governments (3) those that strengthen and diversity the economy, while giving a reasonable return on profit (4) investment in debt instruments such as bonds and blue chip corporations No equity investment at the start, but this would alter The decision-making body was the Heritage Savings Trust Fund Investment Committee which consisted of cabinet ministers Fund did make equity investments, which angered the extreme right in the province and the party Cabinet set guidelines that restricted the shareholdings to 5 percent of any company, they would not seek membership on the boards of companies.

Joint Ventures n n n n Joint Ventures are a particular type of state enterprise Governments- public enterprise and businesses pool their resources Each of the partners has an equity participation in the venture that is not readily transferable, and thus a voice in policy The use of joint ventures implies that n n n there is a project or activity that government wants to see carried out private-sector resources, capital, technical, or marketing expertise, which means 100% state control is not feasible factors exist which preclude the private enterprise from going it alone.

Joint Ventures n The joint venture has a strong appeal n n It looks like a good way to promote economic growth Because they only put up part of the money, governments can stretch out their money and thus have a greater overall impact on the economy Governments also get access to technical information and get a better ideal about the running of a particular industry. Joint ventures became the most prominent form of state capitalism in the 1980 s.

Joint Ventures n n n Many provinces remain reliant on the revenues generated by resource development most joint ventures cluster around the resource sector and involve provincial governments weak manufacturing base, that continue to have a high reliance on resource exports federal system means provincial governments focus there growth strategies on regionally specific comparative advantage Joint ventures in the resource sector are largely used for province-building To stimulate exploration and development of mineral deposits which will, in turn create jobs and general revenues.

Joint Ventures n Private companies also get benefits n n n they can benefit from governments experience reduce financial exposure reduce political risk joint ventures in resource sector popular with all parties. wise to collaborate with the provincial government since they own the resources. becoming involved in a joint venture has attractions for a foreign investor who can overcome regulatory barriers to foreign ownership

Saskatchewan Mining Development Corporation n n n SMDC a classic joint venture vehicle Started by the NDP in 1974 to engage in all phases of mineral production and the sale of minerals found in Saskatchewan SMDC was a wholly owned corporation created by the NDP SMDC invited private corporations to approach it to participate in joint ventures Voluntary participation became mandatory Within a five years SMDC became a major player in the Saskatchewan mining industry, spending one of every three dollars fore exploration in the provinces

SMDC n n n Two biggest mines Key Lake and Cuff Lake Key Lake Mine a joint venture between SMDC (50% ) a German company and the federal governments Eduardo nuclear. SMDC has had a wide variety of partners and has learned a great deal. It gave SMDC experience in marketing uranium. The reasons for the easy relations between SMDC and its foreign partners includes n n n 1) the relatively underdeveloped state of the uranium industry 2) the availability of capital for SMDC reducing costs of exploration 3) the involvement of foreign owned companies that were themselves state owned and were used to dealing with other state owned enterprises

SMDC n n SMDC owned rich, low cost uranium and made a profit of over $60 million in 1987. Government wanted to privatise SMDC, but was forced by the federal government to merge with Eldorodo Nuclear, and sell both of them at the same time as CAMACO The plan to merge was much more beneficial to Elderodo, than SMDC, given the very difficult histories of the two companies. SMDC was a strong company with excellent prospects. It had assets in 1987 valued at $914 million, with revenues of $194 million.

SMDC n n The company was not hampered by excessive debt load, and the debt to equity ration was 1. 4: 1 SMDC had very desirable properties Eldorodo was less than a winner for a variety of reasons. Despite being mismatched, the government ordered them merged into a new company called CAMECO which was created in Oct 1988.

SMDC n n n $1. 6 billion in assents and 61. 5% owned by the government of Sask, and 38. 5% by the government of Canada The plan was to privatise CAMECO in stages - 30% within 2 years, 60% within 4 years and 100% within 7 years. Individual Canadian investors were limited to 25% of the shares and non-Canadian to 5%. In addition non-Canadians were to be allowed a maximise of 20% of voting stock and Sask was gong to press the head office to stay in Sask. There were quick howls from the financial community that the restrictions were too limiting. The late 1980 s was a bad time to sell as uranium was a the bottom of the cycle.

SMDC n n n 130 reactors under construction around the world, but were coming on stream in the 1990 s Mining companies were planning new mines, but the government was disposing of its mines at a time when the industry was in a down turn. The timing of the privatisation was bad, but it would also do nothing to improve the efficiency of CAMECO The Selling of SMDC also would deny the government a window which would allow it to set taxes. Crown ownership and effective taxation and regulation were two parts of the same coin. Another factor was the unique situation of uranium production itself.

SMDC n n n Issues of health and safety better handled through PE? Social policy objectives in ensuring that the native population received benefits. This of course costs money and contradicts the shareholders desire for profit. SMDC had begun to diversify and vary its base SMDC had 30 joint ventures with other companies the promising being in the area of gold.

Conclusions n n Collaboration is the norm in joint ventures as both parties expect something in return. Crowns are an attractive way to invest with private capital because n n project specific investments can be made incentives can be proffered to a large number of private companies divestment can be undertaken or monies written off with the same political visibility and without recourse to the bureaucratically centred procedures that constrain a wholly owned crown corporations It is logical to focus on vehicles other than traditional state enterprises which ties up capital and has statutory limits on activities and investments.