Chapter

3 Efficiency of Public Investment: Lessons from World Bank Experience

Author(s):
Saíd El-Naggar
Published Date:
March 1990
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Author(s)
John W. Wall

The efficiency of public investment is quite a relevant and timely subject in Arab countries, because the public sector invests heavily, and because all resources for development are becoming increasingly scarce. In these countries, public investment is high both as a proportion of total investment and as a percentage of gross domestic product (GDP). This means that in the long run the growth of output, the standard of living, and welfare crucially depend on the efficiency of public investment. As Arab countries have adjusted to the reduced inflows of foreign resources that started in the early 1980s, the tendency has been to reduce public investment, meaning that maintaining any semblance of past growth rates depends on increasing the efficiency of the investment that remains.

The appendix contains graphs that allow comparisons of public investment as a percentage of GDP in selected Arab countries and a group of 30 comparator countries (Pfeffermann and Madarassy, 1989). A glance at these graphs indicates that many Arab countries have higher levels of public investment than most other countries, and that most countries, Arab and non-Arab alike, have experienced a declining trend in public investment in the 1980s. Growth rates of GDP and total investment have also fallen over the same period, in some cases to less than the rate of population growth, implying that living standards are falling. This is an unsatisfactory state of affairs. Reversing these trends in the face of scarce resources for development will require substantial improvements in the efficiency with which available resources are used.

The relevant issue is not whether to undertake public investment, but under what circumstances is public investment efficient. While there is some literature that directly compares the efficiency of public and private investment (Balassa, 1988), in modern economies some level of public investment is inevitable to create the environment and infrastructure necessary to make economic activities of all kinds possible and more efficient. This paper addresses two related issues: what is the appropriate mix of public and private investment; and what criteria can be used to ensure that the public investment is efficient.

The World Bank undoubtedly has had more experience in reviewing public investment plans and their implementation than any other organization in existence (Kavalsky, 1986). Over the past four decades, World Bank staff regularly have reviewed the public investment plans of its borrowing countries, and now conduct perhaps 10–15 such reviews a year. There have been such reviews in many Arab countries—during the 1980s at least once each in Egypt, Jordan, the Yemen Arab Republic, the People’s Democratic Republic of Yemen, Bahrain, Morocco, Tunisia, and Algeria. In conjunction with its project lending, often directly to governments for public investment, the Bank closely scrutinizes individual investment projects, works closely with implementing agencies, and follows the progress of projects it helps fund with regular field visits. The research departments of the World Bank have undertaken cross-country macroeconomic and sector studies of the experience with various forms of public investment to draw lessons learned in one context for assistance in finding solutions to development problems in another. The experience built up through this effort has led to an appreciation of how diverse individual country situations are, but also to some firm conclusions as to what leads to efficiency in public investment.

Establishing Priorities for Public Investment

Basic Governmental Responsibilities

The most important step in ensuring the efficiency of public investment is choosing the appropriate mix of public and private investment in the first place. (The World Bank’s 1988 World Development Report discusses this general area in some detail.) Efficiency depends as much if not more on what the public sector chooses to do as on how well it does it. There is a wide spectrum of experience among countries with respect to public ownership, organization, and control of economic activities; some countries have minimal involvement in the direct provision of goods and services while the involvement of others is pervasive. As in most other aspects of life, there are trade-offs that are reconciled differently in different situations. Most would agree that public ownership and control involve a dilution of incentives to husband resources with care, resulting in welfare losses. Most also would agree that some economic activities, those that display inherent externalities, natural monopolies, or other types of market failures, cannot be left to the unfettered operation of market forces. The very existence of governments is a recognition that some activities are best handled as public undertakings. The challenge is to identify those activities and organize them in the most efficient way possible, fulfilling governmental responsibilities to create a favorable environment in which human welfare can flourish.

Public organization of various activities can be seen as a continuum, ranging from the least controversial type, which almost all would accept as governmental responsibilities, to the other extreme, which most would agree is better left to private initiative. At the beginning of the continuum would be basic defense services, maintenance of law and order, supply of justice, control of money, establishment of standards, funding of basic research, and collection and dissemination of basic statistics and information. A little further on, but still at the noncontroversial end, would be the governmental provision of social services—education, health, and poverty alleviation—often in conjunction with private organization of the same or similar services in the private sector. Basic physical infrastructure—roads, water supply, telecommunications, electricity, flood control, irrigation, and sanitation facilities—is almost everywhere subject at least to pervasive public control and often public ownership and investment.

These public responsibilities are perhaps the most basic undertaken by most developing countries. They should constitute the priorities for public investment. Where there are constraints to resource mobilization for public investment, these should become the core of investments to be protected in times of resource scarcity. Spending too little on basic government services while spending too much in areas that the private sector could have served is perhaps the biggest and most costly loss of efficiency in public investment.

World Bank staff have conducted research into the question of whether public investment is complementary or competitive to private sector investment (Chhibber and van Wijnbergen, 1988). On the macroeconomic level, public and private investment clearly compete for the same resources. Higher public investment requires either increased foreign borrowing or higher private sector net saving, requiring higher domestic interest rates. Either of these means of financing in a world of scarce resources means lower private sector investment. The question returns to which sector makes better use of the resources. Chhibber and van Wijnbergen show with quantitative analysis that in the case of Turkey public investment in infrastructural activities (broadly defined to include expenditures on health and education) is largely complementary with private investment; and public investment in noninfrastructural activities crowds out private investment and reduces overall rates of return to investment. Public investment of the right kind reduces the costs of private activities and creates the conditions for higher private sector profitability.

Public Sector Enterprises

Many developing countries have gone further along the public-private continuum to set up public sector enterprises (PSEs) to undertake a plethora of activities. Some Arab countries—Egypt, Algeria, and the People’s Democratic Republic of Yemen—developed public sectors that were dominant in most areas. In the more recent past, as a result of disappointing performance by PSEs, these three countries have started to move back from the extreme public sector end of the continuum by encouraging the private sector to take on more responsibilities, although a very large part of economic activity still remains under public control.

Ironically, many PSEs originally were set up to make governmental activities more efficient. That is, activities that were at first handled by government departments that were separable functions (for example, electricity or oil production, railways, hospitals) were spun off from the government itself to create a more businesslike environment. The idea was to protect these entities from political interference by separate budgets, cost accounting, cost recovery through pricing, rational employment policies, and management autonomy and accountability. The present-day problems of many of these PSEs attest to the difficulty of actually protecting these entities from political interference, despite the original intentions of doing so.

Often, countries expanded public ownership and control beyond those activities with strong externalities or natural monopolies to others that are elsewhere left to the private sector. Examples of these are production of steel, cement, and fertilizer, road transport, agricultural marketing, housing, health care, and commercial banking. The rationale used was some mixture of the following: appropriation of surplus, the size of the minimum investment required, the large impact of the produced items on consumers’ budgets, and the lack of private initiative. Comprehensive and ambitious development planning often led to the establishment of such PSEs, as it soon became obvious to planners that, left to its own resources, the (often incipient) private sector was not forthcoming in fulfilling the investment plans as formulated.

Experience with Public Sector Enterprises

The experience in developing countries with large-scale public investment in productive enterprises has not been an altogether happy one. While there are examples of efficient, financially viable, and flourishing PSEs, there are also many examples of the opposite. World Bank staff have often been requested to review the experience of public sector enterprises by the governments involved, such as a major study done recently on Egypt. World Bank research staff have distilled lessons from many such studies in papers that indicate a pattern of similar problems (World Development Report, 1988 and Shirley, 1989a).

Despite the desire to provide a businesslike environment for their operation, governments tend to saddle PSEs with mixed mandates, including not only financial targets but also social objectives that often conflict with the efficient operation of these entities. Governments find many reasons to control the output prices of PSEs—to protect vulnerable consumers, fight inflation, and maintain low input prices for other PSEs. Governments also seek to influence employment policies for social objectives such as general employment generation, placement of unemployed university graduates, establishment of minimum wages for the low-skilled, enforcement of maximum wages for managers and professionals for equity reasons, and appointment of senior managers on the basis of political patronage.

Because of these burdens of mixed mandates, governments often protect PSEs from competition as a way of creating rents from which the costs of the social burdens can be paid. PSEs are often protected from import competition through quota restrictions and high tariffs on outputs; and from domestic competition through restrictive licensing of domestic capacity (investment control), preferential access to (subsidized) inputs, and other rules rigged to benefit PSEs over the private sector. This protection holds two negative consequences for efficiency: the protection further weakens the economic efficiency of PSEs themselves beyond that introduced by the social burdens; it also introduces distortions into the entire domestic structure of production, weakening private firms as well.

Perhaps the ultimate protection from competition offered is the unwillingness of governments to allow PSEs to go out of business. Irrespective of ownership or motivation, some good ideas turn out badly in practice, and some originally viable undertakings become nonviable when circumstances change. Problems created when an investment turns sour disappear when the capital and labor are redeployed in other activities. These problems continue and escalate when governments refuse to allow the redeployment, either by continuing the operation of PSEs, or, sometimes, by converting failing private firms to public ones. The motivation is often the protection of employment of labor in these entities or the continued provision of goods and services for which no other private sector alternatives exist. More fundamentally, it protects labor and capital from the stress of adjustment to new employment at the cost of tying up these economic resources in inefficient firms. This unwillingness forces governments to protect sick PSEs further from competition, introducing further distortions, or direct subsidies in one way or another from the government budget.

Mixed mandates and protection from competition not only lead to economic inefficiency but also to financial distress, both for the PSEs and for the government. This financial distress shows up in the rising contribution of PSEs to overall public sector deficits, growing foreign indebtedness, interagency arrears in payments due, and increasing borrowing from the domestic banking system. When the scale of PSEs in the total economy is large, as it is in several Arab countries (Egypt, Algeria, and the People’s Democratic Republic of Yemen), financial distress in PSEs can lead to large macroeconomic imbalances in the economy as a whole—uncontrollable budget deficits, balance of payments deficits, and excessive growth of domestic credit. These imbalances tend to persist and grow as long as governments are unable to correct the root causes—inefficiencies in PSEs.

Reform of Public Sector Enterprises

The solution to this problem is inherent in the diagnosis: the best cure is prevention. Public investment should concentrate on those activities that are the core of governmental responsibilities, and scarce financial and administrative resources should be deployed to make these activities as efficient as possible. Those activities that can be should be left to the market to provide.

Where there is a legacy of a large public sector with inefficient and financially troublesome parts, restructuring of those parts is called for. The basic tools of public sector restructuring are divestiture, financial strengthening, and introduction of more market competition (Shirley, 1989b).

A growing number of countries with problematic PSEs have decided to divest public ownership or control, using a variety of mechanisms, none of them easy to implement. One is the straight-forward option of selling selected PSEs by negotiation or auction, often with some restructuring before or after the sale. Countries that have embarked on such a policy have found it no simple matter, as it is difficult to let go of the healthy ones and to sell the sick ones. Such a program requires careful preparation and determination. Another option is sale to employees. While this option has the advantages of divestiture and employee protection, it requires creative solutions to difficult financial and managerial problems. A third option that is not quite divestiture is to arrange private management contracts with suitable incentives for performance.

Countries that have initiated PSE divestiture programs have found that a change of ownership (or management) is not a complete solution. Where legacies of the burdens of mixed mandates remain and/or the economic environment is distorted by noncompetitive policies, changing ownership or management is only a partial solution. In some cases, the terms of sale of a PSE even worsen the situation, when governments agree to protect the PSE even further from competition as an incentive to complete the sale. In the long run, there is no escape from addressing the financial and competitive problems that caused the deterioration of the health of the PSE in the first place. The World Bank policy staff have embarked on a major research project to study the results of various divestiture programs in several countries.

When financial problems of PSEs are large and pervasive enough to create macroeconomic imbalances, the solutions involve changing the fundamental cost/price relations and instilling financial discipline. There is no creative financial engineering, such as conversion of debt to equity that will solve the problem for long, although such financial engineering is often needed as part of the rehabilitation of the PSEs that have fallen into a financial mess. It is even less useful simply to impose more stringent financial targets for PSEs by fiat without changing the rules under which they operate. The need is to rationalize pricing policies, limit subsidies, control borrowing, improve investment decisions, eliminate interagency arrears, improve financial reporting, and increase the financial accountability of managers.

The path to efficiency requires more than financial restructuring. With enough control over markets, governments could rig financial profitability in a highly distorted environment. This would send signals to managers to improve financial performance while wasting resources and reducing welfare. To increase economic productivity it is necessary to change the environment in ways that send economically correct signals. There is a growing consensus that the most important way to change the environment in pursuit of increased efficiency is to introduce more market competition, both at home and from abroad. Many governments with large public sectors surround PSEs with protection from domestic competition in the form of capacity licensing and cost-plus pricing rules, and from foreign competition by quota restrictions or prohibitive tariffs. These effectively remove all competition from the environment of PSEs and engender complacency in cost control, technical innovation, product quality, and the attitudes of both labor and management.

Changing this environment requires the removal of this cocoon of protection. A first step is to allow firms in the same industry to compete with each other on the basis of costs—by having each PSE face the same ex-factory price rather than calculating this price based on the cost of production of each PSE. A next step is to allow these firms to compete on the basis of price—allowing firms to set their own prices, which is tantamount to allowing the market to fix the price. Introducing competition from the domestic private sector means setting PSEs and private firms on the same basis with respect to both the freedom to invest and access to inputs, including credit and foreign exchange. A further step is to introduce competition from abroad by removing quota restrictions and reducing high tariff protection.

Removing the cocoon of protection is often painful, as it exposes some PSEs that have become inefficient and noncompetitive underneath the protection. Removal of cost-plus pricing rules and their replacement with unified output pricing often exposes PSEs with outdated, high-cost technology to competition with other PSEs in the same industry with newer, lower-cost plants. Setting prices at a level that covers the costs of the highest-cost producer means high prices, and setting them to cover the costs of the low-cost producer means other firms in the industry make financial losses. Exposing PSEs to domestic private sector firms often reveals the higher costs of PSEs owing to overmanning or lax management. Removing import protection exposes PSEs to the lowest-cost producers in the world. For these reasons, the removal of protection must be done gradually, along with carefully designed restructuring plans to avoid large-scale disruptions.

Efficiency Criteria for Public Investment

In addition to choosing the appropriate fields for public investment, economic efficiency depends on how the public investment chosen is carried out. The timing of the investment, its consistency with the macroeconomic environment, the economic evaluation of investments, and the adequacy of their financing all impinge on the returns the economy receives. When setting up and carrying out investment criteria, it is important not to lose sight of the basic development objectives that public investment is designed to serve. Among other things this means realizing that some non-capital development expenditures are as important as those classified as investment, and that sources of funding should not distort national development objectives or strategy.

Timing

The timing of public investment is a crucial determinant of its efficiency. Investing too early or too late sharply reduces economic returns. Two independent studies by World Bank staff have found that economic returns to public investment depend heavily on its timing (Shah, 1988, and Chhibber and van Wijnbergen, 1988). The basic issue turns on whether the economy is pressing up against capacity constraints in areas of public responsibility. When excess capacity exists in basic infrastructure—often when a slow-down of economic activity occurs for macroeconomic reasons—then additional public investment yields low or negative returns. Also, when short-term resource imbalances cause an unusually high opportunity cost to public resources, limiting public investment only to those projects whose returns exceed the higher opportunity costs means a cut in the overall investment program. In fact, it is often public investment that gets cut when governments find themselves in a financial bind.

Cutting public investment when macroeconomic imbalances are large sometimes results in public investment that is too little too late from the point of view of the future growth of the economy. Some of the most important governmental responsibilities—basic infrastructure—require investments with long gestation periods. If these are cut when resources are out of balance, then, in a few years, after the economy resumes growth, it runs into infrastructural constraints (energy or transport) that could only have been avoided by earlier investment. This is a basic dilemma of development planning that can be reconciled only by setting and following clear priorities for public investment to ensure adequate funding for the most important activities.

Macroeconomic Consistency

World Bank staff, when they review public investment plans, often encounter overblown investment programs that have too many projects with too little funding for timely implementation. This results from a legacy of project proliferation owing to an inability by central ministries to prevent line ministries from initiating projects despite inadequate funding. Line ministries have learned that once started, no matter how small the initial funding, approved projects continue to be funded and eventually are completed. This situation leaves the public investment program overprogrammed and underfunded, with much of its scarce resources tied up in slow-moving projects with much delayed benefits. The same level of resources, concentrated so as to complete priority projects expeditiously, results in earlier benefits and raises the efficiency of the total investment program. When priorities are formulated, governments should be mindful of the future infrastructural needs of continued growth. Given the situation they often face when reviewing public investment plans—a large list of ongoing projects, scarce (and often overestimated) resources, and the need to protect investments in basic infrastructure—the World Bank often recommends creating a “core” public investment program whose funding should be protected for timely implementation, with other projects to be funded only if additional resources become available. This solution is clearly second best. The best would be to scale the whole investment program back to a level that can be implemented in a timely way with priority projects necessary to fulfill the most important public responsibilities.

Economic Evaluation of Project

Development literature places great emphasis on economic evaluation of individual projects as a primary means of ensuring economic efficiency of public investment plans. The World Bank also places great emphasis on project evaluation and has been instrumental in developing and spreading techniques to undertake such evaluations (Kavalsky, 1986, and Squire and van der Tak, 1975).

Economic evaluation of individual projects is actually the last step, in a long and complex process, whose usefulness is largely in confirming that an already formulated program of public investment meets minimum efficiency criteria. No country formulates its public investment plans by calculating economic rates of return for every conceivable project, ranking them high to low, and then approving from the top of the list as far down as resources allow. Even if tried, the information costs of such an approach would be impossibly high. In any case, governments do not try (Leff, 1985). The process of formulating a public investment program is subtle and involves both economic and noneconomic criteria.

Formulating an efficient public investment program requires several key components. First, someone needs to supply a vision of a development strategy. This is a highly intellectual element but indispensable if the actual program elements will be mutually supportive, a necessary requirement for efficiency. The strategy must be developed within a macroeconomic framework that relates investment, growth, and resources consistently and realistically, resulting in a resource envelope that defines the scale of the feasible investment program. Individual projects that exhaust the available resources must be prepared in the context of sectoral strategies and development programs designed to fulfill these strategies. Such strategies and programs are necessary to define which projects are worth preparing to the stage they can be rigorously evaluated. A rigorous evaluation, then, is the last stage. It is nevertheless quite an important stage. Quantitative project evaluation of its technical, financial, and economic characteristics is a check on the realism of all the assumptions that have gone into the project formulation.

Foreign Financing

Maintaining a close correspondence between the individual projects approved and the development strategy is an important element of efficiency. One threat to the coherency of a public investment program is the influence foreign financiers sometimes have on the individual investment decisions. While foreign sources usually want to help finance the high priority investments, they sometimes have agendas of their own that are not fully coordinated with the investment strategy of the government. Where foreign financing is small in relation to the total size of the public investment program, it usually is not difficult to find projects that mutually meet the priority development strategy of the government and the agenda of the lender, whereas where it is large, finding an identity of views is more difficult. Governments should take care that all projects, irrespective of their financing source, are fully integrated with the planning and budgeting of the public investment program and reflect the country’s development strategy. Any hidden costs of foreign financing, such as tied procurement, should be considered when deciding how to finance a project. Foreign-financed projects should avoid becoming enclaves with special treatment vis-à-vis the rest of the government.

Capital Versus Noncapital Expenditures

Although the topic of this paper was the efficiency of public investment, it should be noted that noncapital development expenditures are as important as capital ones. At least two issues with respect to noncapital development expenditures are important. One is the operation and maintenance costs associated with investment projects. The other is that in some sectors noncapital expenditures are considerably more important in development programs than capital expenditures.

Operation and maintenance requirements of investment projects create future burdens on the government budget and must be considered when formulating the investment program. For this reason, among others, ministries of finance should be involved in the planning and approval of public investment. By the same token, future operation and maintenance costs must be provided to ensure the realization of future benefits.

In sectors such as health, education, and agriculture, the most important development programs often require only modest capital expenditures, compared with their recurrent expenditure requirements. Government involvement in these sectors usually takes the form of provision of services, which is more staff intensive than capital intensive. For this reason, the World Bank has increasingly emphasized in its work the review of public expenditure programs rather than just public investment programs.

Illustrative Application of Criteria

It would be revealing to see how these criteria would be applied to an actual case. As an illustration, a few examples can be drawn from Egypt’s second Five-Year Plan, 1987–92, which the World Bank reviewed at the Government’s request in March 1987 (unpublished official document). A full citation of the Bank’s analysis and recommendations would far exceed the patience of this paper’s audience, but it is possible to relate the issues identified to the criteria for efficiency developed here.

Macroeconomic Consistency

Egypt’s second Five-Year Plan modestly estimated the resources available for public investment during the period (LE 27.4 billion in 1986/87 prices), despite a highly ambitious GDP growth target (6 percent per annum). Bank staff supported the macroeconomic investment target but estimated that the cost of the investments proposed exceeded this target, owing to various elements of undercosting. The Bank recommended that the total program be scaled back somewhat while protecting the “core” investments needed to enable growth in the future. It pointed to projects in some sectors (for example, transport and land reclamation) where the economic returns looked low and the implementation capacity was constrained.

Timing

There were many timing issues in Egypt’s second plan. An important one concerned the rate of investment in electric power generation. The original power generation investment plan was based on an extrapolation of past trends that were unlikely to continue in the future because of slower GDP growth and the demand-dampening effects of the Government’s pricing policy. This meant that the original plan called for investment in capacity before it would have been needed. Once the plan included a consensus demand projection and a revised generation investment program, it was important to fund this program fully to ensure that the capacity needed to supply the projected demand would be available. Another timing issue concerned the development of natural gas. As natural gas should be developed as rapidly as possible in Egypt, the issue was simply to ensure that the natural gas development program was fully funded for maximum development. A third timing issue was in the transport sector, where the need for new roads was relatively modest compared with the pressing need to maintain roads and bridges.

Economic Evaluation of Projects

The economic evaluation of projects influenced the plan and the Bank’s recommendations in many instances. In an important sense, some view of the economic rate of return permeates the whole planning process and the Bank’s views of the plan. The view that the land reclamation program was too large was based on a view that some of the projects included in the program earned low or negative returns. On the other hand, the drainage program is expected to earn high returns and fully deserves its prominent place in the investment program. Similarly, the high returns from gas development motivate the recommendation to proceed quickly with its development. The industrial sector’s public investment plan contained many potential projects whose economic return was questioned, leading the Ministry of Planning to exclude them from the plan.

Foreign Financing

The Government of Egypt has established a Ministry of International Cooperation to coordinate the foreign aid financing of development projects. This ministry works closely with the Ministry of Planning to ensure that projects financed by such aid fit into the Government’s priorities. The Ministry of Planning has an established mechanism to deal in an orderly way with the additional aid that becomes available in the period after investment plans are made.

Capital Versus Noncapital Expenditures

Egypt’s second Five-Year Plan included many examples of development programs where the noncapital expenditures were more important than the capital ones. Many agricultural programs essential for the growth of productivity (such as research and extension) require salaries and facilities of a largely noncapital type. Most of the education and health expenditures are similarly non-capital in nature. Even in some typically capital-intensive sectors such as transport, the main need during the plan is for rehabilitation and periodic maintenance rather than new investment.

Comment

Mohamed A. Diab

Mr. Wall’s paper addressed two related issues:

  • (a) What is the appropriate mix of public and private investment; and
  • (b) What criteria can be used to ensure that public investment is efficient.

He also attempted to bring to bear on these issues the strategy of the World Bank in assisting Middle Eastern countries in their efforts to formulate policies concerning public investments and related public expenditures.

I wish to indicate that I find myself in agreement with the general tone of his paper, its underlying philosophy, and the explicit as well as the implicit conclusions and recommendations it contains. Moreover, I would like to express some views that support his position.

The controversy on the role of the state in the economic life of a nation is as old as political economy itself. The increasingly rapid technological, social, economic, and political developments in western societies have sharpened professional debates on the subject ever since Adam Smith articulated his theory of the judicious invisible hand in solving the problem of resource allocation and income distribution. The major political and social upheavals that have occurred in European societies in the past two centuries are nothing but a manifestation of the tug of war between antagonistic parties about the role of the state in the organization of productive resources and in the distribution of the goods and services produced. Governments have fallen and new regimes have risen in the name of achieving more economic efficiency and more social justice. The controversy continues, albeit less violently and more maturely than hitherto.

In the Arab Middle East, and since the Second World War, the role of the state in the economic life of the community and the size of the public sector have evolved in stages, each with its own set of motivations and causes. The first was the post-independence stage in the Levant countries and in Iraq, where existing public utilities such as electricity generation and distribution, city transportation, and railways that were owned by foreign concessionary companies were nationalized. This was followed many years later in Egypt by the nationalization of the Suez Canal, a culmination of the surging desire of the Arab nation to eradicate all politicoeconomic vestiges of foreign dominance. During that period increasing financial resources were put at the disposal of national governments not only to provide for an expanding army but also to fund activities that it was felt should better be carried out by the state—such as building roads, airports, seaports, dams, schools, hospitals, and public buildings, laying railways, and installing electricity generation and distribution networks. These infrastructural activities were carried out by governments and regimes that believed in the “sanctity” of private property and individual enterprise, but felt that, because of the relative immensity of these projects, the state was in a far better position to undertake them with speed and efficiency. Along with the expansion of the public sector and the military, an expanding public bureaucracy developed: more self-confident and more assured of its ability to organize resources and to manage centers of production. The observation that I wish to make here is that the expansion of the public sector was very much encouraged and supported by decision makers in the private sector. The expansion of the public sector was looked upon as complementary to and not as competing with the private sector. The economy was expanding fast enough to accommodate the need for resources in both sectors.

As to the efficiency of the public sector in managing the resources put at its disposal, it should be noted that most of the commodities produced have no competitive alternatives, and therefore their production costs and prices cannot easily be checked for economic efficiency by the market mechanism. However, it is safe to say that, on the whole, the work conduct of public sector managers at that time was guided by nationalistic fervor and high ethical standards that ensured, to a large degree, that resources were managed and put to use as efficiently as possible.

The second phase in the evolution of the role of the state in the economy in these countries is marked by the laws of agrarian reform, but more important, by the nationalization acts in the early sixties. Here the expansion of the public sector was brought about with a vengeance. Socialism was declared the new economic order, and the boundaries of the public sector were expanded to include any sizable industrial firm in sight, regardless of its industrial classification! Socialist ideology dictated that all modern means of production should be owned, and consequently managed, by the state. The question of the appropriate mix between the public and the private sectors was, by a stroke of the pen, summarily answered.

A different scenario evolved in the Arab oil producing countries. The gush of wealth took its nationals and governing bodies by surprise. In the sixties, there was hardly any public sector to speak of. Nation states had to be built up practically from scratch. The task was thrown into the lap of burgeoning public institutions because hardly any other actor or vehicle was in sight. Public institutions, and a modern infrastructure, were built up with a scope, resources, pace, and lavishness that is unprecedented in the annals of economic development. The cost in terms of resources and social values may have been great, but financial resources were so abundant, the task and the desire to build rapidly were so great, and the general mood was so euphoric that hardly anybody seriously bothered to note whether resources were properly allocated, whether income distribution was becoming dangerously skewed, or whether public institutions and enterprises were efficiently run. The methodical search for an appropriately demarcated public sector was overtaken by the ability of the state to undertake any enterprise whatsoever.

The role of the state in the economies of the Arab countries has during the past quarter of a century gained an importance beyond the wildest dreams of Arab students of economics of the sixties. When we look now at the map of the public sector in these economies, we find that public enterprises occupy practically all the high ground. Aside from the very heavy investment in infrastructure, the state owns all extractive industries and their ancillary transportation networks, all armament industries, practically all significant manufacturing industries, major food processing industries, and high-quality tourist facilities.

The conclusion to be drawn from this brief description of the expansion of the public sector in selected Arab countries is that its motivations and causes have been quite diverse, and that its size and composition have been brought about more by politics, ideology, and the sudden surge of wealth in some countries than by a gradual and willful evolution of a national concept of a particular pattern of resource allocation between the public and the private sectors. This point is important because it is related to the question of involvement, commitment, and accountability on how resources are allocated and how enterprises are run.

In the Arab countries, the role of the state in the organization, allocation, and management of resources—whether through the public sector or through the maze of rules and regulations, incentives and penalties, coercion or persuasion, encouragement and discouragement—has recently come under increasing scrutiny, sometimes in the open, but more often through the grapevine! The questions that are being asked about the role of the state in the politico-economic systems that have emerged are simple:

  • Have resources put at the disposal of the state been wisely allocated?
  • Has the role manifested a strategy of development that enabled a “big push” to break through the structural barriers to economic expansion?
  • Has it allowed the mobilization of resources that the community could muster locally and abroad?
  • Has it tempted decision makers to indulge in the establishment of “white elephant” projects?
  • Has it led to distortions in the price structure, to inflation, and to significant depreciation of local currency?
  • Has it led to rapid economic development?
  • Has its performance been compatible with expectations?
  • Has it brought about increasing involvement by the community in the decision making on resource allocation?
  • Has the system led to concentration of political and economic power in the hands of a few?
  • Has it been instrumental in the development of dedicated social work ethics that hold the community welfare as an objective?
  • Has it been amenable to more corruption and abuse of economic power?
  • Has it been germane to practices that have benefited a few privileged officials at the expense of the community?
  • Does the system inherently give immunity from accountability both politically and economically?
  • Does the system inhibit creativity and innovation in the management of public enterprises?
  • Does the system provide an attractive climate for the deployment of dynamic resources locally and from abroad?
  • Is the system capable of meeting the challenges of the new technological revolution with all that it entails, and of opening up to creative, innovative, and risk-taking senior and mid-career managers and technicians?
  • Are public enterprises better poised to “engage” foreign centers of production for the transfer of technology and joint efforts to produce goods and resources?
  • Is a democratic political system a necessary prerequisite for an efficient and a nonexploiting public sector?

Answers to questions of this nature fundamentally shape the preferences of individuals, and consequently the community, about the appropriate or desirable mix of the public and the private sector.

The market economy, despite its many shortcomings in areas of monopolistic practices and of social equity, provides a reasonable mechanism for allocating resources where they are needed through daily monetary voting on the part of consumers and investors alike. Decision makers in an economy with a large public sector need to be fed constantly with information about what the community wants in terms of the size, the composition, and the management of the public sector. Entrepreneurs in a market economy would find themselves out of business if they did not display adequate foresight in anticipating consumers’ wishes, and/or if they did not provide efficient management of their enterprises. This is not necessarily the fate of decision makers in an economy characterized by a large public sector. Here the economic and the political decision-making process is so intertwined that the transmission of the communal preference for resource allocation and its efficient organization and management can only be accomplished through the political system. To the extent that the political process allows the free articulation and expression of the communal preference and makes political and economic agents accountable for its implementation, one can say that the question of “what is the appropriate mix of the public and the private sector” is answered.

Ailments in any economic system are recurring diseases requiring continuous recognition, diagnosis, and medication. A community needs lots of glasnost if it is to undertake perestroika. Utopia is, however, a mirage—but a mirage that could serve as a beacon directing and guiding human endeavors toward higher plateaus of communal happiness and welfare.

Appendix
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