Government ownership of an industry or a formerly private company is known as nationalization. By far the more frequent of the two phenomena is government ownership of an industry. Although some authors, such as Lars Bengtsson, have argued that choice of industries is random, nationalized industries typically are those that government considers to be fundamental to national security (from oil to media) or national income (based on a natural resource that may also be a wasting resource), as well as those that are particularly attractive to foreign direct investment. According to Bengtsson, a nationalized industry can be viewed as a governmental hierarchy, whereas an industry with a strong governmental organization that buys, sells, and/or competes with private actors is called a governmental market system. The government can also govern a market with only private actors through regulations, via a regulated market system.
Amy Chua discussed a different class of nationalization in developing economies, wherein the purpose is discrimination against an economically dominant ethnic minority. Here, market processes of competition and rule of law are manipulated to benefit certain ethnic constituents and to disadvantage others; little or no attempt is made to justify this action in terms of socialist or communist ideology. She cited the ethnically targeted nationalizations and confiscations in postcolonial Burma, Indonesia, Kenya, Malaysia, Pakistan, the Philippines, Sri Lanka, Thailand, Uganda, South Africa, and Zimbabwe.
Although the primary focus of this essay is government nationalization of industry for issues of security, income, state building, or public policy, not nationalization to disadvantage an ethnic minority, the expropriation of private property is very often a consequence.
Precedents in International Law
In his study of nationalization in Latin America, David Schneider man noted that constitutional rules once expressly enabled state intervention in the market to redistribute wealth through rules permitting the expropriation or nationalization of property, subject, for example, to the provision of “appropriate” compensation, which protected host country governments from the external pressures generated by foreign economic power. In the 1990s, this type of state capitalism fell into disfavor, and the countries of Latin America mostly abandoned the constitutional design mandating public control of the economy or enabling nationalization of key economic sectors.
Today, both expropriation of property and nationalization are prohibited unless they are for a public purpose, nondiscriminatory, and accompanied by the payment of “prompt, adequate, and effective compensation” that is fully realizable and transferable. This perspective is embodied in international law. In a famous case, the Iran–United States Claims Tribunal—created to resolve the crisis between the Islamic Republic of Iran and the United States arising out of the detention of 52 U.S. nationals at the U.S. Embassy in Tehran and the subsequent freeze of Iranian assets by the United States—it was found that property rights must be respected and that compensation must be paid when the alien owner of those rights is deprived of them by acts attributable to a state. Although a revolution does not by itself create liability, neither a revolution nor any other changed political, economic, or social circumstances can be invoked to avoid liability for deprivation of an alien’s property that is attributable to the state.
Government’s Role In Economic
Growth Despite the ubiquity of government, government as an actor in national economic growth and development has been largely ignored by international business theorists. Government’s importance to economic growth was addressed by Bengtsson, who argued that even in many traditionally capitalist countries, the public sector (involving both national and local governments) accounts for one-third to one-half of GNP. Hence, government is an actor in the economy as a whole, having a substantial influence over the governance structures employed through its right of enacting laws. In fact, the government is a more powerful agent of economic activity than any other single agent in most countries, whether their economies are capitalist, mixed, or planned.
In Storm over the Multinationals, Raymond Vernon viewed the activities of companies expanding into multiple international jurisdictions as a source of new complications for national policies and programs affecting job creation, inequitable income distribution among classes and regions, the availability of scarce supplies, the functioning of local markets, tax revenue, consumer safety, environmental protection, and national security. Writing at the same time as Vernon and Maurice Bye, George Stigler saw the government regulator as an ineffective functionary, held hostage by the more-moneyed, far more strategic regulated firm. Although international business theorists have largely ignored the role of government, a few—such as Vernon, Bye, and Edith Penrose—have examined the public policy implications of government action, including the decision to nationalize.
Dynamics Of Sharing Oil Revenue
In her article “In Profit Sharing Between Producing Countries and Oil Companies in the Middle East,” Penrose explored the economic questions involved in the sharing of oil revenue between the oil companies and the producing countries—two interested parties that stand to gain from bargaining. One of the parties invests capital to start the industry and runs it; the other supplies the raw material, which is a wasting asset. Both parties are interested in promoting the most profitable long-run expansion of the industry, but the producing countries’ governments are concerned with their own oil production, and the oil companies are concerned with investing in the countries from which they can expect the highest returns. Looking at Penrose’s indices of profitability and dividend payout for the oil majors from 1954 to 1966, one can see an increasing loss of profits paid out to foreign investors through dividends. While profits continued to grow, benefiting the majors, the loss of income to the producing countries made the case for government action to ensure profit sharing.
Penrose argued that the proportion of its profit that a company is willing to give up depends on its estimate of the cost of meeting the government’s final demands compared with the cost of resisting them, up to the point where the loss in either case makes the business unprofitable. Conversely, a government’s demands depend on the loss that it believes it can inflict on the company by not giving or by canceling the concession under negotiation—that is, on its estimate of the value of the concession to the company—or on the amount that it thinks the company is prepared to give up to avert political disturbances and maintain political goodwill. The latter alternative applies in the case of negotiations with a company that is already established in a monopolistic position in the country and in circumstances in which the government cannot run the industry.
For an established oil company, the cost of acquiescing to the government’s demands is the additional profit lost in one form or another and the future profits expected. But the cost of resistance is not necessarily the loss of the concession (as it might be in the case of new concession agreements), for the company is in a strong position to precipitate an economic crisis, which may drive the negotiating government out of office. In fact, the company itself need take no positive action, which would force the government to risk political action, arousing the populace against the oil companies, condoning or inciting political harassment, or threatening nationalization on terms unacceptable to the company—steps that, once taken, are not easy to retreat from.
Granting Concessions Versus Nationalizing
If the economy of a country has become heavily dependent on the continuance of oil revenue, and the government cannot run the industry, an existing oil company, if it has a virtual monopoly or acts in concert with other companies, is in an extremely strong position vis-à-vis any single government. The progressive economic deterioration following the cessation of oil revenue is likely to cause greater political difficulties for the government, its eventual repudiation, and the substitution of a government pledged to reestablish the flow of oil revenue.
If the oil companies compete for a concession, the share of profits offered to the government rises to the point where the company obtaining the concession retains only normal profit—the amount of anticipated profit that would just induce the company to enter or continue to invest in the oil industry of the country. In this circumstance, the government would be able to extract nearly the full value of the concession from each company.
If the government can run the industry and obtain revenue not significantly below the revenue it previously obtained from the companies, it is in a good position to nationalize. Forcing the foreign companies out completely would not be to the country’s economic advantage, because the country would lose the indirect advantages of increased rate of innovation; freer flow of technical information, leading to the more rapid application of advanced technology; and a greater supply of technical and managerial personnel. In calculating the advantages of nationalization, the government should take into consideration the alternative product that could have been produced by its resources, had they not been directed into oil production, including lost productivity, foreign exchange, and tax revenue.
Impact of Nongovernment Forces
Bye, the French structural economist, investigated the impact on the world economy of the interplay of flows and forces depending neither entirely on government nor on firms. Like Penrose, he focused on wasting assets (oil and mines). Bye warned that given the differential planning horizons of foreign investing firms and national governments, the latter cannot delay public welfare for long-term growth gains that might materialize only after the resource is depleted; it must fund social programs in the short term via taxes, tariffs, and other actions directed at what he called the “large multi-territorial unit.” Governments, therefore, have an incentive to drive up extraction revenue to the point where the company obtaining the concession retains only normal profit, which is the amount of anticipated profit just sufficient to induce the company to enter or continue to invest in the country’s oil industry. In these circumstances, the government can extract nearly the full value of the concession from each company.
Alternatively, if the government can run the industry itself (nationalize it) and obtain revenue not significantly below the revenue it previously obtained from the companies, it is in an extremely strong position with respect to established oil companies.
It should be noted that nationalization could be done without inhibiting technological progress if the government-owned firm were able to do technology licensing deals or call in consultants. Indeed, given that rival firms stand to make money from technology licensing or consulting services, there is scope for playing them off against one another.
Subsidizing Small Firms
In her introduction to The Large International Firm in Developing Countries Penrose quoted Bye:
The mutual relations of large firms within one and the same industry … have an impact on the world economy which is at least as important as that which the theory of the market assigns to factor proportion
and observed that his remark “applies with full force to [the oil] this industry … ” The international petroleum industry is dominated by a few large sellers, but operating in the interstices of the oil market are a group of smaller independents, whose activities have a significant influence on the industry. These smaller firms exist largely because of government action. Exploration is expensive, and small firms naturally operate at a cost disadvantage in this area; government subsidies and regulations, however, can create artificial but effective barriers to monopoly by making it impossible for foreign firms to operate without a domestic partner.
Investment In Developing Countries
Thomas Andersson’s study of multinational investment in developing countries suggested that the endeavors of many developing countries to obtain benefits such as direct investment, reduced tax rates, and free profit repatriation further reduce their foreign exchange earnings from direct investment, particularly because multinational enterprises tend to repatriate funds rather than reinvest in troubled economies. This situation increases the attractiveness of nationalization, the risk of which again hampers direct investment and other benefits. Since the 1970s, however, nationalization has been in decline.
Andersson’s investigation cited access to inexpensive borrowing, a fall in commodity prices, and the increasingly negative impact on direct investment from continuing the practice of nationalization after most other countries had stopped. Nevertheless, the developing countries’ need for foreign exchange remains critical, as those countries have accumulated multibillion-dollar debts, and exports to the industrialized economies have been squeezed by import quotas and other kinds of protectionism.
Direct investment is increasingly viewed as a favorable source of foreign capital, employment opportunities, and an increase in output and exports. Hence, host country policies have become more benevolent than ever, and the recent investment revival in developing countries is expected to continue over the next decade. Increasing wealth, privatization, and government openness to foreign direct investment (FDI) have led to increased private investment in previously nationalized businesses.
Economies In Transition
According to UNCTAD, FDI inflows to developing countries and economies in transition (the latter comprising southeastern Europe and CIS) rose by 16 percent and 41 percent, respectively, in 2007 to a new record of $98 billion. Whereas resource-rich countries such as Kazakhstan received more than in 2006, the privatization of formerly state-owned enterprises drove FDI toward southeastern Europe.
FDI inflows to Africa, an estimated $36 billion, were supported by a continuing boom in global commodity markets, but new inbound FDI took place in the banking industry. Egypt, Morocco, and South Africa were the main beneficiaries of FDI inflows.
In Nigeria, the government divested 51 percent of its stake in NITEL, the country’s telecom operator in 2006, to Transcorp for $500 million in the hope that privatization would turn around its performance and improve services. Now the government is seeking a new investor to acquire 27 percent of Transcorp’s share in NITEL and to buy another 24 percent of the state’s remaining 41 percent share and take control of the company.
Since its establishment in 2002, the Kosovo Trust Agency (KTA) has sold a significant share of the country’s state-owned enterprises through spin-off and liquidation methods. As of November 2007, KTA administered about 650 state-owned enterprises; about 320 companies were privatized and about 110 firms placed in liquidation.
Bibliography:
- George H. Aldrich, “What Constitutes a Compensable Taking of Property? The Decisions of the Iran–United States Claims Tribunal,” American Journal of International Law (v.88, 1994);
- Thomas Andersson, Multinational Investment in Developing Countries: A Study of Taxation and Nationalization (Routledge, 1991);
- Lars Bengtsson, “Governmental Markets, Regulations, and Hierarchies: Building Trust in the Face of Nationalization,” International Studies of Management & Organization (v.23, 1993);
- Maurice Bye, “Self Financed Multi-Territorial Units and Their Time Horizon,” International Economic Papers (1958);
- Amy L. Chua, “Markets, Democracy, and Ethnicity: Toward a New Paradigm for Law and Development,” Yale Law Journal (1998);
- Fath El Rahman Abdalla El Sheikh, The Legal Regime of Foreign Private Investment in Sudan and Saudi Arabia (Cambridge University Press, 2003);
- Edith T. Penrose, The Growth of the Firm, Middle East Oil and Other Essays (Frank Cass, 1971);
- Edith T. Penrose, The Large International Firm in Developing Countries: The International Petroleum Industry (Allen and Unwin, 1968);
- David Schneiderman, “Constitutional Approaches to Privatization: An Inquiry into the Magnitude of Neo-Liberal Constitutionalism,” Law and Contemporary Problems (v.63, 2000);
- J. Stigler, “The Theory of Economic Regulation,” The Bell Journal of Economics and Management Science (1971).
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