Extending SOE governance

Over the last decade, following successive global and regional crises, state-owned enterprises (SOEs) have doubled in importance, with assets totaling $45 trillion, equivalent to half of global GDP. Previous studies find that SOEs exhibit lower profitability compared to private firms, reflecting the cost of providing goods and services at below-cost prices to underserved communities, promoting employment, or other social goals beyond what is economically efficient, especially during crisis.

Many governments provide financial support to SOEs for performing noncommercial activities through budgetary transfers or subsidies.  Others provide quasi-fiscal support via credit guarantees or lending at favorable terms. However, there are many unfunded or inadequately funded social mandates that SOEs end up fulfilling due to political pressures. When budgetary support is difficult to provide, SOEs are allowed to get contracts from the government without competing in public tenders which makes it possible for them to contract other SOEs or their own subsidiaries to provide goods or services at non-market prices. This tendency by governments to allow exceptions was apparent during the COVID-19 pandemic and again during the latest energy crisis that manifested itself in dozens of economies because of Russia’s invasion of Ukraine.

For example, analysis from Moldova, shows that in 2022 over 65,000 Ukrainian refugees took temporary shelter on the premises of the state-owned MoldExpo Exhibition Center, the Manej Athletic Center, and the Constructorul Sanatorium. These refugees received free mobile SIM cards, medical assistance from the two SOEs. And state-owned railways provided transportation support for 450,000 people who sought to continue to other European countries.  In a different crisis context, Elektroprivreda Srbije – the state-owned energy company in Serbia granted a deferral of energy bills without surcharges during the COVID-19 pandemic, internalizing the cost at least temporarily.

Such activities should be guided by the rules of the general procurement laws, which regulate over 12% of GDP in the average economy, and should be consistently applied to SOE procurement to support competitive markets. 

As many SOEs have dual functions and the social function is often underfunded, public procurement is sometimes used as a vehicle to provide state support.  Therefore, SOE governance needs to cover not just competition law, corporate governance of holding structures, accounting rules and SOE board composition, but also procurement law. We identify two principles that can help in extending the scope for SOE governance to the rules of public procurement:

• First, a single law of public procurement should apply to private companies and state-owned enterprises. This is not the case in many countries, where public procurement of SOEs is either unregulated or regulated by separate provisions. In Latvia, for example, the Public Procurement Law is not applicable if the customer (usually a public body) has control over the supplier’s (usually a SOE) strategic goals or if the supplier’s turnover is made of no less than 80% of specific customer service deliveries.
• Second, when SOEs are themselves the procuring entities, they should be mandated to apply the same rules of public procurement that apply to the general government sector. This is often not the case, creating significant market distortions to the detriment of efficiency. Take the case of PEMEX, Mexico’s largest public entity with 150,000 employees and an annual budget of more than 600 billion pesos, the equivalent of  $30 billion. Since 2013, PEMEX no longer applies the public procurement regime but specific rules applicable to it only. PEMEX data shows that in 2012-2014, this led to a decrease in open public tenders from 54 to 22% of all procurement value.

Using a single set of procurement rules for SOEs and private companies can save costs. A recent study on the procurement of sugar in Russia, reports significant overpricing of contracts with state-owned suppliers compared to private suppliers, especially in repeated contracts. In such cases, the contract prices of SOE suppliers are 16–20% higher. Another study shows the inefficiencies of direct contracting in Poland, which is around 12% more expensive than competitive tendering for the procuring entity. Data from the Statistics Services of Ukraine reveals that sugar and eggs purchased under direct contracts were respectively 60 and 40% higher in March 2022 following Russia’s invasion. Direct contracting generally leads to higher prices even in normal times. In 2021, the price of sugar in direct procurement in Ukraine was 4% higher than in competitive procurement, while the price of pasta was 11.2% higher, and that of gas was 3.1% higher. The war has only aggravated this disparity.

It is still the case that governments would call on SOEs to address crises. Emergency procurement rules would likely apply during such periods. Procurement law must evolve to cover such emergencies for all types of companies, including SOEs.