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GOVERNMENT ENTERPRISE:
THE NEXUS OF SOCIALISM AND CAPITALISM

by
Elmer G. Wiens, 1999

Introduction
Canada's experience
Russia and China
Socialist Incentives
Incentives for Government Enterprises
Federal Provincial Conflict
The Future for Government Enterprises
Federal Elections 1949-97
Predicting Federal Elections
Works Cited

Introduction
      The iron and bamboo curtains are gone. However, government enterprises exist in many countries. Some countries are socialist: all firms are owned by the state. Some countries are capitalist: firms are privately owned. Others are a mixture. Whereas the owners of a private firm run it efficiently for profit, the government must run its enterprises in the interests of the ultimate owners, the people. For an enterprise to do the government's bidding, economists Evsey Domar (1-18) and Mo-Yin Tam (277-284) have proposed bonus incentive schemes for managers. Although the incentive schemes were designed for the former Soviet Union and China, a country (or province) with a mixed economy, such as Canada (or British Columbia), can use them to improve the performance of public firms. By adjusting the values of parameters of the bonus schemes, the central planning agency of a socialist government, or the political party forming the government, can direct the managers to adjust the enterprise's output. The governing party's plans for the enterprise determine the values of the parameters; in a democracy their size can affect the party's prospects for re-election.

Canada's experience
      Today, Canada, Russia and China have fewer government enterprises than they did twenty years ago. Government enterprises, called Crown Corporations in Canada, enchanted Pierre Trudeau (291) and the federal Liberals so much they owned two hundred (Canada, Treasury Board 2). Their opponents, Brian Mulroney and the Conservatives, believed many Crown Corporations, such as the Canadian National Railways, should be privatized because they were inefficient and lost money. After Mulroney defeated the Liberals in the 1984 federal election, he sold twenty-five Crown Corporations (Jorgensen et al. 247).

Russia and China
      While in Canada Trudeau's socialism yielded smoothly via the ballot box to Mulroney's capitalism, the transition to capitalism in the U.S.S.R. has been rough. Mikhail Gorbachev's reforms, perestroika (economic restructuring), glasnost (openness), and demokratizatsia (democratization), destroyed the Soviet Union. Since economic restructuring began in 1991, Russia has privatized thirty percent of its industrial firms and the entire wholesale and retail trade sector. Huge state enterprises still produce cars, oil and gas, electronic components, and military equipment ("Russia"). Under the leadership of Deng Xiaoping China, on the other hand, followed a program of gradual economic restructuring to build a "socialist market economy" ("China"). It has started markets for bonds and stocks. Public enterprises raise money by selling bonds ("Beijing Rules") and in 1998 a few foreign banks gained limited access to China's bond market. Although China's stock market is growing, the state still owns almost all firms.

Socialist Incentives
      In the command-socialist economies of China and the Soviet Union before 1990, a central planning agency decided on each enterprise's output and prices. Anticipating the needs of people was difficult. Sometimes consumers could not buy the items they wanted. A central planning agency can use Domar or Tam's bonuses for managers to induce enterprises to meet consumer demand. Domar suggests that the managers of the Soviet firms be paid a bonus equal to a weighted sum of its profit and sales (4). The central planning agency sets the bonus weights or parameters; the managers maximize their income by selling the firm's products to consumers at market prices that balance demand and supply. Domar's bonus scheme works only when lower prices yield an increase in the value of sales. Under some conditions the value of sales is less when more items are sold at lower prices. Hence some governments might choose Tam's scheme because it works in either case. Tam recommends a bonus equaling a weighted sum of profit and output (279). The government enterprise will increase its output of products when the central planners enlarge the weight on output or on sales, using the appropriate method. Because the managers are paid a percentage of the profit in both methods, they will run their enterprise efficiently. Since 1995, China's state owned firms, controlled by a system of bonuses and directives from Beijing, sell their products at market prices. Russia's public firms also sell their products at market prices.

Incentives for Government Enterprises
      Economists assume people respond to pecuniary incentives. If true for the managers of a public firm, a political party in a democracy can improve its odds of being elected by implementing the bonus scheme by Domar (Wiens "Positive Theory") or Tam (Archibald 80). If a government does not use a bonus scheme (British Columbia), one can impute values to the Domar-Tam weights. Their values depend on the directions the politicians give the managers, depending in turn on the government's supporters. In British Columbia the public firm B.C. Hydro produces most of the electricity. If electricity is too expensive, people will vote for the B.C. Liberal Party instead of the New Democratic Party. Manufacturing companies using electricity also want low rates. Here a larger Tam weight on output, increasing the production of electricity, requires lower rates to sell all the electricity. Alternately, some groups want higher rates. B.C. Hydro pays its dividend to the government, so business people want Hydro to earn a profit to keep taxes low. Unions whose members work for B.C. Hydro want high wages, and people who want to conserve power -- all want high electricity rates. The N.D.P. wants votes from consumers and campaign contributions from firms and unions. By adjusting Tam's weights on profit and output for B.C. Hydro the conflicting interests can be managed in favour of the N.D.P.

Federal Provincial Conflict
      The governments of the Western Provinces often disagree with Ottawa about federal Crown Corporations. Using the vocabulary of Domar and Tam, the West believes Ottawa places too small a weight on federal firms serving the needs of the residents of the West and too large a weight on serving Ontario and Quebec. The weight on Central Canada is too large because most members of the boards of directors of federal firms live in Toronto or Montreal (Wiens Crown Corporations 80). The boards are not accountable to the citizens of the West. Why? Look at the sixteen federal elections over the last five decades. In nine of the ten elections when a political party has won sixty-five percent of the ridings of Central Canada, the same political party has won a majority government for Canada. Furthermore, in fifteen elections the victorious party has captured a majority of Central Canada. Conversely, the victorious party has taken a majority of the ridings in the West in only six elections. The regression equation, a formula that can predict the winning party's percentage of elected seats in Canada, places a relatively large weight on Central Canada, a small weight on the West, and a very small weight on Eastern Canada (See Appendix 1, Regression Equation 1). Therefore, a party wanting to win an election must win in Central Canada. The West ends up under-represented in the party in power and in the Cabinet. Hence the West feels that federal Crown Corporations mainly serve the needs of Ontario and Quebec.

The Future for Government Enterprises
      Will China soon become a democracy with a free enterprise economy? Will Russia be a super-power after its transition from communism to capitalism? Will Canada continue as a united country? The answers depend in part on government enterprises. China could retain government enterprises in just a few key industries and privatize the rest. The Communist Party's strict political control from Beijing interferes with its pursuit of capitalism (United States, C.I.A., China). Political and economic decentralization go hand in hand. At the moment Russia's economy is doing poorly, inhibiting its military prowess. Russia should privatize its military-industrial firms (United States, C.I.A., Russia). Canada should set the Domar-Tam parameters so that federal enterprises serve the needs of all Canadians. Furthermore, the Domar-Tam bonus incentives for managers should displace political directives and interference with the management of Crown Corporations (Hunter and Fong A1+). Even with their drawbacks, the mixed economies of Canada and its provinces function well. Using them as a model, China and Russia could take a gradual, deliberate path to being market economies with democratic governments.


Appendix 1
Federal Elections 1949-1997

Pty =	Winning party
Lib =	Liberal Party 
PC  =	Progressive Conservative Party
M   =	Winning party has a majority of federal seats
C   =	Percentage of seats of Canada taken by the winning party
OQ  =	Percentage of seats of Ontario and Quebec taken by the winning party
W   =	Percentage of seats of the West taken by the winning party
BC  =	Percentage of seats of B.C. taken by the winning party
P   =	Percentage of seats of Prairie Provinces taken by the winning party
E   =	Percentage of seats of Eastern Canada taken by the winning party

Table 1
The Winning Party's Percentage of Seats by Year and by Region

________________________________________________________________________
  Year  Pty    M      C      OQ     W       BC      P       E	
_______________________________________________________________________
  1997  Lib   Yes     52     72     17      18      17      34
  1993  Lib   Yes     60     67     31      19      39      97
  1988  PC    Yes     57     63     56      38      67      34
  1984  PC    Yes     75     74     76      68      80      78
  1980  Lib   Yes     52     74      3       0       4      63
  1979  PC    No      48     58     74      68      78      56
  1974  Lib   Yes     54     71     19      35      11      41
  1972  Lib   No      41     56     10      17       7      31
  1968  Lib   Yes     59     74     40      70      25      22
  1965  Lib   No      50     69     11      32       2      45
  1963  Lib   No      49     62     14      32       6      61
  1962  PC    No      44     49     69      27      88      55
  1958  PC    Yes     79     73     93      82      95      76
  1957  PC    No      42     52     30      32      29      64
  1953  Lib   Yes     64     78     36      38      35      34
  1949  Lib   Yes     73     78     59      61      58      74
  Average             56     67     40      40      40      54
  Ave   Lib           55     70     24      32      20      50
  Ave   PC            57     62     66      53      73      61    
________________________________________________________________________

Number of elections = 16.  Number of majority governments = 10.
The probability of a majority government  = 10 / 16.
The probability a party gets 65% or more of Ontario & Quebec = 10 / 16.
The probability a party wins a majority if it gets 65% of Ontario and Quebec  = 9 / 10.
The probability of a majority in Ontario & Quebec by the winning party  = 15 / 16.
The probability of a majority in the West by the winning party  = 6 / 16. 	
Predicting Federal Elections
Regression Equation 1:

C  = -21.38 + + .113 E  +  .94 OQ + .215 W     

The estimate of each coefficient is statistically significant.  
The proportion of the variation in C explained by the equation is .94.

Examples using the regression equation to predict the percentage of seats 
of Canada won by the victorious party:

1974 Election: C = 53.5,  E = 41, OQ = 71, W = 19 
1974 Prediction: C = -21.38 + .113 * 41 + .94 * 71 + .215 * 19 = 54
1984 Election: C = 75, E = 78, OQ = 74, W = 68
1984 Prediction: C = -21.38 + .113 * 78 + .94 * 74 + .215 * 68 = 73

Regression equation 2:

C = -21.15 + .116 E + .927 OQ + .137 P + .086 BC

The estimate of each coefficient, except B.C.'s, is statistically significant
The proportion of the variation in C explained by the equation is .94

Examples using the regression equation to predict the percentage of seats 
of Canada won by the victorious party:

1974 Election: C = 53.5, E = 41, OQ = 71, P = 11, BC = 35 
1974 Prediction: C = -21.15 + 116 * 41 + .927 * 71 + .137 * 11  + .086 * 35 = 54
1984 Election: C = 75, E = 78, OQ = 74, P = 80, BC = 68
1984 Prediction: C = -21.15 + .116 * 78 + .927 * 74 + .137 * 80  + .086 * 68 = 73.3


Works Cited

  • Archibald, G.C. Information, Incentives and the Economics of Control. Cambridge, MA: Cambridge UP, 1992.
  • "Beijing Rules China's State Owned Enterprises." The Economist 3 May 1997: 54-55.
  • British Columbia. Office of the Auditor General. Crown Corporations Governance Study. Victoria: Queen's Printer for British Columbia, 1996.
  • Canada. Treasury Board Secretariat. Crown Corporations and Other Canadian Government Corporate Interests. Ottawa: Minister of Supply and Services, 1984.
  • "China." Embassy of China in the United States. China Achieving Progress in Market Economy. 29 Dec. 1997. 23 Oct. 1999 <http://www.china-embassy.org/Cgi-Bin/Press.pl?eco01>
  • Colombo, John C., ed. The Canadian Global Almanac. Toronto: Macmillan, 1999.
  • Domar, Evsey D. "On the Optimal Compensation of a Socialist Manager." Quarterly Journal of Economics 88.1 (1974): 1-18.
  • Hunter, Justine, with Petti Fong. "B.C. Ferries Plans Major Cut in Size of Managerial Staff." The Vancouver Sun 15 Sept. 1999: A1+.
  • Jorgensen, Jan, Taieb Hafsi, and Christiane Demers. "Context and Process in Privatization: Canada/Quebec." The Political Economy of Privatization. Ed. Thomas Clarke and Christos Pitelis, London: Routledge, 1993: 234-272.
  • "Russia." Embassy of the Russian Federation in the United States. The Economy of Russia. 1997. 22 Oct. 1999 <http://www.russianembassy.org/economy.html>
  • Tam, Mo-Yin S. "On Incentive Structures of a Socialist Economy." Journal of Comparative Economics 3 (1979): 277-284.
  • Trudeau, Pierre Elliot. Memoirs. Toronto: McClelland & Stewart, 1993.
  • United States. Central Intelligence Agency. The World Fact Book 1999. China. 1999. 23 Oct. 1999 <http://www.odci.gov/cia/publications/factbook/ch.html>.
  • United States. Central Intelligence Agency. The World Fact Book 1999. Russia.1999. 23 Oct. 1999 <http://www.odci.gov/cia/publications/factbook/rs.html>.
  • Wiens, Elmer G. "A Positive Theory of Government Firm Regulation." UCLA Economics: Working Paper #134 1978.
  • Wiens, Elmer G. Crown Corporations and Industrial Concentration. British Columbia: Ministry of Industry and Small Business. Unpublished manuscript, 1982.

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