What is direct and indirect government intervention

Corona crisis: State holdings remain a problematic intervention in the market

The corona pandemic is an exogenous shock for the global economy and the individual national economies, which affects public life in a way previously unknown in peacetime. The German economy, which is strongly integrated internationally, was hit hard. Against the background of such an external shock, state economic interventions to reduce uncertainty and to safeguard companies and jobs are justified. However, these government measures must be designed in such a way that negative effects such as higher prices, less innovation and distortions of competition are avoided. Direct state holdings in companies, which can permanently distort the market, appear particularly problematic. They therefore need clear rules.

The pandemic has tended to strengthen the position of the state in Germany. State actors introduced exit and contact restrictions, ordered quarantine measures and border closings. During the lockdown, the state enforced closings and has to do it again in view of the increasing number of cases. Numerous companies have been and are being confronted with considerable challenges as a result of the measures to contain the pandemic as well as the collapse in sales as a result of collapse in demand and production difficulties, which has in some cases made it difficult to supply society. As a result, there was increasing government intervention in economic activity, for example through direct investments in Deutsche Lufthansa AG, the TUI Group and CureVac. In addition, extensive government guarantees, grants and loans have been and are being granted. If there is no further economic recovery due to a second wave of infections, government interventions are likely to increase again.

The state must act

However, an economic crisis is not only a challenge, it can also be an opportunity. As early as 1934, Joseph Schumpeter formulated the thesis that economic development was not going in a straight line. Economic crises are an integral part of the development process of an economy because they help innovations to break through and form the basis for a renewed upswing. Former US Treasury Secretary Andrew Mellon put it more succinctly to US President Herbert Hoover (President from 1929 to 1933): "Values ​​will be adjusted, and enterprising people will pick up the wrecks from less competent people."

Thus, in the medium term, economic crises can lead to above-average productivity gains if companies with new technologies take the place of insolvent, uneconomical companies or companies introduce new technologies and improve inefficient structures and processes in order to remain competitive. Consumers also benefit from this, as companies withdraw from the market that have not been able to adequately satisfy the needs of their customers. During a crisis in particular, competitive pressure is stronger than during an upswing, because resources are tighter, expectations are clouding over and consumers and companies are scrutinizing their spending more closely. In Schumpeter's sense, it is a creative destruction in which the crisis acts as a catalyst.

However, this view is controversial. For example, US President Herbert Hoover wrote in his memoirs on the Great Depression: “Panic had always left a trail of unnecessary bankruptcies which injured the productive forces of the country.” It can therefore be dangerous for the state not to intervene in a major crisis : If every company can be insolvent at any time, the economic actors no longer trust each other. As a result of these developments, the number of bankruptcies continues to rise, making economic actors even more cautious and intensifying the crisis itself. By liquidating companies with a functioning business model, the crisis can also destroy the basis for subsequent growth, because too many companies and their investments are liquidated. Even start-ups will then no longer receive funding and will therefore not be able to take the place of insolvent companies in the medium to long term. In such a situation, government intervention can restore or secure confidence, stabilize demand and alleviate the crisis.

In addition, the economic contraction as a result of the corona pandemic had no structural, economic or regulatory causes. The trigger for the crisis was not economic exaggeration or the actions of “incompetent people” as Mellon describes it. Although the economic crisis intensifies structural change in some areas - for example in the direction of digitization - it also endangers many companies with a fundamentally functional business model. Ideally, the state should intervene in such a way that the creative destruction can take effect without damaging healthy companies and becoming insolvent. It is therefore not appropriate to prevent bankruptcy in any case, especially since this can also serve to reorganize a company. The distinction between which company will be rescued and which will not, however, is not trivial and may involve hardship (e.g. job losses). In addition, selective intervention can lead to the same crisis effects that have already been described: In principle, any company can still become insolvent. Too far-reaching intervention, on the other hand, can overwhelm the state's possibilities and lead the state to incapacity. Nevertheless, in an acute crisis of historic proportions, state intervention appears necessary.

The state in economic activity

However, government economic intervention also has negative effects. Eliminating competition through conservative state interventions can prevent productivity gains because, for example, uncompetitive “zombie companies” are kept on the market. This is all the more the case when expectations build up that the state will intervene in further crises in favor of established but inefficient companies. The implementation of innovations is thus hindered or even prevented. To assess whether and to what extent a state should intervene, it is helpful to analyze the extent to which the state is already represented as an actor and what experience has been gained in other states. This allows different models of government intervention to be compared with one another and conclusions to be drawn about the impact of these interventions.

Every five years, the OECD uses its Product Market Regulation Study (PMR) to measure which policy measures strengthen or hinder competition in product markets. In this context, the role of state-owned companies is also examined. From the last study from 2018, data are available for 36 of the 37 OECD member states (the USA is missing). The range of state-owned companies varies greatly. A state-owned company is defined as "any legal entity that is considered a company under national law and in which the state exercises an ownership function".

The PMR indicator “reach of state-owned companies” is defined in the interval from 0 to 6. A total of 25 sectors are considered. This includes seven network sectors (e.g. air transport, gas, electricity), each with a weight of 1/8. 18 other sectors (e.g. gambling, wholesale and construction) together also have a weight of 1/8; thus each of these 18 economic sectors has a weight of 1/144. If a state-owned company is active in a sector under consideration, this area is given the value 6, otherwise the value is 0. The total value for a country is made up of the sum of the sector values ​​multiplied by the respective weight. A value of 6 for a state therefore means that at least one state-owned company is active in each of the economic sectors considered. A value of zero means that there are no state-owned companies in the sectors mentioned.

Within the OECD (excluding the USA), Chile has the lowest value with 1.13 and France with 5.38 the highest value, well ahead of Poland with 4.75. With 4.27, Germany ranks fifth. This means that Germany is one of the countries in which state-owned companies are represented in many economic sectors. This is mainly due to the strong economic activity at the local level.

Local level strongly represented in the economy in Germany

Municipal economic activity in Germany has a long tradition. While areas of general interest were traditionally characterized by municipal activities - in addition to water supply, sewage and garbage disposal, this used to include grid-connected energy supply with electricity and gas as well as (as a national responsibility) telecommunications - the municipalities have had many activities over the course of time further areas expanded.

After a phase of privatization of municipal fields of activity from the end of the 1980s until shortly after the turn of the millennium, municipal economic activity has since been on the upswing again. Cities and municipalities rely on public offers of services and use their advantages - preferential treatment for VAT, the possibility of cross-subsidization between profitable and loss-making areas, exemptions from antitrust law and proximity to politics - to the detriment of competition. The number of private businesses and privately organized companies owned by the public sector has been growing rapidly for years. By definition, the now more than 15,800 municipal companies are almost exclusively in the territorial states, the three city-states had a further 774 companies in 2017. According to the Federal Statistical Office, the number of municipal companies rose by 45% between 2000 and 2017. In the same period, their sales even grew by 141%, while the deliveries and services of companies subject to VAT in Germany only increased by 59%.

Triggered distortion decisive

However, the prevalence of state-owned companies does not directly say anything about the effect on the economy and possible distortions in the market. This is clear from the PMR sub-index “Distortions Induced by State Involvement”. This measures the economic distortions triggered by the state and compares them internationally. The distortion can originate from the state as the owner, government intervention through its own procurement, price controls and the complexity of laws and legislative procedures. For the respective form of economic distortion, the OECD uses a corresponding indicator such as the previously mentioned indicator “reach of state-owned companies”.

The distortions are also measured on the interval from 0 to 6, analogous to the reach of state-owned companies. In this context, zero means no distortion whatsoever, while a value of 6 indicates large distortions. With a value of 0.84, the UK had the lowest value in 2018. The highest values ​​were recorded in Colombia with 2.18 and Turkey with 2.20. With a value of 1.41, Germany was in the lower third of the 36 OECD countries and thus shows comparatively little state distortion of economic activity despite strong economic activity by the state - at the municipal level.

The economic effects that a high level of distortion on the part of the state can have can be seen in Figure 1. This shows the gross domestic product per capita and the economic distortion induced by the state. If Switzerland, Luxembourg and Ireland are disregarded, the correlation between distortion and GDP per capita is clearly falling. In other words, the higher the bias, the lower the economic output per capita tends to be and vice versa. The correlation coefficient based on our own calculations excluding Switzerland, Ireland and Luxembourg, which have an exceptionally high GDP despite a high degree of bias, among other things due to the presence of headquarters of internationally active corporations, is -0.54. This value indicates the existence of a negative correlation for the majority of the OECD countries. The effect of government intervention in the economy can thus have an impact on a country's prosperity.

illustration 1
GDP per capita and economic distortions caused by government in the OECD countries in 20181

1 excluding USA and Luxembourg.

Notes: GDP per capita in US dollars, current prices and current purchasing power parity; economic distortions represented by the PMR sub-index “Distortions Induced by State Involvement”, scale of the indicator: 0 to 6. A value of 0 means no distortion of economic activity and a value of 6 means massive distortion.

Source: OECD (2020a, 2020b).

The mere presence of state-owned companies in a sector is not enough, however, to have a negative effect. There is no apparent correlation between the indicator range of state-owned companies and GDP per capita. The correlation coefficient is 0.24 for all 36 OECD member states for which values ​​were available. The correlation coefficient is reduced to 0.1 if Luxembourg, Switzerland and Ireland are not considered. A state participation in a company is therefore not a sufficient criterion for negative economic effects. The purpose of the state-owned company (profit maximization or other goals such as security of supply), corporate management and the respective regulatory environment are particularly important.

In order to avoid a possible distortion, the two regulatory principles of the social market economy must be observed in the event of state intervention:

  1. The coordination of economic activities should take place via markets through prices and competition, which requires private property, freedom of contract and liability.
  2. The market processes should not be disturbed by the use of economic policy instruments (market conformity).

These two principles must also be observed when interfering with the structure of the economy. Wherever possible, rule-based markets should be used for coordination. State intervention must not unnecessarily influence the processes in these markets by, for example, granting advantages to state-owned companies.

Criteria for state intervention through participations

The decision as to whether state intervention is necessary at all should be made on the basis of established criteria. Ideally, these criteria should already have been developed ex ante in the political process and be established before any intervention. Among other things, this can avoid the impression that investments and thus the use of taxpayers 'money are arbitrary or that an erratic handling of taxpayers' money makes government action appear unpredictable. The randomness of government action can be fatal in a crisis if it is unclear who will be saved. It is therefore important to define and communicate its goals before - or during - state intervention in order to inform and involve business and society in such a decision. Possible goals of state participation, especially during the corona pandemic, could be:

  • Stabilization in the crisis: The crisis prompts the state to stabilize companies that would be threatened in their very existence by the pandemic alone. Achieving profit and avoiding losses are not explicit goals; For example, an exit must not be made dependent on the fact that previous stock exchange prices have been reached again.
  • Analogous to the regulation of foreign company takeovers (§55 of the AWV - Foreign Trade Ordinance), state intervention to maintain public order or security in the Federal Republic can be justified. In this context, it is conceivable, among other things, to maintain companies that are indispensable in terms of infrastructure, producers of important software (e.g. for power plant control systems or telecommunications networks) and producers of important goods and services (medicines or armaments). In these cases, the companies serve to pursue political or strategic goals such as the creation of security of supply and the creation and maintenance of know-how, which justifies government support.
  • Prevention of domino effects: Companies such as large banks or network operators that are structurally strongly networked and whose short-term, uncontrolled departure would have significant negative effects on other companies or society, can also be supported by means of state participation. This should serve to prevent an uncontrolled collapse and enable the departure and renewal of the company in a regulated manner.

To implement these goals, clear criteria are required, which should be formulated ex ante. Figure 2 summarizes the most important criteria for the decision on state participation in a test scheme. The following criteria - usually cumulatively - should be met for state participation:

Figure 2
Decision on state participation

Source: own illustration.

  • There must be a sudden, unforeseen market slump that plunged a previously healthy company into a crisis that was not self-inflicted and threatened to exist.
  • Companies in which the state takes a stake must be relevant to the market or the public order and security of the country. Two factors in particular are decisive for this:
  • The company is of a considerable size or is strongly networked with other companies, which in the event of a short-term insolvency has a negative effect on the overall market (customers / suppliers) or many other companies because, for example, an important infrastructure is not available as usual (domino effect) . This also includes the criterion of network relevance, which came into play, for example, when participating in Lufthansa as a national carrier with a global route network that is required by the strongly interlinked German economy. Size and relevance to the labor market alone are not sufficient criteria, as otherwise there is a risk that state investments will impede structural change.
  • The company has pioneering technology and develops security-relevant software and armaments. Without state participation, there should be a risk of the company leaving the company or being taken over abroad. The Foreign Trade Act and, as a first approximation, the industries defined in the Foreign Trade Ordinance (BMWi, 2020) could be used as a definition of relevant technology fields. At least in theory, the stake in the biotech company CureVac also falls into this category. However, it remained unclear whether such a takeover request actually existed, whether the company's vaccine development would be crowned with success and why equally promising competitors were not supported. Here, too, lower-threshold alternatives such as a ban on foreign takeovers and assistance with the organization of domestic participations from the private sector are preferable.
  • There is a gap in the portfolio of state aid offers. A further criterion should be examined whether alternative offers of assistance from the state are not sufficient below the severe market intervention that a participation causes. In the current Corona crisis, these include, for example, discounted loans and extended short-time working regulations.

A state participation or even complete takeover is probably the most direct form of state intervention in a company. However, it is only one possible form of economic intervention. In addition to state participation, for example, in-depth cooperation and the means of a moderated merger are available. A closer cooperation can stabilize several companies in an affected market and help to overcome challenges, which is why this measure should be encouraged by the state. In the current pandemic, cooperation between antitrust authorities is being handled relatively generously (European Competition Network, [ECN], 2020). The merger of two competitors is a long-term and mostly irreversible change in the market. This makes market conformity an important criterion. This means that there should be no mergers that would not have come about through business decisions or that do not make business sense.

A state participation, on the other hand, especially if it takes place as a silent minority participation, has a variable time horizon and can be reversed if the triggering crisis is rather short-term. The corona pandemic is a (hopefully) temporary crisis and the costs of state participation can be justified because long-term costs are avoided, for example by reducing competition when exiting the market or reducing innovations in mergers. Thus, as a reaction to the pandemic, participation should first be preferred to a merger. A merger may be preferable if, for example, as a result of a long-term structural change, demand falls sustainably or there is overcapacity. In this case, structural change can be controlled in a targeted manner. An example of this is the founding of Ruhrkohle AG (RAG) in 1968 (Klute, 2019), which, however, was followed by problematic subsidies for hard coal mining for decades.

Do not lose sight of the framework conditions

In addition to state holdings or brokered mergers, the improvement of relevant framework conditions also represents a political field of action that must not be neglected. For example, the conditions for all companies can be improved through rapid approval procedures or understandable tax law with internationally competitive tax rates, which stimulates innovation activities and enables competition as a selection mechanism to develop its full effect. Rather, the company that best meets customer needs wins through. By improving the framework conditions, it is also possible to react to identified undesirable developments such as emigration or the sale of innovative companies.

Strengthening the framework should also include improving financing options for young companies, for example in the venture capital area. It should be noted that there is already more or less extensive research and development (R&D) and technology funding that benefits many innovative companies. The technology field and project-related R&D funding was only expanded to include tax research funding at the beginning of 2020 (German Bundestag, 2019), which, however, was more restrictive than recommendations from science and industry. It is possible that the scarce state funds can be used more effectively in a more generous tax R&D subsidy that is open to all innovative companies than in investments in individual high-tech companies. Framework conditions, for example in the area of ​​tax loss offsetting, are more restrictive in Germany than in other highly developed countries with which Germany competes for technology-intensive start-ups (LM Law Rechtsanwaltsgesellschaft mbH, undated; Röhl, 2014).

Conclusion

The corona pandemic is a historic shock for the economy and society as a whole in Germany and around the world. In addition to industry, due to the lockdown and ongoing contact restrictions, the service sector is particularly affected, which in many developed countries accounts for over 70% and in Germany for more than 68% of total economic output (United Nations, 2019). The renewed increase in the number of cases is likely to delay the economic recovery and prolong the crisis.

Severe economic shocks like these also have the potential to accelerate structural change through digital applications and business models and thus enable productivity gains and increased growth. However, they can lead to a profound crisis or even depression, which also falls victim to healthy companies and which destroys the basis for new growth. Accelerating digitization can increase the market power of large digital platforms (Monopolies Commission, 2020; Demary, 2020). The state, in turn, can act to mitigate the economic effects on consumers and companies and prevent the crisis from worsening. State intervention can also be justified if, as is currently the case, the trigger of the crisis is not an economic one. Too far-reaching state interventions, especially if they preserve inefficient structures, increase market distortions through state interventions and state holdings and overload the state's scarce resources, can, however, deprive an economic upswing of the basis and cause negative structural effects in the long term.

That is why it is important to ensure market conformity in government measures. In the case of interventions in the economic structure, for example by means of state-sponsored mergers and holdings, this means that no structures may be created in the context of the crisis that would not have formed themselves on the market or that would have failed due to competition law. In the case of direct state holdings, it is also important not to influence decisions in the company politically, not to distort competition and not to lose sight of the state's exit after the crisis. The criteria for decisions about state participation should be established ex ante and be transparent. In addition to direct or indirect intervention by the state in the economic structure, the improvement of the framework conditions is also an important field of action. Here, Germany had a need for action in the area of ​​infrastructure, tax policy and planning and approval law even before the Corona crisis.

* This article is based on Röhl and Rusche (2020).

literature

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Title: Growing Public Ownership Due to the COVID-19-crisis Highlights Importance of Precise Rules

Abstract: The coronavirus pandemic has presented society with major challenges that have required state intervention .. While government measures are necessary in an external crisis such as the current pandemic, negative effects can also arise from excessive government intervention, particularly for the economy. An analysis of the OECD countries shows that the state has already played a major role in the economies of many countries before the coronavirus crisis, especially in Germany. However, state participation in companies does not necessarily have to lead to negative effects if it is structured appropriately. This article discusses how government measures, especially the extension of public ownership, should be designed in order to maintain competition and use the free market as an allocation instrument where possible. This means that no market structures should be created which could not have been created or which fail to comply with competition law. Moreover, state intervention should not be used to exert political influence on business decisions.

JEL Classification: E61, H12, O25