A new social contract

The Arab street might be the visible battleground of the region’s revolutions, but the Arab public sector is where much of it fermented. It was the striking textile workers of the state-owned Misr Spinning and Weaving textile plant in Mahalla El-Kubra who gave the April 6 Youth Movement its name and original impetus in April 2008. It was the late January resignation of Ahmed Ezz, steel magnate and chief manipulator of the November 2010 elections, which signaled first cracks in the regime in which the crony capitalists around Gamal Mubarak, enriched through skewed privatization deals, were losing support. Ezz’ resignation was followed in February 2011 by his arrest and that of a number of billionaire ministers close to Gamal, alleged to have misappropriated state assets. The regime fell soon afterward.

Mismanaged public sectors have been a pivotal, but scarcely discussed cause of the uneven growth and corruption that have allowed the revolutionary fervor in the region to spread beyond a hard core of seasoned activists: In Egypt, underperforming state-owned enterprises (SOEs) in the country’s struggling manufacturing sector have undermined competition and weighed down on growth. Although the postponement of reform in some cases allowed the preservation of state-provided jobs, many companies were not productive enough to allow for reasonable wages and dignified work conditions. The textile mills in Mahalla Al-Kubra, employing a full 24,000 workers, have been run by a corrupt, state-appointed senior management that refused to pay workers their bonuses and condoned widespread abuse on the shop floor.

Conversely, to the extent that better functioning state assets have been sold off, the privatization process was frequently opaque and allowed regime cronies to cannibalize state assets. Ahmed Ezz, who could draw on his political connections to acquire strategic bits of the country’s steel sector, is only the most visible example. This again has resulted in fiscal losses and, more ominous in the long run, private monopolies.

The combination of patronage employment, mismanagement and crony capitalism exacerbated Egypt’s development crisis. Most of the symbols of corruption and socio-economic failure that galvanized revolutionary fervor among ordinary Egyptians were tied in one way or the other to the public sector.

The state of the public sector in many other MENA countries has been similarly problematic, contributing to a regional development crisis and growing public discontent: In Algeria, public industry has been routinely used as a tool of patronage and enrichment of the country’s elite and run at below 50 percent capacity utilization. In Syria, more than 250 state-run businesses provide hundreds of thousands of jobs, but more than 95 percent of them have ended up in the red for many years. Corruption is rife. Even in economically liberal Gulf monarchies, state ownership accounts for almost a third of all assets listed on local bourses, with a total value of $182 billion in September, 2010 — and this does not account for large Gulf SOEs that are not listed in the first place. Loss-making albatrosses like Bahrain’s Gulf Air or Kuwait Airways weigh heavily on state budgets.

Reformers and revolutionaries in the Arab world look to the current crisis as a chance for political and social renewal, for righting past wrongs and negotiating a new social contract. Crises and revolutions do indeed provide opportunities for reform that are inconceivable in the quotidian grind of normal politics, both democratic and authoritarian. While much has been said about the new political dispensations that might emerge from the revolutions in Tunisia, Egypt and beyond, less thought has been given to the forms of economic governance that the Arab spring might produce.

SOEs, many of which are in the strategic energy, telecoms, real estate and transport sectors, in principle form an untapped resource for driving economic growth and transforming the social contract. Better organized and more sensibly structured they could yet have a beneficial impact on many economies and the people in the region. All governments hold these assets in trust for their citizens, which is why SOEs must yield more for them after decades of mismanagement and meager or no dividends.

Real reform is never easy, as established interests need to adjust and ways of doing things change. Most, if not all, shortcomings in the corporate governance of SOEs stem from the way government exercises its ownership rights. The decentralized model of ownership in which each ministry both holds and runs the commercial assets in its sector is essentially a leftover from the days of central planning, when policy and commercial objectives were usually indistinguishable. This model, still prevalent in the region, is at odds with principles of competition policy, and often leads to intransparent, politicized governance with muddled objectives. Deregulation and the introduction of competition combined with strengthening the regulatory capacity in strategic sectors will deliver both sustainable profit and competitive prices to the end users.

The most challenging feat required of state ownership is that government must ultimately be both player and referee, or market participant and regulator. This duality needs to be addressed head on through a legally clear separation between ownership and regulation. In the end it means that ministers will influence a sector and all of its participants fairly and only through regulation. It is only when government ministers act purely as referees that we can claim to have achieved a level playing field for all participants, with a centralized management of state commercial assets that is both transparent and properly insulated from political influence, and managed with the clear objective of value creation.

In some cases, conditions of commercial governance have emerged de facto, if not de jure: In the case of a couple of successful Middle East and North African (MENA) SOEs in strategically prioritized sectors, ownership is for all means and purposes centralized in the hands of a small number of political principals. These hold the handpicked technocrats in charge of strategic assets closely accountable, yet leave them enough room to operate autonomously on a day-to-day level. The focus is on profitability, not patronage, and the rest of the bureaucracy is kept at arm’s length. Impressive success stories such as Emirates Airways in Dubai or heavy industry giant Saudi Basic Industries Corporation in Saudi Arabia are run along these lines — secretive but, by most accounts, well managed pockets of efficiency.

The political conditions that allow such institutional islands to emerge in MENA authoritarian systems are rare, however, and the setup works best when the situation approaches a natural monopoly or at least requires huge capital outlays that can only be provided by the government. More institutionalized recipes of governance will be necessary to improve accountability and results in most other cases.

Within the Organization for Economic Co-operation and Development (OECD), a consensus has emerged that a formally centralized ownership function is the most sensible way to achieve the necessary political insulation to manage SOEs. Centralization enables not only the containment of inherent conflicts of interest between political and industrial imperatives; it also allows the introduction of professional corporate governance skills. Boards of directors are strengthened and political interference in the day-to-day running of commercial operations is prevented. Such a governance structure can hold all relevant actors properly accountable for their success or their failure.

The best possible oversight and most efficient use of commercial funds can be achieved simply by borrowing a tool developed over centuries in the commercial world — the incorporated commercial holding company. Such a holding company or National Wealth Fund must be set up under professional management subject to commercial checks and balances, such as corporate accounting and auditing, as well as clear and publicly articulated objectives. In turn, credit ratings and the usage of the bond market rather than bank financing  boost transparency which further encourages the commercially disciplined management of assets. Some Middle Eastern countries have taken first steps into this direction, including Abu Dhabi’s Mubadala holding, which has introduced a bond rating, following the example of Singapore’s Temasek, the first international government fund to do so.

Internationally, professionally managed National Wealth Funds have created value for decades with a concept that has borrowed many features from the private equity approach, but based on improved transparency as a core principle. Sweden managed to transform its portfolio of state assets and outperformed the local stock market for more than a year during its pioneering reforms in the late 1990s. Several countries have created formal holding companies with very good results. Again, one of the leading international examples is Temasek, the National Wealth Fund in Singapore.  Bahrain has taken a similar step in the shape of its Mumtalakat holding structure, created to consolidate the state’s disparate public holdings in 2006. The Bahraini government’s recent politicization of the public sector — through a purge of politically active employees in a number of companies — is all the more regrettable.

The payoff from making SOEs run more like private sector businesses is that increased dividends flow from government portfolios which become available to take some of the budgetary strain off much needed social spending. Structurally, enhanced performance by a substantial part of any economy drives overall economic growth, while at the same time fostering competition within the individual sectors concerned. This is particularly important given that state commercial assets are generally concentrated in a few strategic industries of vital importance to many other sectors.

In the wake of social revolutions and upheaval, the risk of populism and renewed patronage policies is considerable. The political renewal in MENA can also provide chance for reshaping the old social contract, however. Old-school patronage through SOEs has failed: At least in the more populous countries, it is too thin to tie people politically to the old order or to provide rewarding employment; at the same it undermines national competitiveness and the fiscal balance.

Public sector reform cannot happen in a political vacuum. It will need to be accompanied by a labor market policy that allows the re-integration of public sector employees into the private market, and by tools of social security that allow the separation of – laudable – welfare and basic sustenance policies from public sector employment and SOE-provided services in the course of centralizing ownership. SOE employment as a welfare tool is inequitable, exclusionary and deleterious for long-run development; fairer tools to create a social safety net for all nationals have to be found. The net gains from a managerially autonomous, fiscally accountable and business-oriented SOE sector could not only make an important contribution to financing these tools but also serve as a model for the economy as a whole.

The heavy lifting that is required for such a redefinition of the Arab public sector might only be possible in extraordinary political circumstances. The current revolutionary moment provides a window of opportunity that is too precious to be missed. The current economic situation in the region requires extraordinary measures. Governments responsible for the ownership of commercial assets share the same challenge.  None can ever be an ideal owner, yet it should be incumbent on all to run SOEs professionally and do so in the interests of all citizens, however unpopular that may to be in some quarters, inside and outside of a government. In this sense, a regional reform program for its SOEs is both a financial and social enterprise with global relevance.

Dag Detter is in independent advisor and state asset specialist. He is the former President of the Swedish Government Holding Company Stattum and the Government Director of State-Owned Enterprises. Steffen Hertog is a lecturer at the London School of Economics and the author of "Princes, Brokers and Bureaucrats: Oil and the State in Saudi Arabia."