Too big to fail? Why State bailouts don’t make economic sense

The current financial status of public undertakings has brought into focus the levels of productivity and efficiency of State Corporations and State-owned enterprises as a cause of increasing public outlays over the years. Originally, modern governments developed strategies of expanding State spending without collecting new taxes by owning and investing in public organs as a source of additional public revenue.

However, in Kenya, the framework of several public undertakings has been coupled with challenges stemming from maladministration of public resources, pursuit of imprudent risks, weak corporate governance systems and stiff competition. As a consequence, the entities rely heavily on the Exchequer for bailouts to forestall possible bankruptcy.

The Public Finance Management Act No 18 of 2012 states that the following principles apply in the establishment and dissolution of a public corporation. First, redistributing resources in ways that enhance opportunity and support consistent with the State’s social inclusion agenda; and, second, the correction of market failures to foster social and economic welfare through improved resource allocation where the benefits of national government intervention outweigh its costs.

Globally, governments intervene to bail out institutions through cash, subsidised loans or some other consideration. The bailed-out public entities are often viewed as ‘Too Big to Fail’, owing to their critical role in the economy regardless of the cost to the taxpayer. The term ‘Too Big to Fail’ became popular after the 2007/08 Global Financial Crisis in the US, where the State bailed out financial institutions to avert an international economic collapse.

In Kenya, a classic case of a State-run entity that would be ‘too big to fail’ is Kenya Power. In September 2019, the firm issued a profit warning of a decline of more than 25 per cent of aggregate earnings reported for the period ending 2018. The projected decrease in earnings was linked to non-fuel power purchase costs, consistent with the company’s long-term approach of adopting renewable energy.

The economist Paul Krugman notes that the concept ‘too big to fail’ holds if the economies of scale are worth conserving, are well regulated and are commensurate with their economic impact.

According to the Annual Public Debt Management report for 2018/19 by the National Treasury, the State’s payment of Publicly Guaranteed Debt was Sh1.3 billion. The sum used for highlighted State enterprises faced with financial constraints translates to approximately 0.045 per cent of aggregate public spending for the Financial Year 2018/19. The recipients included East African Portland Cement Company (EAPCC), Tana and Athi River Development Authority (TARDA) and Kenya Broadcasting Corporation (KBC), which received Sh351 million, Sh281 million and Sh740 million, respectively.

As at February 2020, EAPCC had posted a net loss of approximately Sh1.5 billion, accompanied by retrenchment of an estimated 150 members of staff. This gives rise to the question of whether State corporations are financially viable entities. Also, are bailouts really applied as per the guiding principles of the PFM Act?

On January 25 this year, during the Nation Media Group SMEs Expo, the Cabinet Secretary for National Treasury proposed parastatal reforms, including a merger of State entities, to ease the burden borne by the taxpayer. Ultimately, the government must oversee and restore State agencies by reviewing the legal and institutional framework. Thomas Sowell said that “Government bailouts are like potato chips: You can’t stop with just one”.

Ms Nguyu is an economist. [email protected]