services through SOEs (Sorrentino, 2020).<sup>6</sup> That is, governments may want to establish SOEs to carry out countercyclical spending during recessions, to create jobs and provide job security, to distribute incomes and benefits, to open up opportunities for historically disadvantaged population groups, or to exercise strategic control in productive sectors or geographic regions a result of public policy objectives.

While social or political motivations for SOEs are country-specific and influenced by policy makers’ preferences, justifications grounded in economic theory are more universal. Rationalizations of state presence based on socio-political considerations remain dependent on a country’s specific context and political setting, complicating systematic cross-country analysis.<sup>7</sup> However, from an economic perspective, state direct participation in markets through SOEs can be one of multiple ways to address specific market failures, which can be objectively identified on the basis of the underlying characteristics of the specific markets.<sup>8,9</sup> As explained by Putniņš (2015), under the assumption that governments seek to maximize social welfare, the rationale for state ownership should be based on a three-step process: establishing the presence of a market failure, determining whether an SOE is the most desirable policy intervention to address that market failure, and assessing the costs and benefits of using SOEs to address the market failure for a specific market. Other ways to rationalize state participation in businesses include the analysis of the subsidiarity role of state, which establishes that if there are or could be private agents interested in performing an economic activity, then the state does not need to participate as a market player and should focus on supplying essential goods or services that cannot be provided by private agents.<sup>10</sup> The advantage of analyzing SOEs through the economic lens of market failures or subsidiarity is that this analysis relies on intrinsic sector characteristics which are common across most countries, hence the analysis can be more easily standardized.

Hence, by classifying sectors based on intrinsic market characteristics, this paper provides a novel tool for nuanced country-level analysis of state presence in the economy with a view to guiding policy makers in their decision of whether to intervene in a market or to divest an SOE. Whether assessing the overall footprint of SOEs in the economy or understanding potential distortions from state ownership in the corporate sector, simply adding up all SOEs into one figure is insufficient. It ignores the underlying motivations for a given SOE, as well as the varied costs and benefits from SOE participation in different sectors. By proposing an objective taxonomy, this paper provides a robust tool for analyzing SOE 6 Cordella and Vagliasindi (2021) explain that different reasons explain the existence of SOEs, including political, social, and economic motivations. They suggest, however, that SOE performance should be measured against the objective for which they were created rather than the standard profit-maximizing measures of private firms. Heath and Norman (2004) identify five main categories of SOE responsibilities: macroeconomic, creation of good-quality jobs, redistribution, national interest, and addressing externalities.

7 For example, some countries consider strategic those sectors related to national or subnational control of the territory (such as the military), while others use a broader definition that includes electricity, transport, water, hydrocarbons, mining, or financial activity. There are also differences in what constitutes a development objective in different contexts. Some governments may, for example, pursue state ownership in agriculture given its relevance in the economy, even though there are no objective market characteristics to indicate that the private sector would otherwise not enter and invest. See also World Bank (2011), where in the context of underdeveloped private capital markets and weak intellectual property systems, SOEs were rationalized on the basis whether they acted as venues for developing capital-intensive industries in the absence of the private sector.

8 Market failures are cases where suppliers would provide goods and services in suboptimal quantities, resulting in an inefficient market equilibrium and social welfare loss.

9 For example, the provision of insurance is hampered by adverse selection and moral hazard, two types of market failures that are intrinsic to and ubiquitous in insurance markets.

10 In policy implementation, some governments have also developed frameworks to determine where SOEs operate in the economy based on economic and social considerations (Landa, 2016). The analysis of the subsidiarity role of the state is one of the principles to rationalize the role of SOEs in the economy. It establishes that when there is a private sector that is viable and supply goods and services and attend demand, the state should refrain from acting as market player in those activities, and if any intervention is needed it should be in the form of regulation. For instance, according to the Peruvian Constitution, the Government has to follow three criteria for assessing its participation (directly or indirectly) in business activities. First, the State participation in business activities should be authorized by a special law; second, the State participation in business activities should be subsidiary to private businesses such that the State intervention should not foreclose private businesses from the market, and finally the State participation in business activities can only by allowed for reasons of overriding public interest or manifest national benefit.

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