findings pertaining to poor SOE performance are valid across sectors. Finally, SOE performance is linked with economy-wide performance, growth, the government’s fiscal position,<sup>18</sup> and productivity trends.<sup>19</sup>

# III. Framework to Classify Economic Activities Based on an Efficiency Rationale for State Participation

The conceptual framework put forward by this paper stems from the simple consideration that, given the pitfalls connected to SOEs, these should be present only in sectors for which a strong economic rationale for state participation exists. Gaining an understanding of the pros and cons of government intervention in individual sectors through an SOE, rather than letting private enterprises compete, is critical for informed policy making. SOE participation is just one of several alternative ways in which a government can intervene to correct a market failure; often, SOEs are not the best alternative. Market failures can be addressed through other forms (and perhaps less distortive and costly) of state intervention, ranging from information provision to regulation to direct state provision of the good or service, and do not themselves justify state participation _per se_ . In the absence of a market failure (for example, in the manufacturing of food products or textiles), only the distortionary effects of SOE participation could arise, while the SOE’s presence could not be justified by the aim of improving social welfare. While there are other important factors that shape SOE performance beyond the intrinsic market characteristics of the sector in which the company operates –for example, the level of independence of management, the quality and capacity of state supervisory mechanisms, regulatory regimes governing SOEs—they fall beyond the scope of this paper.

The proposed taxonomy is centered around the assumption that the presence and degree of market failures that could be corrected through an SOE can help differentiate among economic sectors. By distinguishing between economic sectors according to the presence (or absence) of specific market failures connected to the process of producing its goods or services, their intensity, and the appropriateness of an SOE as a (potential) corrective measure, one could explore the justification for the presence of SOEs and, as a result, be alerted to the risks of distortive consequences or unintended consequences of SOE presence. A natural conclusion is that sectors with little or no economic rationale should be the first to be considered for SOE divestiture/privatization, given that the well-documented performance gap and distortionary effects of SOEs (the “cons”) cannot be compensated for by a specific economic benefit (the “pros”) (Figure 1).

> 18 SOEs may operate with a surplus or with systematic losses that impact the government’s budget or balance sheets through numerous transmission channels: taxes and dividends on the revenue side, subsidies and transfers on the expenditure side, government loans to SOEs generating interest receipts, government takeover of SOE debt, and valuation effects, which tend to be correlated with SOE performance (Soler and Sy 2021).

> 19 For example, Szarzec, Dombi, and Matuszak (2021) analyze a micro-level data set on the aggregate economic weight of SOEs in European countries according to leading business indicators, and on that basis assess the overall growth effects of SOEs and their relationship with governmental institutional quality, finding that better institutions entail a more favorable growth effect of SOEs. Böwer (2017) argues that the negative productivity aspects of SOEs in general could spill over to affect the economy at large. Mattera and Silva (2018) focus on firms in the steel sector across countries, finding not only that SOEs are associated with poorer economic performance and higher levels of indebtedness than private enterprises, but also that they have contributed to increasing overcapacity. Ehrlich et al. (1994) and Karpoff (2001) corroborate the exposition above by showing that direct government participation in markets, through SOEs, should be reduced, as private companies are higher performers in terms of productivity growth and managerial efficiency. Similarly, Boeing et al. (2016) and Wei et al. (2017) find that private firms benefit the most and carry out more research and development investments relative to SOEs, providing empirical evidence that SOEs underperform private companies with regard to productive investments. Harrison et al. (2019) document that SOEs and recently privatized SOEs in China perform less well than private companies in terms of profitability.

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