considers the demand and supply sides of the market. From the demand side, products must be substitutable from the buyer’s point of view, and from the supply side, sellers must be those that can or could easily produce the relevant product or close substitutes (OECD 1993). The location of buyers determines whether the market is local, regional, national, or international (OECD 1993). For the purposes of this paper, we have relied more heavily on the product (service) dimension of the market definition, however, the geographic aspect of the market should be taken into consideration when analyzing a specific country context, especially in the case of small, landlocked economies. A discussion on the level of disaggregation of industry classification and its relation to the definition of market is presented in section V.

This paper puts forward a “triage” of economic sectors to determine those without a specific economic rationale for SOE presence, those with a strong SOE rationale, and those with a weaker SOE rationale. The paper leverages the existing economic literature to categorize each economic sector into three groups: a “competitive” category, for which SOE presence does not appear to be justified on grounds of economic efficiency/market failure; a “natural monopoly” category, which includes economic sectors whose market structure is characterized by economies of scale and subadditivity costs that could be corrected via SOE participation; and a “partially contestable” category, a residual category which includes economic sectors characterized by some form of market power, externalities, or other market failures which could be addressed through state ownership.

The resulting taxonomy is the first comprehensive categorization to rationalize the presence of SOEs in 563 economic sectors, based on economic theory and the empirical literature of industrial organization, filling an important gap in the literature. There does not appear to have been any attempt in the literature to classify economic activities at such level of disaggregation on the basis of economic theory and evidence. Previous work has focused on studying specific sectors characterized by market failures and the potential efficiency gains from government interventions, but this work has failed to comprehensively analyze disaggregated sectors according to a single analytical framework. As a result, most of the classifications developed so far have focused on aggregate sectors or a limited number of subsectors.<sup>4</sup> This paper analyzes each of the 563 economic sectors of the Nomenclature of Economic Activities (NACE) Revision 2 classification of economic activities at the four-digit level, recognizing that only by appreciating the nuanced differences in economic activities across disaggregated sectors can granular SOE diagnostics and reform recommendations be made possible.<sup>5</sup> State participation in the economy through the provision of goods and services may sometimes pursue public interest objectives in ways that private, profit-maximizing firms cannot, but it often implies significant costs as well. Unintended consequences may include crowding out private investment, allocating resources inefficiently, or introducing fiscal liabilities. These costs and benefits are not homogeneous across sectors, and policies that aim to improve this cost–benefit balance must be informed by a solid understanding of the objective, rationale, or motivation of state participation in a specific sector. The presence of SOEs is motivated by economic, social, or political considerations. These are the categories according to which the literature classifies justifications for state provision of goods and

> 4 World Bank (1995) distinguishes broadly between “natural monopoly markets” and “competitive or potentially competitive sectors”. Dall’Olio and Nelli (2017) extend this approach by categorizing aggregate sectors into four categories, based on a combined assessment of market structure characteristics and public policy objectives: finance, commercial sectors, strategic sectors (oil, mining), and utilities (gas, water, electricity). Nyman, Dauda and Koschorke (2018) analyze along similar lines the economic rationale for state presence of South Africa’s state-owned enterprises across 40 vertically integrated markets. Dauda and Drozd (2020) present the economic rationale for state participation in 44 sectors captured in the 2018 vintage of the Product Market Regulation indicators.

> 5 The Statistical Classification of Economic Activities in the European Community, referred to as the NACE classification, is the industry standard classification system used in the European Union to classify economic activities.

4