Public or Private Ownership of Banks: Which is More Efficient

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Help keep family & friends informed by sharing this article, January 16, 2018 

Devika Dutt of PERI explains the gap between common economic thinking, which favors private ownership of banks, and the data. 

GREGORY WILPERT: Welcome to The Real News Network. I’m Gregory Wilpert, coming to you from Quito, Ecuador. Should financial institutions, mainly banks, be privately owned or publicly owned? A new study by PERI, the Political Economy Research Institute, written by Devika Dutt, has just been published, which relates the theoretical debates about this question among economists to actual empirical evidence. It shows that many economists are blinded by their ideological adherence to the private sector, even in the face of hard facts. The report is titled “Does Public Ownership in the Financial System Promote Superior Performance: A Study of the Literature.” The economic crisis of 2008, which was discussed mainly as a financial crisis expanding to include all sectors of the economy, made this debate about public and private banking much more relevant. Back then, we spoke to professor Leo Panitch, who explained that there are limitations to what private banks to do. 

LEO PANITCH Now in order to do that, it leads onto the next thing. In order to do that, yes, you probably do have to have a banking system that isn’t just regulated, but is a public utility, is a repository of a democratic, accountable state which directs the funds that pass through the banking system in such a way that the climate crisis, the type of production we need in order not to be destroying nature, does in fact happen. 

GREGORY WILPERT: Here to discuss the new PERI report is the author, Devika Dutt. She is a doctoral student at the University of Massachusetts, Amherst. Her work at PERI focuses on exploring alternative ways of organizing financial markets and financial market reform. She joins us from New Delhi, India. Thanks for joining us today, Devika. 

DEVIKA DUTT: Thank you for having me, Greg. 

GREGORY WILPERT: So according to the data you present in the report, immediately after 2008 financial crash, there was a sharp increase in public ownership of financial institutions around the world, mainly because governments bailed out banks and took them over. But in 2010, the ratio of publicly owned banks fell back to the ratio just before the crisis, so banks were privatized once again. What is the argument in favor of private ownership of the banking sector? 

DEVIKA DUTT: So usually, economists have, the best way to put it is a bit of a distaste for publicly owned firms, and they typically argue that publicly owned firms of any kind, banks or otherwise, are typically inefficient and are prone to be operated according to the best interests of whichever politician is in power. And therefore, most of the economics literature does not look very favorably on publicly owned firms of any kind. So that is usually the argument in favor of privatization, that a private firm, because it’s operating according to the discipline of the market, is going to operate in the most efficient manner. However, as we have seen that, especially in the case of banks, and in the case of other firms, but since banks and other financial institutions are somewhat different than other firms, I think it’s safe to say that it’s not such a clear-cut distinction that private firms are necessarily operating in a more efficient and necessarily better manner. 

I feel that, and I think overwhelming evidence also shows that the experience of the crisis is sort of a testimony to that, in which large privately owned financial institutions are operating in whatever we define as an efficient manner, sort of wreak havoc on the financial system. 

GREGORY WILPERT: So a quick look at the map in your report shows that the country with the highest proportion of private banks also tend to be the countries that are wealthier and have a higher percapita income, such as Western Europe, North America, and Australia, and public banking is more common in China, Russia, India, Latin America and the Middle East. Wouldn’t this be an argument for privatization of banks, or is it wrong to assume that a cause-and-effect relationship between private banking and increased wealth? 

DEVIKA DUTT: Well, I think it’s a bit more heterogeneous than that. I don’t think that’s an entirely correct argument. In fact, if you’re looking at necessarily advanced nations, Germany has a very high degree of public ownership, and Germany is one of the most advanced nations of the world, and is for the most part, not as badly affected by the crisis as all these other countries that you have mentioned. So while there might be a correlation in terms of richer countries in general with some notable exceptions like, as I said, Germany, having lower public ownership and poorer countries having higher public ownership, I would hesitate to call it a cause-and-effect relationship, that higher public ownership is causing slower economic growth, and therefore slower growth per capita incomes. In fact, there are several studies to show, which I cite, that that is in fact not observed in the data, that higher public ownership in the banking system is not related to lower GDP growth or a lower growth of per capita income. So I would not agree with that statement. 

GREGORY WILPERT: So to what extent would you say then, that the choice as to who to lend money to is a political choice, and what is the difference between a private bank and a public bank with regard to making a choice about where to lend money? 

DEVIKA DUTT: So the biggest difference with being a private bank – and I want to qualify this statement by saying that usually, since the nature of public institutions is very heterogeneous, and if you can see it in my paper, I’ve outlined all the different kinds of banks which deal with different kinds of objectives – but in general, I think it’s safe to say that while private banks operate primarily to maximize their profits, public banks usually have other objectives that they seek to fulfill. So while they might not necessarily be operating on a loss-making basis – which we would not want them to, because that would be a drain on any taxpayer’s money – however, they operate in a fashion that would likely also be serving other objectives other than profit maximization. For instance, small businesses are credit-constrained almost all over the world. 

What I mean by saying, when I say credit- constrained is that usually, the normal banking system, or the normal financial system, the private financial system, is unable to serve their credit needs, and more often than not, it is public banks or government programs that allow for lending to the small and medium businesses, which generate lots of jobs and lots of growth. For instance, in the United States, the Small Business Administration has a program that encourages private banks to, because the United States has very few public banks, to…so the program of the Small Business Administration encourages private banks to lend to small businesses. Clearly, the government thinks it’s worthwhile to make sure that credit is available to small and medium businesses, which has not otherwise been provided by the private financial system. So this is an example of what I mean by other objectives. So I think that is the main difference between private banks and public banks, is that private banks only want to maximize profit, and public banks want to do other things as well, which would have welfare effects for the society at large. 

GREGORY WILPERT: So can privatization reduce opportunities for corruption in the public sector, because public officials have fewer opportunities to wield public institutions as their own personal system? 

DEVIKA DUTT: I think that’s also a fraught point because privatization, in my mind, does not ensure lack of corruption. In fact, there’s research to show that pretty much no matter what form, if you’re politically connected, regardless of whether your ownership is private or public, you can have influence. You can pay lower taxes and enjoy the benefits of having friends in the government. So while it would be foolish to deny that public ownership does not necessarily mean that to some extent we will find those forms being used, as you said, the personal fiefdom of whatever politician is in charge. However, I would want to say that there is a lack of research to show how much this is the case of private firms. We often hear that disputes between a big multinational corporation like Deutsche Bank – when it ran into trouble with US [inaudible 00:09:28] financial regulators, you would hear news reports in which Anglo-America is sort of intervening in their behalf. 

So in that sense, it may not be the same, but I think it’s not clear or it’s not a plain link to say that privatization would reduce corruption, or would reduce, improve operations and reduce sort of less political favors being handed out, and I don’t think there’s enough research to show the extent of private corruption to show if it’s necessarily less. But once again, I think you’re right, and as I said, it would be silly to deny that there is no corruption in the public sector or in publicly owned firms. However, how it compares to privately owned firms or corruption with private firms, or how they link up to the political establishment, is something that has not been systematically studied, and therefore, it’s a hard comparison to make if privatization would necessarily reduce opportunities for corruption. 

GREGORY WILPERT: And what kind of evidence did you find about how publicly owned banks and privately owned banks and insurance companies and other financial institutions operate differently in times of crisis? 

DEVIKA DUTT: Right. So there is a large body of literature, and I cite all of it in my paper, which says that during the financial crisis, while privately owned firms, privately owned banks are contracting lending because they’re in trouble and maybe their loans are defaulting, maybe their capital ratios aren’t healthy at the time, and therefore, while they’re reducing lending – therefore making the recession worse – there are several studies to show that government-owned banks or public banks are actually playing a stabilizing role, by either increasing or not decreasing lending during times of crises. And in the face of private firms, reducing private banks, reducing credit in times of crises, and this provides a great stabilizing role so that the recessionary forces are somewhat mitigated. 

And in some cases, again, this effect varies across the context and institutions, and I think when countries in which institutions are more robust, the way we define that, the rule of the law is more prevalent – and when they say rule of the law, I think they’re talking about how their future, their checks and balances on corruption which are more than in, say, other countries, the effect is almost, sometimes even counter-cyclical. Which by that I mean that public banks might be increasing lending in times of crisis, which once again, provides them to be a stabilizing force. However, it’s also important to note that public banks are, over the business cycle, in general, bound to have smoother lending, and by that I mean that it’s not like they’re exploding lending during good times, which is then collapsing during bad times. So they’re sort of maintaining a more steady lending pattern in comparison, which once again, provides a stabilizing influence to the economy as a whole. 

GREGORY WILPERT: Okay, very interesting. I was speaking to Devika Dutt who joined us from New Delhi, India today. She’s of the Political Economy Research Institute. Thanks again, Devika, for having joined us today. 

DEVIKA DUTT: You’re most welcome, Greg. Thanks for having me. 

GREGORY WILPERT: And thank you for watching The Real News Network. 

Devika Dutt is a PhD candidate in Economics in the Department of Economics at the University of Massachusetts Amherst. She is also a research assistant at the Political Economy Research Institute. Her research explores alternative ways of organizing financial markets and financial market reform. 

Our Comment 

In Central Bankers at the End of their Rope? Jack Rasmus analyzes Greenspan’s Bank and clearly demonstrates that his underlying faith in the “Efficient Markets Hypothesis” – that is the notion that markets self-correct and can do no wrong – blinded him to the folly of financial deregulation. He points out that, “Greenspan’s generation of business and academic economists were preoccupied for decades with analysis of…‘real’ data, and still are,” and that this bias “led to a kind of financial instability myopia” that resulted in “decades of very poor Fed forecasting, and culminated in the “failure to understand how the global financial structure had changed,” a failure shared by his successor, Ben Bernanke, that would contribute to Fed policies that allowed – indeed contributed – to the banking and credit system crash of 2008” (Chapter 5). 


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