The state-owned enterprise as an entrepreneurial substitute in developing countries: The case of...

World Development, Vol. 16, No. 10, pp. 1199-1211, 1988. 0305-750x/88 $3.00 + 0.00 Printed in Great Britain. 0 1988 Pergamon Press plc

The State-owned Enterprise as an Entrepreneurial

Substitute in Developing Countries:

The Case of Nitrogen Fertilizer

BRIANLEVY Williams College, Williamstown, Massachusetts

Summary. - Variations in the conditions of entry across different sectors of industry suggest a role for state-owned enterprises in developing countries as entrepreneurial substitutes. This role is explored in a case study of the nitrogen fertilizer industry. Limited access to capital by private local firms and the limited incentive of multinationals to invest where control of technology is separate from control over production explain why ammonia plants arc state-owned in most developing countries. The evolution of the industry in India and elsewhere is examined. The impli- cations of entrepreneurial substitution for existing theories of state ownership arc laid out.

1. INTRODUCTION

Why is industrialization in less developed countries often accompanied by the establish- ment of state-owned enterprises? Two distinct classes of theories seek to account for the presence of these enterprises. The first class takes as its starting point those propositions of welfare economics that point to the difference between private and social efficiency. According to this perspective, state-owned enterprises are established in situations where there are economic opportunities that can yield social but not private profits, and in situations where market failures that induce private businesses to act in socially in- efficient ways can be corrected at lower cost via state ownership than by regulating private firms. ’

The second class of theories makes no explicit reference to the distinction between private and social efficiency. Rather, the starting point is the relationship between private firms and the state. The emphasis here sometimes is on the state- owned enterprise as an instrument of socialism, at other times on the state-owned enterprise as a national weapon in the struggle against multinational firms or, alternatively, on the ways in which state-owned enterprises can be used as conduits of government resources either to private firms or other favored clients.’

For all of this proliferation of hypotheses, the phenomenon to be explained is in some sense a narrow one: Aside from a few countries such as Bangladesh, Egypt and those in the communist

bloc, state-owned enterprises in developing countries typically account for between 8 and 15% of manufacturing production and tend to be concentrated in a limited range of sectors.’ Thus, rather than beginning with a particular behav- ioral theory of the state, this study takes as its starting point variations in the conditions of entry across different sectors of industry. It demon- strates how these variations across sectors point to a role for state-owned enterprises in developing countries as entrepreneurial substitutes; it explores the degree to which the hypothesis of entrepreneurial substitution can account for the dominant role of state-owned enterprises in the nitrogen fertilizer industry across a wide range of developing countries; and, finally, it explores to what degree the hypothesis of entrepreneurial substitution is likely to be relevant in accounting for the role of state-owned enterprises outside of the nitrogen fertilizer industry.

2. THE INDUSTRIAL ECONOMICS OF STATE OWNERSHIP

Firms possess different mixtures of advantages and disadvantages based on their access to, and the particular ways in which they use, the resources at their disposal.” In particular, multinational firms, state-owned enterprises and private local firms differ systematically both in their access to the resources required for industrial production and in the ways in which

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they harness these resources to yield useful services. Moreover, there are systematic differences among different sectors of industry in the kinds of resources that are required to initiate production. Taken together, these differences imply that there are likely to be systematic variations among multinational, state-owned, and private local firms in the kinds of sectors where production is profitable. In some sectors production may be more profitable for private local firms than for multinationals or state-owned enterprises. In other sectors, only multinationals may be in a position to initiate profitable production. And in a final group of sectors - the group that is of particular concern for the present paper, and of which it will be argued below the ammonia industry is an example-it may be state-owned enterprises that are best placed to initiate profitable production. Insofar as the institutional differences in access to resources and in conditions of entry are common across countries, at least to some degree countries with very divergent political ideologies will carve out similar roles for state-owned firms. What are the relevant differences in access to resources‘! How do they influence the place of state-owned enterprises?

(a) Finance

Turning first to access to finance, one well- documented feature of underdevelopment is that local capital markets tend to be highly frag- mented.” As a result, it often is difficult for private local firms from developing countries to borrow more than small sums locally at rates of interest equivalent to those prevailing in international capital markets. Nor, except for the largest private firms from developing countries (and for them only after the mid-197Os), have these firms had independent access to international sources of finance: private as well as public international lending institutions typically have insisted that their loans be guaranteed by the governments of developing countries.’ Governments can - and do - channel capital directly to private local firms. But the evidence suggests that public lending to private firms often does not extend to those sectors of industry where minimum efficient scale and initial investment costs are large, perhaps partly because no private local enterprises volunteer to take a lead, and partly because for political reasons governments have been reluctant to loan large sums of capital to the largest and most experienced private local firms in the country, the most likely candidates if any private investors were indeed to come forward.

By contrast. state-owned enterprises have

ready access to capital at or below market rates of interest: Not only are they provided with funds for investment from the coffers of government, they usually are automatically granted the government guarantees that enable firms from developing countries to borrow on private and public international capital markets. Econo- metric evidence confirms that as a result of these differences in access to capital the market shares of private local firms vary inversely with the levels of capital required to Initiate production at an efficient scale, while the market shares of state-owned enterprises tend to be highest in sectors where minimum efficient scales of manufacturing plants are large.’

(b) Technology

Analysis of the relationship between access to technology and the role of state-owned firms begins by laying out a series of familiar propositions from the field of industrial organization that highlight the reasons why in general multinational (rather than private or state-owned national) firms are likely to dominate technology-intensive sectors of industry in developing countries. Thereafter. the industrial organization analysis is extended to highlight the set of circumstances in which state-owned enterprises might take on the role of entrepreneurial substitutes.

The introduction of complex technology into developing countries generally involves its transfer from abroad. One way to effect this transfer is for the firms that control the technology to license their special skills to local firms from developing countries. Alternatively, firms might go multinational and set up their own overseas subsidiaries. As was first recognized by Coase (1937), which mechanism of transfer is selected will depend on the relative profitability of market and internal transactions. Research by William- son (1976). Caves (1971, 1982) and others has un- covered a number of reasons why the relative profitability of internal over market transfer - and thus, in the present context, of direct investment over licensing - is especially likely for transactions involving the transfer of specialized technological information. One reason has to do with the costs of coordination: especially where the transfer involves an ongoing flow of information over the long term, transactions costs are likely to be lower if coordination is effected within a single organization rather than between two independent entities.x The remaining reasons all have their origins in failures in the market for information.

STATE-OWNED ENTERPRISES IN DEVELOPING COUNTRIES 1201

An unusual characteristic of the market for information is that though knowledge may be ex- pensive to acquire, once acquired it becomes somewhat like a public good within the firm - it can readily be disseminated at little additional cost. As a result, especially for technologies available only in oligopolistic markets, there is likely to be an unusually large gap between the rents that can accrue from the use of technology and the direct costs of transfer. Suppliers of technology can capture these rents if they restrict the technology to their own network of international subsidiaries. But if they negotiate licensing agreements, they run the risk of having to share these revenues with the purchasers of technology.

For one thing, firms offering expertise for sale may find it difficult to sell their skills at a price that captures the available rents: with knowledge, as with other commodities, prospective buyers are unlikely to lay out large sums of money without knowing what they are buying. If they reveal too little of the relevant technology, a prospective buyer may not realize the full potential of the technology and so might offer only a relatively low price. But if they reveal too much, a potential purchaser will have less incentive to pay the full value of the technology he is purchas- ing. For another, in the face of relatively low direct costs of information transfer, purchasers might renege on the initial agreements, perhaps by entering into markets they had agreed to stay out of, perhaps by pirating skills and selling them to other buyers. Even if buyers do not inten- tionally break their purchase agreements, they have less incentive than vendors to keep secret the specialized information, especially if they are restricted in how they use it. In general, the supply of skills to independent buyers adds to the risk that vendors might lose control over the flow of information, and thereby reduce the potential returns; where the flow of information crosses national boundaries the likelihood of leakage rises, since international law may provide less protection than is available at home. In all, the transactional obstacles to licensing technology to independent firms appear to account for the disproportionate role of multinationals in technology-intensive sectors of industry in developing countries.’

Identification of the circumstances in which internal transfer is more profitable for vendors of technology than is licensing helps to clarify the conditions for the obverse pattern: the circumstances in which there is likely to be little difference between the returns from licensing and the returns from internal transfer; as noted earlier, in these latter circumstances the opportunities for

efficient entry on the part of local firms from developing countries are likely to be more favorable. Five conditions are highlighted.

First, recall that the incentives for internal transfer were predicated on the large gap between the rents accruing from the use of technology and the direct costs of transfer. It follows that the greater is the extent of competition among technology vendors, the lower will be the rents that can be appropriated from the transfer of technology, and the more favorable will be the opportunities for licensing and entry by national firms from developing countries. A second incentive for internal transfer lay in the difficulties of negotiating a license fee that captured the available rents; it follows that licensing is more likely insofar as the technology to be transferred is geared to the production of some familiar product, thereby reducing uncertainty and thus room for bargaining over the value of the output produced by the technology. A third incentive for internal transfer lay in the risk that buyers might pirate skills and sell them to other buyers; this incentive is weakened to the degree that there is little risk that even after transfer a licensee can reproduce the transferred technology without the assistance of the licenser. Ongoing transfers represented a fourth incentive for internal coordination, an incentive that is absent for transfers which take place only on a one-shot basis. A final condition that favors licensing emerges in those instances where a single technology has applications in such a wide range of different product markets that no single firm can enter them all.

(c) Entrepreneurialsubstitution

Taken together, the propositions about access to capital and access to technology point to a role for state-owned enterprises in developing countries as entrepreneurial substitutes. State-owned enterprises are hypothesized to take the lead in getting production underway in sectors where the size of the initial investment needed to operate at efficient scale is large relative to the financing abilities of local capital markets, but where - even though production might be both based on complex technology and has the potential to be profitable - the nature and patterns of control over technology provide little incentive for multinational firms to set up their own subsidiaries. Put differently, even in developing countries where governments generally eschew state acti- vism, and provide no spkcial subsidies to give state enterprises an advantage in competition with private local or multinational firms, the con-


ditions of entry into particular industries together with institutional differences in access to resources point to the presence of an entrepreneurial gap that can owned enterprises.lcP

rofitably be filled by state-

Econometric analysis can go some way towards testing this hypothesis. Indeed, evidence already cited confirms that conditions of entry shape the pattern of ownership in industry in industrialized as well as developing countries. But insofar as the hypothesis that state-owned enterprises play the role of entrepreneurial substitute depends on the character and patterns of control of particular technologies, it is necessary to look beyond statistical evidence, and explore in depth the in- teractions within a single industry between global patterns of control over technology and industrial ownership in developing countries. One arena for such a case study is the nitrogen fertilizer industry.

3. THE INTERNATIONAL ORGANIZATION OF THE NITROGEN

FERTILIZER INDUSTRY

As noted earlier, in most developing countries with mixed economies state-owned enterprises account for about 8 to 15% of manufacturing production. Yet state-owned enterprises account for over 70% of the capacity in developing countries with mixed economies of the ammonia plants in which nitrogen fertilizer is produced.” To what degree does the hypothesis that state- owned enterprises act as entrepreneurial substitutes help account for the unusual importance of state ownership in this sector?

Given the earlier propositions as to the influ-

ence of access to capital in determining ownership, the reason why private local firms play little role in the ammonia industry is straightforward. The capital costs of setting up an ammonia plant are in excess of $100 million.‘2 Except in developing countries with unusually well-developed capital markets, private local firms will have little opportunity for raising such a sum even at exorbi- tant rates of interest, and so will leave the field to multinational or state-owned enterprises. But multinationals account for only 15% of nitrogen capacity in developing countries. The hypothesis developed earlier suggests that this limited role might be a result of the evolving global patterns of control over the technology of ammonia production.

(a) Nitrogen production: The early years

In the 19th century nitrates mined in Chile were the major source of nitrogen fertilizers. But by the early 20th century, these natural sources had begun to be displaced by synthetically produced ammonia. Prior to World War II the production of synthetic ammonia was in the hands of only a few companies, with German firms the world leaders.” Although at first a number of independent German producers coexisted along- side one another, in the early 1920s a number of German chemical firms merged into a single company, the giant I. G. Farben group; as Table 1 reveals, by 1934 all the German firms which produced nitrogen were under I. G. Farben’s control. I. G. Farben’s largest rivals in the years preceding World War II were companies in the United Kingdom and the United States. As Table 1 summarizes, a single company domi-

Table 1. The structure of the world synthetic ammonia industry in the l!L?Os

Country

Production Percentage national (1938; 000 production by

metric tons) Leading firms leading firms

West Germany United States

United Kingdom

Others

TOTAL

X32 IG Farben 1 OO”% 240 Allied Chemical 87’Y 0

DuPont 124 Imperial Chemical 86 100%

Industries (ICI) 426

l&22*

Sources: Compiled from Lamer (1957) pp. 104. 169-171, 17.5-177, 200; Markham (1958). pp. 98-103. *Calculated on the assumption that there was no change between 1934 and 193X in the ratio of synthetic ammonia to total nitrogen production.


nated the production of ammonia in the United Kingdom, and in the United States two companies together accounted for 87% of synthetic ammonia capacity.

At first, these giant companies followed the familiar pattern of firms with ready access to capital and close control over a sophisticated technology - they began to set up ammonia operations abroad. Already in the 192Os, I. G. Farben had secured equity interests in the operations of its major French and Norwegian com- petitors in nitrogen production. ICI and DuPont also invested abroad. ICI set up ammonia operations in a number of territories under British influence, notably Canada and South Africa. And DuPont also extended its ammonia network abroad, setting up facilities in Canada, Argen- tina, Brazil, Mexico, Uruguay, and Chile: its operations in Canada and Argentina were joint ventures with ICI. Thus, by the late 1930s the stage seemed set for the rapid global expansion of a small number of ammonia producers. But this was not to be. World War II altered radically the structure of the world’s ammonia industry.

Germany’s defeat in the war led to the dissolution of I. G. Farben by the allied powers. In addition, all of Farben’s patents, including those which dealt with the production of ammonia, were made available without payment to any firm that wished to use them. Although three of the independent firms into which I. G. Farben was reconstituted - Hoechst, BASF and Bayer - themselves eventually developed extensive international networks of their own, for a while at least the dissolution of I. G. Farben interrupted the momentum of foreign expansion.

As for the industry in the United States, during the war, with ammonia an important input in the manufacture of explosives, the US government began building its own ammonia plants. By the end of the war, government-owned plants accounted for almost two-thirds of synthetic nitrogen capacity in the United States.” The US government sold off these plants after the war, targeting these sales to ensure that Allied and DuPont would not again develop a stranglehold over the industry: rather than selling off to the two erstwhile ammonia giants, plants were offered instead to firms which previously had played at most a marginal role in the industry. Once the government sales were completed, the combined market share of Allied and DuPont had fallen below 40%.

The sale of government-owned plants in the United States along with the breakup of I. G. Farben caused large declines in the market shares of some of the major producers. Consistent with the earlier theoretical discussion, this decline in

oligopolistic concentration, and the associated reduction in the ability to extract rents from the transfer of technological expertise, reduced the incentive for firms to set up production facilities abroad.i5 In the long term, a propensity towards high concentration in nitrogen production could conceivably have reasserted itself and brought widespread foreign investment in its wake. Here, though, another factor intervened.

(b) Engineering and construction of chemical plants

Prior to World War II, the technology of ammonia production was controlled by the giant producers and was a major source of their market power; chemical companies usually used in- house engineering units to design and build their process plants, procuring from outside suppliers whatever components they could not manufacture themselves. Postwar, however, plant construction and the related control over ammonia technology began to slip from the hands of nitrogen producers to independent, highly-specialized construction and engineering firms for whom the transactional advantages of capturing the rents from their technological edge by setting up networks of overseas subsidiaries rather than by licensing were rather limited. Thus, as Table 2 reveals, fewer than one-half of the primary contrac- tors, and fewer than one-third of the vendors of process technologies hailed from the home countries of new, large ammonia plants constructed in the postwar period in Western Europe and Canada. At least as striking (though not evident in Table 2) fewer than one-fourth of the plants in Western Europe were built using either in-house technology or project management.”

What accounts for the shift from direct control of technology to a pattern in which independent engineering companies specialize in the construction of turnkey plants with no associated equity share” in subsequent plant operations? As already noted, one explanation, at least for ammonia, is the abrupt decline in the oligopolistic power of the major producers. The earlier theoretical discussion points to some added reasons. It was argued earlier that the transactional disadvantages of licensing technology as com- pared with internal transfer will be lower where the transfer of technology is only on a one-shot basis, where there is little risk of the licensee itself reproducing the technology, where the technology is geared to the production of some familiar product, and where a single technology has a wide range of diverse applications. Ammo- nia plants meet all of these criteria. Not only is


Table 2. Place of origin of primary contractor and of process technology for large ammonia plants constructed in Western Europe and Canada between I945 and 1982 (by number of plants)

country Total of Place of origin of primary contractor and of process technology: number plant Local United States Other of location Contractor Technology Contractor Technology Contractor Technology plants

France 9 5 0 0 1 5 10 Netherlands 0 3 5 2 5 5 10 United Kingdom 3 7 2 0 2 2 9* West Germany 10 3 3 3 1 5 141. Italy 5 1 3 3 2 4 10: Canada 2 1 11 8 0 3 131

Total 29 20 24 17 11 24 66

Source: Unpublished data supplied by Tennessee Valley Authority, Marketing and Distribution Economics Section. *Information on place of origin of contractor was available for only seven plants. tInformation on place of origin of technology was available for only 11 plants. $Information on place of origin of technology was available for only nine plants. BInformation on place of origin of technology was available for only I? plants.

the world market for nitrogen fertilizers well-

established, the transfer of ammonia plants often is a one-shot affair, undertaken on a turnkey basis that leaves the licensee ignorant as to the details of plant design as even the basic skills needed to operate the plant are provided.” Finally, and importantly, chemical plant construction appears to be characterized by technological convergence,‘” with a single basic technology enjoying applications in such a wide range of different product markets that no single firm can enter them all.

Even in the era when chemical companies en- gineered their own plants they regularly turned to outside suppliers for components. At first “they had to design and manufacture critical components themselves because engineering firms could not or would not work to the exacting specifications required.“2” As the market for components grew, however, some engineering firms developed the skills required to work on the technological frontier. As the number of these firms proliferated and their expertise grew, it became increasingly difficult for chemical companies to keep track and make use of best-practice technology. This difficulty was compounded by the fact that engineering fabrica- tors often worked with oil companies and electric utilities as well as chemical companies; innova- tions that initially were developed for one industry often could usefully be adapted for another. Moreover, this cross-fertilization was not restricted to the fabrication of components. Advances in plant design in one sector sometimes

turned out to be useful in another. Indeed, in- novations in the design of ammonia plants in the 1960s were based in part on technology that had long been used in other petrochemical plants.” It was in the face of this flood of innovation in both the chemical and engineering industries that independent construction and engineering firms emerged and combined in-house innovation, the capacity to scan the environment to keep track of best-practice technology and the ability to supply and adapt these technologies for a range of users.

4. THE EVOLUTION OF OWNERSHIP IN DEVELOPING COUNTRIES

It is not only an analysis of the international patterns of control over ammonia technology that points to a role for state-owned enterprises as residual entrepreneurs. There were times after World War II when attempts were made to secure direct foreign investment in ammonia production in developing countries. The history of these efforts in India, Brazil, Mexico and South Korea provides striking evidence that in the long run the structure of the industry generated little incentive for multinationals to stake out a position in the industry. India will be considered in the most depth, as it has by far the largest industry and the longest experience. Subsequently its evolving patterns of ownership will be contrasted with the experience of the other three countries.

STATE-OWNED ENTERPRISES

(a) hdia

When India attained independence from the British in 1947 no ammonia was produced locally. At the time, private local business showed little interest in initiating production of nitrogen fertilizers. Not only was the capital investment for an ammonia plant beyond the reach of local business, total consumption was small, below 100,000 tons even in 1953.” Faced with these difficulties it is not surprising that, as Table 3 illus- trates, state-owned enterprises, willing to take the risk that the domestic market would be slow to develop, and with access to capital, took the lead in establishing India’s nitrogen fertilizer industry.

By the early 1960s. the fertilizer industry in India was entirely state-owned, total production was small, and plants often were based on ques- tionable technology. It was against this back- ground that US officials took the initiatives that opened up the second phase of the industry’s growth, a phase marked by efforts to secure equity participation in new ventures by multinational firms based both in the United States and

elsewhere. This second phase offers useful in- sights into the forces that propelled multinationals, the Indian government and private Indian business to seek some form of partnership with one another. It also highlights the influence of the structure of individual industries in cementing or - as in this instance - undermin- ing the efforts to establish these joint ventures.

By 1960, India had become a focal point for global economic competition between the United

IN DEVELOPING COUNTRIES 1205

States and the Soviet Union. The United States felt threatened by both increasing flows of development assistance from the Soviet Union to India and by the proliferation of state-owned industry in India. Indeed, in 1963 the United States government denied assistance to an Indian steel plant on the ground that it was to be run by a state-owned enterprise.z3 Against this back- ground, the Indian fertilizer industry seemed an especially ripe target of opportunity for the United States. Here was a sector where rapid growth was crucial for India’s economic development. It was a sector controlled by state-owned enterprises which increasingly were out of step with the rapid advances in technology that were bringing down the costs of producing ammonia.

The political and economic situation within India also was propitious for an attempt to inject foreign capital into the economy. In the late 1950s India had run into the first of a series of endemic foreign exchange crises. The country desperately needed to import selected items of capital equipment if rapid and efficient growth was to be achieved. But with foreign exchange so scarce Indian business lacked the funds to pay for this equipment.24 In part for this reason both the Indian government and private local business had come to look with increasing favor on increased involvement in India by foreign capital. A special spur for opening up the fertilizer industry to foreign investment was a threat made by the Aid India Consortium between 1963 and 1965 that the continued flow of aid was conditional on the

of the fertilizer industry to private

Table 3. The evolution of ownershtp of the ammonia industry in India, Brazil, the Republic of Korea and Mexico

Percentage Percentage Percentage Capacity multinational state-owned private

Country Year (000 tons) firms* firms local firms

India 1965 288 0.0% 100.0% 0.0% 1973 1,796 39.1 54.1 6.8 1981 5,406 13.0 81.8 5.2

Brazil 1971 122 100.0 0.0 0.0 1983 944 0.0 100.0 0.0

Republic 1967 428 39.3 60.7 0.0 of Korea 1981 1,165 56.5 43.5 0.0

Mexico 1969 488 0.0 100.0 0.0 1982 2,460 0.0 100.0 0.0

Source: Tennessee Valley Authority, Marketing and Distribution Economics Section, World Fertilizer Capacity (Muscle Shoals: unpublished serial). *Includes joint ventures between multinational and local firms.


The United States Agency for International Development (AID) and the Bechtel Corpora- tion (which had already secured a foothold in In- dia in Engineers India Limited, a joint venture with the Indian government) took the lead with plans to inject United States capital into the Indian nitrogen fertilizer industry. AID put together a joint venture involving American firms back in 1962. Then in 1964 it proposed to Indian officials that nitrogen fertilizer targets be set above the estimates of India’s Planning Com- mission. That same year, the United States ambassador to India presented a proposal for a massive fertilizer program to the Indian Minister for Petroleum and Chemicals: A number of United States companies were to form a consortium under the leadership of Bechtel; the consortium would build five ammonia plants each with an annual capacity of 200,000 tons; equity would be shared on a Xl:50 basis with the Indian government.lh

The Indian government was remarkably flex- ible in its negotiations with the consortium.” After some initial resistance, it accepted that most components for the plants would be im- ported. And it offered substantial marketing concessions. Prior to 1965, fertilizer marketing was in the hands of agricultural cooperatives and prices were strictly controlled. The consortium sought instead complete freedom of pricing and distribution, a recommendation which AID had first made to the Indian government in 1964. The Indian government agreed to experiment with uncontrolled prices and marketing for a period of seven years.

Despite these concessions, negotiations between the Indian government and the consortium eventually broke down. One reason for the breakdown doubtless was the Indian government’s long hesitation to embrace transnational firms, a hesitation which was shared by elements of the local business community. In- deed the government did not agree to all the terms sought by the consortium. It insisted that none of the foreign exchange used in the project come from government assistance that would anyway be granted to India; it refused to provide the consortium with a commitment that tax rates would remain unchanged for seven years: and it would not agree to buy surplus production at a price that would ensure the consortium a 20% profit after tax. But the major reason for the breakdown of negotiations seems to have been the lack of enthusiasm of the consortium members themselves.

From the first most of the members were reluctant participants in the consortium. Their mo- tives for joining in the first place were the

defensive ones so familiar in oligopolistic industries - they were reluctant to be left out of a venture that promised to be of considerable size. “Most of the members felt that the consortium was something too large not to be associated with.“” Only one of the consortium members, Allied Chemical, had substantial prior experience in the ammonia industry. Five of the initial members - Exxon, Shell, Texaco, Mobil, and Asiatic - were oil companies. Though some of these oil companies had recently been making rapid inroads into the United States nitrogen industry, their moves there were hesitant; in the early 1970s they began selling off their US ammonia interests. Indeed, some oil companies seemed to be after other game along with ammonia; in 1965 they threatened to withdraw from the consortium unless they were also given a share in a planned Indian oil refinery.2y Two construction and engineering companies (CNEs) Bechtel and Kellogg, made up the rest of the consortium; as already explained, for good reasons CNEs have long avoided taking equity in ammonia and other projects.

Even after the hesitancy of the consortium members became apparent and negotiations broke down, the Indian government did not give up its effort to secure foreign participation in ammonia production. The concessions on pricing and marketing granted to the consortium were extended to any foreigners who made commit- ments before the end of 1967 to enter the industry.“’ Even so, by the early 1970s only four nitrogen plants with foreign equity participation had come on stream;” as Table 3 implies, the share in total ammonia capacity of plants with foreign equity participation peaked in 1973 at less than 40%.

Subsequent to 1973 the Indian ammonia industry entered into a third phase of expansion, a phase in which national firms. state-owned for the most part, accounted for all of the increments in capacity. As Table 3 reveals, industry capacity trebled between 1973 and 19X1 ; by the latter year almost 82% of total capacity was in the hands of state-owned firms. The details of this third phase of expansion have been examined elsewhere, so here only a few points will be highlighted. First, an important signal of the shift from foreign equity came in 1969 when the World Bank agreed for the first time to lend funds to the state- owned Fertilizer Corporation of India, an important departure from the longstanding World Bank policy of not lending to government-owned industrial enterprises.3’ Second, after 1973 there continued to be foreign involvement in the Indian ammonia industry, only now it was channeled through the construction and en-


gineering enterprises. Third, there was continual conflict throughout the 1970s between the efforts of the Fertilizer Corporation of India to expand its in-house, indigenous technological capabih- ties, and the desire to contract with transnational construction and engineering firms as a way of assuring that new plants would have the capabil- ity of producing fertilizer at low cost; the outcome of that conflict was the breakup of the Corporation into five separate companies.33 Fourth, the 1970s saw the entry of a number of new local firms into the ammonia industry. Two of these firms were wholly privately-owned; two were joint ventures between state governments and private local businesses; and a fifth is a joint venture of the Indian government and shareholder-farmers from 10 states.34 The emer- gence of these firms highlighted the opportunity for ready entry into the fertilizer industry where capital was available.

(b) Brazil, Mexico and South Korea

The evolution of ammonia production in Brazil, Mexico and South Korea is strikingly similar in some ways to the Indian pattern. State- owned enterprises are major producers in all three countries. And in both Brazil and South Korea, there were efforts in the 1960s to bring foreign investors into the industry. In Brazil, as in India, state-owned enterprises were the first to try and produce nitrogen fertilizers locally.“’ But these were small-scale operations. Production of ammonia in large-scale plants began only in the mid-1960s. The largest shareholder in the first large plant was the US-based transnational, Phillips Petroleum, with 60% of the equity. AID, which played a leading role in the push for foreign investment in India, provided a $15 million loan for the project. The World Bank’s In- ternational Finance Corporation, with 10% of the equity, and a private Brazilian group were the remaining shareholders.3h

Yet once again, as Table 3 reveals, there was no continuing impetus for foreign investment in ammonia. No other overseas investors set up facilities in Brazil even as the demand for ammonia began to expand. Indeed, in 1974, apparently fearful that the imposition of price controls on fertilizers in 1975 would saddle the venture with endemic losses, Phillips Petroleum sold out to the Brazilian state-owned giant, Petrobras, which has since taken the lead in the development of the industry.“’

At first the South Korean experience followed very closely the pattern in India and Brazil. In the late 1950s state-owned enterprises set up the

first ammonia units in the South, previously, all local production was located in the North of this now divided country. Once again, some of the major investments in the 1960s were joint ventures with US-based transnational companies. And once again AID provided funding for the projects; these AID loans apparently were conditional on the inclusion of foreign partners in the projects.3x

From then on, however, the development of the industry in Korea followed a different path than it did in the other countries. To be sure, as Table 3 shows, in 1981 enterprises that were entirely state-owned accounted for almost half of Korea’s ammonia capacity. But, unlike the experiences of India and Brazil, a major new ammonia project initiated in Korea in the 1970s included a joint venture partner from the United States.‘”

Finally, we turn briefly to Mexico. As Table 3 shows, from the first ammonia production in Mexico was dominated by the state-owned Petro- leos Mexicanos (PEMEX). PEMEX’s domi- nance was assured by the passage of legislation in 1958 which reserved the production of basic petrochemicals for state-owned enterprises. But in other sectors of industry foreigners have found ways around restrictive legislation. So the rapid growth of PEMEX’s ammonia operations provides some added support for the proposition that state-owned enterprises are especially well placed to overcome barriers to entry into ammonia production.

(c) Conditions of entry and foreign ownership

Economic theory, the evidence as to the organization of the world ammonia industry, and the history of ammonia production in India, Brazil, South Korea and Mexico all afford grounds for confidence in the hypothesis that conditions of entry into the industry account for the lack of foreign investment in ammonia production in these countries. Even so, it is worth making explicit note of an alternative hypothesis, namely that the political sensitivity of fertilizer prices might make governments in developing countries determined to control fertilizer production themselves, or at least might inhibit foreign firms from making investments in the industry lest - as was apparently feared in Brazil - price controls undermine the profitability of the investment. There are two difficulties with this hypothesis. For one thing, as we have seen not only did governments in developing countries encour- age foreign investment in the ammonia industry, albeit with little success, there is little foreign in-


vestment in ammonia production anywhere in the world, neither in industrialized nor in developing countries. More fundamentally, any ability of governments to control fertilizer production themselves, or to enforce price controls while maintaining production levels, must itself be traced to the superior bargaining power of governments relative to any putative foreign investors. And the roots of this bargaining power lie in the underlying conditions of entry into the industry,“” precisely the conditions that account for the absence of foreign investment in ammonia in the first place.

In all, the combination of distinctive patterns of international technology transfer and the associated ability of national firms from developing countries to make turnkey deals with foreign construction and engineering companies, a worldwide absence of foreign investment, and high capital costs of entry, together seem to be the major underlying forces that shaped the eventual pattern of ownership. With one noteworthy ex- ception. the evidence suggests that local enterprises will continue to dominate the industry throughout the 1980s.

5. ENTREPRENEURIAL SUBSTITUTION IN PERSPECTIVE

An emphasis on conditions of entry has pointed to the presence of a set of industrial sectors with a rather unusual characteristic: Pro- duction in these sectors can be undertaken profitably, yet the special disabilities of private local firms in raising capital, together with the limited incentives of multinationals to invest in sectors where they lack close control over technology, imply that no private investment may be forthcoming; state investment may be necessary if production is to get underway.

Obviously, identification of these sectors does not imply that the hypothesis of entrepreneurial substitution can account for the presence of all state-owned enterprises in industry in developing countries. Consistent with the alternative theories noted at the start of this study. in some sectors state-owned enterprises are indeed the result of takeovers of foreign firms: state firms in other sectors may indeed exist as a result of efforts to reap social externalities that are not in- ternalized in the investment decisions of private firms: state-owned enterprises in yet other sectors may indeed exist to channel funds to favored clients. But what is implied in this paper is that in at least one of the few sectors that are dominated by state-owned enterprises throughout the de-

veloping world, conditions of entry and entrepreneurial substitution are important in accounting for the presence of state-owned enterprises. But what of other sectors? How widespread is likely to be the incidence of conditions of entry that might point to state-owned enterprises as entrepreneurial substitutes?

As outlined earlier, a host of conditions all need to be present together for the hypothesis of state-owned enterprise as entrepreneurial substitute to have any explanatory power. These conditions of entry are likely to be present only in a small subset of industries. The ammonia industry has been shown to be one good example. The steel industry also is dominated by state-owned enterprises in most developing countries. Given the industry’s large capital requirements, and its use of technology procured from abroad together with a worldwide dearth of steel multinationals, the hypothesis of state-owned enterprise as entrepreneurial substitute might well prove useful in accounting for the role of state-owned enterprises in that sector as well. More generally, the kinds of sectors in which state-owned enterprises take on the role of entrepreneurial substitute are likely to vary with the level of a country’s development. In particular, the volume of finance that private local firms can raise for new ventures at reasonable rates of interest is especially low in countries with poorly developed capital markets. Thus the absolute capital requirements which call for entrepreneurial substitution by state firms are likely to be lower in least developed countries than in their more developed counterparts. A corollary of this proposition is that as capital markets are extended, private firms may displace state-owned enterprises from sectors where they had previously been dominant.J’

Although large initial capital requirements and particular global patterns of control over technology are sectoral characteristics that must neces- sarily be present if state-owned enterprises are to be effective entrepreneurial substitutes, they are not sufficient. As has been explored elsewhere, depending on the external environments in which they operate. state-owned enterprises may be ill- suited to take on tasks that demand continual adjustment to changing conditions.” Thus opportunities that may look profitable to private local firms were they able to raise capital at international market rates may turn out to be unpro- fitable if taken up by state firms. So a further condition necessary for state-owned enterprises to profitably take on the role of entrepreneurial substitute may sometimes be that efficient management in the sectors they enter entail largely a mastery of routine tasks. Indeed. it was the effort to go beyond the relatively straightfor-


ward task of operating ammonia plants and to attempt in addition to master the skills needed to design and build these plants that led to the poor performance and eventual dismemberment of the Fertilizer Corporation of India.

Further research will reveal the degree to which the hypothesis of entrepreneurial substitution helps account for the role of state-owned enterprises in industry in developing countries outside the ammonia industry. But even if it turns out that the hypothesis leaves much unex- plained, a final example from the ammonia industry reveals why it is an important addition to the already long list of explanations for the presence of state-owned enterprises in developing countries. The failure of efforts by United States firms and the Indian government to set up joint ventures in the ammonia industry provoked re- criminations from which it took years to recover:

NOTES

Factions within the Indian government drew the conclusion that multinationals could not be reli- able partners in the promotion of development; groups within the United States were streng- thened in their conviction that the Indian government was hostile to private firms and treading down a path to socialism.‘” Perhaps more than any other approach. a depiction of the state- owned enterprise as an entrepreneurial substitute suggests that, at least in some sectors, ideology may have little to do with the decision as to whether to get production underway with state or private firms. In sectors where such a depiction is an accurate one, the presence of state-owned enterprises will have less to do with the heady rhetoric of competing ideologies than with the more pedestrian question of the conditions of entry into a particular industry.

1. For examples of this approach, see Jones and Mason (1982); Bos (1981); Reed (1973), and Turvey (1971).

2. For the socialist motivation, see Kelf-Cohen (195X); for a discussion of state-owned enterprises as national champions, see Vernon (1980). Peter Evans (1979) suggesis that state-owned enterprises supply inouts to private firms at low cost; Shafer (1983) illus- trates how state-owned enterprises can be used to channel resources to bureaucrats and other political clients.

3. See Jones and Mason (1982)

4. For an early characterization of firms in this way, see Penrose (1959).

5. See Goldsmith (1969); also McKinnon (1973).

6. Kindleberger (1970). Mason and Asher (1973), World Bank (1977-81).

7. Levy (1988).

8. For a detailed discussion, see Williamson (1975); for some empirical evidence, see Teece (1976).

9. Levy (1988); for evidence from industrialized countries of the relationship between technological in- tensity and the market shares of multinational firms, see Caves (1974).

10. This hypothesis is similar to Gerschenkron’s (1962) analysis of the role of the state in relatively back- ward nations of Europe; Gerschenkron, however, does not link his analysis to differences in conditions of entry across industries.

11. Estimated from data on fertilizer plants provided by the Tennessee Valley Authority. For an overview of

ownership trends in the fertilizer industry, see Shields and Harre (1978).

12. See Sheldrick (1980).

13. Except where noted, historical details of the structure of the ammonia industry are from Lamer (1957).

14. Details of the structure of the US fertilizer industry are from Markham (1958) and Martin (1959).

15. In general, other things being equal, the relationship between the degree of oligopolistic concentration and the extent of foreign investment appears to have an inverted U-shaped distribution, with the incidence of foreign investment rising as an industry moves from a tight-knit to a loose-knit oligopoly, and then declining as concentration diminishes further; see Caves (19X2) pp. 97-100.

16. Calculated from data provided by the Tennessee Valley Authority, Marketing and Distribution Econo- mics Sections.

17. Stobaugh (19X2) found that construction and engineering companies took equity in only one of a sample of 139 plants that they helped to establish.

1X. For a discussion of the mechanisms of transfer in the ammonia industry, see Levy (1983).

19. The phenomenon of technological convergence is analyzed in detail in the context of the machine tool industry by Rosenberg (1963).

20. The discussion in the text on technological convergence among construction and engineering companies draws heavily on Freeman (1968).

21. Greenberg, Hill, and Newberger (1979), p. 101.


22. Data on the first phase of expansion of the Indian fertilizer industry are from Food and Agricultural Organization (1960); also Fertilizer Association of India (1977) pp. IV-13.

35. See Banco National de Desenvolvimento Econo- mica (1965). pp. 21-23.

23. For details, see Kidron (1965), pp. 113-123; 237.

24. See Frankel (1979).

25. Kidron (1965); also Murray (lY71). p. 5.

26. For details of the scheme, see the cast prepared by Kapoor (undated).

36. See “Phillips Petroleum says construction opens at $70 million Brazilian fertilizer venture.” Wall Street Journal (23 November 1966), p. 6; Economist Intelli- gence Unit, Quarrerly Review of Brazil No. 1 (1968). p. 13; and “Giant Brazilian fertilizer plant sets prece- dents for international financing.” Business Latin Arnericu (15 December 1966). pp. 3-4.

37. See “Phillips Petroleum pares investments in Japan and Brazil,” Wall Street Journal (28 May 1974), p. 17.

27. Details of the negotiations are from Murray (1971). 38. Jones (1979) pp. 1 l-19; also Jones. Sakong. Kwak

and Yu (1976). 28. The quotation is from Kapoor; for a general analysis of defensive foreign investment, see Knicker- bocker (1973).

29. Kapoor. p. 9.

30. “India nears fertilizer investment decision,” N~M: York Times (13 October 1967). p. 57.

31. Fertilizer Association of India (1977) pp. IV-X, IV-23. IV-31.

30. One possible reason for the inclusion of this partner - the Williams Group-may have been the access it had to supplies of phosphate rock; the new project was to produce phosphatic as well as nitrogenous fcrti- lizers. The Williams Group also has investments in nitrogen operations in Argentina and Pakistan.

40. See Vernon (1973), pp. 46S3; also Moran (1974).

41. For an elaboration of this proposition, see Vernon (1980).

42. Levy (1987). 32. “Indian government fertilizer plants get World Bank support.” Financial Times (20 June 1969).

33. For a more detailed discussion. set Levy (1983).

34. Fertilizer Association of India (1977). and data supplied by the Tennessee Valley Authority.

43. For this point, see Frankcl (197’)).

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