Faculty and Research

© Review of Economics and Statistics, February 2005
Volume: 87 | Issue: 1 | Pages: 135-47

Publication type: Journal article

Research Archive Topic: Business Economics and Public Policy, World Business

Abstract

An unanswered question in the debate on public sector inefficiency is whether reforms other than government divestiture can effectively substitute for privatization. Using a 1981–1995 panel dataset of all public and private manufacturing establishments in Indonesia, we analyze whether public sector inefficiency is primarily due to agency-type problems or to the environment in which public sector enterprises operate, as measured by the soft budget constraint and the degree of internal and external competition. The results, obtained from fixed effects specifications, provide support for both models. Ownership matters because, for a given level of government financing or competition, public sector enterprises ("PSEs") perform worse than their private sector counterparts. The environment matters because only PSEs which received government financing or those shielded from import competition or foreign ownership performed worse than private enterprises. The results suggest that the efficiency of PSEs can be increased through privatization, through manipulation of the environment, or through a combination of both approaches.

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