India's
public sector means less for more
By Kunal Kumdu
MUMBAI - The Economic Model of India assigned a pivotal role to its public
sector, which came to control "commanding heights" of the economy after the
Indian parliament adopted a resolution in 1956 to achieve a "socialistic
pattern of society" as a national goal.
In pursuance to this goal, a large number of public sector units (PSUs) were
set up in different sectors of the economy. Unfortunately, however, the
expansion of the public sector took place not in the direction of the
traditional, theoretically correct provision of public goods and
infrastructure, but to non-traditional command over the economy, in particular:
(a) Nationalization to occupy the "commanding heights" of the economy and
regulations to protect them from internal and foreign competition, (b)
Widespread subsidies, explicit and implicit, and (c) Administered prices and
related regulations.
By the close of the 1970s, it became evident the countries that had adopted the
Soviet economic model succeeded neither in attaining growth nor alleviating
poverty (eg, South Asian countries), while those that had followed essentially
free-enterprise policies progressed at enviable rates and reduced poverty
impressively (eg, East Asian countries). Having witnessed that outcome, a
number of countries started backtracking. To mention a few: a drastic tax cut
(from a 55% marginal income tax rate to 28%) in the United States under
president Ronald Reagan (1981-89); privatization in the United Kingdom during
Margaret Thatcher's rule (1979-90); denationalization in France under its
socialist government (1980s); and extensive open-market experiments in
communist China under the leadership of Deng Xiaoping (1979-1997). Those
economies that stuck to their command policies scarcely climbed out of the
hole. The climax was reached in 1991 when the Soviet economic model collapsed
in its own land and the Soviet Union disintegrated.
It may be asserted, in this connection, that it is not the size of the public
sector as such, but the non-traditional functions that it has been required to
perform that proved to be their bane.
Implicit Inefficiencies
Apart from measurable losses, opportunity costs, and deadweight losses, PSUs
are plagued by several immeasurable inefficiencies. The latter are among the
sources of measurable losses but also cause additional damages. On the one
hand, the PSUs are invariably managed by senior bureaucrats, whose tenures are
protected by civil service rules, which are scarcely affected by their
productivity or the level of performance in the PSU concerned. These also
reflect on the quality of management.
The observations of India's Comptroller & Auditor General (CAG) for the
period 2001-02 highlight deficiencies in the country's management of PSUs,
which resulted in serious financial implications. The irregularities pointed
out are broadly of the following nature:
Unproductive expenditure/imprudent investment and loss of interest, financing
charges amounting to Rs 7.13 billion (US$154 million) in 39 cases due to bad
investments, pay and allowances for idle labor, injudicious import of
components etc.
Excess/irregular payment of Rs 2.90 billion in 12 cases was made to PSU staff
of ex gratia, bonus, salaries, wages, extending benefits in excess of norms
etc.
Avoidable expenditure of Rs 1.46 billion in 32 cases due to use of unproven
technology, delay in installation of equipment, failure to ensure correct
specification of material, import/procurement of spares at higher rates,
detention of vessel beyond lay time, power factor surcharge, poor cash
management, payment of demurrage, customs duty, excise duty etc.
Loss of Rs 1.03 billion occurred in 24 cases on account of undue favor to
parties, defective agreement/contract terms, unrealistic feasibility study,
wrong estimates, failure to obtain bank guarantee, delay in award of work,
failure to make counter offer, failure to take financial safeguards, forfeiture
of earnest money deposit etc.
Loss of revenue/sale proceeds of Rs 690 million in 18 cases due to delay in
realization/non-realization of debts, purchase without working out parity
calculations, unnecessary borrowings, manufacture of machines without order,
unwarranted restriction on production, loss of generation of power, premature
deal to sell an aircraft, non recovery of lease rentals etc.
Avoidable loss of Rs 570 million in 11 cases due to delay in finalization of
tenders, failure to invoke risk clause, non-compliance of terms of the
contract, non-adherence to delivery schedule, finalization of contract
documents without clients' approval etc.
Loss of Rs 300 million in 10 cases due to adoption of incorrect tariff, excess
settlement of claims, non-realization of royalty etc.
This takes the total estimated loss to Rs 14.07 billion for that year alone due
to managerial inefficiencies.
Then there are laws that loss-making PSUs cannot be shut down. Workers cannot
be fired. The PSU losses are taken care of by the government. These conditions
create the notorious incentive problem with regard to improving the health of
the organization. On the other hand, the inefficiency problem is further
exacerbated by continual political interference in the affairs of PSUs. Outside
interference frustrates internal efforts to increase efficiency and
productivity. Among the consequences of political interference, the following
are prominent:
Excess employment
Political favors are done/returned by imposing workers on PSUs. As a result,
almost all of them suffer from excess employment. In India, it is easy to hire
a person, but firing one is extremely difficult. Protected by pro-labor
legislation and political clout, not all workers may have the motivation or
feel the pressure to work efficiently.
Excessive cost per worker
Irrespective of the levels and the rates of improvement (or decline) of
productivity, in general PSU workers enjoy better amenities on top of job
security. Understandably, they oppose privatization tooth and nail.
Requirement of social services from commercial PSUs
There are certain segments (health, education, transport etc) government should
play a role in, either due to a lack of private participation or a lack of
reach by private companies. However, we have a situation where even commercial
PSUs are required to provide social services. Quite often the PSUs end up being
personal fiefdoms of the ministers under whose control they happen to be. The
ministers not only extract their pound of flesh but also force the PSUs to
undertake activities in their constituencies for gaining political mileage.
The additional cost, however, weakens the competitive position of the PSUs
vis-a-vis the private domestic sector and foreign firms. While the requirement
relieves the government of levying taxes to pay for social services, it is a
highly inefficient way of providing the same. It certainly reduces the capacity
of PSUs to compete with private sector firms.
Unproductive activities
Finally, the allegations of enhanced propensity for corruption and unproductive
activities when PSUs exist cannot be easily brushed aside. Pilferage of
electricity, kickbacks for jobs and appointments, sharing profits with
suppliers, rent seeking, and graft and grab in general, are experienced by the
common man.
The results are for all to see. According to the audit carried out by the CAG
in 2001-02 (their latest available audit report), of the 268 central PSUs in
India for which they could carry out the audit, only 139 earned profit. Their
total profit was to the tune of Rs 469 billion. On the other hand, total loss
recorded by the remaining was Rs 240 billion, which translates into an overall
net profit of Rs 229 billion.
The total equity investment by the government in these companies was to about
Rs 914 billion, out of a total equity of Rs 1.09 trillion. Thus the
government's share of total net profit was Rs 191 billion. Interestingly,
during the same period, India's subsidy to the PSUs (related to administered
prices) amounted to Rs 209 billion, much more than the overall net profit
attributable to the government. During this period, total dividend received by
the government was only Rs 60 billion. Need one say anything more to point out
the actual state of affairs as far as the return on capital goes.
The dismal story does not end there. Of these 268 companies, equity investment
in 97 companies has been totally eroded by their accumulated losses. As a
result, the accumulated net worth of these companies has become negative to the
extent of Rs 477 billion. As a corollary, recovery of the loans extended to
these companies by the government becomes doubtful.
Conclusion
Thus, if the objective of PSUs was to create economic surpluses for investment
and growth, they have failed miserably. To the contrary, PSUs have gobbled up
large chunks of productive resources, have become dens of inefficiency, and are
suspected to be the breeding grounds for corruption.
The story of the PSUs controlled by the local governments in different states
in India is not different either, if not more worrying. But that's for the next
part.
Kunal Kumar is a senior economist with a leading bilateral Chamber of
Commerce in India. He has a master's degree in economics, with a specialization
in econometrics from the University of Calcutta.
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