View: Selling PSEs improves efficiency, frees government to do the business it’s meant to do
Partially motivated by efficiency considerations, but largely driven by fiscal squeeze, the government has made some progress in cutting its stake in PSEs since the launch of reforms in 1991.
There is broad agreement among economists that governments should only enter activities that serve a public purpose.
Defence, education, health, infrastructure and poverty-reduction programmes fulfil this condition. With some exceptions, manufacturing and services do not.
For instance, government manufacturing steel or running hotels serves no public purpose. Instead, this public money could be freed up for investments in infrastructure or education, with private firms filling the gap in the manufacture of steel and running of hotels. Indeed, not having the luxury of the government underwriting their losses and having to compete in the marketplace, private enterprises have agreater incentive to improve efficiency and cut costs.
Nevertheless, for historical reasons, the public sector in India has entered many activities that serve no public purpose. Soon after Independence, India adopted the goal of building ‘a socialistic pattern of society’. Prime Minister Jawaharlal Nehru saw a progressive expansion of the public sector in production activity through increased investment as a key instrument of achieving this goal. To this, Prime Minister Indira Gandhi later added nationalisation of industries as another instrument.
In 1991, India effectively abandoned the socialist model and began moving towards a market economy. Three decades later, it would seem that India would have moved entirely away from investing public money in manufacturing and services activities, except in areas such as defence that have a public purpose. But this has not happened.
By invoking phrases such as ‘strategic’ or ‘priority’ industry, or appealing to ‘development objectives’, ministries have continued to pour precious public resources into activities that the private sector can perform more efficiently with no sacrifice whatsoever of public interest.
Evidence shows that the public sector performs quite poorly relative to the private sector in production activities. In the accompanying charts, we compare earnings before tax (EBT) and net profits as proportions of total sales for central public sector enterprises (PSEs) and listed private enterprises for years 2016-17 and 2017-18. In manufacturing (excluding petroleum refining and power generation) as well as non-financial services, listed private enterprises uniformly beat central PSEs by a wide margin.
Partially motivated by these efficiency considerations, but largely driven by fiscal squeeze, the government has made some progress in cutting its stake in PSEs since the launch of reforms in 1991. In the vast majority of cases, this policy has taken the form of reduction in government equity without letting the share in total equity fall below 50%. Only during the administration of Prime Minister Atal Bihari Vajpayee did the government sell majority stakes to private owners in a small number of firms.
You Have to Hand It to Them
Disinvestment has accelerated during 2014-19. In value terms, it raised Rs 2.9 trillion during this period and accounted for a gigantic 65% of all disinvestment revenues since 1991. In terms of shares, 2014-19 accounted for half of all equity stakes sold since 1991. However, in no case has the management of a PSE passed into private hands during this period.
A 2013 study of enterprises privatised during the Vajpayee era by one of us (Gupta) finds that the gains are vastly more when the government sells majority stakes with management transferred into private hands than when it sells a minority stake and retains management control. The study found that on average, the gains from majority privatisations exceeded those from minority privatisations by 23% in terms of sales, 21% in terms of profits and 28% in terms of employment.
Fears that private owners would fire workers turned out to be without basis. In fact, improved efficiency led to an expansion of enterprises and employment after management passed into private hands.
In recent years, government investment in social sectors has become extraordinarily large. GoI has launched, or greatly expanded, programmes relating to universal primary education, rural employment guarantee, public distribution of food, rural and urban housing, cooking gas and health insurance. The government is also building infrastructure on a large scale.
Given these facts and its traditional roles in administration, defence and internal security, GoI is stretched beyond its capacity. Therefore, a withdrawal from production activities that can be transferred to private sector without sacrificing any public cause will also be helpful in refocusing the scarce administrative resources of the government on what only it can do for people. In the short run, disinvestment also provides the government much-needed fiscal resources. In recent years, GoI’s revenue resources have fallen behind its expenditure needs.
Let the Right Hand Borrow
To keep public debt from rising, it is extremely important for it to avoid borrowing more and more from the market. Given the government’s commitment to holding the line on fiscal deficits, public borrowing has quietly shifted to off-Budget public entities.
But this only postpones the accumulation of debt. Moreover, since even public entities must pay higher interest rates on their debt than the government, the eventual addition to debt is larger than if the government borrowed directly. Therefore, sale of PSEs is a win-win solution all around. It improves efficiency, helps contain fiscal deficits and debt, and sends a powerful signal of GoI’s resolve to keep moving ahead with difficult reforms.
Gupta is associate professor of finance, Indiana University, US, and Panagariya is professor of economics, Columbia University, US
Views expressed above are the authors' own.