ANIL K MAKHIJA

I Introduction

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This article focuses on the centrallyowned PSUs, which may account for 85 per cent of the total assets in the public sector.2 It describes their performance, the evolution of policy regarding privatisation, the successes and failures of the privatisation plan so far, and the challenges it faces. That PSUs in India have underperformed may be widely known, but it is instructive to examine the nature of the underlying problems. The stated government policy, which has been strengthened by unambiguous court rulings, has evolved to embrace privatisation fully. Moreover, a reasoned and transparent administrative apparatus for privatisation through open competitive bidding is also in place. Yet, in the decade and half of its life, the privatisation programme has made remarkably little progress. Interestingly, though labour may have added to resistance to privatisations, it seems not to have been the main obstacle. Instead, the primary culprits here may be entrenched managers and politicians, who seem happy to see privatisations elsewhere but “not in my backyard”. The article concludes with a proposal aimed at addressing this issue.

The socialist experiment of PSUs did not meet expectations in India, or elsewhere in the world. PSUs have tended to perform poorly, and glaringly so when compared with firms in the private sector. Gathering steam in the 1980s, as the socialist model came to be questioned and even Russia undertook Perestroika reform, there was demand for privatisation of government-owned enterprises in many countries. Arguably, there are many benefits of privatisation: Private ownership is more efficient than stateownership; privatisation can be an important source of government revenue (over $ 1 trillion have been raised already worldwide, according to Megginson and Netter 2001); privatisation will end the ongoing subsidies to loss-making PSUs; equity from privatised PSUs can help develop local capital markets; world financial markets have matured to the point that the private sector can better finance large long-term investments; and problems of market failure such as monopoly can be better handled through regulation. No wonder, the list of countries with privatisations likely exceeds one hundred today.

The official impetus for privatisation in India came as part of a broader change in policy. In response to an external debt crisis and the blessings of the International Monetary Fund (IMF), in 1991 India introduced major reforms to liberalise the economy, including plans for privatisation (though it was initially referred to as disinvestment to disassociate it with the fears of job losses and other capitalist “evils” commonly attributed to privatisation). In about the first 10 years of the programme only an average of 19.2 per cent of the equity of some 40 PSUs was sold [Gupta 2005], with no sales of a majority stake. According to the World Bank (2001), in 1999 south Asia accounted for only 4 per cent of the revenues raised through privatisation by developing countries. Though the pace picked up after that with equity sales to large block purchasers, who are called strategic partners, it has added at best only another 15 privatisations to date. Simultaneously, the number of failed privatisations, where no further attempts are ongoing is 13, including Air India, Indian Airlines, Scooters of India, and NIDC. In fact, the government has thus far barely raised half the revenue it has itself targeted from its privatisation programme. Yet, one would have predicted a much faster rate of privatisation, based on the clear evidence

Economic and Political Weekly May 20, 2006 of poor performance of PSUs and the extent of consensus to privatise them.

Performance problems in state-owned enterprises may be inherent because they are beset with severe agency problems, with managers in control while the ownercitizens do not assert their ownership rights effectively. Indeed, there is mounting evidence that PSUs underperform when we examine pre- and post-privatisation data.3 Megginson and Netter (2001, Table 5) summarise the findings of three empirical studies that compare the financial and operating performance of newly-privatised firms against their prior performance as state-owned enterprises.4 After privatisation, the firms show significantly higher profitability, higher efficiency, generally higher investment levels, higher output, higher dividends, and lower leverage. Interestingly, the evidence is surprisingly mixed on whether employment (total employees) changes as a result of privatisation.

There is also another large literature which compares the performance of stateowned enterprises with private firms. Boardman and Vining (1989) find that private sector performance is superior. Finally, there are numerous case studies. An excellent example of these is the work of La Porta and Lopez de Silanes (1999) which covers the entire population of Mexican privatisations, and compares performance to industry matched private firms. They find that the ratio of operating income to sales went up by significantly.

Arguably, state-owned enterprises underperform because they are purposely pursuing other goals, not profit maximisation [Shleifer and Vishny 1994]. Or, stateowned enterprises may be run inefficiently because of poor managerial incentives [Vickers and Yarrow 1991].

One reason for the lower margins for PSUs seems to be their cost structure. From Panel B of Table 1, in all years and in all cost categories, the PSUs had higher costs compared to private firms. Furthermore, there is a discernible trend among private firms to cut costs over time, while the PSUs appear to be unsuccessful in controlling their expenses. The situation appears to be worsening.

Finally, a recent study by Gupta (2005) examines Indian PSUs that were privatised between 1991 and 1999. Note that during this period, government largely divested minority shares (only 19.2 per cent of the equity on average). Gupta (2005) finds that “both the levels and the growth rates of profitability, labour productivity, and investment spending improve significantly following partial privatisation…Since improvements in operating performance are not accompanied by lay-offs, this suggests the continued presence of political interference by the government in these firms. Thus, the results support the hypothesis that partial privatisation addresses the managerial rather than the political view of inefficiency in state-owned enterprises.”

Management is definitely implicated in the underperformance of state-owned enterprises, a situation that is likely worsened by political factors.

III Evolution of Policy and Practice

It all began with the 1991 liberalisation, when government even avoided directly mentioning privatisation, calling it disinvestment instead. But, over time the scope of the programme has expanded to fully embrace privatisation,5so that by 2000 there were few conceptual constraints on (i) what size of equity stake to divest, (ii) what industries were too strategically important to let go into private hands, (iii) who would be allowed to buy PSUs, and (iv) whether or not the PSU was profitable.

Table 2 provides a listing of year by year privatisation activities. Behind this trend lie a variety of reasons: Even as the government faced budget deficits, the poor performance of the PSUs required continuing subsidies. There was also greater ideological acceptance of privatisation, consistent with worldwide challenges to the socialist economic model. Notably, there were a number of different governments in power during this period. Thus, Congress initiated the programme in 1991, the United Front formed the Disinvestment Commission, the National Democratic Alliance (NDA) (Bharatiya Janata Party-led) government set up the department of disinvestment, and now Congress has established a national investment fund for channelling privatisation revenues. Labour and left-oriented parties have managed to go along. Finally, attempts to stall the privatisation process through the court system – a frequently effective strategy in India – were dealt a severe blow in a landmark Supreme Court decision involving the BALCO privatisation.

The evolution of privatisation policy since the start of economic liberalisation in 1991-92 is briefly outlined below:

(1) Interim budget and budget speech, 1991-92, Chandrashekhar government The GoI enunciated a policy to divest up to 20 per cent of its equity in selected PSUs to mutual funds and investment institutions in the public sector, as well as workers in these firms. The stated purpose of the policy was to place equity across a broad base, improve management, increase resources to the enterprises, and to raise funds for the general exchequer. Initially,

IV Should India Adopt Rapid MassPrivatisation?

In light of the poor performance of PSUs, and a growing willingness to privatise, it may be argued that India should adopt a process of rapid mass privatisation, as in Russia and the Czech Republic. For example, in a few months in 1992 the Czech Republic privatised nearly one thousand state-owned enterprises through a voucher scheme [Hingorani, Makhija and Lehn 1997]. Though the Czech privatisation was largely clean, the largest Russian enterprises were sold in a massively corrupt fashion to individuals that the Russian press has dubbed “kleptocrats” [Black, Kraaakman and Tarassova 2000]. These problems were waved away and rationalised, however, under the theory that any private ownership is ultimately preferable to state-ownership.

The results proved to be disappointing in both cases, and resulted in stagnant economies for most of the 1990s. In the Czech Republic, a nexus of governmentowned banks and managers in poorly performing privatised firms allowed bad loans to persist, thus failing to liquidate unprofitable firms or undertake necessary restructuring. In Russia, without proper controls against it, massive self-dealing by insiders led to looting of firms, rather than the hard work of better monitoring and the creation of new value. Common to both, the Czech Republic and Russia, was an absence of the development of an infrastructure of laws and regulations prior to privatisation. Strong proponents of a laissez-faire philosophy, such as prime minister Vaclav Klaus whose government oversaw the Czech Republic’s mass privatisation, believed that markets would respond spontaneously to a need for laws and regulations. In a sense, both countries were poorly served by western advisors that promoted a “shock therapy” approach to privatisation, to expeditiously install one of the pillars of the so-called Washington Consensus.

China represents the other extreme approach to privatisation. Since the adoption of the open door policy under Deng Xiaoping in 1978, the economy has flourished. However, the engine for growth has not been the state sector. In fact, China has thus far not made any significant moves to privatise some 3,40,000 state-owned enterprises. While the private sector has thrived, about half the state enterprises operate at a loss [Cao 2000]. With over 200 million individuals employed by stateowned enterprises, the state sector does provide an important social safety net. Chinese officials plan to ultimately “securitise” state-owned enterprises. Possibly by that time, the non-state sector will have grown to such an extent that the privatisation of state enterprises will be a non-event. In the meantime, state subsidies continue.

Between the extremes represented by the Czech Republic and Russia, and China, India’s case-by-case approach is arguably the correct path, though it needs to be speeded up. Unlike in China, the Indian PSUs can be privatised without jeopardy to the economy as a whole, and yet free the GoI of its burden of ongoing subsidies. Most importantly, to unlock their maximum potential each firm optimally requires owners with requisite business knowledge and with sufficient holdings to make it economically worthwhile to monitor management and ensure efficiency. Moreover, there is considerable scope for dislocation, mismanagement, and manipulation in a large scale Czech-style wholesale privatisation.

The question then is how we can speed up the privatisation process while retaining the value benefits of a case-by-case approach.

V What Is Holding Up thePrivatisation Programme?

The prominent groups with vested interests against privatisation of PSUs are workers and their labour unions, managers, and politicians. Workers have not shown as much resistance as might have been expected, though they have organised some very visible large protests. There are a number of reasons for this. One, privatisations have been accompanied with sweeteners for labour. Voluntary retirement schemes provide compensation of three or more years of salary for early retirement. Shares have also been offered to workers at a third of the market price to buy their nod for privatisation. Two, strikes could prove to be counterproductive if superior private market alternatives are available to customers (e g, rival airlines to Indian Airlines). Indeed, in many cases consumers may not be sympathetic to the cause of PSU workers because they are increasingly exposed to the better services and choices offered by private providers (e g, telephony). Finally, it is unclear if privatisations thus far have led to significant forced declines in employment, though the most difficult cases, as in banking, may lie ahead. In controversial cases like BALCO and Modern Foods, where there were heightened fears, labour has discovered that they may not be adversely affected by privatisations after all.

Paying off managers, and particularly politicians, within the privatisation package is much harder because of their larger private benefits of control. In the BALCO case, where workers were eager to retire with an average payment of Rs 4,00,000 in the voluntary retirement scheme, one wonders if the offer of twice that amount to executives was greeted as adequate compensation. It is common knowledge, bolstered by anecdotes of egregious looting, that without effective monitoring of PSUs, managerial opportunities for private benefits of control are immense.

The situation is even more intransigent for politicians. PSUs with their bloated employment rolls serve as vote banks, bought off with periodic doles of government subsidies. There are also opportunities for providing political patronage, such as jobs and contracts, in order to curry favour with voters or to obtain kickbacks. While privatisations may offer benefits to the population at large, their costs are localised. This may explain the phenomenon of “reluctant privatisation”, whereby researchers are finding international evidence that after the official privatisation of state-owned enterprises governments find ways to reassert control [Bortolotti and Faccio 2004]. In other words, managers and politicians may actually favour privatisation, as long as it is not their PSUs.

Dinic and Gupta (2005) offer empirical evidence of the significant role of politics in resisting privatisation in India. In particular, based on the privatisations that

Economic and Political Weekly May 20, 2006

occurred between fiscal years 1990 to 1995, they find that a PSU is more likely to be privatised if it is located in a state where the ruling party and its allies do not face serious challenge from opposition parties. If, however, the largest opposition party has won a large share of seats, then privatisation is less likely to occur in that state. Moreover, they find that there are no cases of privatisation such that the privatised PSU is located in the home state of the politician in charge of the ministry to which the PSU belongs.

If India’s privatisation programme is to make headway, we must admit to these realities and address them.

VI A Proposal

Even if everyone privately agrees that PSUs are underperforming and ought to be privatised, it will take committed leadership to proclaim that the “emperor has no clothes”. However, the opposition seems surmountable at the moment, and there is a window of opportunity to markedly speed up the process. The following scheme attempts to break up the manager-politician nexus, and possibly turn managers into proponents of the privatisation of their own PSUs.

productive use. Competing parties may beallowed opportunities to revise their proposals. If no competing proposal appears,then the basic proposal should be accepted,motivating managers and ministries toseriously develop basic proposals.

(iii) National investment fund: Revenuefrom privatisations will flow to the nationalinvestment fund, which was recently setup. Managed professionally, the returnsfrom this fund will be applied to improvements in education, health and employment. Instead of plugging annual budgetdeficits, privatisation revenues will makethe nation more competitive.

India faces growing international competition. Privatisation can be an important tool to enhance the country’s competitiveness by putting the sizeable assets of PSUs to more productive use, to free government resources from going into subsidies, to raise revenues for health and education to make the nation more competitive, and to bring better opportunities for the workers and managers in the PSUs.

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Email: Makhija.1@osu.edu

References