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Why Privatisation Is Failing In India

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Why Privatisation Is Failing In India

  1. 1. Why privatisation is failing in India Sumit K. Majumdar Institutional considerations have limited the success of the disinvestment effort in India. For privatisation to succeed, what is needed is an appropriate institutional mechanism. This has not happened, says Sumit K. Majumdar. WHILE the concept of privatisation has moved from being novelty to orthodoxy, it is hardly a ubiquitous feature in several institutional jurisdictions. India is a case in point. The present establishment has provided lip service to the concept. It has undertaken, at best, a lacklustre attempt at privatisation. Privatisation succeeds and fails for several reasons. Of relevance to the Indian situation are four factors: commitment, competition, transparency and mitigation. These factors interactively make privatisation yield the necessary results. Of these four factors, India scores highly on competition and transparency. But it scores poorly on commitment and mitigation. A consistent commitment to the cause of privatisation, as displayed by Ms Margaret Thatcher's Conservative government, in the early 1980s in Great Britain, is necessary for privatisation to succeed. This attribute has been conspicuously lacking in India. Given the lack of a clear political majority to govern, the various governments since 1991 have had to play a balancing game in satisfying various political constituencies about whether to privatise. Between 1996 and 1999 India had four prime ministers. The prime minister, the finance and disinvestment ministers may have had a keen interest in seeing privatisation succeed, but the other coalition members of the government had opposing views. A corollary to commitment is the creation of an institutional framework, so that policies needed to transform an economy can be implemented. Diluted commitment
  2. 2. The overall commitment to the cause of privatisation has been diluted and appropriate institutional mechanisms have not been evolved to meet global standards. The issue of whether competition, in other words the enhancement of market contestability, has a stronger effect than privatisation in influencing superior performance is yet open. Evidence supports the notion of evolving competition as an equally strong disciplining force for improving the performance of public sector firms. Even if privatisation has taken place, a substantial portion of the performance improvements can be attributed not to it, but to competition. If anything, the period after the 1991 reforms is one where market contestability has been strongly enhanced in India. The creative destruction caused by the entry of new firms into the large and evolving market is just the beginning. A third factor is transparency, the lack of which has caused significant problems in the case of Russia. Where property and control rights cannot be easily defined because of the history surrounding the political economy of a country, or the nature of the industry, such as in electric or water utilities, there is an aversion on the part of potential purchasers to proceed. Insider ownership with its attendant problems of possible collective action and the lack of ready defensibility of claims by new owners to the assets of the enterprises, raise costs and the efficiency benefits of privatisation are vitiated. In India, transparency has never been an issue since the debates have taken place in public view. And, if anything, there has been a surfeit of information. Judicial activism is also a major feature of the institutional environment. These factors, conversely, might lead to multiple opinions by various stakeholders and this could shift the focus of the debate. Mitigating factors The fourth issue is mitigation, which implies the presence of safety nets that can absorb the fallout of restructuring that is inevitable to transformational changes in ownership. The lack of mitigating factors that compensate those affected by the re-structuring has been the bone of contention between the advocates and opponents of privatisation in India. A component of the mitigating element is institutional competence so that privatisation process is managed well. Here there is an apparent paradox. A state that privatises well will also have managed its state enterprises well. Thus, a relatively incompetent government will manage its privatisation badly. Given India's track record of managing state enterprises, the lack of institutional competence also signals the absence of a mitigating factor. This is evident by the slow progress of privatisation. One reason why it is better to let the market forces play out is, institutional incompetence. While privatisation, since 1991, has been conceptually agreed to as a reforms policy measure that requires full implementation, the reality is that progress on that front has been minimal. Since the bulk of the paid-up equity capital in the industry
  3. 3. is owned by government companies, to disinvest a large portion of it to the public-at- large would be difficult. This situation was quite different to that in Great Britain, for instance, where just a few companies, such as British Airways and British Telecom, were privatised in full glare of the media. The share of government companies' equity ownership in the British corporate sector was small. On the other hand, where the state sector has been dominant, as in Russia, the problems have been extraordinary. So it is actually quite difficult to privatise an economy of a very large country with significant state presence. Nevertheless, the track record of India is particularly poor. Between 1991-92 and 1997-98, the actual receipts from privatisation were Rs 11,000 crore. From 1998-99 to 2001-02 the amounts raised were not much more. The total receipts during this period amounted to Rs 14,856 crore. Thus, in the decade since the reforms were implemented, approximately Rs 26,000 crore was raised through privatisations. The sum budgeted was Rs 66,000 crore. The rate of realisation was just 40 per cent. Also, the sums actually received amounted to perhaps less than a tenth of what was sunk over time in the various enterprises set up by the central and State governments. The real concern lies with the structure of the process of privatisation, which could well have been one of themes for Mr Rube Goldberg, the American cartoonist whose commentaries dwell on expending maximum effort to achieve minimum results. First, the ministry or department concerned, under whose charge the company falls gives its views. Next, these recommendations are processed by a Department of Disinvestment, which is the administrative body consisting of a group of serving civil servants. These are then further debated on by a Core Group of Secretaries on Disinvestment headed by the Cabinet Secretary. This is the bureaucratic body that ultimately decides what ought to be done. The final decision on whether a company is to be privatised is taken by a Cabinet Committee on Disinvestment, consisting of ministers who are, in almost all instances, senior politicians. To add to the list of this large collection of administrative bodies is an alphabet soup of bodies. There is also the Bureau of Public Enterprises within the ministry of Heavy Industry and Public Enterprises. To deal with almost `terminally' ill government companies, of which there are several, there are the Board for Industrial and Financial Reconstruction, the Appellate Authority for Industrial and Financial Reconstruction and a Board for Reconstruction of Public Sector Enterprises. Many considerations, other than economic, lay behind the creation of government enterprises in India. The same set of considerations are possibly at play when it comes to privatisation. Since the process is cumbersome and time-consuming, with decisions guided by administrative and political considerations, rather than economic, it is no wonder that the amounts raised by privatisation are small. Decisions on privatisation are taken by a large group of bureaucrats who are not at the cutting edge of economic thought or business practice.
  4. 4. Problems of collective action remain, since there are a variety of bodies, each taking part in the process of decision-making. Also, there are so many involved in the process that there are tendencies to free-ride. No civil servant has a tenure long enough to be held accountable for a decision. Institutional considerations have, thus, limited the success of India's privatisation efforts. This reflects the state's incompetence in achieving its aims. For privatisation to have succeeded what was needed was an appropriate institutional mechanism design. This has not taken place in India. The process, while transparent, is not equipped to implement a disinvestment strategy according to global standards. The procedures to divest were created by members of a system that set out to invest in government companies in the first place. Therefore, there may well have been a desire to design mechanisms to safeguard what they created — the public sector enterprises. Since both implementation and design are concerns, it is useful to evaluate whether the weak versus strong state paradoxes apply to India. A state that is competent enough to manage its enterprises well, will privatise well. Similarly, a state strong enough to create appropriate safeguards and implement them can re-appropriate the assets if that is found to be necessary. Yet, there is a third paradox. A robust and dynamic free market economy also requires the presence of an effective and centralised state with superior mechanism design and efficient implementation abilities. While the activities of the government are transparent and it is committed to economic growth and a free market economy, clearly its mechanism design and implementation abilities, make it a weak state. The need to create the appropriate mechanisms is perhaps necessary if any privatisation is to be undertaken. But this is unlikely, as the present system has inherited more than half a century of post-independence practice and at least a century of organisational history. On the other hand, introduction of laissez-faire in 1991 has actually promoted substantial market entry. Perhaps the time of the government is better spent in designing the regulatory institutions and the infrastructure that permits private competitive industry to succeed. Darwinian competition has hit the Indian industry. The pressures from the market will provide enough pressures for public sector enterprises to restructure their activities, focus on key strategic parameters. (The author is professor of Technology Strategy at the University of Texas, Dallas. He can be reached at

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