The Privatization of Public Sector Units

The June 2nd Business Standard carried an opinion by Mr A B Bardhan, Secretary of the Communist Party of India, on the question “Should the disinvestment ministry be scrapped?” He said,

Even Lord Keynes would not have approved of disinvestment! Even he believed that there are some areas the government should not step out of. … Disinvestment means privatizing profits and nationalizing losses…. Profit making public sector units should not be privatized for two main reasons. First, because they are major contributors for taxes, and, second, they pay huge dividends. … Selling profit-making PSUs, like Oil and Natural Gas Corporation, is akin to selling jewels to buy groceries. … I am against privatization of the state electricity boards. I simply do not understand the merits of the decision of setting up state regulatory commissioners even as private distributors increase costs repeatedly. In a state like Delhi, for instance, can any private power distributor without an established work force be able to carry out electrification? …

For the record, I have to make a disclosure first. Mr. Bardhan is a respected elder to me. So when I differ with him vehemently, I do so with the utmost respect and regard for him. With due respect, I think what he says is nonsense and nonsense of the most pernicious kind. The entire piece in the Business Standard is a study in how wrong-headed thinking carried on over an entire life-time can warp the judgment of a well-meaning and idealistic person. I don’t doubt for a moment his total commitment to the lot of workers. I am confident of his sincerity for the well-being of labor. But good intentions are far from sufficient in making things better. Let me save you from drowning, said the monkey to the fish, as he put it up on a tree.

Now to some specifics. The appeal to authority that Mr Bardhan makes in invoking Keynes is disingenuous at best. Agreed that the government should not step out of some areas. But which areas should that be? Should the government be in primary education or should it be in power generation and distribution, or should it be in neither or should it be in both? Should the government be running airports and airlines, or should it be enforcing law and order?

To answer questions such as those, we need to first ask: what would happen if the government were not to be in a specific area. Would the private sector step in? Or will it get neglected leading to social welfare losses? It is very simple to demonstrate that primary education will not be optimally provided by the private sector because it has public good characteristics and there are major positive externalities which cannot be adequately captured by any private provider. Primary education, therefore, is a prime candidate for government financing, irrespective of whether the actual provisioning and delivery of primary education is by the private sector or the public sector.

On the other hand, the government should not be in the running of airports and airlines simply because in a competitive marketplace the private sector will provide an optimal solution. The point to note especially is the competitive marketplace bit. Airports and airlines are not natural monopolies. Monopolistic control of airports and airlines leads to the kind of outcome we are so familiar with in India (thankfully, the government monopoly of domestic airlines has ended) with shoddy airline service, massive supply constraints, the worst airports in the entire civilized world.

Now about the bit about PSUs paying dividends (out of profits, presumably) and contributing taxes. So do many private sector firms. So that is no argument against privatization. He forgets that while making profits is important (whether it be a private or a public sector firm), it is also important to ask whether the firm making a profit faces competition or not. If you grant me the monopoly to provide, say, telecommunications services in India, I would make a humongous profit, pay lavish dividends, and contribute to taxes. Of course, I would also screw over the country by curbing supply (monopolies control supply to maximize profits), charge an arm and a leg for shoddy telephone service, and generally I would talk very loudly of how wonderful an employer I am since my employees don’t have to face the threat of me going out of business and laying them off. So the employees would also lord it over the people who need telecommunications services by threatening to cut off their telephone services unless consumers grease their palms every so often. See, my being a monopolist meets all the conditions that Mr Bardhan requires for the public sector to be in a specific business.

What I describe above is exactly what the government did in the telecommunications sector — it was a public sector monopoly and as expected the country suffered immensely as a consequence. Now there is a degree of relief (but not entirely) since the market is somewhat competitive (more about this some other time.) I am not against PSUs. The more the merrier. But here are the two conditions that they should meet:

1. They not be monopolies.
2. That they have a hard budget constraint.

The first condition means that other firms should be allowed, if not actively encouraged, to be in the business. So for instance, the public sector firms BSNL and MTNL can be in the same sector as other private firms providing telecomm services. It is only when the public sector firm is the only game in town when the sector goes to hell in a handbasket.

The second condition is required to prevent the public sector unit from being a drain on the public purse. Suppose that BSNL is a player in a competitive market but bleeds crores of rupees every month absent a hard budget constraint. That would be against the rules of the game (that is, it would not be subject to the same conditions that its competitors face in that they exit the market if they cannot efficiently run their business) and it would impoverish the public as well.

{Continued in “Wrong-headed policies condemn millions to misery“}

Author: Atanu Dey

Economist. View all posts by Atanu Dey