Paul Streeten
Published Date:
September 1988
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I congratulate Mr. Bhatt for presenting a large number of wide-ranging issues regarding the public enterprise syndrome. I shall attempt to present initially the propositions and issues contained in the paper, not necessarily in the same order.

According to my understanding of public enterprises, Mr. Bhatt makes the most important observation about public enterprises almost casually, toward the end of his paper. Public enterprises are creations of the state, and this can only be understood in relation to the nature of the state. Public enterprises, like any other public policy instrument, are conditioned by the nature of the social forces that coalesce in the government, and the functional performance in reality, despite the rhetoric, is critically dependent on the basic interests of the classes constituting the dominant groups in the government. Thus, the public enterprise in a bourgeois-dominant democratic regime performs qualitatively different functions from the public enterprise in a mass-based socialist state or in the intermediate regime a la Kalecki. While Mr. Bhatt has reported this, quietly, he certainly has not made much of it. In fact, he minimizes the importance of this fact when he uncritically accepts the Jones and Mason proposition that ideology of state does not matter. However, it should be noted that the ideology pronounced in the constitution, or even in the rhetorical chapters of the planning documents, does not necessarily portray the functional ideology of the state which is revealed through governmental operation where the coalition of social forces is most directly alive.

Mr. Bhatt has stressed the point that development is an important responsibility of the government in the developing countries, where the pace has to be faster, and greater direction needs to be given, compared with the historical situation of the developed countries of today. In this context, public enterprises have been used to initiate the economic transition involving structural change or adaptation. The intensity and extensity of the use of public enterprises in this context is directly related to the stage of a country’s development. Mr. Bhatt refers to development in narrow economic terms and notes the often-repeated proposition that the role of the public enterprise is greater in economically backward countries in the sense that its share in gross fixed capital formation, industrial investment, and industrial gross domestic product is greater than in economically advanced countries. He leaves out altogether the compulsion of the nature of the state and such factors as the decolonization process.

The high visibility of public enterprises is due to the nonavailability of competent domestic entrepreneurs, whose effective presence is a necessary, and is alleged to be a sufficient, condition for reducing the role of public enterprise in a free market or mixed economy. However, two other necessary conditions remain unstated. First, there has to be a social transition to identify and promote such talent, and, second, there has to be a political evolution that puts this group, or a group dependent on or coalescing with it, in power. In other words, the bourgeois democratic revolution on the completion of primitive capital accumulation needs to be completed in order to minimize the role of public enterprise in the developmental entrepreneurial activities. This is the second proposition of Mr. Bhatt’s—that lack of entrepreneurial managerial tradition is the basic rationale for the imposed or induced importance of public enterprise.

How to fill this lacuna? The prescription is that public enterprise build, quickly and on a sound basis, physical and financial infrastructure, the cost of which has to be borne by the society, since development will benefit society. Public enterprise has been allotted another role—to assume responsibilities where the private sector is not yet competent to do so. Examples are areas where risk is high, projects that have long gestation periods, sectors that require sophisticated technology, and projects that are strategic to development but are low yielding. This is, as you would recognize, an extension of the infrastructure argument. What puzzles one is the fact that public enterprise is considered inevitable for such activities, even by those who are convinced of the inefficiency of public enterprise. The answer to the puzzle lies in the political economy and not in efficiency economics as such. Unless public enterprise performs these functions, private capital interest would not emerge as a dominant force. There is a third role that public enterprises play in the name of development: they provide key inputs—goods and services—for the growth of the private sector in the name of growth and development. The subsidy so provided is considered a cost of development and thus has to be borne by the people at large. The cost efficiency of such a subsidy game is rarely raised by public enterprise opponents.

This takes us to an interesting question. Public enterprises are required to assume risks, supply subsidized goods and services, and provide infrastructural facilities; but addressing externalities and creating inducements may not provide them with the opportunity to produce a surplus. They were created to produce “development” or “an environment for development.” If the public enterprises have been operating efficiently in the technical sense (i.e., productivity is as good as it can be given the circumstances, and process wastage is not considerable), then the generatable surplus can only be dissipated through procurement, pricing, distribution, and compensation policies. If the dominant coalescing groups do not desire to see a surplus as a return to investment (in the revealed sense) for various reasons, then dissipation is allowed to occur through all or some of those policies. The mass-based proletarian coalition seems to have, at least theoretically, a compulsion to generate and extract such a surplus in an aggregative sense, but a bourgeois regime or intermediate regime may not have such a compulsion at all or may have it only in certain stages of development (e.g., capital accumulation) or in certain sectors. The entire discussion by Mr. Bhatt is based on the premise of poor financial performance of public enterprises and does not analyze the causes of this. He mentions elsewhere that there is no apparent reason for poor performance of public enterprises. However, it is assumed that causes lie in the government enterprise nexus which has made public enterprises “agents without principals.” A poor financial performance has become critical for mixed-economy developing countries, particularly for those dependent on aid resources, because those resources seem to be constrained by the international economic situation. Mr. Bhatt repeats the assertion that the net resource inflow to developing countries will continue to decline. As public enterprises will have to continue a developmental role in many of the developing countries in terms of gross domestic capital formation, industrial investment, and industrial output, it has become necessary for public enterprises to operate efficiently in financial terms. However, Mr. Bhatt is conscious that performance criteria for public enterprises cannot be the same as those of the private sector. He seems to suggest that an agreed goal mix, with appropriate costing and weightage, could provide a single yardstick in financial terms for evaluation of the performance of public enterprises. A development role may, however, be adequately performed in the aggregate, through externalities and multiplier effects, even without a reasonable return on investment.

This, in fact, puts the public enterprise in the perspective of growth and adjustment—the theme of this seminar. The deficits generated by public enterprises are reducing available developmental resources, and thus the removal of deficits would be helpful in the mobilization of domestic resources. Mr. Bhatt recognizes two important factors in public enterprise inefficiency: first, the adversary relationship between enterprise management and government, and, second, the inappropriate selection and evaluation of projects and top management personnel. He wishes to eliminate the first through a creative dialogue between government and enterprise that identifies operational goals and strategy. He visualizes that if this can be done, then enterprise and government can enter into a management contract and eventually privatization will take place, reducing the responsibility of government in productive sectors. This can be done through institutionalizing the decision-making framework, including the selection of top management and such important things as choices of project, technology, and location. The second set of problems, he recommends, should be addressed by a development bank rather than a ministry. He assumes that a development bank does not assume the character of a public enterprise or become a part of the bureaucracy. However, Mr. Bhatt forgets that even in the United States, the failure rate of new or old private enterprises is quite high in normal times, despite any such constraints. Further, Mr. Bhatt suggests that public enterprises should grow over time in classical fashion, with acquisition, skill, performance, confidence, and innovation playing significant roles in extending the opportunity frontier. He concludes that financial viability will generate confidence and secure supportive assistance from government. In order to generate such success, it is necessary to induce competitive pressures on public enterprises. All these add up to one thing: making public enterprises emulate enlightened private enterprise culture. This is perhaps easier said than done, and private enterprise experience provides no guarantee of success.

Finally, Mr. Bhatt brings in the question of motivation and recommends Theory Z as a mode. But management is a culture-based phenomenon. What works in Japan may not work in societies with different social values and institutions. Can Theory Z be effective in an environment where Theory X produces the result?

The entire exercise on public enterprise, as presented by Mr. Bhatt, seems to be premised on the following: First, it has become necessary to transform public enterprise management culture from development to performance, since that would reduce the burden on the budget and make public enterprises attractive for divestiture. This seems to be an escapist view. Second, public enterprise performance is conditioned by political stability, commitment of the state to socioeconomic development, capacity, and a willingness of the political and administrative apparatus to evolve mechanisms that promote creative adaptation of the decision structure and processes to a changing environment. This is an ideology that provides a powerful motivation for group effort and learning through convergence of goals and expectations, which are difficult to find in developing countries, and hence public enterprises should be restricted. This is a defeatist view. Mr. Bhatt forgets the nature of the state wherein the coalescing forces may desire public enterprises in spite of the absence of such efficiency criteria if creation of these enterprises serves their class interests or if that is the immediate survival and growth route available. Further, it should not be forgotten that public enterprises and public institutions have been used, and can be used, for rapid, effective social transition under a committed leadership, as evidenced in the experience of such diverse economies as those of the Republic of Korea and China. The cost—suboptimal performance in financial terms—may simply have to be borne. In addition, the conditions enumerated for public enterprise are also relevant for private enterprise. Should the proposition for restriction of public enterprise apply equally to private enterprise?

T.L. Sankar

I would like to join Professor Ahmad in congratulating Mr. Bhatt for presenting a very balanced analysis of a wide spectrum of issues relating to public enterprises in developing countries.

Mr. Bhatt has rightly emphasized that public enterprise performance cannot be judged by the same criteria as private enterprises and has cogently listed a number of reasons for this—the more important among them being (a) the instrumental role that they have to play in a developing economy and (b) their size, structure, and technology, compared with those of the private sector. However, he has considered the capacity to generate surpluses as the principal criterion for judging their performance and for comparing their performance with that of private enterprises. The paper deals mainly with various structural deficiencies in public enterprise management that adversely affect the surplus-generating capacity of the enterprises. The public sector has to trade off the profitability of the enterprises, either in the short run or in the long run, for the sake of optimizing the total benefits likely to accrue to the nation or the society as a whole. Concerns for interclass equity and intergenerational equity which public enterprises have to reckon with in some cases are not of any significance to the private sector. It is therefore possible, and sometimes unavoidable, that some public enterprises will lose at the enterprise level (now or in the foreseeable future); these firms’ losses may very well be acceptable, provided their contribution to social profitability is more than adequate to offset them. This point is fairly well recognized in the literature on the role of the public sector in economic development, while the management literature tends to overlook this aspect. Mr. Bhatt, in my humble view, has taken more of a management view.

In the plan documents of various developing countries, the rationale for investing in public enterprises has been set out clearly. The main reasons advanced, irrespective of the political ideology of the regime, are (a) to gain control of the commanding heights of the economy; (b) to provide critical development inputs of strategic value; and (c) to generate a surplus for sustaining a high level of capital formation. Needless to say, in Indian plans, in addition to the above objectives, public enterprises are also expected to contribute toward achieving self-reliance. It is therefore not surprising that a fairly large share of public investment has been made in areas of low profitability and/or high risk. The performance appraisals of the public enterprises should, therefore, take into account their contribution to social gain when analyzing their financial losses.

However, one cannot but agree with Mr. Bhatt that the surplus-generating potential of the public enterprises has not been fully realized, and it has become a constraint in financing the development plans. Any nonfinancial objective or socioeconomic constraint imposed on a public enterprise would no doubt erode, to some extent, its financial profitability. Under any given set of constraints there would nevertheless be an achievable level of profits which would be enterprise-specific and be determined with reference to the total objective functioning of the enterprise. The performance of the management of each public enterprise would have to be appraised against the specific anticipated surplus of the particular enterprise.

How, then, could such performance levels be achieved? Mr. Bhatt attempts to answer the question based on a small number of case studies of successful public enterprises in developing countries. He concludes that “there is no inherent reason for the poor performance of public enterprises in terms of their effectiveness and efficiency in relation to the major goals, provided certain key decision mechanisms are institutionalized.” Mr. Bhatt has suggested a suitable institutional framework to reduce (or minimize) the influence of political and bureaucratic interference and ad hocism in the decision-making process. While there can be no dispute about the identification of the ills, the suggestion that by setting up institutional arrangements, we could overcome the problem appears to be facile and does not carry conviction. The creation of institutions is no doubt a necessary condition but is hardly likely to be a sufficient one. The Indian experience with institutionalization of decision making is a good example to show the limitations of Mr. Bhatt’s arguments. Though the Public Enterprise Selection Board has been in existence for nearly two decades, there has been no perceptible change in the quality of top management. Further, as many as 15-20 percent of the public enterprises under the Central Government have remained “topless” for several months in recent times. The Bureau of Public Enterprises has been in existence for three decades. If there is an issue on which there is near unanimity among public enterprise chief executives in India, it is the need to curb the interference of the Bureau in their affairs

The performance of a public enterprise depends on a number of factors, and it is difficult to isolate any of them as the primary one. In a recent study by the Institute of Public Enterprise, the public enterprises are classified in terms of (a) return on capital employed and (b) competitiveness of the environment, both based on their market shares. Out of the 158 central government enterprises (excluding 48 units which are taken over), 84 are in the competitive environment. Of these, 36 are financially successful (i.e., earn a return of 10 percent and above on capital employed). Similarly, in the noncompetitive environment, 38 out of 74 are financially successful. Since, according to the above analysis, there is no systematic association between competitiveness and financial performance, it is difficult to conclude that by merely providing a competitive environment the public enterprises would improve their performance. Therefore, one could argue that the performance of these enterprises would probably depend on their ability to cope with the intervention from “outside.”

Mr. Bhatt’s suggestion of entrusting the financial institutions with the investment decisions of public enterprises is also questionable. Anyone closely associated with the financial institutions would testify that they are not free from pathology, which afflicts the public enterprise system in general in India. Very often, behind their apparent profitability and professionalism, it is not uncommon to find sordid instances of favors done for particular firms and particular industrialists, mostly on the interference of politically powerful agents.

We therefore come back to square one and ask what, in the ultimate analysis, would contribute toward improved public enterprise performance. According to Mr. Bhatt, “In the final analysis, public enterprise performance depends on (a) political stability; (b) commitment of the state to socioeconomic development; (c) the capacity and willingness of the political and administrative apparatus to evolve learning mechanisms that promote creative adaptation of decision structures and processes to a changing environment; and (d) an ideology that provides a powerful motivation for group effort and learning through the convergence of goals and expectations.”

If we agree on this, one should discount much of the emphasis on the structural improvement of managerial functions that has been dealt with in great detail in Mr. Bhatt’s paper. If a government compromises the development imperatives because of distributional pressures, no amount of reforms or “institutionalizarion” could provide the remedies for the poor performance of a public enterprise. The time has come when the issue has to be faced squarely—in terms of the politics and economics of the development process.

As Professor Raj pointed out, “While there has been much verbal support for public enterprises . . . perhaps the most important reason why they have not been able to grow, in the manner once hoped and expected, was simply that there have not emerged any political forces in the country genuinely interested in making such enterprises yield adequate profits and savings of their own.”1 I submit, therefore, that we should not seek managerial solutions but instead should create a countervailing force to the political power of the regime by bringing together people who are affected by the performance of public enterprises. Finally, a centralized system at the one end, and the highly decentralized management system of the Yugoslavian type at the other, have to be studied closely in evolving totally new institutional arrangements to make— if a rhetorical expression is permitted—public sector enterprises really a “people’s sector.” Unfortunately, I have no clear proposals to suggest. But this much appears clear to me: a study that suggests that depoliticalization would lead to the better performance of public enterprises is like a study that concludes that “poverty is the cause and affluence is the solution.”

K.N. Raj, V.T. Krishnamachari Memorial Lecture, delivered under the auspices of the Institute of Economic Growth, New Delhi, on November 20, 1985. This has been published, in slightly abridged form, in Mainstream (New Delhi), Vol. 24 (December 14, 1985), pp. 7-10 + and (December 21, 1985), pp. 15-19. The above quotation appears on pp. 17-18 of the December 21 article.

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