Chapter

chapter fourteen Public Enterprises and Autonomous Agencies

Author(s):
A. Premchand
Published Date:
March 1989
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There are only two qualities in the world: efficiency and inefficiency.

G. B. SHAW. John Bull's Other Island

Public enterprises and autonomous agencies have grown in size and scope during recent years. Their working reveals many problems common to both industrial and developing countries. It appears that public enterprises have added to the budgetary pressures by shifting some burdens to the government budget, thus endangering its already fragile balance. Government's role as a model employer appears to have contributed, in several instances, to a general wage push in the economy. The sick units taken over by government have become, in many cases, permanent activities of government. Instead of contributing to additional resource mobilization, enterprises have become more dependent on the government budget. Instead of fulfilling development tasks, they have contributed to delays, inappropriate investment choices, capital intensive technology, cost escalation, credit expansion, prevention of credit to other needy sectors, and, overall, to an inefficient allocation of resources. The autonomous agencies have also grown in some countries and have by their existence diminished the importance of government budget and reduced the amount of legislative control. Both these areas represent significant segments of the total activity of the public sector, and the financial issues relating to the operations of both make systematic analysis a compelling necessity. The relationships between government and enterprises have hitherto been examined in the literature in terms of provision of finances, forms of enterprises and the formal controls exercised in the process of release of funds, and utilization of funds by enterprises. But the structural budgetary relationships between government and enterprises, in particular, the type of financial controls exercised, have not been given due consideration. The autonomous agencies and their issues have received much less attention. This chapter considers the nature of these organizations, their budgetary relationships, and the broad ranges of issues in the policy and institutional areas.

Public Enterprises and Autonomous Agencies Distinguished

Public enterprises do not lend themselves to precise definition, as illustrated by the many attempts made during the last two decades.1 In one of these attempts, Hanson offered more of a description than a definition when he stated that they primarily relate to “industrial, agricultural, and commercial concerns which are owned and controlled by government … where the state ‘participates’ in mixed enterprises, the criterion employed is that of control. If the state contributes more than 50 percent of the capital of a mixed enterprise, it automatically has a controlling interest. It may actually exercise control even when it holds a small proportion of the shares. In either case, the enterprise is included in the ‘public’ category.”2 The System of National Accounts (SNA), added an additional criterion relating to their activities and defined enterprises as organizations that are “entirely, or mainly, owned and/or controlled by the public authorities consisting of establishments which by virtue of their kind of activities, technology and mode of operation are classed as industries.”3 Elsewhere, the System added the criterion of marketability and included in public enterprises those “large incorporated units (government enterprises) that sell most of the goods or nonfinancial services they produce to the public.”

The operational aspects of the definition of ownership, control, and marketability are, however, ambiguous, lead to practical problems, and do not in any event permit a meaningful international comparability, which is one of the aims of the National Accounts System. The ownership criterion has been limited in this approach to enterprises in which “all, or a majority, of the shares of, other forms of capital participation in, or the equity of the unit” are owned by public authority. In practice, this could eliminate some of the enterprises where a minority share is held by government but the enterprise is basically controlled by it. In partial modification of this definition, Leroy Jones suggests that “[a] public enterprise is a productive entity which is owned and/or controlled by a public authority and which is autonomous and/or produces a marketable output.”4 Ownership for the purpose is defined as being where more than 10 percent of the equity is held by the public authority and output is considered as marketed where at least half of the current costs are covered. The application of this approach does not reduce the problems faced in the SNA definition and gives rise to a number of borderline examples. There may be several enterprises where government capital may be limited but its control is extensive for purposes of “goal realization.”5 Many countries in West Africa and Asia have enterprises that, in view of their strategic role, are totally controlled by government but are organized as “mixed companies” (joint ventures) with only minority shareholdings. Similarly, the application of the criterion of 50 percent recovery of costs for proving marketability would mean the elimination of enterprises engaged in the provision of infrastructure services or in the fulfillment of other national objectives, or those that have “long periods of initiation” and therefore cannot recover costs in the early stages of operation. An associated criterion is the addition of a value-added measure, but the application of this would result in the elimination of trading enterprises owned by government. Each definition thus appears to have one limitation or another and cannot encompass the variety of enterprises and local practices. For purposes of analysis, however, the reference here is to nonfinancial public enterprises (NPEs) that (a) are engaged in the production and sale of goods and nonfinancial services and (b) keep separate budgets and accounts. These may be organized in any form. From the budgetary angle, these primarily consist of organizations that are owned and controlled by government, that have received their initial investments from government, that are under the administrative control of a sponsoring ministry, that generally have access to government budget, and that are used as instruments of government policies within the macroeconomic framework. Financial institutions, which primarily work as deposit accepting and credit providing institutions, are not included in this category for the reason that, although they are owned and controlled by governments, their operations come within the ambit of monetary policy. Also excluded are defense-oriented industries and other institutions organized to provide specific social services such as education and medical services.

Autonomous agencies, which are also known as decentralized entities, have not been defined in the same formal way as enterprises. But their nature is revealed by the common spectrum of experiences and, for analytical purposes, the reference here is to organizations that are set up by government with a specified degree of functional autonomy to provide a service to the public or to undertake a promotional or developmental activity. These agencies may be engaged in the production and sale of services, but their primary purpose is not so much commercial as to provide a service. NPEs may often have operational revenues that are earned mainly by the sale of goods and services. Autonomous agencies to which the commercial motive is secondary are dependent to a large extent on government transfers, earmarked revenues, or related sources of revenue. The activities of autonomous agencies are generally the traditional concerns of government and would normally be undertaken by it but for their separate organizational status. Enterprise activities, however, represent an extension of government into business. The difference between the two is not merely one of financial dependence on government but of purpose and character of activities. The service motive or the administrative agency function of government dominates the autonomous agencies. Enterprises are, in theory, primarily commercially oriented, they charge a price that is expected to be determined by market forces, and they have the authority to borrow both domestically and from abroad either on their own credit or through government-guaranteed loans. For autonomous agencies fees are charged to recover a part of their cost. Prices of enterprise products may also be established to yield higher returns and may at times be used as substitutes for taxation. No such role is generally assigned to autonomous agencies, nor do they have powers to borrow on their own either from the domestic banking system or from the market.6 Frequently, however, these distinctions are not observed and in practice some commercial activities may be undertaken by those that are shown as autonomous agencies and, conversely, some organizations shown as enterprises may be pursuing noncommercial activities.7 These distinctions are, however, important for they have a substantial influence on the nature of budgetary relationships, controls exercised in the financial process, and the evolution of appropriate evaluation criteria.

Nonfinancial Public Enterprises: Evolution, Growth, and Objectives

Nonfinancial public enterprises (NPEs) represent a significant aspect of state activity.8 Their growth reflects a change in the philosophy of the state. From what was considered to be limited supervisory functions such as law and order, the role of the state has expanded into industrial, manufacturing, and commercial activities, in addition to its regulatory role. This change has been contributed to by ideological, sociopolitical, and situational and practical factors. Among the ideological factors is the growth of socialist thought and the shift of production from private to public ownership that it implies. In developing countries, this was accompanied by the prevalence of a national sentiment that viewed some private enterprises as successors of former colonial governments. The distrust these countries had for such firms led to greater participation by the state in production activity. From the social and political point of view, the lack of skills within the private sector9 and a recognition that that sector could not be relied upon either to create the required employment or to provide opportunities for education and training have also contributed to greater participation by the state. In some countries, interests emerging from the political and economic survival have contributed to a greater role for state enterprises. The nationalization of foreign-owned private companies in the wake of independence belongs in this category. In numerous other cases, it was a combination of practical and situational factors that contributed to the spread of state ownership. After World War II, enterprises were used for the reconstruction of the economy and as tools for fighting recessions. The countercyclical role envisaged for enterprises was based on the belief that action through market mechanism was not adequate, as “pushing the string” had its limitations, and that more active and direct participation in the economy was essential. The growing emergence of sick industries in the private sector, together with the desire to maintain output and employment, has often forced governments to acquire enterprises. Once acquired, however, enterprises tend to develop their own durability. There were also deliberate plans for acquiring ownership, which, in turn, was influenced by the following factors: (a) a desire to compensate for the private investment in sectors where it tended to be shy either because of high taxation of profits, capital scarcity, or the high risks involved; (b) defense considerations and strategic needs necessitated direct government ownership in some sectors; (c) a recognition that state participation could promote development in backward regions, in areas where infrastructure services were needed, or in areas where major foreign investment was needed; and (d) consideration that acquisition of profitable activities could make a more substantial contribution to the national resource mobilization efforts. Acquisition of export businesses and management of traditional fiscal monopolies were partly motivated by this factor.

The more recent growth in the state enterprise sector can, in part, be ascribed to the tendency of state-owned enterprises to acquire subsidiaries because of their product relationships or, in some cases, simply because of a need for diversification or because of the availability of an investment opportunity. Also, government-owned financial institutions have started owning and investing in new promotional ventures. Examples of this are to be found in almost all countries, particularly in India, Italy, Korea, Spain, and the United Kingdom. The state sector now covers a vast area of economic activity and its functions range from agricultural farms to highly sophisticated and high-risk ventures such as aerospace industries and include the manufacturing of capital and consumer goods, mining and extractive activities, and trading and marketing. In many countries, strategic sectors such as energy, transportation, communications, and iron, steel, and coal production are completely operated by state enterprises. Since 1938 there has been a gradual extension of the state sector to the exploration, refining, and marketing of oil products and the share of state-owned oil companies in 1975 was more than 60 percent of total production. Yet another sector where growth in developing countries had been sizable was in the establishment of marketing boards. Although these boards are to be treated, in terms of the above-mentioned criteria, as autonomous agencies when their role is regulatory or advisory, some of them have a monopoly on importing or exporting, on domestic trading and are responsible for price stabilization for producers and consumers and are, therefore, a part of enterprises. The growth of fractional activities in the sphere of public utilities to a wider sphere implies that, with advancement at each stage of industrialization and trade, government enterprises tend to become more prominent in national economic decision making. But the increasing importance of NPEs in economic management does not necessarily imply that economies dominated by state enterprises are equivalent to centrally planned economies. It is generally true that the successful operation of public enterprises leads to the growth of auxiliary industries and results in generally increased investment opportunities for the private sector. In a centrally planned economy, more emphasis is laid on physical allocations and administered prices, while in economies that are dominated by state enterprises, reliance continues to be placed on the market system.10 Other distinguishing features are to be found, apart from ideology, in the degree of ownership, extent of operation, and severity of controls.

The wide network of enterprises has been classified in a variety of ways. For example, these enterprises are classified by legal form—corporations, companies, boards; in terms of branches of operations such as those manufacturing capital goods or consumer goods; in terms of motives—provision of merit goods, ownership of natural monopoly, prevention of noncompetitive practices; in terms of roles—promotional, supplementary, and replacement; and in terms of size—location, forms of production processes, rate of return, and related features. For purposes of examining the budgetary relationships, however, it is more appropriate that these enterprises be divided into distinct and meaningful cognate groups that indicate the economic environment in which they function, the broad tasks expected to be performed by them, and their budgetary relationships. Broadly, these groups comprise public utilities and manufacturing, capital and consumer goods, mining and extractive industries, trading and marketing, and other quasi-commercial services. The relative roles of these enterprises may change in the context of the objectives of government.

The growth of enterprises essentially reflects the wide variety of objectives that governments have for them. Among others, these objectives include eradication of poverty, attainment of self-reliance, egalitarian distribution of income, promotion of employment, balanced regional development, and prevention of concentration of economic power. An ever-present objective of public enterprises is to ensure an efficient allocation of resources. Government ownership may not by itself guarantee or even promote efficient resource allocation. A certain degree of market behavior, in particular the acceptance of opportunity cost pricing, may be needed on the part of enterprises if this objective is to be achieved. Social and distributional objectives are common for public enterprises and have, in fact, contributed to the expansion of public ownership. In developing countries, the objective of growth is also important and public enterprises are assigned key roles in the development plans. Both growth and distributional objectives are pursued by massive investments in the expansion of enterprises and by implicit taxes or subsidies in the prices of enterprise outputs. Charging a price that is less than the social cost of the resources used in production, for certain goods and services (and depending on the price and income elasticities of demand), may be a more effective method of shifting real income than direct budget expenditures. However, some subsidies may have the disadvantage of not discriminating against the groups of beneficiaries and the total costs of subsidization may be obscured. Stabilization objectives of government are achieved both by selective enterprise-oriented measures and the aggregate impact of NPEs on government budget. The main difference in the growth of enterprises in industrial and developing countries is that enterprises were used by the former to salvage the uncompetitive concerns that at the end of World War II and since then were left with undercapitalization and insufficient modernization. During the 1960s and 1970s, however, there was a shift of emphasis, and policies of price restraint for the enterprise products were adopted in the hope that such policies would check the acceleration of inflationary pressures. In the developing countries enterprises were used during the early 1950s and 1960s as instruments more of development, although marketing boards continued to play a major role in stabilization by protecting the producer (by guaranteed prices) from short-term external fluctuations. During periods of recession, selective expansion is undertaken by governments in public utilities and other enterprises. But their major policy instrument is the takeover of sick units when massive unemployment is threatened or similar disruptions are expected. During periods of inflation, the instruments available to government are price restraint on enterprise products, investment deferral, reduced provision of capital, and greater emphasis on self-financing. Where deficits of enterprises are contributing to higher government budget deficits, selective measures of price revision, cost reduction, reduced subsidies, and limits on domestic and external borrowing are observed.

The above-stated objectives are not always reconcilable and, indeed, it is a moot point whether deliberate efforts are made to reconcile them. In general, however, most NPEs are also expected to pursue noncommercial objectives. Given the multiplicity of goals, the question for consideration is whether in this regard there is a single paradigm governing the approaches of public authorities. It is argued that NPEs should be commercially oriented and, like any other private sector counterpart, should aim at profitability. The pursuit of this maxim implies that enterprises should operate efficiently and maximize their profits—an aspect that is to be related to other responsibilities that devolve on enterprises as instruments of government policy. It seems to be the general expectation that public enterprises work as model employers and respond to public demands in a more positive way while protecting the interests of their investors (society itself) and their consumers. The conversion of these goals into day-today management and their reconciliation with the profit goal has never been an easy one. Indeed, these goals remain the unresolved dilemmas of the society.

The role and guiding spirit of enterprises have been viewed differently at various stages of development. In industrial countries during the early years of nationalization after World War II, the policy approach was that enterprises should aim at recovering their total costs. In practice this meant the adoption of a no-profit, no-loss approach. This, in due course, yielded to an approach that emphasized commercial profitability.11 Later, the concept of profitability was developed further and the new aim for NPEs was that they should obtain profits that reflected the opportunity costs of capital. These considerations, together with the role of NPEs in stabilization, development programs, and as fiscal agents for raising revenues or as instruments for subsidization, form the desiderata for an evaluation of government budgetary processes.

Autonomous Agencies: Nature and Status

Over the years two considerations have led to the increase of autonomous agencies. First, there was a feeling that government departments that have to function within the formal structures and regulations of government might not be best suited to performing certain tasks, particularly those having considerable contact with the public. The financial discipline in the government might contribute to delays and associated problems and it was hoped that these could be minimized if agencies were separated from the discipline inherent in the government budget. Second, in some countries where the approval of budget appropriations by the legislature tended to be delayed and where the legislative overview was considered more of a hindrance by the executive than an exercise of legitimate function, efforts were made to separate portions of the budget and preserve them in the constitution with their own revenues. There was also a feeling (that does not lend itself to empirical verification) that the budget deficits could be managed within specified limits by a process of limiting the scope of the budget by setting apart some activities. Parts of the budget so separated were financed by borrowing and, being independent, were not reflected in the computation of government budget deficit. The systems in which these autonomous agencies prevail may be divided into limited (less than 20 in number), intermediate (20 to 50), and extensive (more than 50). Table 25 shows data for 31 industrial and developing countries and the number of agencies operating in each. It shows that the highest number of autonomous agencies are to be found in Europe, Latin America, and some British Commonwealth countries. Most of these agencies are educational (generally universities) and medical institutions, and several regulatory and promotional organizations. Their revenues are derived from budget transfers and are complemented by other receipts—primarily fees—drawn from the sale of services or regulatory functions.

Table 25.Autonomous Agencies in Government1
CountryNumber of Agencies
Limited Systems
Australia19
Cyprus3
Germany, Fed. Rep. of1
Haiti5
Jordan7
Kuwait5
Malaysia12
Mauritius10
Netherlands16
Yugoslavia10
Intermediate Systems
Bangladesh33
Canada22
Ivory Coast40
Morocco39
Singapore23
Tunisia35
Extensive Systems
Argentina182
Belgium107
Bolivia57
Brazil206
Colombia74
Denmark8002
Egypt53
France109
Iran, Islamic Rep. of120
Jamaica91
Peru150
Portugal247
South Africa76
Sri Lanka60
Venezuela53
Source: Compiled from country notes in International Monetary Fund. Government Finance Statistics Yearbook, 1980, Vol. 4 (Washington, DC., 1980).

Data restricted to central governments only; excludes social security agencies. Number refers to those agencies that have their own budgets.

Approximately; refers to government agencies (quasi-statslige institutioner).

Source: Compiled from country notes in International Monetary Fund. Government Finance Statistics Yearbook, 1980, Vol. 4 (Washington, DC., 1980).

Data restricted to central governments only; excludes social security agencies. Number refers to those agencies that have their own budgets.

Approximately; refers to government agencies (quasi-statslige institutioner).

The role assigned to the autonomous agencies is broadly the same as those of spending agencies. To that extent, the emphasis on allocative efficiency, stabilization, and distributional goals, and concerns of growth apply equally to the autonomous agencies. The approaches adopted toward their budget making are also the same as those of the spending departments. The primary differences between autonomous agencies and enterprises are in the source of funding and in the exercise of controls. As budget-making aspects of spending departments were considered earlier, the following discussion focuses on NPEs only.

Budgetary Relationships: Enterprises

The growth of NPEs has contributed to a change in the character of government budgeting. The concerns of the government budget were traditionally regarding the allocation of resources to functions such as administrative, social, and economic services, but now they relate to a host of issues, including financing enterprises, appraising of investment and pricing policies, and the rate of return. Governments now routinely review the budgets of enterprises for two reasons: first, to determine the role of enterprises in the allocative, distributional, and stabilizational aspects of the management of the national economy; and second, in a narrower sense, to determine the resources to be transferred to enterprises. These reviews, in turn, are based on reviewing the validity of the estimates of production, sales, and related finances. These concerns may have appeared remote not so long ago but have now become an accepted part of the budgeteer's lexicon.

Government is both the major shareholder of and, in many countries, the principal banker for enterprises. Budget is the main link that provides a continuing relationship with the NPEs throughout various stages of policy formulation and execution. Public enterprises are distinguished from others, mainly in terms of the financial significance inherent in their permanent relationship with government.12 The permanent relationship has two important features. First, because the government provides all the money either from its budget or from its financial institutions,13 there is, in general, little likelihood of a threat of liquidation of enterprises. Although this is not universally correct, it has contributed to the perception that the financial problems of enterprises, in due course, become the problems of the government budget. This imposes an additional responsibility on the government budget not merely to invest or approve specific expenditure proposals but to anticipate the problems of enterprises and the impact of their operations on the government budget. Such anticipation in turn generates some institutional and procedural imperatives that are reflected in the budgetary process. Second, from the enterprise point of view, the parameters of its budget other than sales revenue, are exogenously determined by the constraints characterizing the government budget. Income policies, resource mobilization measures, perceived rate of growth of expenditure, or the ratio of budget deficit to GDP all tend to influence the transfers to and from the government budget. These factors are viewed, albeit legitimately, as constraints that would not be felt if enterprises were left to their own devices. This approach has, however, some limitations. The enterprises that are dependent on government cannot, by their very nature, be able to generate their own resources to the required degree. There may, however, be some enterprises, such as manufacturing industries functioning in an open competitive environment that may be self-reliant, which anyway may be independent of some part of the fiscal discipline that stems from the government budget. State ownership implies certain social and economic responsibilities and these cannot be entirely ignored in considering the financial requirements of enterprises. If it is argued that enterprises are to be insulated from the macroeconomic responsibilities of government, then the onus of adjustment, when required, will shift to the rest of the public sector. A plausible-case, however, can be made for certain enterprises (for example, public utilities) to be exempted from the macroeconomic functions but efficiency considerations of management require that such enterprises be specified in advance. It may also be noted that the “freedom approach” may not be tenable in countries where banking institutions are either owned by government or often function in close harmony with the budget and a joint determination is made for the fiscal resources to be made available to enterprises (e.g., in Korea). Moreover, in pursuing a stabilization program, credit limitations apply equally to all enterprises and the NPEs may not fare differently in obtaining loanable funds. Specifically, in developing countries, the public sector, which plays a dominant role in the economy, may have to beat the major brunt of adjustment needed for stabilization and this, in turn, affects the budgetary prospects of enterprises. The intimate relationship and the complementarity between a government and enterprises leads to a policy framework in which there is little option for NPEs but to work in tandem with government.

Structural Aspects

Budgetary relationships between government and enterprises are dependent on the form and nature of the organization of the latter and to that extent government budgets may not fully reflect the activities of enterprises. Broadly, however, three types of institutional practices can be distinguished. The typology is not rigid and there may be cases that have all the following features in varying degrees.

First, there are systems where enterprise budgets are included in the government budget or where the dividing line between the two budgets is thin. Enterprise activities that are organized on a departmental basis or those whose budgets are annexed to the government budget belong to this category. In countries that follow the French tradition of limite de caisse, public enterprise budgets are subsumed in the national budget and transactions of enterprises are carried out through a special account established in the Treasury and are managed by it on behalf of enterprises. Another variant of this broad approach is the practice prevalent in some countries, such as the United Kingdom and the Federal Republic of Germany, under which financial requirements of the enterprises are included in the medium-term expenditure plans of the government. In countries with economies that are dominated by public ownership of production activities the enterprise budgets, while not formally included in the central budget, are considered in close conjunction with the government budget and are subjected to the same review as those of departmental budgets. Formal administrative procedures may differ among countries, but these relationships imply a greater degree of integration between government and enterprise budgets.

Second, enterprise budgets in some countries are formulated under the direction of the government but are not included in the government budget. This relationship may be described as directional. This is different from the centrally planned economies in that the scope of direction is rather narrow. In countries that have formal development plans, capital outlays of enterprises and their pattern of financing are reviewed as integral parts of the plan. In countries that have no plans, enterprise budgets may still be considered and approved by the ministries of finance.

Third, there are some countries where enterprises formulate their own budgets and are subjected to government review only in regard to specific aspects, such as capital expenditure or subsidies given for specific purposes. This type of relationship is less formal and enterprises are generally endowed with a greater degree of autonomy. In some of these cases, capital transfers from government may not fully reflect the capital budgets of the enterprises, for there are other sources of financing. In some countries, project loans received from abroad may be on-lent to the enterprises through government budget, while in other countries, loans may be received by enterprises on the basis of government guarantees.

The form of budgetary relationship is also influenced by the structure of enterprise budgets. The enterprise budgets are organized on a dual basis, viz., revenue and capital. The revenue budget consists of the sales and income budget, production, research, and development budgets, selling expenses, and administrative overheads. The capital budget consists of the proposed outlays on plant, machinery, and buildings. Supplementing these two, a cash budget showing the flows of receipts and outlays is also prepared. The transactions between government budget and enterprise budget, however, receive asymmetrical treatment in that an expenditure item in the former will be a source of revenue to the latter. The broad spectrum of budgetary relationships are illustrated in Chart 8. These procedures, however, have some limitations. In departmental enterprises whose budgets follow the conventional budget structures of government, estimates of receipts and outlays are not formulated in the commercial format. In some countries, for example, Sudan, even the commercial public enterprises may prepare their budgets in terms of the government budget chapters, viz., salaries, capital equipment. The budgetary structures of enterprises, unlike those of government, do not appear to have received serious consideration and are generally assumed to be adequate as they conform to commercial formats. The links of public enterprises with government are, however, such that some modifications appear appropriate for a variety of reasons. First, strategic or corporate planning and budgeting appear to follow two different paths, the former emphasizing product development and diversification and the latter tending to be a purely financial exercise.14 An integration of these two aspects is, however, essential to serve the internal management as well as for rendering greater accountability to government at the prebudget scrutiny stage.15 Recognition of this aspect induced some governments to adopt a type of performance budgeting for public enterprises.16 A continuing experiment undertaken in this respect in India shows that performance budgets vary widely in quality and have tended to become perfunctory routines rather than significant inputs into the decision making of government or enterprise management. Second, as the overall nonfinancial public sector is the key factor in national economic management and as national income accounts and related forecasts are used as the basis for policymaking, it seems essential that enterprise budgets are improved to facilitate quick compilation of national accounts. Some countries, notably France, have evolved general accounting plans that would meet the requirements of enterprises while serving the needs of national accounts. Elsewhere, however, experience suggests that difficulties are experienced primarily because enterprise budgets are structured to meet different purposes and their balance sheets do not provide the detail needed by national accounts.

Chart 8.Budgeting Relationships Between Government and Public Enterprises

Budgetary Process

The budgets of public enterprises are prepared within the time dimensions and the processes specified by government. Operational procedures vary from country to country. Generally, however, public enterprises draw up their budgets first, and after these are approved by the boards of directors they are sent to the sponsoring ministries, which, in turn, process them for approval by the central agencies. In some countries only capital budgets of enterprises need to be submitted, while in some others both revenue and capital budgets have to be submitted to government. In countries with large holding companies (Spain, Italy, Korea) or sector corporations (Bangladesh, Pakistan) a major role is played by intermediate enterprises in coordinating the budgets of their subsidiaries. In some cases, the budgets of subsidiaries are also submitted to government, but it is largely an area where much is dependent on the specific situation and initiative of government. The relationships between the sponsoring ministry and finance and planning agencies also differ from one country to another. In Portugal budgets are approved by the sponsoring ministry and only the relevant transfers on current account are shown to the Finance Ministry, while the capital budget and its relevance to the plan are reviewed by the Planning Department. In Tanzania only projects involving transfer of funds from government are considered by the central agencies, while in India the Financial Adviser (who works for the sponsoring and finance ministries and who also functions as a director on the enterprise board) is associated at every stage of budget making from inception to eventual acceptance by government.

The approaches to decision making reveal some departures from the traditions of budgeting. The allocative problem for enterprises is viewed differently from the problem of resource allocation to other services or public goods. Unlike public goods, where the evaluation of costs and benefits is difficult and resort has to be made to imputations, allocations to enterprises involve a more tangible terrain in which the likely rate of return can be identified with some precision. This is not to suggest, however, that no difficulties are experienced in applying the techniques to enterprises. There is, admittedly, a general recognition and acceptance of the shortage of capital and an appraisal is undertaken to reflect an implicit capital rationing. In industrial countries the project appraisal reflects a greater range of technological choices and their relative merits, while in developing countries it tends to be mostly feasibility study of a design that had already been chosen.

The review of enterprise budgets is influenced in part by the typology of enterprises and in part by their financial status. Public utilities, trading and marketing organizations (particularly those responsible for the procurement and distribution of essential food items), and mineral and extractive enterprises are given detailed consideration, while industrial and manufacturing units receive less. This approach reflects the belief that utilities and trading organizations are more dependent on the government budget (or the government budget is dependent on the enterprise as, for example, in Saudi Arabia and Zambia) for subsidies and price support measures. It is also the general experience that enterprises with deficits receive more attention than others, even if the latter are not making profits. The process within governments reveals numerous weaknesses in dealing with enterprise finances. While the degree of their actual incidence varies from country to country, the following observations are based on experiences that allow generalizations to be made.

First, although enterprises have become a major element in the government's economic strategy in the budgetary process, little or no advance indication is given to them about the possible availability of funds. The estimates indicated in the plans are generally overtaken by events and the annual availability of resources may be considerably different from those stated in the plans. Budgeting has, therefore, tended to become a process of aggregation rather than an iterative one, with interface of central guidance on overall resource constraints, on the one hand, and enterprise requirements on the other. Enterprises formulate their budgets on a need-based approach and governments often work on a resource-based approach. As the initial resource availability is either unclear or is not given due importance, the review within government tends to be ad hoc and resort is made at a later stage to across-the-board cuts in allocations when actual resources are less than estimated. Adjustment to the reduced allocations within enterprises is often not possible within the time allotted and the fiscal year starts with a budget that is far from being synchronized with reality.

Second, government guidance, where provided, has seldom been adjusted for inflation. Apart from the fact that this approach has contributed to investment deferrals or cutbacks, it also has the significant implication that the impact of inflation on the enterprise performance and its feedback to government is not properly recognized.

Third, the nature of financial control exercised by government is tactical and its outlook is narrow rather than being systematic and objective for the whole operation. In the circumstances financial control tends to be arbitrary and the wider linkages between the enterprises, the government, and the national economy are neglected. The areas given special attention and the degrees of emphasis vary widely among countries. In India attention is on resource mobilization; in the United Kingdom and Korea it is on external financing and the limits on borrowing. Thus, budgetary allocations tend to develop their own bases and narrow rationality rather than concern with the overall role and performance of enterprises.

Fourth, part of the problems experienced in the budgetary process can be laid at the door of the enterprises as well. For their part, they continue to rely on conventional approaches, which reveal undue optimism in their corporate plans and faith in their estimates. They tend to argue in conflicting directions—that their requirements are not substantial, that variations in their estimates are well within the margin of error of government estimates, or, alternatively, stress the strategic nature of their requirements. Recognizing the total dependence on the exogenous variable of government resources, enterprises believe that the place assigned for them in development plans will insulate against short-term changes.

The combined working of the approaches of government and enterprises has, in the process, contributed to a situation where instability has become a characteristic of both levels. In some countries, the converse of the above process works, as additional outlays are routinely proposed for enterprises in pursuit of growth policies but, in the absence of a review of the previous experience, such outlays impose additional strains on the financial management capabilities of enterprises. Yet another commonly observed fact is that budget review pursues the current favorite themes such as prices, financial requirements, and little or no attention is paid, except when losses are severe, to x-efficiency factors such as organizational slack manifested in different ways.17

Difficulties are also experienced on the institutional front. Very few countries have facilities for the systematic collection of annual data on the performance of enterprises and frequent delays in the preparation of balance sheets tend to impede budget review. In some countries, the NPEs have grown so rapidly and become so large that the ability of a central agency or its staff to judge the quality and practicability of thousands of plans covering complex areas is severely limited in terms of knowledge of local environment, administrative efficiency, or the economics of specific proposals. Moderate advances have been made in organizing central bureaus to specifically look into the enterprise budgets, as, for example, in Mexico. The coverage of these bureaus is, however, limited to major enterprises. Another factor that merits recognition is the lack of clearly delineated responsibilities of the sponsoring ministries and those of the central agencies in the government. Viewed from the enterprise side, it appears that there is no single corporate presence in government and that enterprises are frequently caught in the crossfire.18

Budgetary Issues

The receipt side of the government budget includes taxes paid, interest payments, repayment of loans, dividends on equity, and other contributions by enterprises. The expenditure side of the budget is more complex and the transactions are numerous and include grants or subsidies, investment in equity, loans on-lent, and short-term advances by government. Although provided under different accounting “heads” in the budget, the sum total of these facts reflect the concerns, priorities, and strategies of government. These are further supplemented by the arrangements in regard to borrowing from internal and external sources. The use of these instruments and the determination of the amounts to be given or received have, over the years, given rise to many issues, some of which are considered here from the point of view of the budgetary process.19

Transfers to Government

The magnitude of enterprise contribution to government budget is determined by the exogenous factor of rate of growth in revenues mandated by government and by the endogenous factors of enterprise performance. The former is decided as a part of the plan exercise and within that framework the levels of resources to be generated by public enterprise are estimated. The exercise implies a comprehensive examination of the enterprise's capacity to earn and to determine the share of earnings to be retained and the share to be transferred to government. The analysis will include a consideration of the size and nature of markets, the policy goals of government, existing levels of technology, and the availability and utilization of human skills. These exercises are carried out in the context of the formulation of the development plan at a highly aggregate level and greater specificity is expected in the annual budget exercises. Once formulated, however, they are to be communicated to the enterprises. Available experience points out that resource mobilization through enterprise operations is often the last measure in government priorities for raising revenues and, even in countries where enterprise budgets are fully integrated with the government budget, these are often determined by ad hoc considerations. Moreover, not all governments are empowered to receive contributions from enterprises.20 In Sri Lanka specific legislation had to be enacted in the early 1970s to permit enterprises to make contributions. In Korea no dividend is payable to government under the legislation and surpluses are retained by enterprises for further investment. In some countries, lack of forward budgeting and advance corporate strategies meant that the size of the contributions tended to be fixed arbitrarily. Elsewhere, the determination was rendered difficult as the government's budget review did not cover the revenue budget of the enterprises.21 In some countries, the exercise lacked realism and enterprises had to borrow funds to pay the contributions. In monocultured economies reliance was placed on few enterprises as the major contributors of government revenue. As the cyclical factors influencing the enterprise performance were not taken into account, contributions to the budget suffered and, in the absence of short-term adjustments in expenditures, led to inflationary financing. Variations of these experiences are common and underline the need for a clear framework that specifies the revenue expectations and the industrial and business strategy that would ensure their accomplishment.

Transfers to Enterprises

The determination of the overall resources to be transferred to enterprises is made with reference to the framework of sociopolitical approaches of government and the role assigned for enterprises in development plans. The size of the resources transferred annually is, in practical terms, based on the price and capacity utilization policies and the expansion envisaged in the capacity. If, for example, price restraint is to be adapted, more resources may have to be transferred to enterprises. There are four main issues that arise in the transfer of funds: (a) whether the capital transfers fit into national priorities; (b) the form they should take—grant, equity, loan, or subsidy when used for current purposes; (c) the extent of self-financing generated by enterprises; and (d) the extent to which NPEs should be permitted to borrow. In considering these areas, three aspects need to be kept constantly in mind. First, while the effects of channeling additional funds to enterprises will depend largely on the form of the instrument, in each case the effects on the enterprise will always be the same regardless of the origin of these funds. In other words, the effect of the form will not change depending on whether these funds originated in the budget, the domestic financial system, or the external sector. Second, the macroeconomic effects of channeling additional funds to public enterprises will not depend on the form of the instruments but upon the origin of these funds and whether such funds imply (or not) an increase in the aggregate demand and credit. If such additional funds are not compensated for by reductions, for example, in credit to other sectors of the economy, total credit increases, causing an expansionary effect on the economy. Depending on the circumstances, the expansion may result in economic growth, inflation, or a deterioration in the external balance. Therefore, the financing of capital expenditure and the financing of operations need to be coordinated in terms of reliance on the government, on the domestic banking system, and on foreign borrowing. Third, the resource needs of enterprises change depending on a variety of factors, including their cycle of operations, sectoral type of activity, the operating results, amortization of loans, investment in expansion programs. The dynamics of enterprise finances are such that, in the absence of a well-formulated financial policy, the size of the actual available resources could differ from the needs causing inefficiencies and misallocation of resources. Shortage of resources will prevent the enterprises from operating at full capacity, while excess resources could contribute to building up needless stocks and the allocation of funds to nonessential activities. Furthermore, the effects of both tend to be cumulative over a period. Shortage leads to operating losses, which tend to further aggravate the full utilization of capacity and could, over a period and unless rectified, suffer cumulative erosion. On the other hand, enterprises that suffer no such shortages may be able to utilize their resources in more efficient ways by improved research and development and may develop activities conducive to lower costs and higher profits. Thus, temporary setbacks may become a more enduring and steadily debilitating feature, while resources properly endowed and used could lay the foundation for cumulative improvement. For the purposes of our discussion here, however, it is assumed that resource use would be undertaken with normal prudence.

Capital transfers—the initial capital for enterprises and the additional funding for expansion—are made, in theory, after an appraisal of the economic aspects of investment and the specification of the link between the proposed investment, its rate of return, and the necessary pricing policies. Investment programs—including those that are financed by enterprises need to be coordinated at the national level in order to pursue interdependent policies and to ensure their adherence to national priorities. Frequently the lack of coordination between government investment plans and the self-financed plans of enterprises have led to situations where government-owned holding companies acquired units in lower priority areas. While this is not necessarily universal in its occurrence, it is advantageous, however, to plan capital transfers within the framework of a nationally coordinated program. It is equally desirable that comprehensive appraisal is done of the proposed transfer and its place in the financing of the project. Too often, it appears that governments have tended to set investment levels, and thus capital transfers, intuitively rather than by relying on actual market tests or on estimates of market conditions.

Equity/loan

The form or instrument chosen for making the transfer may be a capital grant, a loan, or equity participation in the initial stage or a subsidy during the operational phase. Limiting our focus at this stage to the establishment or the expansion of the enterprise, the relevant instruments are grant, loan, or equity.22 The implications of each of these forms are different for the government in terms of the new rights and powers of control that it acquires; they are also different for the enterprises, particularly on their cost structures and financing problems. For an enterprise, the implications are of significance, because the composition of its capital structure affects its financial image and, in a broader context, its very ability to raise additional finances. The instruments are, therefore, analyzed from the viewpoint of government as well as of the enterprise.

The terminology of grants, equity, or loan may not, however, fully denote the implications or the actual nature of the transaction. For example, in several countries initial capital may be made available in the form of an advance and its final form may eventually be determined. In Italy enterprises derive their capital from endowments (dotazioni) on which no interest is paid and repayments are made only when net profits are made by enterprises. In practice, however, repayments occur rarely and the endowments become grants. In Korea the initial capital and annual injections of capital for meeting losses are in the form of equity, which, in effect, does not differ from a grant as no dividend is payable. The choice of a grant for making the transfer, although often resorted to, seems to be an instrument that cannot be justified from any point of view except that of the enterprise. From the larger allocative efficiency viewpoint, provision of free capital to enterprises may be justified only when it is recognized as an explicit subsidy. But as capital is provided in most countries without any charge or obligation to repay, it could be argued that if the intent is to subsidize the product or a group of consumers, it could be done more efficiently by other means. Within the enterprise, grants do not become a cost element and the price of the capital will not be reflected. As an extension, because these funds are free, they are unlikely to induce any financial discipline. In a narrower sense, grants could perhaps be justified only when the budget is in surplus, which, in any event, is a rare occurrence.

Financial resources may therefore be provided to NPEs either in the form of equity capital or as a loan.23 From an economic angle both are to be considered as the nation's resources allocated to a specific purpose and ought, therefore, to rank as a source of cost relevant to that output or the enterprise. Although this consideration should be dominant during budget review, it seems that it is the least important one, and greater weight is given to accounting and managerial factors. Equity funds involve a risk capital with ownership participation and a role in the enterprise management decisions. They are expected to remain invested in the enterprise for a long term, and if they are remunerated, this would be according to the actual performance of the enterprise. Loans, however, do not imply ownership participation and may not usually have a role in management, except for certain new investment decisions, and are to be repaid according to a prearranged agreement regardless of the financial performance. Loans reflect a temporary resource, which when repaid (unless replaced) could reduce the availability of enterprise funds. Their terms are apt to be more standardized, reflecting market conditions and practices and they will rarely be adjusted to meet the specific requirements of an enterprise. Servicing loans is a cost that is shown in the accounting statements and may lead to lower profits, while where financing is provided in equity form, the absolute size of profits would be larger. Loans allow greater flexibility for the government in the management and rotation of funds. For enterprises that look to the open market for capital, the chances are likely to be much better the lower the proportion of loan capital is to its total capital structure at the time of borrowing. The choice between the instruments is far from easy and typically reflects the larger dilemmas faced elsewhere.

A survey of the practices for equity/loan transfers from governments to enterprises reveals a lack of similarity across the same sectors in different countries.24 In the United Kingdom, all listed public corporations carry loan capital rather than equity. In Guyana loans exceed equity, while the reverse is true in Peru. In Tanzania and Uganda loans dominate. In the Philippines all nonfinancial public enterprises have the lowest loan component, while in India loans exceed equity in consumer goods industries; in capital goods industries, equity is dominant.

The aggregates do not, however, reveal the dynamics of budgeting in providing these resources and it is in this respect that more issues are faced. From a budgetary angle there seems to be a natural preference for a higher loan component in government outlays. First, the government's own funds are largely borrowed and are passed on to enterprises as loans. Second, a high loan component makes the forecasting of government receipts relatively easy, because there is a certainty about the flows of income. There are also, however, several budgetary practices that tend to undermine the policy importance attached to loans by government and the financial performance of enterprises. Many governments lend funds to enterprises without systematically evaluating alternative sources of funds and without careful analysis of the terms and conditions. Short- and long-term loans are made without specific provision for amortization and often have interest rates substantially below market rates. This has led, at one extreme, to an excessive volume of government loans and consequent capitalization in the financial structure of enterprises; at the other extreme, government funds have often become the easy financing option. There are also cases, however, where the cumulative amortization of loans has resulted in enterprises having insufficient funds, reflecting undercapitalization and inadequate working capital. It is for these reasons that enterprise managements argue that loans can adversely affect an enterprise that has a long gestation period, that the fixed interest charge by government can be onerous, and that extensive capitalization adversely affects their ability to gain new business. The government's point of view is that there are limits to the taxpayer meeting the expenses of the enterprise, that easy finance implies a built-in option for enterprises, and that, as interest is an expense, it is tax exempt and, therefore, does not burden the enterprise.

Technical arguments advanced by each group have impeccable logic but they only obscure the basic problem of providing enterprises with finances. What is the most appropriate way? How can the differing points of view of government and enterprises be reconciled? Some suggest, with a view to inducing market-based financial discipline, that the enterprises should depend on the commercial banking system or related financial markets.25 This in a way tends to beg the issue of the rationale of public enterprises. It does not necessarily mean, however, that enterprises should entirely disregard the markets not, given the social role of enterprises, should they be exclusively guided by the market. More pragmatically and specifically in the context of government budgeting, the means of financing need to be considered both in terms of the costs and goals of governments and the capital costs of enterprises. The experience cited above indicates the necessity for a conceptual framework that specifies the equity loan ratios for all enterprises or different ratios for different sectors, whether such ratios should be observed throughout the life cycle of enterprises, or whether they should be flexible reflecting the various stages of growth. Once such a framework is formulated, budgetary decision making would be less ad hoc and the type of distortions in practices described earlier would be minimized.

Subsidies

A major issue of transfers relates to the quantification of subsidies provided to enterprises. This, by its very nature, requires a clear policy on what to subsidize and at what level. Generally, subsidies are given for three purposes: (a) to compensate for noncommercial objectives specified by governments; (b) for price restraint for essential and strategic items of consumption; and (c) to finance operational losses through ex post transfers. There are also indirect subsidies that may not be reflected in the budget. Reduced interest rates and preferential treatment for government procurement of goods are in this category; there are other transactions that are less transparent and are hidden.26

Compensation for the pursuit of noncommercial objectives is a well-established practice and is most common in the transportation sector when noneconomic routes are used, for transporting schoolchildren, for hauling freight to backward regions. Subsidies for noncommercial objectives are best indicated in advance, so that the enterprise can draw the line between commercial and other transactions. Moreover, it facilitates the proper appraisal of costs and benefits in that the social advantages and the social element in the outlays can be identified. Although there was considerable reluctance in the initial phase of public enterprise development,27 it appeared that the pursuit of economic efficiency and social philanthropy imposed unnecessary strains on enterprise management and there is now general acceptance of the need to compensate enterprises for costs incurred in pursuing functions that would normally have been avoided.

Subsidies for selling products or services at a price lower than cost have a long past and have become integral parts of explicit state policies since the French Revolution. More recently, especially during the last decade, compensation for observing price restraint in inflationary periods has become a common occurrence. In addition to subsidies of this type, transfers are also made to cover the operational losses of enterprises after these losses have been incurred. The determination of the size of subsidies of the first two types is made by three techniques: (a) recoupment of the actual expenditure of enterprises; (b) adjustment in the rate of return of enterprises; and (c) specific compensation. The first approach, which has been prevalent in certain sectors in some British Commonwealth countries for more than a century,28 has the inherent disadvantage of placing the government at the receiving end and the enterprises, for their part, do not have any major inducement to pursue cost reductions.

The second method, although practiced in some arbitrary forms, requires as a first step the determination of the presumptive rate of return. The third method, which has several advantages, appears to be used infrequently and for minor purposes such as cost differentials or when an activity is promoted even though its cost is higher than comparable products. A necessary consequence of the recoupment approach is that subsidies tend to be determined not in advance but after the event. Even where precise indications are given, as for the fertilizer subsidy in India and Korea, the eventual magnitudes do not lend themselves to controls, as prices of inputs and world prices vary from the estimates. Subsidies for price restraint are often budgeted initially on a notional basis and are revised later on the actual basis. This implies that, in practice, subsidies tend to be open ended and, in an inflationary context and where such transfers are quite large, government budgetary outcome differs greatly from estimates.

Financing of losses

Transfers to enterprises for covering their losses in some countries are made as loans, equity, and even subsidies. The problems relating to the choice of the appropriate instrument is, however, subsidiary to the major questions on the nature of losses, their magnitude, the impact on the budget, and the type of policy mix that could be evolved to minimize the problem. Budget review should be more concerned with an analysis of the factors contributing to losses, which, in public enterprises, occur because of the low rate of utilization of installed capacity, uneconomic prices established by government, heavy reliance on borrowing and, therefore, higher costs, capital intensive nature of the enterprises requiring higher depreciation provisions, and higher costs attributable to managerial or operational inefficiencies. Each of these factors requires a different policy approach. In some cases, capital restructuring would be needed, while in others more fundamental solutions are involved when losses were due to a structural shift in demand. However, if transfers are routinely made from the budget, this could lead and, indeed has led, to situations where the burden is transferred to the taxpayer and there would be little compulsion for enterprises to improve their efficiency.

Self-Financing and Borrowing

How much of the investment made by an enterprise should be self-financed? Self-financing is dependent on the past financial performance of enterprises. Investment is, on the other hand, forward-looking and the coordination of these two involves a detailed review of the budgets of enterprises and their priorities. When self-financing is linked to capital transfers from government, as is often true, the specific capabilities of enterprise to raise resources have to be examined in terms of the pricing and related financial policies. Their economic implications require clear recognition of policy choices. Predetermined self-financing affects the consumer because it leads either to higher prices to cover costs or to increased profits. It also raises the issue of present consumers paying the cost of increased investment for what may benefit only future generations.

Practices in this regard show that self-financing levels are often set arbitrarily and, therefore, have unintended consequences. These levels are frequently not attained, and thus contribute to a slackening in the rate of expected growth of the firm. In other cases, the absence of coordinated investment plans leads either to enterprises having abundant liquid funds or to their building up excess capacity. In some cases, the effects tended to be even perverse, in that investments were made at a time when they added to inflationary pressures and withheld when financing was needed to counteract recessionary tendencies. These aspects underline the need for more coordinated budget reviews.

Another area where leading policy and institutional issues are raised relates to borrowing by enterprises. Two schools of thought are recognized in this regard—those that advocate freedom to borrow domestically and externally, and those that support an integrated or coordinated borrowing program for government and enterprises. The former school believes (a) that there is a need for diversification of sources of borrowing, (b) that the purposes for which enterprises borrow are different from those of government, and (c) that it is healthy for enterprises to borrow on their own to keep their standing in the market. Such independent borrowing would probably reduce dependence on government budget, induce a better financial discipline, and might be helpful in preventing acceleration of the values of gilt-edged securities. The latter school's opposition to this approach has both ideological and practical bases. Issue of a debenture by an enterprise implies payment of a return to the holders, and such payment, it is contended, is contrary to the purpose for which government funds were utilized to establish the enterprise in the first place. This, of course, is the ideological part of the argument. From a more pragmatic point, it is argued that centralized government borrowing both for government and enterprises has a number of advantages: (a) from an economic point of view, centralized borrowing is easier to control in terms of timing and to assess its impact; (b) that it could be costlier for enterprises to borrow independently, as their borrowings are often for shorter periods than that of the government and the yields have to be higher; (c) that as these borrowings carry on explicit or implicit government guarantee, they would not attract new risk capital other than that already destined for the public sector; (d) that if the enterprises borrowed in the form of stock issues it would complicate the management of the gilt-edged market, particularly when the government budget is to be financed by nonbank borrowing; and (e) that centralized borrowing allows enterprises to make premature payments to government, which they could not if they had borrowed from the public in the form of stock or from a bank, except with a penalty in the case of the latter.29 Public enterprises now borrow nearly a fourth of their total borrowing from international markets and half of this is accounted for by borrowing by developing countries. It is, therefore, suggested that centralized borrowing by government better appraises market opportunities and servicing capacities. Actual practices, however, vary and indicate that this is an area where more concerted efforts are needed. In the United Kingdom, borrowing is central and controls are exercised to limit external financing.30 In France enterprises borrow in domestic and foreign markets but always with the approval of the Ministry of Finance and National Economy. In India and Korea enterprises cannot issue stock to the public and all long-term capital is provided by government or its financial institutions. In respect of foreign borrowing, similar restrictions apply and government approvals are needed. In Portugal enterprises can borrow externally after informing the central bank but without any specific approval from the Ministry of Finance. In some countries, controls on foreign borrowing appear to be lax. For example, in Ivory Coast, although regulations require consultation, the Caisse Autonome d'Amortissement has not been effective in preventing borrowing from abroad. In some countries, finance ministries became aware of foreign borrowing only after the event and arrangements had to be made for the servicing of the debt. In the United States, several public enterprises at the state and local level borrowed extensively from the markets with guarantees provided by government and, as some of them could not service the loans, repayments became the responsibility of the relative state governments.31

Pricing Policies and Practices

The financial performances of enterprises revolves around the pricing policies because, in the final analysis, if there is one factor that has the most impact on enterprise finance it is the pricing policy. The recovery of the loans extended or the possibility of earning a return on investment is dependent on the use of the resources transferred from government and the prices charged for enterprise products and services.

The price theory of firms has been debated considerably and the debate continues. For more than five decades, there have been discussions on whether the principles of marginal costing have been an “empty box” or not. These arguments are extensive and it is not intended to discuss them here. The purpose here is merely to enumerate the general theories of pricing and their current status and implications for government budget and enterprise finances. Pricing practices are also briefly considered, with particular reference to the belief that prices are no longer considered as being determined either by costs or prices but by the public interest and the state of the cash flow of the public sector as a whole.

Adopting the general principles of pricing of the neoclassical concept of a firm, it appears that three main factors influence the prices of public enterprises. These are the market structure, the type and category of goods, and the nature of the economy and its horizontal and vertical linkages for a specific commodity. Enterprises may produce intermediate goods or goods for final consumption, and may sell to the public, to other public enterprises, or to government and may experience, in some cases, near-monopoly conditions while elsewhere enterprises may compete with other private enterprises. The pricing alternatives available to enterprises are opportunity cost base pricing, marginal cost-marginal revenue pricing, marginal cost pricing, average cost pricing, and cost-plus-margin pricing.

The most important objective in pricing goods and services is to ensure efficient use of the economic resources required for their production. Any use of resources involves an opportunity cost in terms of the alternative uses that have been forgone. In the absence of explicit reasons to the contrary, prices paid for goods and services should ideally cover the costs of the factors of production. The nature of the opportunity costs relevant to public enterprises are, however, different, as they relate to the social opportunity costs or the costs incurred by the society as a whole. In certain instances, these costs may differ from the private costs reflected by the market prices paid for resource inputs. In practice, the quantification of such allocative charges or benefits raises a number of difficult issues. As the capital invested in an enterprise is itself a resource input, it can be expected that the capital employed will earn a return equal to its opportunity cost. By estimating the opportunity cost of capital in the economy, as reflected by the rate of return that is earned by alternative investments, and by taking into account the various factors that might influence the expected return to capital,32 the actual performance can be used to deduce whether pricing policies are consistent with efficient resource allocation and other government objectives. If prices are different from desired levels, it is expected that the financial effects of these variations are, as far as possible, explicitly budgeted so that the costs to society are known. This approach represents an ideal and is useful as a guideline. Its main limitation lies in abstracting market conditions, in particular, demand aspects.

The traditional marginal cost and marginal revenue approaches are in a way covered by the above principle. In sectors where there are large investments and in enterprises that work under near-monopoly conditions profit maximization takes place when marginal cost is equivalent to marginal revenue. The application of marginal cost pricing also offers an efficient pricing rule but when considered as a separate entity, it does not reflect the demand aspect. Both these approaches have been debated extensively for a long time and major problems appear in their application. Specifically in regard to public enterprises, public and consumer interests may militate against profit maximization for its own sake. Also, in an industry where marginal costs are increasing and where the difference between average and marginal costs is substantial, it could lead to unreasonably high profits. If prices are fixed with reference to declining marginal costs (which is generally true for public utilities), it can mean that they may not cover the average costs and will contribute to losses. Also, marginal costs do not lend themselves to easy quantification. For one thing, the marginal product is not itself often identifiable and the computation of marginal costs is, therefore, neither simple not specific. Efforts made in industrial countries reveal that such computation is expensive and computed marginal costs are not very different from average costs.33 Marginal costs are dependent on the capacity utilized, which is based on demand, which, in turn, is based on marginal costs. These costs are variable over time and are influenced by several factors, including technology, nature of the market.34 On the whole, however, marginalism continues, even if elusive in practice, as a major theoretical base for the determination of prices, not because of its practical applicability but mainly for the reason that no theoretically viable alternative has been advanced.

The average cost concept is often favored for public enterprises, mainly for two reasons. At an aggregate level, it implies the achievement of a no-profit, no-loss objective. At a more specific level, it facilitates the activities of enterprises that produce a mix of consumption and intermediate goods. It is, for example, very difficult to apply the concept of marginal costs to commodities or services that distinguish different income groups (such as railways) or types of products (such as postal services for inland and foreign mail; mail within a country, following the Hill principle, costs the same regardless of distance). Average costs are easier in such cases, but admittedly are not allocatively efficient, except when they are equivalent to marginal costs. In practice the pricing of public enterprises has been based on accounting costs or cost plus reasonable margin. These terms are variously defined but generally include a socially desirable rate of return on capital and appropriate provision for the service of capital, reflecting amounts for replacement and selective expansion (including those induced by changes in technology). These accounting costs, in turn, have to be comprehensive enough to incorporate the impact of cross subsidization and changes for peak and off-peak usage. The use of the social rate of return is a delicate task and care should be taken to ensure that it does not become a basis for rationalizing failures or for obvious mismanagement.

The experience in this regard illustrates that the market environment is not a textbook abstraction but covers the legal framework, institutional practices, tax/subsidy incentives, degrees of economic power exercised by participants, and information available for decision making. It also reveals that in both industrial and developing countries there are extensive systems of administered prices that may be evolved by specialized bodies working on a regular basis within the government or ad hoc bodies appointed for the purpose. Prices are determined both for the public and private sectors on a common basis and are generally so formulated as to provide a remunerative rate of return on the capital. The cross-country experience reveals some broad features of price determination. (1) Tariffs of public utilities, which are expected to have a greater role in the promotion of social welfare, involve generally, an element of subsidy by the government. (2) Prices for basic materials may also be subject to government control regardless of the ownership of enterprises. Included in this group are steel, chemicals, and fertilizers. (3) Prices of public enterprises whose products are sold to the government or to other public enterprises are determined by negotiation with the government. However, when the policy is to provide cross-subsidization, the subsidy becomes a part of the government budget. (4) Prices that are fixed by market forces. Within these approaches, the import or export prices of items are used as guidelines for the determination of administered prices after appropriate adjustment for the social welfare function. From the viewpoint of the government budget, it is important that the implications of the first three categories are determined in advance.

Ideally, it is expected that such advance determination would be adequate for ensuring budgetary stability during a given year. In practice, however, this has been very difficult during recent years because of higher inflation rates. Governments have tended to use the pricing policies of public enterprises as an optional technique for restraining the rate of inflation. This is particularly true for strategic and basic materials such as steel and fertilizers. In the United Kingdom, such an approach was particularly popular during the early 1970s. Similar experiences in other countries are legion. In the United Kingdom, public enterprises were compensated for the pursuit of price restraint by a reduced rate of return, while in other countries subsidies were paid to both public and private enterprises. In some countries, where approved prices cut into the profit margins of private firms, suitable adjustments were made in tax provisions for depreciation, so that the overall effect could partly be mitigated. These approaches caused a widening of the budget deficit, which in the event had to be financed through borrowing. It is a moot point whether the overall policy goals were served at all, for any restraint on the inflation rate achieved through price policy is offset by the increased money supply flowing from higher budget deficits. In several countries, when budget deficits threatened to become major problems, hurried adjustments were made to make marginal increases in prices but always with a lag. To the extent there is coalescence between government and public enterprises to achieve stabilization, it is essential that the continuing impact of the latter on the government budget is reviewed at each stage. It also suggests that in such situations prices cease to be based on costs (although parity would be maintained) and have more relevance, even if debatable, as anti-inflationary measures. The choice between initial price restraint and eventual inflation, on the one hand, and free play of market forces and formulation of prices reflecting the full costs, on the other, is a difficult one and is influenced by a variety of factors that are admittedly not economic in character.

Control of Enterprises and Agencies

The primary concerns of the government in relation to enterprises and agencies as illustrated in the budgetary process are threefold—to inquire (a) whether they have been contributing their share to the budget or to the financing of their own and other investment plans, (b) whether resources are being used in a manner consistent with goals of allocative efficiency and stabilization of the economy, and (c) whether, in the event of overriding social objectives, their impact on enterprise and agency finances has been identified and quantified. The answers to these questions are provided but only partly by the budgetary process. Supplementary control mechanisms are, therefore, used for the purpose. The factors that have influenced the framework of controls are not merely financial in nature but reflect broader concerns.

Since the pioneering work by Berle and Means,35 a good deal of ground has been covered in literature on the growing gap between ownership and control and the methods that could be adopted by shareholders to gain control over the activities of corporations. The role of the government is, however, different from that of a shareholder. It is a role that transcends the narrow concerns of the shareholder and reflects the concerns of the major financier, the development planner and promoter, manager of the economy, and arises from the government's function as a protector of the consumet's interests. The need for government control stems from the more specific functions that occur in performing these varying roles. As a coordinator, the government has to assess the linkages of the enterprises and agencies with the rest of the economy and has to coordinate their activities. In this broad sphere it assumes the role of a player as well as a referee and neither role can be performed to the exclusion of the other. Government has to ensure that the correct methods are adopted by the enterprises to achieve their specified objectives. Moreover, in certain spheres where public enterprises have a monopoly, government has to ensure by controls that the advantage is not taken by enterprises in a way contrary to the interests of the community and, finally, controls are needed as a feedback mechanism in the government to fulfill its own role as a manager of the economy.

Growth

Reflecting the above concerns, a wide network of control systems have evolved. Their growth indicates three distinct phases. The first phase was the era of the arm's-length principle (also known as the Morrison formula), which basically sought to reconcile the needs of autonomy of enterprises, on the one hand, and accountability to government and parliament, on the other. The autonomy requirements of entities reflected the basic recognition that there must be quick decisions in business, that government officials may not be able to make the right decisions, and that conducting a business involves risk taking that may not be possible within the traditional government environment. This principle was adapted in various ways to the requirements and the constitutional setting of the country concerned. Where there was no legislative accountability, as was true in some Latin American countries, appropriate adjustments were made to suit the presidential systems of government. This framework, however, was soon found to be inadequate and generally less flexible in meeting the growing requirements of government. Development planning and demand management of the economy have made imperative regular consultation between government and enterprises. Also to achieve the diverse tasks, control measures combining managerial, efficiency, and economic considerations were evolved and implemented. This phase, which is the second one, implied abandoning the arm's-length principle and resorting to controls that occurred frequently and included restrictions on credit, investment, and pricing policies. In effect, the pervasive nature of the controls was such that the dividing line between government and enterprises was not visible and there appeared to be a seemingly indivisible structure of decision making and control. While this may have served some purpose, it was the associated problems that deservingly got more attention. It was recognized that national interests were to be served by enterprises and that controls were essential for the purpose. The issue was whether such controls have to be exercised to the point of becoming counterproductive. As governments and enterprise management became interchangeable terms, controls became extensive and could not be distinguished from interference. Apart from the fact that this dampened the enthusiasm of enterprises, it also became evident that government agencies could not properly reflect market conditions and the dilatory procedures of government have, on the whole, adversely affected the performance of enterprises. The recognition of these problems led to the third phase, in that there has been an increasing momentum to develop a framework of objectives with a specification of a rate of return, leaving the enterprises with the operational freedom necessary to manage themselves within given parameters. The third stage of development is still limited to only a few countries and is, in a way, a return to the arm's-length principle but with a more elaborate specification of the economic and commercial terms and policies of the enterprises. The arm's-length principle, by its nature, was more hierarchical, bureaucratic, and unidirectional, while the third phase essentially emphasizes the assignation of financial and organizational responsibilities.

The control of autonomous agencies has not kept pace with the above developments. The primary problem in controlling them appears to be felt more at the government end than at the receiving end. The large number of agencies (although, in terms of financial implications to the budget, they were minor compared with enterprises and social security agencies) led to the inevitable fragmentation in decision making, which was rendered even more difficult where the agency functions and finances were preserved in the constitution. Government controls were, therefore, largely confined to those that arise in the budgetary process.

Anatomy and Working of Controls

Reflecting the above-described three stages of growth, a vast spectrum of controls has evolved. Controls so exercised are both formal and informal. The latter are generally invisible and are exercised in subtler forms during the budget review but are far more decisive in their impact than formal controls. The nature and purposes of these controls are illustrated in Table 26. In considering the exercise of controls, a distinction should be made between the statutory, personnel, and budgetary approaches, on the one hand, and the economic and evaluative controls, on the other.

Table 26.Government and Nonfinancial Public Enterprises and Agencies—Structure of Control
TypeNature of ControlsPurposes
Formal and organizationalStatutoryThe broad spectrum of relationships and controls are specified in the relative legislation. Autonomous agencies frequently invoke this aspect to resist government controls
ExecutiveThis relates to the powers of governments to appoint chief executives and members of the boards of management
Emergency powersLegislation concerning some enterprises endow governments with operating power providing specific guidance in emergencies
Policy directivesArm's-length principle implies that ministries are not responsible for the day-to-day operations of enterprises. Where necessary, specific directives may be given concerning prices, production costs, social goals
Annual and other reportsAnnual reports of enterprises are reviewed by governments and frequently submited to legislatures. This review provides an opportunity to evaluate the overall performance of enterprises. Similar requirements are there for autonomous agencies, as well to obtain the prior approval of the government even where formal budget provision exists
InformalMoral suasion and other pressureGovernments also use pressure informally to influence enterprise and agency policies. These opportunities generally arise during the budget preparation stage. Government has no leverage where agencies are endowed with earmarked revenues
PersonnelAppointment of civil service members as managersIn a number of countries, enterprise managers are appointed from the Civil Service. Their recruitment careers are managed by central personnel agencies of governments. In some cases, creation of the top-level posts in enterprises requires the prior approval of government. These powers enable governments to have greater control, both direct and indirect, on the management of enterprises
BudgetaryApproval of budgetsIn some countries, draft budgets of some enterprises are required to be approved by government
Contributions, new investments, self-financing ratios, Subsidies, write-off of loansWhere budgets are not required to be approved by government, selected transactions relating to transfers from and to government are determined in the annual budgetary process
Release of funds and related cash managementGovernments enforce a number of controls in the course of releasing the already budgeted funds. In some cases, disbursements within enterprises are also regulated by government personnel
BorrowingLong-term borrowing from domestic financial institutions and borrowing from foreign sources, with or without government guarantee, require prior government approval
Approval of specific expendituresProposals for expenditure over specified ceilings are required to obtain the prior approval of government
EconomicFramework of economic objectives and rates of returnGovernments announce advance plans specifying the economic role of enterprises and the target rates of return
Development and stabilization plansPlans for economic development and stabilization programs specify the role of enterprises. These include the specification of levels of production, standards of service, type of technology used, manpower levels. In some cases, these targets are evolved in close consultation with enterprises
Efficiency managementTo ensure economic use of resources, productivity factors, and related efficiency yardsticks are prescribed by government
Credit restrictionsAs an integral part of stabilization policies, limits are set on the availability of short-term credit from the banking system. In some cases, banking institutions are also entrusted with selective overseeing responsibilities on the domestic and foreign borrowing by enterprises and agencies
Inquiries by economic and regulatory bodiesPrice commissions and other regulatory commissions appointed by government frequently review selected aspects of the work of enterprises
EvaluativeConsultation and evaluation by central coordinating agenciesSpecialized bureaus in the government perform the role of consultant to NPEs in respect of common matters affecting them. Annual reports on such operations are also submitted to the legislature

The controls enumerated in Table 26 suggest that they are extensive and can meet any contingency. In practice, however, not all these controls are to be found in countries. Also, the exercise of controls is dependent on the operating environment in each country and is closely linked to the prevailing approaches to decision making, the types of communication available, the motivation of those who are responsible for the exercise of controls, and the type of leadership used in the process. More recently, in view of the numerous problems faced by enterprises, control mechanisms have been the subject of extensive discussion and the analysis of the issues has followed predictable, albeit traditional, lines. Management analysts, concerned as they are with the organizational processes, the role of individuals, their power, and established patterns of behavior, suggest that there are too many strata of control in the government. It is further pointed out by these analysts that the responsibilities for controls are vested with minor functionaries who have no background of enterprise management and that, in general, there is no policy direction.

A more frequent comment is that control became an euphemism for excessive and whimsical ministerial interference. Such interference could be due to the lack of a policy framework or, alternatively, could refer to situations where, despite the availability of a framework, frequent consultations with and policy guidance from government is needed because uncertainties and volatilities in the economy make essential periodic departures from the policy framework. This, in turn, leads to greater dependence on government. In most developing countries, public and private enterprises work in an environment in which the supply of strategic materials is controlled by government. When enterprises incur losses, which happens to be true for most of them, there is a general shift of decision making to government as the latter has the responsibility for developing measures intended to improve the financial condition of enterprises. Such direct management only adds to the excessive government control already prevailing. These aspects illustrate the delicacy involved in a fragile relationship, where a movement in either direction is likely to be misconstrued depending on the angle from which the situation is viewed. Too often, excessive control by government has been used as a bogey to explain away the enterprise's lackluster performance. More significant is the fact that, if there are situations in which controls are probably tight and that leave little or no discretion to the enterprises, there are other situations where enterprises have become too independent and have remained impervious to the economic management requirements of governments. If extensive controls engendered lack of trust and accountability became questionable, inasmuch as there was externalization of decision making, the lack of controls has admittedly made difficult the functioning of government. The future needs may be a relaxation of Argus-eyed controls in some cases and a modest beginning toward establishing a semblance of controls in others.

Alternatives

The problems associated with exercising controls have received considerable attention from both academicians and legislative committees and several suggestions have been made for improvement. Some suggestions are more philosophical in nature, while others are exclusively oriented to institutional aspects. The former suggestions consider the control problems being experienced as due primarily to centralization and excessive bureaucracy and that the situation could be improved by greater delegation of power and by making managements responsible for prices, wages, product mix, and the overall performance of enterprises. In this view, the villain is government ownership itself and what that ownership implies in terms of acquisition of control. Administration becomes an end in itself and its attendant consequences will very soon be felt. The alternative is to divide the public enterprise into several decentralized units so that, left to themselves and untrammeled by restrictive government controls, these units would continue to maximize their profits. This approach, however, ignores the fundamental features of public enterprises, particularly their social and economic functions and as fiscal instruments. More practically, it is evident that some activities are organized as public enterprises on the premise that there would be economies of scale, which would be lost if they were to be divided. For enterprises operating in a competitive environment, such decentralization would not be needed. The benefits of competition are, however, not always empirically verifiable and, if any, would depend on the efficiency of competing firms and may not be relevant when there are a few large firms with decreasing costs.36 The question could also be raised whether centralization per se is undesirable. There are obvious examples, as in France, where, notwithstanding a highly centralized control, its possibly adverse impact appears to have been substantially mitigated when concerted approaches have been adopted. There are also cases where the evidence is not conclusive in suggesting that decentralization and greater delegation of managerial powers are either welcomed or utilized by enterprise managements.

Technical or institutional suggestions aim at improving the working of controls by modifications in the organizational structure. These suggestions are rooted in the belief that specialized agencies or forms that are consistent with the requirements of public enterprises would provide more purposeful control and less friction between government and enterprises. One of these suggestions relates to the establishment of a separate ministry for public enterprises and is obviously based on the Italian experience. Such ministries existed in one form or another in Malaysia and Turkey, while in Zambia the experiment was abandoned. In Pakistan the major corporations were placed under the control of one ministry but later these were decentralized. A separate ministry would have greater functional relevance where the size of the public sector is relatively small and where the number of enterprises is manageable enough to be controlled by a single agency. The arrangements will permit specialization and consistency in ministerial control. But particular care needs to be taken in delineating the functions of such a separate ministry and, the relationships that a ministry will have with enterprises, within the government, and with other central agencies.37 A single ministry may help to bring together the ownership and control into a coherent unit but by itself it can solve only part of the problem. As noted earlier, the strata of control and the diffusion of power are only two of the many problems associated with control. An institutional device can be successful only if it is also accompanied by relevant changes in the policy framework.

A more acceptable form of specialization at the enterprise end is provided in the sector corporations that bring together various enterprises working in one sector under one top management. Large sector corporations were formed in Bangladesh, India, Pakistan, the United Kingdom, and Zambia. These provide a viable form of organization in situations where there are many small enterprises operating in the same sector. This consolidation helps communication and, from the point of view of the government, could be considered convenient and desirable. However, it appears that sector corporations could become powerful in themselves and can often substitute for the role of the sponsoring and central ministries. Control is thus exercised not by the government but by the sector corporations—a feature that changes the balance between government and enterprises. More significantly, the political and legislative accountability functions became suspect as they remained only in name with the government, while substantive controls were exercised by the sector corporations.

Yet another suggestion implemented in a few countries relates to the organization of a central bureau within the government to supervise and coordinate the activities of the enterprises. One such example is the Bureau of Public Enterprises, which functions as an integral part of the Finance Ministry in India and as a clearinghouse and which performs a wide variety of roles (in some instances shared with other agencies) such as investment, performance appraisal, policy coordination, wage negotiation, selection of personnel for staffing enterprises, and acting as an arbitrator in specified areas. Its role consists of disseminating information instead of exercising any controls that continue to be vested by the administrative and central ministries. Even this technique is viewed with traditional wariness by enterprises and is considered in some quarters as an additional stratum of control. In Korea, when an attempt was made in the early 1960s to establish such a bureau, it was strongly resisted by both enterprises and sponsoring ministries. Even in India the establishment of the Bureau led to the formation of a countervailing organization in the form of a standing convention of the enterprise managements.

There recently has been another suggestion in the United Kingdom to establish a policy council, separate from the corporate board, whose functions would be to formulate and determine corporate aims and the strategies needed to attain them, to lay down criteria relevant for each enterprise's performance, and to endorse corporate plans, annual budgets, pricing, and cost assumptions.38 The council, as recommended, comprises the representatives of the main interest groups (government, enterprises, and workers) and is, in effect, expected to provide the necessary guidance on the management of their activities to the boards of enterprises. The main advantage of such a council was to bring together the parties involved. Beyond that, however, it offered more potential problems than solutions in that it would have become a supramanagement body effectively superseding the government and preventing it from exercising its own legitimate role. The proposal also relies far too heavily on corporate strategy as a panacea for all problems. In the event, it was rejected.

The suggestions and the responses to them illustrate that there is no single formula that is acceptable to all and that eases controls. The constant refrain of control is to ensure that the aims, policies, and performance of enterprises is in conformity with government goals. Such controls should not be based on short-term expediency so as to become a continuous stream of government intervention but should aid the economic management tasks. The philosophy of control should be based on concertation rather than on disjunction. Some of these elements are contained in the economic evaluation framework, which, in a way, shifts attention from the exercise of the minutae of control to its broader purposes.

Evaluation of Enterprise Performance

A framework specifically evolved for the purpose of evaluating enterprises serves the control as well as other purposes including that of providing an incentive to enterprise management. Evaluation presumes the existence of ex ante objectives. The need for objectives for public enterprises can be argued both from a negative and from a positive point of view. From a negative angle, the absence of objectives implies a lack of clear understanding of their role and when they should be doing what. Obviously this cannot be met by a vague and routine incantation of the need for enterprises to adopt commercial approaches. State enterprises have multiple objectives and if any or all of them are to be served, the preference function of the state should be revealed in as specific a manner as possible. From a positive point of view, the government's investment vests it with a proprietary interest and thus, with anticipation of a return. Ownership by itself will not yield a return unless a formal structure of objectives is provided to the organization, as well as a good deal of financial freedom. Also, the role of the enterprises in national economic management makes it obligatory for the government to indicate the adjustments it is prepared to make in its own forecasts. Although the need for objectives alone is not seriously questioned, the difficulties in evolving such a framework have prompted many to fear they might lead to further problems and solve none. Some suggest that the movement from the grand abstractions of allocative efficiency to operational goals is fraught with many conceptual and measurement issues and, once formulated, evaluation criteria might tend to be rigid and might reduce the initiative of the enterprise management in attending to its own business. While some of these apprehensions are not without merit, it appears that what is at issue is partly the content of the objectives and partly the way in which they should be evolved.39 To an extent, the enthusiasm of some may also have been partly dampened by the experience of the United Kingdom,40 which has tried over the years to evolve a viable framework. While its experience reveals some of the problems likely to be encountered, it also illustrates that a framework cannot be immutable and will have to change with time, reflecting the changes in the economy as well as changes in the underlying philosophy of management.

Given the broad range of objectives, admittedly no single measure would be adequate to cover them, much less provide satisfactory answers. From the broad fiscal point of view, however, the natural areas of emphasis would be economic and financial. The economic aspects would include factors such as capacity utilization, wages and productivity, value added by enterprises, export performance, and import substitution. The key element in most of these spheres is the price policy. The framework should, therefore, specify the considerations that are to be kept in view in formulating prices. As prices affect the utilization of capacity, the rate of return, and other related aspects such as self-financing and future investment, the framework should provide guidance for the objectives that can be ignored temporarily and the objectives that must be fulfilled in any event when, contrary to expectations, market conditions change.

The narrower requirements of budget review relate to the financial performance of enterprises and its measurement. Such a focus is natural, for the pattern of the issues that will emerge or the type of demand that may be made on national resources will depend on the financial performance alone. Expectations on financial performance may be stated in more than one way and are frequently found in the legislation concerning the enterprises or other policy pronouncements. But they are too general and too aggregate to permit a meaningful evaluation of the enterprises. Guidance should be specific, should preferably be industry oriented, and, where feasible, should be targeted to enterprises. The specification of what has to be earned and retained is a complex task that involves the measurement of a flow of profits against a stock of assets. There are numerous ways in which the numerator and the denominator can be defined and each can provide a different result.41 To provide a comparative and a reliable framework, therefore, guidelines have to be provided on the measurement and treatment of depreciation, the measurement of assets, and related aspects.42 Different approaches in regard to some of these technical aspects can change the values of reported return and can be misleading. The rate of return as envisaged in this framework is the result of the work of several factors and should be considered as meaningful only in revealing the aggregate picture. It cannot reveal whether the poor or good performance is due to price, organizational or other factor, and the determination of the contribution of each group of factors requires separate, and presumably more substantive, analysis. When deficits are incurred, they need not necessarily be considered as reflections of failure. In some cases, they may be a prelude to a new era of better performance or wider markets. The framework should, therefore, specify the nature of the return expected over a period and should be cognizant of the shifts during the short and medium terms.

Exclusive emphasis on financial performance may become a red herring and thus detract from the other important issues of efficiency. Such issues frequently have been seen as crises in management and therefore greater attention has been devoted in the literature to the structural elements of organization and how these influence the flow of signals for increasing or reducing work. This, however, reflects only a part of the picture. Another aspect that has come to be used as the basis for evaluation, although in the noncentrally planned economies the experience is limited to two industries in France (and, to a lesser extent, in Senegal), is the one relating to the measurement of productivity (productivité globale des facteurs). This measurement offers a basis for providing incentives where needed but has tended to be viewed with some concern by participating labor unions. The application of the measurements is seldom automatic and makes sense only when these measurements are used in full awareness of their scope and limitations and of the internal and external conditions of the enterprise being assessed. Misuse of the measurements can quickly lead to loss of confidence and respect for them and may very soon be used for proving a success even when this is not true. On the whole this is an area that has a great potential and, in view of possible abuses, measurements are best used in conjunction with other economic and financial targets instead of independently.

The framework for evaluation should preferably be evolved in consultation with the enterprises and should seek to highlight the totality of the performance of enterprises. It should not be so elaborate as to reduce the initiative of the enterprise management and should have minimum transaction costs. The introduction of such a framework will require clarity about government objectives and, at a more practical level, may need changes in the accounting and reporting systems to help monitor activities.

This has contributed to some problems in identifying government enterprises. In Canada, for example, it was hard to determine how many crown corporations have been established by various governments, let alone their importance or whether their number has changed over time. In fact, there has been no clear picture of the extent of government business activities in Canada in the postwar period. See Richard M. Bird (1979), p. 3.

United Nations, A System of National Accounts (1968), p. 236.

In a case study of enterprises in Nepal, the above type of public enterprises were called “quasi public enterprises.” See Nepal (1977).

In some countries, e.g., the United States, they may be given a corporate form to overcome the borrowing limitation.

For example, in Korea, the Korea Trade Promotion Corporation and Korean Labour Welfare Corporation are considered as enterprises, although both of them are primarily organizations that are administratively promotional or regulatory.

Because of definitional problems, it is difficult to provide comparable data for countries. NPEs contribute about 40 percent of GDP in Bolivia, 25 percent in Pakistan, and 16 percent in India. In 1974, the share of these enterprises in total invested capital in India was 45 percent, 38 percent in the Islamic Republic of Iran, and 18 percent in Sri Lanka. In terms of number of enterprises, they grew in India from 5 with a total investment of Rs 290 million in 1951 to 153 in 1978 with an investment of Rs 128,510 million. In the Philippines, they increased from 5 public utility corporations and 39 other enterprises in 1973 to 13 public utilities, 18 industrial corporations, and 38 other enterprises in 1978.

In Turkey, the Government adopted a policy of statism during 1923–32 because of a shortage of skills within the private sector, although it was recognized that the dominant role should be played by private initiative and capital. See James W. Land (1971).

The distinctions between centrally planned economies and others tend to be fuzzy in practice. The movements of laissez-faire and collective ownership have, over the years, led to liberal-social democratic solutions and increasingly countries that hitherto stressed collective ownership are moving to “market socialism.” For an interesting discussion of these aspects, see Assar Lindbeck (1977).

In 1969 a seminar of experts conducted by the United Nations reported that “the sentiment of supervisory authorities is increasingly more favorably disposed to the commercial profitability criterion…. The shift away from the practice of ‘no profit, no loss’ in the British nationalized industries together with the renewed emphasis on profit in the recent Soviet reform program have reinforced this trend of official thinking. The profitability criterion, it seems, has now become the official doctrine.” This did not, however, specify the level or the measurement of profit. See United Nations, Improving Profit Performance of Public Enterprises in Developing Countries (1969), p. 29.

Transfers from government budget to NPEs cake a variety of forms and there are formidable difficulties in providing data on a comparable basis for the quantitative aspects of the relationships. Some conclusions can, however, be drawn from the examples of India and Korea. In India the annual government investment from the budget in its NPEs was more than a fourth of total government capital expenditure during 1975/76–1978/79. As a proportion of total expenditure, it was more than 10 percent. During the fourth plan period (1969–74), about 8 percent of the total plan resources was contributed by all government enterprises. Subsidies provided by the central government were on average 6 percent of total expenditures during the late 1970s. In Korea the annual government investment in its NPEs during 1975 and 1976 was about a fourth of its development expenditure, which declined to about 9 percent in 1979. At a share of total government expenditure, it was 12 percent in 1975 but declined to 3 percent in 1979. Similar magnitudes are observed in many industrial and developing countries.

In some countries, operational funds are obtained from the commercial banking system.

This problem may not arise in some traditional public utilities (e.g., electricity) that have only one product and, as such, physical and financial planning go together.

During recent years, considerable emphasis has been laid on the formulation of corporate plans in both industrial and developing countries. These plans are generally required to be reviewed and approved by the government.

In India, the Administrative Reforms Commission (1966) first suggested the introduction of a comprehensive budget to compensate for the shortcomings of the commercial type of budgets. For a critique of this approach, see A. Premchand (1969a). pp. M13–17.

For an exposition of the diversity between ownership and single corporate presence, see J. B. Heath (1980).

In this process, a major philosophical issue is whether government should second guess or review the budgets of enterprises. In their normal approaches, enterprises are not different from spending agencies and, like all other national organizations, they seek to maximize their avenues. They, therefore, need to be reviewed in order to be in conformity with national priorities.

A distinction should be made between economic rents payable for monopoly positions that enterprises have and dividends or return payable on investment. In Spain, enterprise contributions to government cover both these aspects.

Similar problems are also experienced in the identification and utilization of internal resources (retained earnings, reserves, etc.) of enterprises.

Viewed from the enterprise angle, its capitalization will consist of four items—grants, equity, loans, and reinvested surpluses. The last category refers to internal resources.

There is a wide range of other financial instruments with mixed characteristics and not all of them are applicable to NPE finances. Preferred shares, for instance, involve a prior claim to dividends should the enterprises be dissolved. Similarly, secured bonds give the holder a first claim on a designated property; debentures pledge the general credit of the company.

See United Nations, Financing of Public Enterprises in Developing Countries: Coordination, Forms, and Sources (1976), Monograph 2 on “Capital Structure of Public Enterprises in Developing Countries,” pp. 33–73.

For a recent discussion of this view, see John Redwood's “Government and Nationalized Industris” (1976a), pp. 33–46, and “The Future of the Nationalized Industries” (1976b), pp. 33–44; and Michael Lipton's “What is Nationalization For?” (1976), pp. 33–38. It should be noted that market mechanism may not fully serve the goals of the society. For example, left to the market, enterprises may show a proclivity to oversubstitute capital for labor, which, while rewarding the enterprise, may hinder the growth of employment in the economy.

One of the problems with which the European Economic Community (EEC) attempted to grapple was whether grants given for new plant and equipment were actually used for that purpose. From the enterprise angle, all funds are interchangeable and it is not easy to establish the specific use of subsidies. For the practices in the EEC countries, see Public Enterprise in the European Economic Community, METRA (Oxford) Study. Also, see Kenneth D. Walters and R. Joseph Monsen (1979), pp. 160–70.

In the United Kingdom, for example, Herbert Morrison (1950) argued: “It would be wrong to subsidize the socialized industries … to do what I have suggested should be expected of them as good citizens,” p. 5.

For an interesting discussion on recoupment and its early experience in Australia, see R. L. Wettenhall (1966), pp. 391–413.

For an extended discussion on this, see United Kingdom, The Nationalised Industries (1978).

Such limits are expected to reduce the administrative dependence of enterprises on government and to promote more responsible management. See United Kingdom, “Financial Control of Nationalised Industries (1980b), pp. 6–7. In practice, however, the dependence of enterprises on the Treasury tended to be even higher with changes in the market climate or in the rate of predicted inflation. In the event, the dependence also contributed to more budget expenditures and increases in the public sector borrowing requirement.

This was particularly true in New York State. For an account of this, see Anne Marie Hawk Walsh (1978).

The opportunity cost of capital may be higher in a developing economy because current amounts of investment are lower than the opportunities available.

For a comprehensive discussion of the application problems, see United Kingdom, A Study of the U.K. Nationalised Industries (1976b).

To mitigate some problems, a concept of iterative marginal cost has been developed, corresponding to the French marginalist school concept of “coûr marginal à longue terme de développement,” but the marginal costs developed under this procedure may not be the ones to fully reflect the imperatives of allocative efficiency. See Ralph Turvey (1969), pp. 284–99.

This should not mean that there is no place for competition. The important goal of a public enterprise ?s to secure markets and provide services to customers at lowest cost. These goals can also be achieved by careful planning. It is the responsibility of enterprise management to do this. Planning should not be viewed as an alternative to competition but as a process that incorporates market signals into significant decisions. Competition by itself will not achieve this purpose.

The Select Committee on Nationalised Industries in the United Kingdom suggested at one stage the creation of a ministry of nationalized industries. As envisaged in this proposal, regulatory functions (with the relationships being the same as with private companies) would be vested with the subject ministries, while financial and economic controls would, respectively, be administered by the Treasury and the new ministry. It is, however, very difficult in practice to separate financial controls from economic ones. The proposal was, in the event, considered to be irrelevant. See David Coombes (1971), pp. 159–62.

See the general report of the United Kingdom, A Study of the U.K. Nationalised Industries (1976b), p. 11. For the Government's response, see United Kingdom, The Nationalised Industries (1978). Also see William A. Robson (1977), pp. 6–16.

The frequently held view is that enterprises have multiple objectives, that they are difficult to quantify, and that agreement on trade-offs or relative weights to be attached to different objectives is not feasible. In practice, however, this is not as difficult as it seems. Noncommercial objectives are more often existential in the sense of justifying the investment decision itself and, operatianally, some of the techniques described in the earlier sections of this chapter are found to be adequate to quantify the financial implications of noncommercial objectives. Care should be taken, however, to ensure that not all enterprise losses are considered as public benefits.

The Government of the United Kingdom issued three White Papers (1961, 1967, and 1978) in this regard. They mark three different stages in devising a system of control over public enterprises. For an analytical assessment of the 1978 guidelines, see David Heald (1980), pp. 243–65; and Ray Rees (1979), pp. 3–31.

In some countries the return is calculated with reference to the total gross assets irrespective of their form; in some with reference to net assets (i.e., assets net of current liabilities); in a few others, the base of net assets is adjusted to exclude the resources invested outside the enterprise. In a few others, the base refers to net operating assets and excludes the investments on construction and other activities that have not yet become operational. In some countries, it is calculated with reference to the net worth only. Each of these approaches captures only some of the aspects and their choice is dependent on the purpose expected to be served.

The approaches of the economist and accountant are different in this respect. The former rearranges the data in terms of a constant series and aims at assessing the alternative yields of investment. The accountant's approach relies heavily on the balance sheet and aims at presenting the picture at a given time.

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