Pulin B.

Nayak, (2012) Privatization, in

NOCE

PRIVATIZATION

Privatization is broadly defined as the transfer of various activities from public to the private hands.
Specifically it is the sale by the government owned enterprises to the private economic agents.
Privatization can be done by selling the state owned enterprises fully or partially which makes a different
form of enterprises which are known as Public Private Partnerships, in which there is transfer of some
responsibilities to the private sector. According to the political economic theory, privatization is a tool of
shrinking the welfare state. On the other hand there is another idea of privatization that it brings an
efficient system of resource allocation as compared to the public sector. Many economies have been
accepting the reforms in their economies through encouraging privatization since many decades.

The author has reviewed the theory of privatization that has emerged in the past two decades and the
strategy of disinvestment followed by the Government of India has also been empirical analyzed.

Privatization Theory

It is widely accepted that public ownership brings efficiency looses that are non-negligible and these
efficiency losses can be higher than the gains (Sheshinski and Lopez Calva, 2003).

The two major perspectives to defend the co existence of public and private sectors which defends the
transfer of economic activities to private hands are: Managerial and Political

According to the managerial perspective, the monitoring is poor in the publicly owned firms and the
incentives for efficiency are weak (Vikers and Yarrow, 1988). The look after and the working of the firms
under public ownership is imperfect because of the absence of the threat of being taken over by other
firms and market competition.

The political perspective contends that it is political interference that distorts the objectives and brings in
the possibility of soft budget constraints faced by public sector (Shleifer and Vishny, 1994). But in the
privately owned firms the political interventions are not possible.

The main difference in the private and publicly owned firms is the transaction costs faced during the
initial attempt of production activities. These costs are quite lower in the case of public sector enterprises
than that of private one. Fundamental privatization theorem has also been discussed which focuses on the
imperfect information about the production environment. It provides under which conditions government
projects are attained through an auction procedure whereas it is stringent in the private sector. It has been
concluded that neither public sector nor private sector can fully resolve the difficult incentive problems
that arise when consideration of imperfect information result in the delegation of authority (Sappington
and Stiglitz 1987).
The degree of competition has been proved to be the most significant factors for improving the
monitoring possibilities and the productive efficiency of any firm but not the ownership. Competition also
facilitates performance comparisons that improve the trade-off between the incentives and the risks.

Privatization: Empirical Evidence

Empirical studies are divided into three categories-

i) Case studies

ii) Cross sectional comparisons of public and private sector performance

iii) Statistical analysis of pre and post divestiture performance of enterprises.

The conclusion obtained from different economies (both transition and non-transition) are diverse. In a
study of British enterprises which were privatized in 1980s shows no improvement in the performance.
Whereas in a study by Megginson and Netter (2001) claimed improvement in terms of efficiency,
performance and profitability in the privatized firms.

Another analysis by Galal et. al. (1994) of post privatization of 12 large firms in UK, Chile, Malaysia and
Mexico concluded that in no case workers were worse-off but in some instances workers were better-off ,
and claimed that divestiture make the world better and efficient.

It is important to mainly emphasis on the sustainable through consolidation and stability of the firms
which gives better outcomes for the whole economy.

Privatization: Indian Experience since 1991

In India, privatization can be discussed after the economic reforms of 1991 when the government gave
huge emphasis on the policy of liberalization. Indian public sector accounted for more than one-fifth
(1/5th) of the economy’s GDP. Most of the public sector enterprises showed negative growth, therefore,
government of India took a major step of privatization and named it as disinvestment.

Department of Disinvestment, government of India (2006) revealed the data on profits of the
manufacturing public sector enterprises were lower than that of manufacturing firms in the private sector.
The reason mentioned for this gap is the expenditure on power, wages and interest as a fraction of net
sales being higher than that of private sector manufacturing firms.

In the interim budget of 1991-92, government decided to disinvest upto 20 percent of the equity in
selected PSUs in favor of mutual funds, financial or investment institutions in the public sector. The
Rangarajan Committee report on Disinvestment, (April 1993) emphasized on a substantial disinvestment
of up to 49 percent for industries reserved for public sector. It was recommended that enterprises that had
dominant market share and had to be maintain a separate identity for strategic reasons could kept the level
of ownership of 26 percent, which means disinvestment could take place up to 74 percent. In rest of the
cases 100 percent disinvestment was recommended. Government was recommended the holding of major
6 industries with 51 percent or more equity which are-i) coal and lignite, ii) mineral oils, iii) arms,
ammunition and defense iv)atomic energy, v) radioactive minerals and vi) railway transport.

In 1996, a Disinvestment commission was established by the government of India to formulate the
procedural decisions of all the activities in a transparent manner. The revenues generated were allocated
for health and education. In 1999, Disinvestment Commission recommended for the transfer of
management of 58 PSEs. The purpose was not only to balance the budgetary receipts but to have a long
term viability of these PSEs.

In 2000-01, the government policy on disinvestment and re-structuring recommended the following-

i) Restructure and revive potential viable PSEs

ii) Closed down of PSEs that cannot be revived
iii) Bring down government equity in all strategic PSEs to 20% or lower
iv) Protect interest of workers

The entire revenue from disinvestment was to be used for social sector, restructuring PSEs and
restructuring public debt.

In May 2004, under the UPA government, the Ministry of Disinvestment was converted into a
Department under the Ministry of Finance. Government made it explicit to retain ‘navaratana’ companies
including BHEL.

In January 2005, ‘National investment Fund’ was established into which the realization of sale of
minority shareholding of the government would be channelized in profitable PSEs. The fund was
maintained outside the Consolidated Fund of India and the income from this fund was to be used for-
investment in social sector projects that promotes education, health and employment, capital investment
in revivable PSEs in order to enlarge their capital base to finance expansion and diversification.

Author has concluded with the argument that there is no certain superiority that which sector is better. For
the productive efficiency, the degree of competition and regulatory environment has been found more
important rather than ownership.