Nothing succeeds like success

Ajit Ranade

But it’s worth reflecting on the privatisation-performance equation

Does ownership matter? Specifically, will a privatised Balco, or rather a Balco with a 51 per cent private ownership, generate more profits, be more productive and efficient, and grow more vigorously? Or is it possible for Balco to to do all that and remain under public ownership? My intention is not to incite heresy, but this question of the relevance of public versus private ownership is an old question, and worth revisiting.

Recall that the still-alive Indian planning model advocated public ownership of the “commanding heights” of the industrial terrain in order to blaze a trail of rapid industrialisation. This implied the public ownership of key input industries (mining, metals, oil), infrastructure industries (electricity, railways, airlines) and ownership justified on grounds of national security. Public ownership (and industrial policy) was also needed to pursue the multi-pronged objectives of employment creation, balanced growth and providing a role model to the fledgling private sector.

That was long before the liberalising (liberating?) nineties. We now believe that private firms always do better than public firms. Well, mostly. Economists who run regressions of firm performance against ownership have to be careful to separate out the effects of other parameters. If a firm has done badly it may not be due to public ownership per se, but because of adverse market demand conditions, or due to costlier inputs, or regulatory conditions. But despite these caveats, the global evidence in support of privatisation is strong.

Theoretically speaking, ownership does matter. Owner-run companies do better than manager-run companies. This is called the “principal agent problem”. A firm is typically run by a manager (the agent), who in turn is answerable to a boss, the owners of the firm (the principal).

The principal-agent problem arises out of conflicting objectives of the two. If the owner is the government, then the “acting boss” in the firm is an appointee of the government, leading to another principal-agent problem. And the government itself is appointed by its boss, the voting public, leading to yet another principal-agent layer. When a firm does badly, the owners are unable to detect whether this is due to adverse market conditions despite the utmost efforts of the managers, or whether it is to be blamed on the managers’ sloth. Good managers might get punished for no fault of theirs, while bad managers might prosper. Furthermore, devising an incentive and compensation scheme to extract the best efforts from managers is itself tricky. Should it be mainly through Esops? Or just handsome salaries? Or bonuses? A privately owned firm reduces the principal-agent problem to its minimum - one layer.

Private owners are also focused on the value of the firm. I remember reading about a McKinsey study that claimed that the winning formula for the most successful firms was focusing on enhancing shareholder value. And that means a sustained increase in share prices. In case of the public sector the shareholders are the general public. So what does it mean operationally to focus on shareholder value? Since the shares of publicly owned firms are neither traded nor priced, there is no unambiguous measure of value.

Should we just look at profits or the balance sheet? But there are problems. Assets of public firms, listed at historical prices, could be undervalued. Also high profits might also include hidden subsidies, or assured government contracts, or a beneficial regulatory regime. In such a case, would not the general public be better served by the sale (roughly equal to present value of future expected profits) to a private player, who will then get the firm to grow even more vigorously, thereby leading to higher tax returns to the exchequer?

The nature of very diffused ownership in case of publicly owned firms also dilutes incentives to run it well. The actual process of privatisation has to address several questions (all of which have answers), such as what about job losses? Whose interests will be disenfranchised? How to generate a political consensus? How will privatisation create more value than public ownership, and so on.

The hang-up with privatisation should not let us forget its twin — competition. The failure of much of public sector firms can be as much attributed to a lack of cost discipline due to absence of competition. We have seen lately that, with competition, many of the sleepy bigwigs like LIC, Indian Airlines, MTNL, VSNL have been on their toes and almost shaken to dynamism! Witness the flood of innovations and new services being offered. So maybe it’s all about fostering competition, not just privatisation.

A final thought on private ownership. American tax laws are skewed to induce greater owner-occupied housing, since that leads to clean and crime-free neighbourhoods. Yet the Swiss are the leading non-owners of houses (70 per cent tenants), but hardly the bastion of neighbourhood crime and drugs!