426 P R I VA T I Z A T I O N
capita expenditure quartile attended private schools (8 per
cent in rural areas, 29 per cent in urban areas).
Establishing a causal relationship between the growth
of private schools and the consequent increase in schooling
segregation, and the quality of government schools is
difficult. However, the inverse correlation at state level
between private school enrolments and the schooling
attainment of the poor is suggestive of such a relationship.
Private school enrolments at primary level are amongst the
highest in the northern states of Punjab, Haryana, and
Uttar Pradesh. For rural India, for example, data from
1995 (NSS 52nd round) reveal that 16 per cent, 23 per
cent, and 26 per cent of the primary students in rural areas
of these states respectively were enrolled in private schools,
relative to the national average of 12 per cent. These states
are also characterized by below-average schooling
attainment of the poor. I define poor households as
those whose per capita expenditure fell below state-
specific poverty lines. By this definition, the percentage
of poor rural children between the ages of 12 and 15 who
reported completing primary school was 36 per cent, 34
per cent, and 39 per cent in Punjab, Haryana, and Uttar
Pradesh respectively, below the (rural) national average of
42 per cent. In fact, only the states of Bihar (26 per cent)
and Rajasthan (28 per cent) report lower primary school
completion rates amongst poor households. Interestingly,
primary school completion rates for the non-poor in
Punjab (76 per cent) and Haryana (72 per cent) exceeded
the national average (69 per cent), while it was 62 per cent
in Uttar Pradesh. Correspondingly, the gap in primary
school completion rates between the non-poor and the
poor in Punjab (40 per cent) and Haryana (38 per cent)
far exceeded the national average (27 per cent).
This necessarily short entry cannot do justice to the
many issues that arise regarding primary schooling in
India. Rather than attempt to be comprehensive, I have
focused on identifying a few policy constraints on
improvements in primary schooling in India.
India’s poor resource base resulted in an extensive
approach and in a decentralized schooling system with
tacit support for private schools. While this approach has
succeeded in increasing enrolment, and other measures of
school quantity, the difficult task of improving school quality
and achievement levels remains. The government has
advocated further decentralization of school administration
to village governments as a means of ensuring improvements
in quality. Enhancing local accountability of schools and
schooling staff is likely to generate some efficiency gains.
However, it is unlikely that communities characterized by
significant levels of private schooling will devote themselves
to improving the quality of government schools.
Improvements in school quality, as well as reductions in
schooling inequalities and regional schooling gaps, may
require a mix of centralized and decentralized control,
with the extent of each varying with the socio-economic
characteristics of the region.
ANJINI KOCHAR
References
Drèze, Jean and Amartya Sen. 1995. India: Economic Development
and Social Opportunity, Delhi, Oxford University Press.
Kochar, Anjini. 2004. ‘Reducing Social Gaps in Schooling:
Caste and the Differential Effect of School Construction
Programs in Rural India’, Stanford University, manuscript.
Myrdal, Gunnar. 1968. Asian Drama: An Inquiry into the Poverty
of Nations, New York, The Twentieth Century Fund.
PROBE. 1999. Public Report on Basic Education, New Delhi,
Oxford University Press.
Weiner, Myron. 1991. The Child and the State in India, Princeton,
Princeton University Press.
■ Privatization
The past quarter century has witnessed a significant
move towards privatization in economies across the
globe. Several industrial countries have embraced it as
have most of the transition economies of East Europe
and large parts of the developing world. After the initial
push received in the early 1980s during the Thatcher–
Reagan era the process appears to have gathered momentum
after the decline of communism in the erstwhile Soviet
bloc. In India privatization or disinvestment of the
public sector emerged as a major public policy option
after the country embarked on a process of economic
reforms in 1991.
Even though the question of the appropriate balance
between public and private enterprise is one of the
foundational issues in political economy, it has received
relatively little attention in mainstream economic analysis
until quite recently. In the past two decades there has
emerged an appreciable literature that examines the diverse
theoretical and empirical issues pertaining to privatization
(Shleifer and Vishny 1994; Sheshinski and Lopez-Calva
2003, among others).
Privatization may be broadly defined as the transfer
of various activities from the public to the private sphere.
Specifically, it could mean the sale by government or state-
owned enterprises (SOEs) to private economic agents. It
could refer to a sale that is effected in full or in part. It can
also mean a partnership between the public and private

sectors through a transfer of responsibilities from the public
to private sector. In terms of broad political economy it
could also simply mean a shrinking of the welfare state.
It would be tempting to assume that since privatization
has been accepted as a legitimate, and even a core, tool of
statecraft by more than a hundred governments in the
past two decades, its economic merits are firmly settled.
There is in fact a widespread perception that privatization
brings about outcomes that are superior from the point of
efficiency in terms of resource allocation as compared to
the situation under public ownership. However, these
conclusions are without any firm basis either in theory or
in empirical analysis.
In the following section I shall briefly review the theory
of privatization that has emerged in the past two decades.
This will be followed by a brief account of the rather large
body of empirical work that has developed in recent years.
I shall then consider the strategy of disinvestment that has
been followed by the Government of India in the past
decade and a half.
Privatization: Theory
Within the standard microeconomic literature, it is well
established that under perfectly competitive conditions,
absence of information asymmetries, and complete
contracts, it does not matter whether one is operating
under private or public ownership. The original arguments
for government intervention come up in the context of
market failure that can arise due to myriad factors. Under
conditions of natural monopoly, denoted by decreasing
average costs in the relevant range of demand, the
possibility of monopoly power by a private owner created
the rationale for public ownership.
Yet it is widely contended that public ownership brings
about efficiency losses that are non-negligible (see, for
example, Sheshinski and Lopez-Calva 2003). They could
well be higher than the gains that may be ensured by
solving a market failure problem. This comes about
especially when the scope of competition becomes larger
with an increase in the size of the market, with the economy
possibly getting opened up to international trade and
adopting higher levels of technology. The emergence of
the theoretical work on regulatory mechanisms that
examines their allocative as well as distributive properties
has also prepared a rationale for seeking an alternative to
public ownership.
There are two broad perspectives, viz. the managerial
and the political, that may be used to explain the presence
of inefficiency under the public sector. The managerial
perspective holds that monitoring is poorer in publicly
owned firms and therefore the incentives for efficiency are
PRIVATIZATION 427
weak (Vickers and Yarrow 1988).1 The argument here is
that monitoring under the public sector is imperfect vis-à-
vis the private sector. This is often, though not always, due
to the fact that these firms are not traded in the market,
unlike private firms. This eliminates the threat of takeover
should the firm perform poorly.
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
managers (Shleifer and Vishny 1994). The possibility of soft
budgets protects public-sector managers from the threat of
bankruptcy. Using simple game theoretic tools it is possible
to demonstrate that the political loss in closing a publicly
owned company is greater than the cost of using taxpayer
money or public debt to bail out a public-sector company.
It is argued that privatization would effectively drive a
wedge between politicians and managers and would
make restructuring more likely by making it too costly
for politicians to subsidize firms.
In a seminal paper Sappington and Stiglitz (1987)
examine the choice between public and private provision
of goods in a context where both modes involve significant
delegation of authority. They argue that the main difference
between the two modes concerns the transactions costs
faced by the government when attempting to intervene in
the delegated production activities. It is shown that such
intervention is generally less costly under public ownership
than private. They then proceed to put forward what they
call the fundamental privatization theorem. The theorem
specifies the conditions under which privatization is
optimal. It focuses on the special concerns introduced by
imperfect information about the productive environment.
It provides conditions under which all of government’s
objectives may be attained by an appropriately designed
auction of the rights to produce a given product or service.
It is shown that the conditions under which privatization
is optimal are rather stringent. The authors conclude by
emphasizing that neither public nor private provision can
fully resolve the difficult incentive problems that arise
when considerations of imperfect information result in the
delegation of authority.
This leads to the position that it is not ownership, but
the degree of competition, that ultimately matters for
improving monitoring possibilities, and hence for
productive efficiency. Major gains in efficiency can be
expected by increasing market contestability via
deregulation policies. Competition implies not only free
entry into the market, but the freedom, especially on the
1Vickers and Yarrow have analysed this in one of their books on
privatization.
428 P R I VA T I Z A T I O N
part of SOEs, to fail. Competition also facilitates performance
comparisons that can generally improve trade-offs between
incentives and risk when several agents, or managers,
facing uncertainties are being monitored.
In addition to the above micro-theoretic issues one
needs to also consider the macroeconomic implications
of privatization. Privatization may be used as a tool for
improving the government’s fiscal condition. When carried
out through public offerings and mixed sales it can help
increase the level of stock market capitalization and the
development of the financial sector generally. The literature
on the macroeconomic effects of privatization is not quite
as rich from the theoretical perspective as that on the
microeconomic effects.
Privatization: Empirical Evidence
In recent years a large body of empirical investigations has
been carried out to assess the impact of privatization
programmes in diverse settings (see, for example, Megginson
and Netter 2001). There are several methodological
problems with research in this area in addition to the
problem of data availability and consistency. Some
problems arise due to the nature of the accounting or
stock data. One needs to determine the correct measure of
operating performance, selecting an appropriate
benchmark with which to compare performance, and to
decide the appropriate statistical tests to be employed. Many
of the studies on performance changes after privatization
examine the effects on groups such as workers, but few
examine the impact on consumers. Empirical studies on
privatization may be broadly divided into three categories,
(i) case studies, (ii) cross sectional comparisons of public-
and private-sector performance, and (iii) statistical
analysis of pre- and post-divestiture performance of
enterprises. Both transition and non-transition economies
have been studied. The conclusions obtained are diverse.
In a study conducted to examine the performance of
several British firms that were privatized in the 1980s, it
was revealed that there is little evidence of any systematic
improvement in performance, and promises made
in political speeches remained unfulfilled. This is to be
contrasted with the conclusion that Megginson and Netter
(2001) come up with: ‘Research now supports the proposition
that privately owned firms are more efficient and more
profitable than otherwise comparable state owned firms.’
In an important study Galal et al. (1994) compare
actual post-privatization performance of twelve large
firms, mostly airlines and regulated utilities, in the UK,
Chile, Malaysia, and Mexico to predict performance if the
firms remained SOEs. They capture the net change in
welfare, defined as the sum of the changes in welfare of
consumers, enterprise profits (including effects on buyers,
the government, and other shareholders), the welfare of
labour, and welfare of competitors. They document net
welfare gains in eleven out of the twelve cases, which
equal, on average, 26 per cent of the firms’ pre-divestiture
sales. In no case were workers worse off, and in three
instances they were significantly better off. They therefore
conclude that divestiture makes the world a better place.
Yet it is important to apply caution in drawing
unqualified support for privatization. Most statistical analyses
of pre- and post-privatization performance are marred by
the failure to control for the economic environment.
These could contribute to improved performance in the
post-divestiture period and therefore need to be factored
out. In many cases where privatization appears to have
resulted in efficiency enhancement, one finds that there
has actually been contemporaneous deregulation or other
competition-enhancing measures.
Kalyuzhnova and Andreff (2003) provide a valuable
assessment of the privatization experience in Eastern
Europe and Russia now that more than a decade has
passed since the end of communism there. There were
several experts who had advocated overnight mass
privatization programmes in the early 1990s. Many of
these measures were simply ‘robbery by the old elite and
the new oligarchs’. It is very important to consider whether
it is desirable to go in for a ‘big bang’ policy of massive
overnight asset transfer, or whether one should not
promote an evolutionist and organic transformation of
business enterprise. The first purports to ending state
ownership in a drastic manner, using giveaway through
voucher schemes and tolerating takeover by managers
and management buyouts. The latter may be described
as a bottom-up development of a new private sector but
no giveaway of state property. The emphasis here is on
consolidation and stability so as to make growth sustainable.
Privatization: Indian Experience since 1991
A consideration of the privatization experience in India
may well focus on the period after 1991, when the
government embarked on a comprehensive process of
economic reform and liberalization. At that time the
public sector in India accounted for more than one-fifth
of the country’s GDP. Since a large number of public-
sector enterprises (PSEs) regularly showed negative profit
margins the government was keen on a programme of
privatization, calling it disinvestment instead.
Data from the Department of Disinvestment,
Government of India (2006)*, reveal that the profit
*http://divest.nic.in

margins of manufacturing PSEs are systematically lower
than the figures for manufacturing firms in the private
sector. This is at least partly due to the fact that the
expenditure on power and fuel, wages and interest as a
fraction of net sales are all systematically higher than the
corresponding figures for similarly placed private-sector
manufacturing firms.
In the interim budget of 1991–2 the government took
a policy decision to disinvest up to 20 per cent of the
equity in selected PSUs in favour of mutual funds and
financial or investment institutions in the public sector.
The disinvestment, which was to broad base the equity,
was to improve management and enhance the availability
of resources for these enterprises. The Rangarajan
Committee report on the Disinvestment of Shares in
PSEs in April 1993 emphasized the need for substantial
disinvestment, and recommended that the percentage of
equity to be divested could go up to 49 per cent for
industries especially reserved for the public sector. It
recommended that in exceptional cases, such as enterprises
that had a dominant market share or where separate
identity had to be maintained for strategic reasons, the
target public ownership level could be kept at 26 per cent,
that is disinvestment could take place to the tune of 74
per cent. In all other cases it recommended 100 per cent
divestment of the government stake. Holding of 51 per cent
or more equity by the government was recommended only
for six scheduled industries, namely (i) coal and lignite,
(ii) mineral oils, (iii) arms, ammunitions, and defence
equipment, (iv) atomic energy, (v) radioactive minerals,
and (vi) railway transport.
In 1996 the government established a Disinvestment
Commission. The purpose of this body was to formulate
procedures so that any decision to disinvest would be
taken and implemented in a transparent manner. The
revenues generated from such disinvestment were to be
allocated for education and health and for creating a fund
to strengthen PSEs. By August 1999 the Disinvestment
Commission made recommendations on fifty-eight PSEs.
The recommendations indicated a shift from public
offerings to strategic/trade sales, with transfer of
management. The Commission also observed that the
essence of a long-term disinvestment strategy should be not
only to enhance budgetary receipts, but also to minimize
budgetary support to unprofitable units while ensuring
their long-term viability. By 1998 government was of the
view that ‘in the generality of cases its shareholding in PSEs
will be brought down to 26 per cent’. In PSEs involving
strategic considerations, namely arms and ammunitions,
atomic energy, and railway transport, government was to
retain majority voting.
PRIVATIZATION 429
By 2000–1 the government’s policy regarding
privatization and public-sector restructuring comprised
the following considerations: restructure and revive
potentially viable PSEs, close down PSEs that cannot be
revived, bring down government equity in all strategic
PSEs to 20 per cent or lower, if necessary, and fully
protect the interests of workers. The entire receipt from
disinvestments and privatization was to be used for
meeting expenditure in social sectors, restructuring of
PSEs, and meeting public debt.
The Ministry of Disinvestment was converted into a
Department under the Ministry of Finance with effect
from 27 May 2004 after the UPA (United Progressive
Alliance) government headed by Dr Manmohan Singh
as Prime Minister assumed office. From this point on,
the disinvestment programme had to be in conformity
with the National Common Minimum Programme. All
privatizations were from now on to be considered on a
transparent and consultative case-by-case basis. It was
made explicit that the UPA would retain the existing
‘navaratna’ companies, which include the BHEL (Bharat
Heavy Electricals Limited), in the public sector and that
these will be permitted to raise resources from the capital
market. The government constituted a ‘National Investment
Fund’ in January 2005 into which the realization from
sale of minority shareholding of the government in
profitable PSEs would be channelized. This fund would
be maintained outside the Consolidated Fund of India
and the income from this Fund would be used for the
following purposes: (i) invest in social-sector projects that
promote education, health care, and employment and
(ii) capital investment in selected profitable and revivable
PSEs that yield adequate returns, in order to enlarge their
capital base to finance expansion or diversification.
The total quantum of receipts on account of privatization
during 1991–2005 is Rs 49,214 crore. This is just a
little above the half mark figure of the target receipts of
Rs 96,800 crore for this period. Even though there is a
strong reform lobby that calls for rapid mass privatization
in India from time to time it would be well to remember
that the experience in Russia and Eastern Europe alluded
to in the earlier section is far from reassuring.
After the initial phase of enthusiasm in the 1980s
and then the onrush during the 1990s, we are now at a
stage where we can take a more measured approach to
privatization. There is certainly no clear superiority of
private vis-à-vis public ownership from the standpoint of
economic theory. More than ownership it would seem that
the degree of competition and the regulatory environment
are more relevant to productive efficiency. The empirical
evidence presents a mixed picture. As the world environment
430 PUBLIC DISTRIBUTION SYSTEM
gets more competitive it would be necessary to put the
sizable assets of the PSEs in countries like India to more
productive use. Ultimately it is this consideration that
should be of relevance rather than the simplistic
presumption that the public sector is necessarily inefficient
or that privatization is an all-purpose panacea.
PULIN B. NAYAK
References
Galal, Ahmad, Leroy Jones, Pankaj Tandon, and Ingo Vogelsang.
1994. Welfare Consequences of Selling Public Enterprises,
Oxford, Oxford University Press.
Kalyuzhnova, Yelena and Wladimir Andreff. 2003. Privatisation
and Structural Change in Transition Economies, Basingstoke,
Palgrave Macmillan.
Megginson, William and Jeffry Netter. 2001. ‘From State to
Market: A Survey of Empirical Studies on Privatization’,
Journal of Economic Literature, 39: 321–89.
Sappington, David and Joseph Stiglitz. 1987. ‘Privatization,
Information and Incentives’, Journal of Policy Analysis and
Management, 6: 567–82.
Sheshinski, Eytan and Luis Felipe Lopez-Calva. 2003.
‘Privatization and Its Benefits: Theory, Evidence, and
Challenges’, in K. Basu, P. Nayak, and R. Ray, eds, Markets
and Governments, New Delhi, Oxford University Press.
Shleifer, Andrei and Robert Vishny. 1994. ‘Politicians and
Firms’, The Quarterly Journal of Economics: 109(4), Nov:
995–1025.
Vickers, John and George Yarrow. 1988. Privatization: An Economic
Analysis, Cambridge, MIT Press.
■ Public Distribution System
The public distribution system (PDS) refers to a network
of retail outlets (popularly known as ‘ration shops’) through
which the government sells grain (principally rice and
wheat) and kerosene. The scope of this entry is restricted
to the public distribution system for grain. Grain sales
occur at a fixed price called ‘issue’ price that is typically
lower than market price. Two conditions govern the sale
of subsidized grain. First, the buyer of grain must possess
a ‘ration card’. Second, grain purchases are subject to a
quota. The public distribution system is supported by a
procurement operation that obtains and funnels supplies
to the PDS. Through the Food Corporation of India (FCI),
the government procures grain at the ‘procurement’
price and then stores and transports it to the various
consuming locations.
Till the late 1960s, the principal policy question was
how food could be procured cheaply. Towards this end,
the government imposed mandatory levies on rice mills,
instituted zoning regulations on movement of grain from
surplus to deficit areas (so that prices are lower in the
surplus zones), prohibited external trade except on
government account, and severely curtailed large trading
operations through ‘anti-hoarding’ controls on stocks.
The food policy context changed in the 1970s with
the technological breakthroughs of the Green Revolution.
Earlier concerns about movements in inter-sectoral
terms of trade adverse to industry faded away. With large
food surpluses, declining real prices of foodgrains, and
greater political clout of farmers, the emphasis of food
distribution shifted to support of farmgate prices,
stabilization, and subsidy for lower-income groups. Food
subsidy as a major item of government expenditures
made its appearance around this time. In recent years,
the principal policy issue for the government has been to
find acceptable ways to cap the food subsidy. Issues that
are current in the policy debate are the efficacy and
impact of food-subsidy expenditures.
Issues in Intervention
In principle, food market interventions are supposed to
enhance the efficiency of food markets as well as improve
the equity of food market outcomes. The efficiency effect
arises from price stabilization. As private storage of
foodgrains is typically unprofitable across years, markets
do not provide price stabilization even though it is socially
desirable, as poor risk-averse food consumers cannot
obtain credit or insurance against crop failures. The
reduction in risk is beneficial to producers as well.
Even with stabilization, the market outcome involves
unacceptably low food consumption for the poor.
The equity objective of food market intervention is to
augment the food consumption of such target groups by
offering subsidies.
Both these goals could be achieved by procurement,
storage, and distribution. To meet the equity goal, the
government offers limited quantities of food to poor
consumers at subsidized prices. Suppose this requires an
annual distribution of 15 million tonnes of grain. The
supply of this grain is secured by procurement. However,
annual procurement could vary depending on the size of
harvest and available stocks. In times of abundant supplies,
the government will wish to procure more than 15 million
tonnes (and build stocks) while the procurement target
would be lower than the distribution target (drawing on
stocks) in times of shortfall. Such a scheme could smooth