ROLE OF THE PUBLIC SECTOR IN INDIA

SHASHANK KAUSHIK ADHIRAJ CHOWDHURY SAANDHY KUMAR GANERIWALA SAYON GHOSH

Acknowledgement:
We are grateful to the faculty of Department of Economics, St. Xaviers college for their unwavering support and cooperation. We are also thankful to St. Xaviers College, for providing us with much needed infrastructure help.

ABSTRACT Background studies of the role of public sector in India post Independence reveal that due to widespread neglect during British rule, the independent Indian economy was characterized by a weak industrial base, low levels of savings, inadequate investments and infrastructural facilities. The Indian government through its Industrial Policy Resolutions (1948 and 1956) decided to boost economic growth by adding to the manufacturing capital stock in the subsequent periods. However continued expansion in public sector manufacturing is infeasible due to inefficiencies in bureaucratic public sector functioning and also since the primary objective of the government should be infrastructural development (Social Overhead Capital) which complements private investment in Directly Productive Activities (DPA). So considering a closed, newly-born and underdeveloped economy like that of Indias post independence, our model describes the roadmap that the government should follow so that public sector boosts economic growth. Our model suggests that the government should increase manufacturing investment at a decreasing rate so that it leads to economic growth but at the same time paves the way for entrance of private sector. The government thus slowly increases attention towards infrastructural capital formation which is its primary objective and ultimately arrives at a point where net public investment in manufacturing becomes zero.

Introduction The definition of Public Sector goes as follows: It is defined as the aggregate of all sectors where the State has direct control over production, delivery and allocation of goods and services. Public sector enterprises (PSEs) prioritize social welfare as their fundamental objective. Since infrastructure development is one of the determining factors of societal welfare, hence the responsibility of generating long term infrastructural investment lies with the government. Infrastructure is defined as the sum of mining, electricity, gas and water, transport and communication [R. Nagraj: Public Sector Performance Since 1950 A Fresh Look]. A command economy also allows, within its framework, direct participation of the governmental agencies in manufacturing activities. Hence the role of public sector depends on the nature of the economy. Since the present analysis focuses on the role of public sector in India, it necessitates a background study of the prevailing situation of the Indian Economy from the time frame chosen - post independence to the present situation. In India the public sector organizes its above-mentioned activities through departmental or non-departmental undertakings. A departmental undertaking is organized, financed and controlled like any other Government department. It is self-contained but it is under the overall control of the departmental head and the ministry concerned. It includes the Post and Telegraph department, the Port Trusts, etc. Non-departmental enterprises include the

ONGC

and

SAIL.

Evolution of public sector in India, was a process which was initiated only after Independence. India inherited a backward agrarian economy marked by low levels of income, employment, inadequate capital and disparate inequalities in the levels of income. Inter-regional inequalities in standards of living were starkly significant. A low level of national income implied low gross domestic savings and hence low levels of investment. A weak industrial base as a result of neglect and apathy during the British era, made investments in core areas an imperative. There was also a lack of risk-taking entrepreneurs to finance core investment projects as it involved long gestation periods of low profitability or cost related losses to emerge as a viable option. All these reasons led to the passage of the Industrial Policy Resolution (IPR), 1948 followed by the IPR, 1956. In the 1948 Resolution, the development of core sectors of the economy was proposed through the growth of Public Sector Enterprises (PSEs). It laid down that arms and ammunition, atomic energy and railways will be the exclusive monopoly of the central government. The six sectors reserved for the public sector, where assistance from the private sector was also welcome were coal, iron and steel, aircraft manufacturing, ship building, manufacturing of telephones, telegraphs and wireless apparatus. It laid an emphasis on the expansion of production, both industrial and agricultural, specifically on the production of capital goods and equipments.

The low levels of income still persisted and it was proposed to widen the scope of public enterprises in the manufacturing sector as it would lead to the increased flow of goods and services in the country and hence push the income levels up. So the investment in manufacturing capital (capital used directly in productive activities) had to be given a boost. This led to the passing of the IPR, 1956 or the P.C.Mahalanobis plan. In this plan the manufacturing activities of the public enterprises rose rapidly. The objective was to accelerate economic growth and boost the process of industrialization to achieve a socialistic pattern of society in the successive five year plans. Given the scarce capital and inadequate industrial entrepreneurial base, the Resolution accorded a predominant role to the State to assume direct responsibility for development. All industries of basic and strategic importance and those in the nature of public utility services, besides those requiring large scale investments, were reserved for the public sector. The Industrial Policy Resolution - 1956 classified industries into three categories. The first category comprised 17 industries (included in Schedule A of the Resolution) exclusively under the domain of the Government. included inter alia, railways, air transport, arms These and

ammunition, iron and steel and atomic energy. The second category comprised 12 industries (included in Schedule B of the Resolution), which were envisaged to be progressively State owned but private sector was expected to supplement the efforts of the State. The third category contained all the remaining industries and it was expected that private sector

would initiate development of these industries but they would remain open for the State as well. Another objective spelt out in the Industrial Policy Resolution - 1956 was the removal of regional disparities through development of regions with low industrial base. Among the prominent enterprises set up under this plan were Heavy Engineering Corporation(1956), Hindustan Organic Chemicals(1960), Fertilizer Corporation of India (1961) , Bharat Heavy Electricals Limited(1964), Bharat Heavy Plates and Vessels(1966).

Importance of Public sector enterprises Public sector through its increased participation in the industrialization of the economy has contributed a lot towards building a strong industrial base and to ensure selfreliant economic growth. The table below shows the growth in the number of central public sector enterprises and investment. The number of CPSEs has increased from 5 to 247 as on the end of FY 2006-07. Corresponding total investments have increased from Rs 29 crores to Rs 421089 crores. It is evident from the figures that capital stock of the country has risen manifold, as planned by our policymakers. These enterprises also contributed to the national exchequer through payment of dividends, interest on government loans, taxes, duties, etc.

Table 1: CPSEs
Particulars No.

GROWTH OF
of Total investment (Rs

CPSEs As on 1.4.1951(eve of 1st FYP) 5 As on 1.4.1956(eve of 2nd FYP) 21 As on 1.4.1961(eve of 3rd FYP) 47 As on 31.3.1966(end of 3rd FYP) 73 As on 1.4.1969(eve of 4th FYP) 84 As on 1.4.1974(eve of 5th FYP) 122 As on 31.3.1979(end of 5th FYP) 169 As on 1.4.1980(eve of 6th FYP) 179 As on 1.4.1985(eve of 7th FYP) 215 As on 31.3.1990(end of 7th FYP) 244 As on 1.4.1992(eve of 8th FYP) 246 As on 31.3.1997(end of 8th FYP) 242 As on 1.4.2002(end of 8th FYP) 240 As on 31.3.2007 247 Source: Central Statistical Organisation

crore) 29 81 948 2410 3897 6237 15534 18150 42673 99329 135445 213610 324614 421089

Expenditure towards capital accumulation by the public sector also led to a rise in the Gross Domestic Product of the nation as shown in figure 1 below.

FIGURE 1: Trend of Public Capital Formation and GDP(Market Prices)

SOURCE HANDBOOK OF INDIA ECONOMY 2009-2010 RBI

Apart from this the public sector has also contributed to the progress of the economy through generation of employment opportunities. Public sector enterprises employ a large workforce in different disciplines. This led to a rise in the level of personal income and hence savings, necessary for the selfsustaining growth of the economy. In 1970-71, public sector employed around 11.1 million people which rose to 18 million in 2006-071. Public sector undertakings have located their plants in

backward and untrodden parts of the country. These areas lack

basic industrial and civic amenities like electricity, water supply, etc. Steel plants at Bhilai, Rourkela and
1: Source of employment statistics: Reserve Bank of India

Durgapur, fertilizer factory at Sindri, machine tools in Rajasthan and Precision Instrument plants in Kerala are few examples of the

development brought about by setting up PSEs in backward areas. This has brought about a complete transformation in the socio-economic status of the people of these regions. Public sector in India currently contributes about a quarter of the GDP which increased from slightly less than one-tenth in 1960-61(earliest year with firm estimates). The largest share of public sector gross value added that is 12-13% of GDP comes from non-departmental enterprises producing many private goods and services. This share is appreciable but the extension of the public sector has been under criticism for their inefficiency as well as for financial losses. In our next section, we will explore the causes behind the poor financial performance of the public sector enterprises. Limitations Public sector enterprises in India receive a lot of criticism on their poor service, shortages, low financial returns and delays in delivering goods. Although Nagraj [1993] found that the financial performance of the public enterprises in India improved in 1980s and the resource generation effort is now

comparable to that of private corporate sector, it is generally agreed that the performance of public enterprises on the whole has been less than their potential and below the expectations with which they were set up.[Sudip Chaudhuri: Public Enterprises and Private Purposes] Authors try to explain the shortcomings of public sector enterprises in various ways. The factors responsible for the poor performance of the PSEs are managerial weakness, low level of work ethics, inefficiency in the use of technology, political and bureaucratic interferences, pricing policies etc. In case of India there are various other factors which explain the unsatisfactory performance of the PSEs. With the advent of the P.C. Mahalanobis Plan, investment in the manufacturing sector was increased as mentioned in section 1. These investments created a lot of backward and forward linkages which should have been utilized for the full capacity absorption of prior investments. There was a sharp fall, in the public sector gross fixed capital formation, of 14% in 1966-67 and it remained in a state of stagnancy till the mid 1970s. Only after that, did the aggregate public sector investment in absolute terms started rising. Therefore this fall and stagnation was a severe demand shock for public sector enterprises. It led to underutilization of capacity and consequently losses. There are instances from Indian history where imported capital was given preference over indigenous capital. In most of the cases, PSEs were sidetracked by criticizing them for being costineffective and inefficient in comparison with similar foreign

enterprises. This was common in bilateral trade agreements. Despite the presence of domestic firms producing the same product, the order was given to foreign companies leading to demand problems for installed capacity of PSEs. It was argued that the delivery system of domestic firms was poor and also they were unable to meet the required specifications. One example given in Public sector for private uses by Sudip Chaudhuri is of the Shipping Corporation of India (SCI) and Cochin Shipyard. SCI imported vessels rather than buying from the sister PSE arguing that the imported ones were cheaper than those produced by Cochin Shipyard. If SCI had purchased vessels from Cochin Shipyard, at prices higher than international prices, its margin of profits would have declined. Given that, the profits on aggregate would have been higher and would have benefitted society more. Thus, the mindset of considering the economy as an aggregate and then arriving at decisions by the individual firms is lacking. The concerned ministries are also involved in these contracts. Thus, these decisions are prone to manipulations and such contracts are tampered with, courtesy the vested interests of a few. Due to poor planning and political interferences, there have been unutilized capacities of capital stock lying idle with the PSEs, which became the cause of their failure. So it will not be rational to say that there are problems at the firm level and public sector enterprises are inefficient. However, it will be true to say that public sector is inefficient rather than public sector enterprises. So if the PSEs can get rid of this dubious circle of

influence purportedly exerted on it by those in the top echelons of power, the results may be a tad promising. Do we really need PSEs? The backward state of the Indian economy was the primary reason for the advent of public sector enterprises in the manufacturing sector. Post independence, the dismal state of industry, income and employment and low entrepreneurial spirit left the government with no option but to stimulate the manufacturing sector. Had there not been such stagnancy and backwardness, the public enterprises could have focused only on providing infrastructural facilities for the general good of the society. Infrastructural capital has the nature of public goods, so it is non-excludable and non-rival. However, no private sector would be interested in investing in infrastructural capital. Private sector can take up the manufacturing investments more efficiently as it offers short-run profitability and returns. However there is a catch. For private investors to have any incentive of financing manufacturing, the infrastructure needs to be provided for by the State. Herein, lies the irreplaceable role of the PSEs to provide and augment the infrastructural facilities of the economy. Thus, the government should limit its investment in the manufacturing sector only to the areas which are of strategic importance to the nation as railways, nuclear energy etc and concentrate more on the infrastructural development. R. Nagraj, in Public sector Performance since 1950 A Fresh Look has stated that the share of infrastructure in the gross public sector capital formation has risen over the years while the share of manufacturing has declined. So, in a nutshell, the Government of India had to take up manufacturing investment because of the weak industrial base of the country. But, it is desired that after developing the required industrial base for the private sector to build on it, the government should gradually cease investing in manufacturing

capital and focus on the policy of enhancing capital.

infrastructural

The graph below clearly depicts, that over the years, public investment in infrastructure has gone up and manufacturing has reduced. The government with an initially higher share of infrastructural investment continues to better it, whereas its investment in manufacturing declines after an initial spurt as it has now built a strong industrial base for private entry.

COMPOSITION OF PUBLIC INVESTMENT IN INDIA

MODEL We consider a closed economy at the initial stages of its development. The economy is characterized by a weak industrial base, low levels of savings, inadequate investments and infrastructural facilities. Due to a weak private sector, the government has to draw a roadmap for the growth of the public sector which will provide the required thrust to the economy and thereby act as the driver of economic growth. The public sector would first be required to widen the base of manufacturing investment in the economy by filling up gaps in important and necessary capital goods such as steel, heavy machine tools, exploration and refining of oil, heavy equipments, chemicals, fertilizers etc. As the gaps start to get filled, income rises. The private sector slowly becomes self reliant and financially strong enough to undertake substantial investment programmes in the manufacturing sector. The government slowly reduces its share on manufacturing investment as entrepreneurial spirit within the country develops. It continues this decreasing rate of manufacturing investment till the economy has reached a particular desirable level of GDP. At this desirable level, the private sector becomes self-reliant enough to take complete control of the manufacturing sector. The government thereafter concentrates on its primary objective the creation and expansion of infrastructure (Social Overhead Capital), for example- modernization of highways, development of civil aviation, development of irrigation system, ports, telecom and power.

In our model we chart out the pattern of public manufacturing investment from the starting point (with low levels of private investment and income) to the crowding out point, where the government achieves its desirable growth target. At this point it is feasible for the government to

move away from the manufacturing sector so that public manufacturing investment is crowded out by private manufacturing investment.

To set up our model we first look at the revenue available to the government and the composition of government spending. We assume that the government earns its revenue just from tax receipts. R represents government revenue,t represents the tax rate and Y represents the national income. Hence,

We assume that the budget is always balanced and thus government expenditure = government revenue. We denote government expenditure by E. Hence,

Now we come to the composition of government expenditure. Government expenditure comprises of

(i)

Autonomous Expenditure ( ), which is expenditure on daily government activities, salaries to government employees, pensions, etc. We assume to depend positively on Y. However is so small that we can neglect it.

(ii)

Manufacturing Investment Expenditure ( Investment Expenditure ( )

(iii) Infrastructural

We define Hence

as the investible surplus available to the government for its investment activities.

We define Manufacturing investment expenditure (

) such that

where

is the share of investible surplus assigned to manufacturing. is

Since the government slowly decreases its involvement in manufacturing investment, considered to be lesser than 0.

We define Infrastructural Investment Expenditure (

) such that

where

is the share of investible surplus assigned to infrastructure. is

Since the government slowly shifts attention towards expanding Social Overhead Capital, considered to be greater than 0. Thus, from to , we have

Now we introduce the stock of public manufacturing capital in our model and denote it as Output depends on such that

The existence of a positive relationship between public capital formation and shown through an empirical exercise. Hence, changes to changes to

has already been

changes to changes to changes to +

We also introduce the depreciation of public manufacturing capital and define Breakeven Investment as the investment which just replenishes the depreciated capital. If be the depreciation rate, then

We consider that the government takes decisions regarding its investment expenditure after every 3-5 years. Initially when there is complete absence of any significant investment initiatives from the private sector, the government allocates a substantial share of its investible surplus to manufacturing activities. If the economy begins with public manufacturing capital stock of corresponding curve for the in Period 1, the

governments manufacturing investment will be

where

Therefore, the net manufacturing investment in Period 1 is

Hence public manufacturing capital stock ( At the beginning of Period 2, the new

increases by

in Period 1.

in the economy is

The national income has increased from rises, the government

) in Period 1 to to

) in the 2nd Period. As the GDP , thereby increasing its share

decreases its share of investment on manufacturing from of infrastructural investment . Hence the government obtains a new

curve for Period 2.

Therefore, the

of the government in Period 2 is -

Public manufacturing capital stock thus increases by new in the economy at

in Period 2. Correspondingly the

the beginning of Period 3 is

Consequently the government follows the same policy of decreasing slowly decreasing its level of involvement in manufacturing activities. Hence the in the economy at the beginning of Period j is

from

to

thereby

and the corresponding Hence,

will be

Slowly the government keeps on reducing

in each period till it reaches the crowding out point.

This point is defined such that Here the government stops adding to the manufacturing capital stock to allow entrance of the private sector in manufacturing activities. Henceforth the government shifts its attention towards providing better infrastructure ie it is concerned only with . If the period be denoted by n, then

Period Numb er 1 2 3

at the beginning of the Period

Share of

. . . j . . . n

. . .

. . .

. . .

. . .

. . .

. . . 0

In the above table, we show the levels of capital, manufacturing sector for every period. Here,

and net investment in the public

The n different curves which the government obtains correspond to n periods of 3-5 years. Hence the curves represent the decision of the government regarding the manufacturing investment

activity in each short run. To obtain the long run manufacturing investment curve of the government, we join the points in each period on the short run curves. Hence we obtain the curve. can be an increasing or a decreasing function of However the government would ideally want its long run manufacturing investment to increase with capital. ie or, or, or, or,
{since tends to 0 according to our assumption}

or,

is a value slightly greater than 1. For simplicity we assume that

Hence,

ensures that the

curve is positively sloped.

Now we consider the Second Order Conditions

Now the first term on the right hand side is negative since In the second term (since we assume

(from FOC) and

to be linearly related to

and

Hence the second term is also negative. Hence, . corresponding to every percentage increase in curve which increases at a decreasing rate. is less than

Thus if the percentage decrease in 1, the government will obtain a

An increasing

curve would ensure that the government reaches its crowding out point at its

desirable level of national income ie the government ceases additional manufacturing activities only after the private sector has matured enough. If on the other hand, for every percentage increase in

, the government decreases

by more than 1%, then it will get a negative

curve which would ensure that crowding out of public manufacturing investment by private investment happens prematurely at a low level of national income. At this level, the private sector is not developed enough to control manufacturing activities independently. Hence the government must always ensure that

This is shown in the diagrams that follow -

Fig 1: Showing POSITIVELY SLOPED CURVE.

From the diagram we see that where is the subsistence level of capital stock i.e. the minimum amount of public manufacturing capital that must exist in the economy for development to be possible.

Fig 2: Showing NEGATIVELY SLOPED CURVE.

In any period j, the net manufacturing investment

curve is

FOC: or, Now we replace minimised. SOC: Therefore, In the proof that is maximised for a given value of (= ). period is falls from to and . With a fall in rises which is by to find out the level of capital stock where is maximised or

now maximised at a lower value of capital stock. This can be shown in the diagram below-

In the diagram,

Fig 3: Showing Long Run pattern of Net represents the capital stock where

is maximized and

represents the

capital stock where is maximized. Thus we see that stock for every passing period.

is maximized at a lower capital , given the rate of

For the 1st period, share of public investment in manufacturing being the crowding out point for curve. This amount is

depreciation( ) the government can easily predict the amount of capital stock that will exist at in the above diagram.

If the government decides not to revise the short run share of public manufacturing investment then the final existing capital stock maybe too high. This will result in an over-intervention of the public sector which may drive away the seeping in of private entrepreneurs. The government would obviously be more concerned about allowing the private sector to come in after a certain level of capital stock. If the present share( ) leads to a higher level of capital stock than the desirable level at the crowding out point, the government would certainly bring down the share of manufacturing investment. Thus, we obtain the second and the subsequent Net Investment curves for . since is positive. In the 2nd period net

The capital stock has already increased from investment changes from to to . Since

is positive, capital stock still increases from

. Therefore we move on to the 3rd period where, from the diagram it is visible that net

investment takes a downward turn from to . In the subsequent periods as well there is a decrease in net investment with capital stock rising lesser and lesser amount in each period.

There will come a period when will be such that for the existing capital stock, net investment is zero. Therefore, there is no more addition to the capital stock. This is the desirable crowding out point where the government decides to invest only as much to replenish the already existing capital stock. Therefore public capital having reached the desirable level of capital stock now makes way for private entrepreneurship.

In the diagram, if we trace out each short run net investment point corresponding to capital stock of , , etc., we will obtain the Long Run Net Investment Decision curve of the government. The LR Net Investment Decision curve shows an initial increase in net investment when capital stock was too low and the government was desperate to increase capital. After a certain stage we see a fall in the net investment. With each period going by, the government decides to lower its net investment, thereby reducing the rate of increase in capital stock until the rate becomes zero. There are two reasons for this decrease in net investment:
i)

The government believes that the efficiency level of private entrepreneurs is higher. Therefore, too much investment in the public manufacturing sector may reduce the chances of private entrepreneurs to find scope in investment, thereby reducing efficiency and also the productivity of the nation. Thus, there exists the problem of substitutability of the private sector by the public manufacturing sector. Therefore, time and again the government revises its decision to invest in manufacturing capital. This, thus ensures the prevention of public over-intervention in the manufacturing sector.

ii)

Social welfare in the form of infrastructural capital is a major concern for the government. Therefore, with increase in capital stock (and thereby a higher GDP level) the attention of the government is diverted towards infrastructural investment.

Our model exclusively speaks about a developing country where the animal spirit (John Maynard Keynes) of entrepreneurs is lacking. Entrepreneurs are not willing to take that extra risk to start Directly Productive Activities (DPA) under shortage of Social Overhead Capital. To support their upbringing, what the government can do is provide Social Overhead Capital (SOC).Provision of Social Overhead Capital being a non-profit activity; it is strictly a public good and can only be provided by the government. Therefore, the government is naturally more concerned about providing SOC in the form of infrastructural investment. From diagram (i) it is visible that at each period infrastructural investment increases not only because investible surplus ( ) increases (due to rise in ) but also because the share of infrastructural investment ( ) increases over each period. In period 1, In period 2, In period 3, i.e. the length bp . i.e. the length dq. i.e. the length fr. where From the diagram it is visible that increases in each period i.e.

bp < dq < fr. Therefore, with an increase in Social Overhead Capital over the n periods, the government is providing enough scope for private entrepreneurs to enter the manufacturing sector. Thus, investment in SOC acts as a complementarity for the private sector. Thus, if we look over the n periods of investment we will find the government solving two problems. It not only reduces its share of investment in manufacturing sector to promote substitution of public sector by the private sector but also enhances the complementarity factor which eases the entry of private sector.

REFERENCES
R. NAGRAJ: PUBLIC SECTOR PERFORMANCE SINCE 1950 A FRESH LOOK(1993) SUDIP CHAUDHRI: PUBLIC SECTOR AND PRIVATE USES (1994) RBI: HANDBOOK OF STATISTICS ON INDIAN ECONOMY 2009-2010 AND CENTAL STATISTICAL ORGANISATION JOSEPH STIGLITZ: ECONOMICS OF PUBLIC SECTOR

MISHRA AND PURI: INDIAN ECONOMY(1999) BALBIR SAHNI: SAVINGS AND EONOMIC DEVELPOMENT (1967)