GS Paper: GS3-12.Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth

Context

There is a consensus that privatization is the panacea. Policymakers often cite the private sector’s ability to grow faster. This may not always be true.

Meaning of Privatisation

It means the transfer of ownership, management, and control of the public sector enterprises to the private sector. India adopted a mixed economy model, where the Public Sector Enterprises (PSEs) were established on a socialistic pattern of development. However, due to the poor performance of several PSEs and the consequent huge fiscal deficits, privatization was pursued. 

Privatization can suggest several things-

• Migration of something from the public sector to the private sector.
• It is also used as a metonym for deregulation when a massively regulated private firm or industry becomes less organized.
• Government services and operations may also be (denationalised) privatised. In these circumstances, private entities are tasked with the application of government plans or the execution of government assistance that had earlier been the vision of state-run companies. Some instances involve law enforcement, revenue collection, and prison management.
• Privatization of the public sector companies by selling off parts of the equity of PSEs to the public is known as disinvestment.

Is privatization a solution?

• No significant difference in performance: Studies indicate that the gap in growth (and service) between public sector undertakings (PSUs) with autonomy and private firms is not significant.
• Experience of the privatization in the UK: One study highlighted that the famed British privatization initiative of British Airways, British Gas, and the Railways led to no systemic difference in performance.
• Evidence on performance after privatization is even more mixed in developing countries.
• Multiple factors: Growth post-privatization is often due to multiple factors, for example, better funding under a private promoter versus a starved government budget, a better business cycle.

Failure of Privatisation

• Privatization as a revenue source:  As a state, we have sought to hock our generational wealth in PSUs for the past two decades, with limited success.
• Failure to raise funds: Actual receipts from disinvestment have always fallen significantly short of targets.
• In total, between FY11 and FY21, about ₹5 lakh crore was raised (that is, about 33% of just FY22’s projected fiscal deficit (PRS India, 2021) – some of this, notably through stake sale to other PSUs.
• Considering social and institutional constraints, it is a slow process. For instance, BPCL’s long-awaited journey.

Challenges

• Challenge of valuation: For instance, about 65% of about 300 national highway projects have been recording significant toll collection growth; any valuations of such assets will need to ensure they capture potential growth in toll revenue, as NHAI’s highway expansion bears fruit and the economy recovers.
• Social consequences: There were about 348 CPSUs in existence in 2018, with a total investment of ₹16.4 trillion and about 10.3 lakh employees in Central Public Sector Enterprises (in 2019). Push for massive privatization resulting in mass layoffs in a period of low job creation.
• Concentration of wealth: A greater concentration of public assets in select private hands is also a medium-term concern. About 70% of all profits generated in the corporate sector in FY20 were with just 20 firms.
• Across sectors, a whiff of oligopoly is emerging – cigarettes continue to be dominated by a single player, paints have one entity with ~40% in FY21, airports now have a new operator with about six airports plus a 74% stake in Mumbai’s international airport, while telecom has just three players left.
• Such concentration, mixed with the privatization of public assets, is likely to lead to higher usage fees (already being seen in telecom) and inflation, coupled with a loss of strategic control.

Way forward

• Outright privatization is not a solution: Selective PSU Reform must be considered.
• The Maruti model is instructive – the government had a joint venture with the Suzuki Corporation, but ceded control, despite Suzuki having only 26% shareholding, in return for a push by Suzuki for greater exports from India and manufacture of global models in India
• Stake sale route: Empirical evidence highlights that stake sales are considered a preferred route (about 67% of all PSUs sales in about 108 countries between 1977 and 2000 were conducted via this route), as it gives time to ensure price discovery, allowing improved performance to raise valuations over time.
• Global Experience: In China, for the past few decades, growth has been led by corporatized PSUs, all of them held under a holding company (SASAC), which promotes better governance, appoints leadership, and executes mergers and acquisitions.
• In Singapore, the Ministry of Finance focuses on policymaking, while the holding firm is focused on corporatizing and expanding its PSUs on a global scale.
• PSUs with greater autonomy, with the government retaining control via a holding firm, can also be subject to the right incentives.

Conclusion

The time has come to take a relook at privatization. Simply pursuing this path, while utilizing such proceeds for loan write-offs or populist giveaways in the election cycle will not do.

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Context

Consumer goods distributors in Maharashtra has been protesting against Colgate’s alleged unfair treatment of traditional distributors vis-à-vis B2B (Business-to-Business) technology companies such as Reliance’s JioMart, Udaan and others.

The disruption caused by B2B companies

• Nearly half-a-million of India’s distributors pick up goods from consumer companies such as Colgate and deliver them to 13 million small local stores located in 7,00,000 villages and towns across the country through a web of millions of traders and other intermediaries.
• Enter the new age technology B2B companies.
• They have developed technologies to connect directly to the kirana store through a mobile phone app, bypassing the intermediaries.
• They supply goods to the local store for lower prices than the charged by the distributor.
• Unable to match such prices and facing the peril of losing business, India’s distributors claim these are unfair practices and want manufacturers such as to stop supplying goods to the technology companies.

Issue of disruption caused by the pricing power and predatory pricing

• Creative destruction: New innovations disrupting an existing process and rendering incumbents futile is generally a healthy process of ‘creative destruction’, as the Austrian economist, Joseph Schumpeter, postulated.
• But this disruption in India is driven not entirely by technology innovation but also through pricing power.
• These technology companies bear the loss on the products they sell to the local store.
• Further, they offer extensive credit terms and working capital to the local stores.
• In other words, these technology companies rely not just on their mobile phone app innovation but also steep price discounting and cheaper financing to win customers.
• Evidently, these companies use the money to not only build new technologies but also to undercut competitors and steal market share. 
• This practice, called predatory pricing, is illegal in most countries including India.
• These companies are supplied with funds from foreign venture capital firms, which in turn are largely funded by American pension funds and university endowments.
• The flip side is that India’s millions of distributors and intermediaries have no access to such finance.
• These small companies are cut off from the endless stream of free foreign money that gushes into new age ‘startups’ and established large corporates.

Problems created by predatory pricing

• While consumers may benefit from lower prices, the livelihoods of millions of distributors, traders and their families suffer.
• To be sure, this is not just an India problem but a global one.
•  Social media companies such as Facebook give away their products for free and e-commerce companies such as Amazon sell at lower prices, benefiting consumers enormously, but also causing immense social strife and disharmony.
• But in India’s case, there is an added complexity of foreign capital flows.
• Access to this capital is only available to a tiny proportion of Indian businesses but threatens the livelihoods of millions of Indian families, as in the case of distributors, causing massive income and social disparities.
• This unequal access to capital creates leads to anti-competitive behaviour.

Consider the question “What is predatory pricing? What are the issues created by predatory pricing?”

Conclusion

To be clear, this is not a Luddite argument against e-commerce or technological innovations. The issue is about illegal predatory pricing and abuse of pricing power by startups and big corporates through preferential access to easy foreign money.

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