Public sector reform: International experience

Successful reformers hardened budgets by reducing or eliminating direct subsidies, putting access to credit on a more commercial basis, strengthening regulation of PSE monopoly prices, and reducing or eliminating hidden subsidies.

ECONOMISTS HAVE generally held the view that private ownership of the means of production would be better in terms of economic efficiency than public ownership and public management.

Public ownership owed its origin to the phenomenon of widespread marked failure in industries in which competition is impossible or undesirable, or where major externalities exist.

Following the Second World War, the British Labour Government launched widespread social reform programme, namely, free health scheme under the National Health Service, universal unemployment insurance and free education and also proceeded with nationalisation of core industries such as coal mines, iron and steel, electricity and gas, ports and shipbuilding.

This set the stage for public sector enterprises. Not to be outdone, the French Government outlined a new economic programme which provided for three distinct sectors _ private sector, controlled sector and the nationalised sector. Here, public utilities communications, airlines, automobiles and banks were either nationalised or maintained under majority State ownership and control. By the early Fifties, policymakers believed that governments needed to intervene in various spheres of economic life.

The primary reasons for State intervention in developing countries, namely, market failure and equity-cum-income distribution considerations were soon supplemented by many others, such as lack of private entrepreneurship, managerial cadre, regional imbalance in industrial development, national security, and employment generation.

A common feature in almost all developing and many developed nations was that government's involvement in the economy was equated to ownership and control of the means of production and distribution, Thus, nations that eventually developed large public sectors refused to consider the possibility that social welfare objectives could be just as well achieved by private ownership coupled with appropriate regulation and tax measures.

It was then believed that State ownership would result in enhanced efficiency of these enterprises which would outperform those run by profit seeking private entrepreneurs.

By the Eighties, however, public sector enterprises were performing considerably worse than private enterprises, except where, as a result of deliberate government policy, they were monopolies, or where entry restrictions, high tariffs and quotas existed. The quality and quantity of output and sales revenues of most public sector companies were found to be consistently below targets, unit fixed as well as variable costs were often much higher than those in comparable private companies, and the quantum of budget support and various price subsidies needed to finance such enterprises began to rise alarmingly.

Soft budgets exacerbated the inherent inefficiencies of public sector companies. These problems became all the more serious because poorly performing public sector companies sucked out resources that were urgently needed for meeting more fundamental economic and social wants.

The fiscal and financial problems of many countries after the second oil shock of 1979 forced governments to refocus on their public sector enterprises (PSEs). They were forced to address the following issues: Could PSEs be reformed and made more accountable to market discipline without dilution of state ownership?; whether ownership per se was a critical factor in relatively poor performance?; Was there something intrinsic in government ownership that created poor incentives for managers and workers, reduced the efficacy of monitoring and altered the rules of governance resulting in lower corporate value?

The first question led to attempts to maintain the public sector with greater autonomy, less ministerial interference and more weightage being given to profitability and management by objectives through the memorandum of understanding.

In less than a decade, it became amply clear that experiments with government ownership and greater autonomy was at best a half way house. PSEs did not have the incentive structure to differentiate between rents that are necessary to promote efficiency and those which merely reward unproductive rent-seeking activities.

In trying to promote the former and limit the latter, these companies merely succeeded in creating a milieu for static and dynamic inefficiencies. Thus, France, which is well-known for its statism, has been forced to resort to privatisation of its public enterprises. Similarly, Italy, known for its preference to State ownership, is also gradually coming to realise that privatisation of the public enterprises would be a better bet. So is the case with Germany, another believer in the efficiency of the State. China too, has now embarked on massive privatisation of its public enterprises.

The second issue, whether State ownership is critical to efficiency has resulted in disinvestments, privatisation and dismantling of large segments of the public sector. This is particularly true of the U.K., Mexico, Chile, Argentina, Poland, the Czech Republic and others. The question, therefore, is what makes for success in public sector reform?

Successful reformers introduced more competition by liberalising trade, easing restrictions on entry, and unbundling of large enterprises. Then they disinvested many of their public sector enterprises in competitive sectors, reducing the risk that government, under political pressure, subsidises the public sector enterprises to help them cope with private companies.

Competitive pressures only improve performance if PSEs face hard budgets. So successful reformers also hardened budgets by reducing or eliminating direct subsidies, putting access to credit on a more commercial basis, strengthening regulation of PSE monopoly prices, and reducing or eliminating hidden subsidies. To ensure that PSEs could not get easy access to credit, successful reformers also reformed the financial sector by strengthening supervision and regulation, relaxing controls over interest rates, and reducing direct credit. They also relaxed entry restrictions and privatised banks once the reform of the SOEs were well under way. Most of them also increased managerial autonomy and signed explicity performance agreements.

The Government's credibility is also necessary for successful PSE reform. Governments that announce economic reforms are expected to keep their promises; they should be able to withstand opposition to policy changes; and they should submit to international restraints such as treaties or covenants which make it costly to overturn reforms.

Public sector reforms cannot be viewed in isolation; they have to be part of the whole gamut of economic reform.

It has been observed that many countries start on public sector reform with good intentions, but do not continue on that path for long.

G. Ganesh

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