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A number of major policy initiatives toward public enterprises are being pushed vigorously by the government.

Phrases like "MOUs" ''holding companies" and "privatisation" have become a part of the current economic

jargon. A closer examination reveals that they have spawned out of a common sourcethe Arjun Sengupta Reporton Public Enterprises. Yet, this Report has never been subjected to any debate. Primarily, because it has not yet

been made public by the government. The present critique is based on an unauthorised publication of this Report.

The author finds that it contains some excellent ideas; however, (hey are too few in number and the manner of

presentation obscures their importance. This paper analyses each section of the Report to see the contradictions

involved and the linkages between various issues. It singles out two recommendations for immediate implementa

tion. First, the information base regarding public enterprises should be strengthened by installing an information

system. Second, a system of performance evaluation, based on clear targets and linked to an incentive system

should be implemented.

IN the recently concluded InternationalCongress of Public Enterprises (January20-22),1 it was apparent that neither the

public enterprise (PE) managers nor thegovernment policy makers had a clear picture of the government's policy towards thiscrucial sector of our economy. Consequently, the debates had no focus and the participants simply made speeches on a varietyof topics such as the memorandum ofunderstanding (MOU), the number ofgovernment directors on the board of publicenterprises, etc If there was a common bondlinking these topics, it was provided by thefact that they had all spawned from the samesource: the report of the Arjun SenguptaCommittee to Review Policy for Public

Enterprises.Realising the critical role assigned to thepublic sector in the mobilisation of resourcesfor the Seventh Plan,

2the government of

Indi a decided to set up a high-level commi ttee to review and suggest policies for improving the performance of public enterprises.This Committee , headed by Ar ju n Sengupta,then special secretary to the prime minister,was set up in September 1984, just sixmonths before the start of the Seventh Plan.It is to the credit of this Committee that theyfinished their work on time by the end ofDecember 1984. It is to the discredit of thegovernment that this report was neither

placed before the parliament nor releaseddirectly for public debate. It was eventuallymade public by Mainstream (June 21, 1986)after a period of a year and a half. One ofthe cardinal principles of policy-making isthat unless a public policy is publiclydebated, public interest is likely to suffer.The Sengupta Report is a classic example ofthis principle in action.

The purpose of this paper is to providea comprehensive critique of this Report.There are two ways of organising an analysisof this sort. Either, one can divide the discussion under various conceptual categories, or,

use the same categories found in the originaldocument. In this paper, we have opted forthe latter approach.

Such a discussion, however, could easily

suffer from the same major problem associated with the original Sengupta Report-lack of prioritisation. If one were responsi

ble for implementing the recommendationsof the Sengupta Committee, it would be difficult to know where to begin. Therefore, itcomes as no surprise that two years after thesubmission of the Report, there has been

'hardly any action taken on its recommendations.

3To avoid similar problems, we will

begin by providing a central focus aroundwhich our arguments will be organised.

It 1 had to summarise my evaluation ofthis Report, I would argue that in general,the Sengupta Committee failed todistinguish causes from effects of the fundamental problems of contemporary publicenterprises in India. Further, it also failedto prioritise causes. Consequently, theyemerged with a long list of sixty-nine recommendations to cure both causes as well aseffects. It is little wonder, then, that publicenterprise reform has proved to be such anoverwhelming task.

In this paper, we will show that the twomost important recommendations of theSengupta Report are as follows:

a) The performance of a chief executiveof a public enterprise should be evaluatedon the basis of an agreed set of clear targets(Recommendation number 10.34; see also,para 4.39).

b) An appropriate information systemcapable of monitoring pub lic enterprise performance in terms of these targets shouldbe developed (Recommendation number10.48; see also, para 5.17).

All other recommendations are linked inone way or another to the above. Some ofthem follow logical ly as obvious corollaries,while others represent prerequisites for implementing the above-mentioned recommendations. In other words, these recommendations represent the heart of the Report; allother recommendations represent either forward or backward linkages. The failure to

recognise these conceptual relationshipsleads to much fuzziness in the body of theReport. However, let us begin from thebeginning.

The Sengupta Report starts with theusual mandatory letter of submission and.acknowledgements. The most curious aspect

of this section is the conspicuous absenceof academics from the list of persons consulted for this Report. There are two possibilities. Either academicians were too busy tospare their time for this committee or thecommittee could not find any qualified

academicians. Unfortunately, 1 am unableto accept either of these reasons and theReport does not provide clarification on thismatter.

The introductory section has the objectiveof establishing the importance of this Reportor just ifying this exercise. It tries to do soby attempting to establish two facts. First,

it tries to show the importance of the roleplayed by public enterprises in the Indianeconomy. Second, it attempts to show thatthe performance of the public enterpriseshas been very poor.

Roth of these issues are widely believedto be true, and hardly require a major effort. However, i f a high-level committee suchas this one decides to address them, oneexpects a much higher level of introspectionand analysis of these popular perceptions.Unfortunately, the Committee disappointsus even in this introductory section, whichshould have been rather straight forward .4

This section starts by tracing the very

familia r story of the growth of public enterprises in India by reproducing well knowndata on the subject. However, the storyends abruptly in 1983-84, when the capitalemployed in public enterprises stood atRs. 32,202 crore, with a turnover of Rs 46,777crore and employment exceeding 2 millionworkers. The real challenge was to predictthe future of this sector. Will it continue toplay a similar role or will it be phased out?Or, perhaps, can it be phased out? Shouldit be phased out?

These are not rhetorical questions designed for promoting a polemical debate. Public

policies have to be structured very differentlyif the thrust of the government is towards"priv atis atio n" (euphemistically referred toas "rationalisation" by international agen-

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cies). The Committee deals with this issuein a cowardly fashion by hiding it in anobscure corner of the Report (para 7,4). Aless timid stance in this section would havegone a long way in clearing the currentdoubts about the government's intentionstowards the issue of privatisation. Since the

prime'minister has mentioned the Report approvingly more than once in the course ofhis interviews, these questions have acquiredreal significance.

The assertion of the poor performance ofpublic enterprises also betrays a carelessnessin developing the argument. The onlyevidence cited is in terms of the financialprofitability of public enterprises. TheReport argues that the Sixth Plan target of10 per cent profitability ratio in constantprices was not met by the public sector.

This reasoning is surprising in view of thefact that because the Committee quotes the

Industr ial Policy Resolution of 1956 to suggest that public enterprises should be judgedby their "total results", and yet the Committee goes on to ignore this aspect of publicenterprise performance. At one point (para1.2), it commends the achievement of publicenterprises, "in terms of their contributionto the quantitative targets of production, tothe establishment of a modern industrialstructure, to balanced regional developmentand to the formation of technological skills"Surely, these must be considered when passing any judgment on public enterprise performance Unless, of course, these goals weregiven a small weight in the aggregate index

of targets. If so, who decided to give themthese small weights? The above-mentionedtasks ate absolutely critical for a developing nation in its ini tia l stages of growth. Ifanything, they should be given greater weightthan financial profitability.

I am not trying to defend or condone thepoor financial pr ofit abil ity of public enterprises. Rather, 1 am merely, highlighting atypical problem with such analyses of publicenterprises, often found in popular journalism. Instead of rising above this trap, theCommittee succumbed to it. Curiously, theCommittee criticises the government for a

similar failure. "While public enterpriseswere to be judged by their total results' themonitoring and evaluation system of thegovernment has not been adequate to thetask" (para 1.5).

The Report claims that the financial profitability of public enterprises has declinedcontinuously in constant prices. This goesagainst its own indictment of the government for the failure to have an adequateinformation or evaluation system. Who isresponsible for these constant price calculations? Proper constant price proceduresrequire information on the price-quantitybreak down of value figures in'the financial

statements. Any other method has to be avery crude alternative.

Why should the fact that public enter

prises failed to meet the target of 10 per cent

profi tabil ity during the Sixth Plan be considered an indictment of their performance?Rather, it could be a reflection of the naiveteof the planners. D id the Committee examinethe assumptions and procedures for settingsuch targets in the Sixth Plan? It is entirelypossible that even if our public enterprises

were doing infinitely better than the situation today, some enthusiastic planner mightset an unrealistically high target and make thepublic sector look bad. An equal amount ofattention should be given to this target-settingprocedure in the Planning Commission.

Those who have studied the literature onpublic enterprise performance evaluation,consider it to be self evident that "financialprofits" do not have a one-to-one relationship with "managerial performance". Thistopic has been dealt with extensively inseveral places [Sen, 1971; Jones, 1979;Trivedi, 1986b]. Hence, I will merely give a

quick example to illustrate one class of problems with financial profitability as ameasure of public enterprise performance.Financial profitability looks at costs andbenefits from a private individual's point ofview. Therefore, an increase in taxes leadsto lower profits and a lower level of indi

vidual welfare. However, an increase in taxesdoes not change the total welfare of society.From society's point of view, this is simplya transfer of welfare from one party toanother. It is a re-d istribut ion of welfare, nota reduction of welfare. It is quite possiblethat the decline in profits of public enter

prises may have resulted from an increasein the tax burden. Similarly, there are manyother instances where "public" and "private"costs and benefits differ. Unless the Committee has already examined all such factors,its assertions about public enterprise performances should be treated as very tenuous atbest.

Finally, the failure to meet plan targets ishardly the crime of the century. All sectorshabitually and regularly fail to meet variousplan targets: The private sector, for instance,has been criticised for its lack of importsubstitution and employment generation.The point is not that it is alright to ignoreplan targets; however, failure to meet-thesetargets, in itself, does not necessarily makeone sector worse than all others as suggestedby the Committee. In fact, the PlanningCommission does not meet its own targetssometimes. Remember the days of "RollingPlans" and "Plan Holidays" when the concept of five-year plans was it self in jeopardyfor a while.

It is clear that the various points discussed thus far lead us to a common source oftroubles regarding the above confusion: lackof clarity of and the goals of public enterprises as well as inadequate info rmation andmon itor ing capabilities of the government.While the Committee staggers its waythrough the issues discussed above, it is toits credit that it recognises the need for

reform in these areas (as mentioned at thebeginning of the paper).

P UB L I C E NT E RP RISE AN D NAT IO NAL

P L A N N I N G

In the next section of the Report following

the introduction, the relationship betweenpublic enterprises and nat ional planning ishighlighted. One can hardly argue withaxiomatic statements like the following:"public enterprises in India have to functionwithin the framework of planning and, inmany areas, they are in effect the principalinstruments for the realisation of plan ob

jec tives" (para 2.1). I must object however,to harping on the time worn cliches like "thecentral issue is to find the right balancebetween autonomy and accountability"(para 2.6). This is a dead issue in theliterature on the subject. This trade-off between autonomy and accountability hauntsus only as long as we talk about the "quantity of controls" and not the "quality ofcontrols".

To see this we have to realise that, broadly.speaking, there are basically two ways ofcontrolling an enterprise. One can, either,hold an enterprise responsible for results(also known as Management by Objectives).Or, where goals are difficult to specify, onecan control the enterprise by controlling procedures and processes.

The latter is achieved by laying downdetailed rules and procedures for monitoring. This requires a great deal of interven

tion in the operations of the enterpriseand, hence, leads to allegations of lack ofautonomy. However, when autonomy isgranted it is often abused as the goals arenot clear. That is, accountability suffers.Which, in turn, invites a cut-back in autonomy and takes the enterprise to "squareone", i e, less autonomy but more accountability. This classic "autonomy pendulum"can be observed in public sectors all over theworld since most governments find it hardto specify goals. The situation in India is,therefore, not unique.

However, one need not be trapped, ad

infinitum, in this pendulum. If one canimprove the "quality of control" by specifying goals and objectives clearly anddeveloping performance information andevaluation systems to monitor public enterprises, this dilemma would disappear.

Another example of the Committee'sobsession wit h secondary issues is its attemptto produce yet another classification ofpublic enterprises. The Committee claimsthat from the point of view of planning andbudgetary management, public enterprisesmay be grouped as follows (para 2,5);

(a) Enterprises operating in the core sector.5

(b) Financially viable enterprises in the

non-core sector, and(c) Enterprises in the non-core sector in

curring losses.It is easy to see that this classification can-

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not be justified on the basis of either theplanning or budget management compulsions. In para 2.1, the Committee argues that"public enterprises are not islands untothemselves and the decision taken by oneenterprise affects the fortunes of others".Therefore, whi le the core sector is certainlycritical for other sectors, it is equally truethat other sectors may also be critical for thecore sector. For example, coal in the core sector is absolutely critical for cement in thenon-core sector (these categories are basedon the Report, para 2.3). Cement bottlenecks, however, can be devastating for mostcore sector-industries including coal. Thatis, a non-core sector product that affects acore sector product can acquire an equalstatus and thus blur the distinction proposed by the Committee.

Similarly, from the point of view ofbudget management, the distinc tion betweenviable and loss-making non-core sector

enterprises is equally spurious, Why shouldthis distinction be confinedto the non-coresector? From the budgetary managementpoint-of-view, profits and losses in all sectors are of interest. Further, there is no financial caste system operating in the publicsector. In other words, it is not divinelyordained that certain enterprises once bornin the loss making sub-caste of the non-coresector will be branded as such for, at least,this life on earth. Financial viability is notan absolute concept. Today's loss makersmay be tomorrow's success stones and viceversa. This is true regardless of the sector

to which one belongs.Another major source of confusion and

contradiction is presented in para 2.1 of theReport. It is argued that the relationship between the government and public enterprisescannot be reduced to the usual annualinteraction between shareholders and cor-porate management. A more active interaction between them is unavoidable in thecritical areas like investment priorities andformulation of large projects.

This argument exemplifies a conceptualconfusion spread, throughout the Report.The study of public enterprises can be div id

ed for analytic purposes into three areas:a) Investment decision, b) Pricing policy,c) Performance Evalu ation. 6 Investmentdecision deals wi th wh ethero r not to set upa given enterprise or undertake a given pro

jec t. However, once an enterprise is created,the next issue becomes what price to chargefor its products and services. Finally, performance evaluation tries to judge the performance of a public enterprise managerwith a given stock of capital (investmentdecision) and a given set of prices (pricing.decision).

7

The most common source of confusionarises when commentators mix these threeareas. In para 2.1, also, investment decisionhas been dragged in while discussing performance evaluation. A great deal of interactionmay be required before an enterprise or pro-.

ject is set up. Once it comes in to existence,though, there is no reason why the "usualannual interaction" cannot be a feasiblepolicy. That is, there is no reason why thegovernment can specify goals of the enterprise at the beginning of the year and holdit responsible by evaluating enterprise performance at the end of the year.

Indeed, para 2.1 contradicts another partof the Reportpara 3.10. Since the latter is,in my view, the very heart of any prospective solut ion that is likely to emerge, I wou ldlike to quote it at length:

In our approach government should beprimarily concerned with overall strategicplanning and policy rather than with day-today functioning of the public enterprises.Once the goals have been mutually agreedto, the enterprises should be allowed tooperate without further interventions by thegovernment in day-to-day functioning. Theenterprises should, however, be held strictly

accountable for their performance in relationto the goals set and there should be an appropriate mechanism for evaluation of theirperformance.

This para clearly reiterates many of thepoints we have already made In particular, itargues for a "management by objective" typeapproach, which is to be accomplished byincreasing the quali ty of controls and reducingthe quantity. The trouble is, paragraphs containing such bright gems are scattered sparselyin the marshlands of the eternal conceptualfog of the Report. As a result, only a determined adventurer can retrieve them.

ORGANISATIONAL STRUCTURE OF PUBLIC

ENTERPRISES

The Report, also, fails to capitalise on certain useful ideas within its pages by failingto relate them to other aspects discussed inthe Report. Section I I I is a good case inpoint. It starts by arguing that because ofthe parliamentary form of government, ourpublic enterprises cannot be free fromgovernmental scrutiny of their generalpolicies as well as some aspects of their day-to-day operations. It goes on to suggest thatsince Parliament's authority in such mattersis supreme, it may be necessary to evolve aconvention by which members of parliamentaccept some self-imposed restraints on thenature of the questions they ask.

Instead of taking the parliamentary intervention as a given fact, if the Committee hadexplored the reasons for it, this recommendation would not have been necessary. In myview, the main reason everyone feels free tointerfere with public enterprises is becausetheir goals are not clear, nor is it clear whois thei r real master- enterprises areknown to have multiple goals, which areoften contradictory, and mult iple principalswith different and often conflict ing perspec

tives. As a result, each principal , parliamentbeing one of them, feels entitled to push itsown favourite goals for a public enterprise.However once the management by objective

(MBO) type approach with clear targets isaccepted, the scope for unwarranted intervention will be greatly reduced, if not

eliminated altogether.

The Committee's suggestion of "evolving"a parliamentary convention for non-intervention is far-fetched and appears to be

pol itical ly naive. How do you "evolve" conventions? By defini tion , the term "evolve"implies an automic and gradual self-development. It could take ages for the complete realisation of this pipe-dream. Thereason why this is a non-starter is the samereason why. we have opted for a plannedeconomic development rather than let thefree market take its time to bring about thesame results.

Even in a politically mature parliamentarydemocracy like the United Kingdom (werethey do not even have a writ ten consti tuti onand conventions rule the roost), they foundit necessary to pass the "Self-DenyingOrdinance" which limit s governmental meddling by law and not by conventions. Theabsence of politicians on the Sengupta Committee as well as the list of people interviewed, may, perhaps, explain why suchrecommendations managed to slip into theReport.

All of this confusion pales in comparisonto the problems associated with the Committee's proposal to form holding companies. The committee argues that the onlyway to reduce governmental intervention inthe day-to-day operations of the enterprisesis to create a holding company in between

these two groups. Thus, the administrativeresponsibility in respect of indiv idual companies will be that of the holding companyand, thereby, elim inat ing government's day-to-day contact with the enterprise.

It is surprising that the Committee makesonly a passing reference to the fact that th isconcept has been tried in many Europeancountries. Further, it does not say whetherthese experiments have been successful ornot. The most widely cited example of theholding company concept is that of the IR Iin Italy. To the best of my knowledge theIta lian public enterprises are not consideredto be examples of excellence. Why did notthe Committee look for examples fromdeveloping nations, where circumstances arecloser to the prevailing conditions in India?It would not have had to look very far. Ourneighbour to the west, Pakistan, tried the"holding company" experiment by formingthe "Bureau of Industrial Management"and, subsequently, abandoned it. Why goeven that far? The Committee's total omission of our not so successful attempts atholding companies in India in the steel andcoal sectors are also inexplicable. At the veryminimum, by discussing the reasons for thetroubles with these holding companies and

the Committee's suggestions to overcomethem would have shown that the Committee had given adequate thought to thismatter.

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Any serious report would have alsodiscussed the pros and cons of their modelsof managing the government-public enterprise interface. The onus of burden lies withthe Committee to explain why the conceptof "holding company" has not caught onike wild fire among the nations of theworld, in spite of such a sound theoreticalbasis claimed by them on behalf of thisconcept.

Attempts to form holding companies bymerging public enterprises in the same sector, tends to also contradict another majorpolicy thrust of the govermentindustrialliberalisat ion. These monstrous giants wouldgang up on whatever competition theremight be from the private sector. Further,the "healthy" effects of competition betweenpublic enterprises would also be lost. Theabove statement derives its legitimacyfrom research findings that efficiency is promoted not by having a particular type of

ownershippublic or privatebut by theexistence of competition [Jones andVogelsang, 1982; But terworth, 1987]. Privatemonopolies can be as inefficient as publicones. However, the situation of mostdeveloping nations like India is that in manyof our crucial sectors only public enterprisewill or can exist. Hence, they only feasiblesource of competitive pressure is inter-publicenterprise competition. The sectoral holdingcompany concept seems to undermine thispossibility.

The mega-conglomerates created by merging huge public enterprises would pose

another problem. It would promote excessiveautonomy since the enterprises would bevery powerful in comparison to contr olli ngauthorities. Any country'that ignores thelessons from the experience of Pertamina inIndonesia, is likely to have serious regrets.This mega-company became a nationwithin a nation and went into an uncontrollable binge of expansion and acquisitions. Through unwise investment decisions,it held the destiny of the entire nation at ransom. There are numerous examples, such asthese, from all around the world, where thechief executives of such huge enterpriseshave eventually become more powerful than

.the ministers above him. At one point(para 3.20), the Report docs point out thepossibility of having "too large" a holdingcompany. However, it docs not tell us howlarge is too large.

In fact, by putting loss making units underthe profitable ones one may jeopardise theperformance of the latter in two ways. Oneis, of course, the genuine burden of supporting a loss maker. Second, by providing aconvenient excuse or scapegoat, the government may tempt the successful enterprisesinto complacency. If things go wrong in thefuture, the profi table enterprise has a readily

available excuse to shirk its responsibility.In short, the Committee's advocacy of this

concept of the holding company, again,betrays the confusion between cause and ef-

somehow, prush the unpleasant tacts underthe rug and stall. In time, a new minister willcome and expose the mess and call for the .setting up of yet another committee. Thisscenario will not materialise, if the dirt underthe carpet becomes unmanageable and isexposed willy-n illy . By the time this happens,one can be rest assured that the mess willbe of scandalous proportions and, perhaps,only divine intervention could save the

situation.Finally, given the limited availability of

technical manpower required for publicpolicy formulation and implementation, thechoice is quite clear. Either one can utilisescarce resources for the cosmetic exercise ofmerging and de-merging enterprises to formholding companies and weather the stormscreated in the process of upsetting the givenstructures. Or, one can use them for settingappropriate goals for public enterprises inthe existing structure and develop a reliableinformation system to monitor and evaluatetheir performance. In my opinion, the realbattles have to be fought and won on the lat

ter front.Section III of the Report contains two

more controversial recommendationsoneregarding the government directors on theboards of public enterprises and the other,regarding the memorandum of undcr-stading. The common problem in bothinstances relates to what the Report does notsay about these issues rather than what itdoes.

For example, if one reads para 3.19 of theReport, one gets the impression that theissue of government directors is fairlystraightforward and not very contentious.

The Committee takes note of the suggestionmade by some groups that there is no need

forrepresentation of the government on theboard of directors of public enterprises, but,

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feet. A l l of these changes suggested by theCommittee address only the effect, leavingthe cause untouched. The problem ofgovernmental intervention arises becausethere is a non-congruence of goals. The chiefexecutives of public enterprises have onenotion of the mission of their enterprises,the government, another. Thus, even whenboth parties are well-meaning, there is boundto be friction which, of course, becomes

worse when one of the parties becomestainted with lack of sincerity. Having aholding company will not eliminate thedivergence between the perspectives of thetwo parties. Hence, intervention by thegovernment in the day-to-day affairs of theenterprise will continue. Once clear-cut goalsare set and agreed upon by all parlies,however, much of this friction will disappear.

The Committee recommends (para 3.24)that the concerned ministries should evaluatethe performance of holding companiesunder them. There is convincing evidencethat such a model of performance evaluation does not work very well [Young, 1986;Mehdi, 1985]. Serious and credible performance evaluation is a di ffi cult j ob and hassubstantial economics of scale associatedwith it . It is much better to have it centralisedthan decentralised.

Further, as I have argued elsewhere[Tr ived i, 1985a], ultimate ly it is the primeminister who is accountable to the peoplefor his government's performance. There isoften a frequent shifting of ministers fromone department to another under the sameprime minister. Therfore, the minister in-chargc of a technical ministry will neverquite reveal to the prime minister the serious

ness of failure on the part of a public enterprise under him , even if he is fu lly aware ofit. To do so would also reflect on hisown performance. His attempt will be to,


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recommends that this practice should continue nevertheless. They argue that government directors are generally a posit ive sourceof help and mediation betweeen the government and the enterprises. However, if onehad listened to the four to five hundred topmanagers and chief executives gathered forthe International Congress of Public Enterprises in Delhi, one would get a very different picture.

There were three categories of opinionsexpressed at this conference. The overwhelming sentiment seemed to be thatgovernment directors were a definite sourceof nuisance and obstruction in the conductof business and ought to be done away with.The second group argued that while government directors may be a potential source ofconflict, they can be taken care of, if handledwith tact. Some chief executives even bragged about their ability to manipulate and con-trot government directors. Finally, there were

some who argued for the presence of at leastone government director since the government as the owner had the right to have itsrepresentative on the board of directors. Inany event, it is clear that no one was arguing for the Committee's position that government directors were a source of positive help.The closest they came to the Committee'sposition was in implying that governmentdirectors are a necessary evil that can hemanipulated by a skilled chief executive.

The Report does not help in buildingthe Committee's case, Later in the samepara (3.9), they recommend that the sub

sidiaries of the holding company need nothave government directors on the boards.This seems to contradict their own line ofreasoning. If government directors are apositive source of help and me diat ion, whatis the harm in also having them on theboards of subsidiaries as well They shouldnot be there only if the committee felt thatthey are a problem. If so, why was that issuebrushed aside.

in my view, however, the conflict with

government directors is merely a symptom,not the cause of public sector woes. The problem, again, is the non-congruence of goals

of government directors and chief-executives.It is fair to say that most government directors are well meaning individuals trying todo their job as besi as they can. That is, toprotect and promote the interest of thegovernment as the shareholder. Similarly,most of the chief executives are honourableand able people trying to promote theinterests of their respective companies. Mostproblems arise because, often, these twoview-points do not coincide. This is, then,the real problem. Once goats are clearlydetermined and agreed upon by the government and the enterprise, these conflicts arelikely to become a non-issue. Conversely, so

along as the fundamental problem of non-convergence of goals remains unsolved,all other changes will be tantamount tocosmetic surgery to hide systemic problems.

The fina l controversy in section I I I of theReport relates to the proposals for the"Memorandum of Understanding (M OU )"The MOUs are the latest buzz-word in policymaking circles. The prime minister has putthe weight of his personality and officebehind it. The impression is being createdthat they will , finally, salvage the public sec-tor in India. Most reports implicate theSengupta Committee for spawning this-"b ril li an t" idea. Therefore, it is truly surprising to find that in the Report there is onlyone substantive para (3.23) on the topic ofthe MOUs.

The cavalier fashion in which the Committee has dealt with this issue would tendto suggest that this concept is both soundand widely known to everyone. However,even a cursory survey of public enterprisechiefs, BPE officials and technical ministries.reveals that practically everyone is in thedark about the concept, rationale and the

modus operandi of the MOUs.As a matter of fact, the concept of MOUs

is a very simple one and the Report does anadequate job of describing them (para 3.23):

The Holding Company would also specifyits plans for investments, production, capacity utilisation, dividends, etc, for a 5 yearperiod and, therefore, enter into the memorandum of understanding with the government on mutually agreed basis. Certainobligations would also be cast on theministry or department regarding provisionsof equity, price level, etc. This memorandumof understanding would be reviewed each

year and updated and the performance of theholding company judged on this basis, making due allowance for the failure or otherwise of the ministry or department to fulfilits pari of the understanding.

It is, indeed, quite unfortunate that theCommittee should choose the easiest andleast controversial aspect of MOUs forinclusion in its Report and duck the majorissues in this connection. For example, it isnot clear why MOUs cannot be implementedbetween the ministries (administrative as wellas technical) and public enterprises withinthe present structure. Is the formation of

holding companies a necessary condition forthe implementation of MOUs?The problem here is similar to that en

countered with respect to other recommendations made by the Sengupta Committee.No rationale is provided for preferring thisparticular approach. One possible reasoncould be the success of the MOU type approach elsewhere in the wor ld . As always theCommittee does not seem to have carefully(if at all) considered the internationalexperience in this regard.

All such contractual approaches arecopies of the famous French contracts between the government and public enterprises

in France. Instead of the word "copies", Iwas thinking of saying that such notionsderive their "inspiration" from French contracts. Unfortunately, there is nothing inspir

ing about the French experience. After twenty years of experimentation with this system,the French public sector had incurred arecord deficit around the same time thatSengupta and his associates were recommending this system to us in India. Therefore,it is completely understandable that theydid not want to make a reference to theEuropean experience as they did in the caseof the holding company concept.

There is a saying that goes: " I f it ain'tbroke, don't fix it ." By this crit erion too, theFrench contract system was a failure. In thespan of twenty years, they went through fourphases of such contracts: (a) Contrats deStability (b) Contrats de Programme,(c) Contrats de Enterprise, and (d) Contratsdu Plan. These contracts were abandonedfor one reason or the other [ Green, 1982].The ju ry is sti ll out for the last phase of thesecontractsContrats du Plan.

All of the above is still not enough to sug

gest that the French system of "contracts"should not be given a chance. So long astheir experiences have been carefully analysed and lessons learned from their failures,we are on a solid ground. I am merely concerned with an attempt to re-invent the"square" wheel and the potential costsassociated with such experimentation. TheCommittee gives us no reasons to help usallay our concerns in this matter.

Further, the French experience with thecontractual approach is not the only oneavailable to help us in designing our policiesfor India. Perhaps for us, the more relevant

experiences are those of Senegal, Gambia,Pakistan, Korea and Bangladesh. All ofthese countries have adopted similar contractual approaches with varying degrees ofsuccess.

The In dian government's experience withMOUs thus far shows that adequate framework was not done by the government in thisregard. It has taken the government morethan two years to come up with two complete MOUs. This information is, by necessity, based on rumours as nothing has beenmade public. While the government is dragging its feet in signing MOUs, the public sec

tor has already fallen way behind the targetsfor the current plan. At this rate, by the timethe MOUs do arrive, it may be too late forany enterprises.

Moreover, the two existing MOUs havebeen reportedly signed with chief executives, who, perhaps, require it the leastV Krishnamurthy of SAIL and S P Wahi ofONGC. These managers are reputed to beachievers and are cited as success stories. Letthe government try negotiating with someknown losers.

If this is such a major policy thrust of thegovernment, why has there been no publicdiscussion on it. Perhaps the government has

figured it all out and needs no input fromanyone. The anxiety this is creating amongchief executives is most undesirable. No oneknows what this animal called " M O U "

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really looks like, or, who will be negotiatingon behal f of the government. Some reportshave created the impression that the prime

.ministe r is direct ly involved in this process.One woul d also like to know, what the sanctions for non-fu lfill ment of the contractualterms are? Who will arbitrate in case of contractual disputes?

Some would argue that a similar system,though a less formal one, is already in operation. The technical ministries regularly meetwith public enterprises under them and tryto reach an agreement on their goals. Theminis try of programme implementation hasacquired similar experience in monitoringproject implementation. The governemntshould carefully examine these experiencesbefore plunging ahead with half-baked ideas.

In particular, two issues come to mind.First, how can the government insure thatpublic enterprises are not negotiating fordeliberately low targets so that they can look

good without much effort. This is particularly true in the absence of a goodinformation system with the government.This is the reason why the Korean government decided to have a computer basedinformation system before negotiatingdetailed targets. Their experience warrantsclose scrutiny, particularly because they arebeing marketed as a success story in thebusiness of MOUs.

Finally, one would have to be careful thatpowerful chief executives do not "get offeasily" by using their clout to negotiate lowtarget. This is the kind of trade -off that the

Committee should have examined, i c, theadvantages of a large holding company andthe disadvantage of concentrating too muchpower in the chief executives of theseenterprises.

AUTONOMY OF PUBLIC ENTERPRISES

Section IV of the Report with the autonomy of public enterprises, conceptualisedas the "quan tity of controls" . It argues thatthe original objective of providing maximumautonomy in the day-to-day management ofpublic enterprise has not been met. The main

culprits, according to the Report, are thespecific clauses in the Articles of Associations; Bureau of Public Enterprises; government guidelines and directions; the procedures followed for scru tinising investmentfunding, etc.

In bringing up these issues, the Committee is not breaking any new ground. Endlesscommittees before this one have alreadymade similar comments.8 This is not tobelittle their recommendations in these areashowever. In fact, some of their suggestionsare good and should be implemented immediately, if they have not already been implemented. An example of this class orecommendations relates to the length of thetenure of the chief executives and full-timedirectors. The Committ ee recommends thatthe tenure of chief executives and full-time

directors should be five years subject to aprobationary period of one year and removalat three months notice for unsatisfactoryperformance. The Committee is absolutelycorrect that the present practice of giving atenure of two years is undesirable; two yearsis too short a time to bring about anysubstantial changes or improvements in largeorganisations (para 4.31).

In the same section discussed above, theCommittee spends a lot of space on peripheral issues. For instance, it recommendsthat disciplinary proceedings against board-level appointees is the responsibility of thegovernment. Also, it states that the government should consult the chief executive inappoin ting part- time directors. These comments are reasonable, except that theydetract from the larger issues by clutteringthe pages of the Report.

The Committee also suggests manychanges which may be categorised as

"cosmic" because adequate justification isnot provided. For example, para 4.1 suggeststhat various limits relating to the size of pro

jects going to the Expenditure Finance Committee and the Public Investment Boardshould be raised. They may reduce the quantity of control marginally, but do notincrease the quality of control.

Further, there are recommendations thatcan only be called platitudes. For instance,para 4.40 urges the need for training andretraining of workers. It goes on to say:"Further it is desirable that each enterprisemanagement must submit to its board of

directors, once a year, a manpower budget,the training or retraining plans for allcategories of employees, particularly themanagerial cadres." It is d iff icu lt to disagreewith such banal recommendations. Thetrouble is that it does not tell us the consequences of non-compliance. Moreover, itseems ironic that while the Committeeargues against guidelines, and yet, it goes onto prescribe some fresh ones.

Finally, there are recommendations in Section IV which are simply of f the mark, pureand simple. For example, para 4.6 recommends that in the case of a financially viable

non-core sector, there is no need for detailedscrutiny of investment proposals. Thisequates financial viability with superior performance. As we know, however, that financial viability can also be due to favourablepric ing policies, among other things. In theabsence of a strong performance information system which can calculate the trend inconstant prices, this recommendation couldbe very misplaced, to say the least.

Interestingly, in other parts of the Report,the Committee shows that it is aware of theissue of constant prices. In para 4.27, itclearly states that the bonus should be linkedto an increase in productivity at constant

prices, not to financial profits and losses.This brings us to another general problemwith the Sengupta Report. There are somany inconsistencies between various parts

of the Report that an impression is createdthat it was created by slapping togetherpieces writ ten by several people who d id noteven bother to eliminate such gaping gaps.For example, the argument regarding a fiveyear tenure for a chief executive and full-timedirectors (para 4.31) could have been tied tothe MO U requirement for a five-year planin para 3.23. Similarly, there are innumerableinstances in which the MOUs would makesome of the recommendations redundant.In para 4.14, the Committee says that amechanism has to be found to compensatethe enterprise for the non-commercialburdens imposed by the government. TheCommittee overlooked the fact that the MOUis one such instrument for explicitly dealing with precisely these types of problems.

ACCOUNTABILITY OF ENTERPRISES

As mentioned earlier, there are two ways

of controlli ng an enterprise. One is by specifying targets at the beginning of the year andleaving the enterprise free to pursue these ob

jectives in their own way. On ly at the endof the year they are to be evaluated on thebasis of the agreed parameters. However, asindicated earlier, most governments find itdifficult to specify such concrete goals forpublic enterprises since these enterprises areexpected to achieve multiple goals that areoften conflicting. The situation is madeworse by the existence of multiple principles,wi th varied perspectives, tryi ng to push theirown particular goals. Therefore, most

governments settle for a policy of controlling enterprises by stipula ting operating procedures through a myriad of rules. This isviewed by most public enterprises on a "lackof autonomy".

The situation in India is similar to thestylised scenario depicted above. It followsfrom this, if we arc to increase operatingautonomy for public enterprises, accountability needs to be strengthened. Thus, Section V, which discussed these issues, isperhaps the most important section of theentire Report. For this reason it was also amajor disappointment.

This portion of the Report suffers fromevery class of problem mentioned earlier inconnection w ith other sections. First of al l,it contradicts other sections of the Report.Para 5.3 suggests that the memorandum ofunderstanding should be arrived at betweenthe government in the administrative ministryand the public enterprise management. Onthe other hand, para 2.3 clearly states thatit is the holding company that should enterinto a memorandum of understanding withthe government. It is as if the person writ ingSection V did not read Section I I I , wherethe main recommendations was to create abuffer between the government and the

enterprises in the shape of a holding company to minimise government interventionin the affairs of the enterprises under itscontrol.

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The author of this section of the Reportalso ignores much of the recent progressmade in the field of performance evaluationof public enterprises. No new ideas arepresented and much of the, recent literatureon the topic is not utilised. In fact, onceagain, some of the oldest and most hackneyed themes are repeated. For example,para 5.4 states, "Public enterprises pursuea number of objectives simultaneously anda single measure of performance is diffi cul tto specify." No one would, or could, arguewith this statement; however, it does not address the more substantive issues: What arethe various measures of performance for apublic enterprise? How does one combinethem to get a true picture of the overall performance of the enterprise? Unfortunately,on both fronts the answers in the Report arevery unsatisfactory, to put it mildy.

In regard to the first question mentionedabove, the Committee suggests, "there arc

certain objectives that are common and theseshould form the basis for general performance criteria. These general criteria mayfall into four groups: (1) Financial performance, (2) Productivity and cost reduction,(3) Technical dynamism, (4) Effectiveness ofproject implementation" (para 5.4), Thereare numerous problems with both the individu al categories of these criteria as well asthe group as a whole

For example, no rationale is given for thechoice of these particular criteria. It seemsthat "repair and maintenance", "corporateplanning."' etc, are equally important for all

public enterprises and should qualify to beincluded in this list of general criteria.Perhaps, if the Committee had explained itschoices, one could better understand theirreason for excluding other equally validcriteria.

Further, no indication is given as to thecourse of action to be undertaken whensome of these criteria are mutually conflicting. For example, "technical dynamism" involves costs in the present and may resultin lower financial profits in the current year.As a matter of fact, this problem of confli cting goals has been overlooked altogether in

the Report.This contradiction extends to variousindi vidual categories of criteria as welt. TheCommittee suggests the following threecriteria to evaluate financial performance ofpublic enterprises;

a) Gross margin on assets (for all enterprises), where:

Gross margin=Sales minus operatingcosts (excluding interest)Assets = Gross fixed assets plus inventories

b) Met profit on net worth (for core sectorand profit making enterprises), where:Net profit = Gross Margin minus depreciation minus interest

Net w orth = Equi ty plus reservesc) Gross margin on sales (for service enter

prises), defined as: Gross margin dividedby sales

To see the nature of problems associatedwith this recommendation, consider thefollowing example. Imagine, that a publicenterprise in a particular year, compared tothe previous year, increases its sales byRs 100 and also its consumption of intermediate inputs by Rs 100. From the pointof view of society as a whole, therefore, thistransaction is a neutral one. It does not leadto value added or surplus welfarethe society gains exactly what it sacrifices. However,if one looks at criteria (a) and (c) above, onegets a contradictory and confusing message.Criterion (a) remains unaffected, whilecriterion (c) decreases. Now, if we were usingthese criteria for controlling public enterprises, it is not clear what we should makeof this dilema. Should we penalise themanager or leave him alone? The Committee docs not provide any clarifications.

Consider another example. Suppose thereare two public enterprises, similar in every

respect, except that one was set up in yearV and the other one in year t + 1'. Let us alsoassume that the prices of everything in thesetwo years remain the same, except for fixedassets. Naturally, if we were to compare thesetwo enterprises, we would find that the oneset up in year t + 1 has a larger denominatoras per criterion (a), and, hence, appears tohave a lower gross margin to asset ratio. Thisis obviously unfair to the manager of thisenterprise as be is producing the samesurplus from the same physical amount ofproductive capacity.

Similar problems relate to the Commit

tee's recommendations regarding the monitoring of productivity and cost reduction.These recommendations are preceded by aplatitudinous assertion reminding us that:"Mo nit ori ng performance in terms of financial profitability has to be supplemented bysome simple monito ring of productivi ty andcosts." However, the indicators suggested areneither simple nor supplementary. TheCommittee recommends that capacity utilisation, raw material costs (at constant prices)per unit of output, etc, should be used tomonitor productivity and costs. This is surprising as it goes against one of the mostfundamental principles of economics - thelaw of dimini shing returns. Accord ing to thelatter, when a variable factor (say, rawmaterial) is added to a fixed factor (say.plant capacity), beyond a certain point, eachadditional unit of the variable input leadsto successively smaller outputs. Therefore,in most cases, an a priori case can be madefor a conflict between capacity utilisationand raw material costs (at constant prices)per unit of output.

In addition, calculation of raw materialcosts per unit of output at constant pricesis no simple matter, cither. To do an acceptable job, one needs prices and quantities of

all raw materials as well as outputs. Thisinformation is not reported in the conventional, audited account of enterprises (exceptfor a selected few industries, like cement).

Therefore, unless a sophisticated information system is in existence, the governmentwill have little success in their constant pricecalculations.

Para 5.11 also argues, "it is particularlyimportan t to undertake such monito ring ofcosts and productivity in the core sectorenterprises-. " It is these kind of statementswhich show the lack of determination toundertake real reforms. As already mention-ed, such distinctions between core and non-core sectors in our inter-dependent world appear to be artificial and unjustifiable.

The recommendations regarding themonitoring of "technical dynamism" and"project implementation" are also writtenin a hurried manner. For the former, a quantitative indicator (number of product andprocess innovations introduced) and aqualitative assessment are suggested. Noconcrete steps are proposed, however, tocombine the qualitative and quantitative

aspects to come to a composite evaluation.One could go on with these problems for

some time. The danger is that it may startto look like nit-picking. Therefore, let ussummarise the main points. There is clearlya danger in using partial indicators likelabour productivity, capacity uti lisation, rawmaterial efficiency, etc. They only capturea limited aspect of the total reality. To overcome this, the most common mistake madeis to opt for a multiple indicator which issimply a weighted average of a number ofpartial indicators. The Committee, too, fellfor this age-old trap. This oversight is hard

to understand since there existed sufficientliterature [Sen, 1971; Jones, 1979; Jones andTrived i, 1983; Nawab, 1984; Trived i, 1985aand 1986b] at the time of writing this report,to caution them against these dangers andsuggest feasible solutions. Unfortunately,one cannot go into the details of thesesolutions within the confines of this article.

Similarly, in making its recommendationsregarding information systems, the Committee appears to be oblivious of the existingbody of knowledge .and collective experienceof the developing nations in this regard. Currently, a distinction is made between a per

formance information system (PIS) and amanagement information system (MIS). Theformer system is meant for use by government bodies in monitoring the socio-economically relevant behaviour of its publicenterprises. It is intended as a part of a largersignalling system which guides managers tomake decisions in the national interest andrewards them for doing so. The purpose ofthis kind of information system is not tomake a final arbitrary decision as to howwell managers have done. Rather, it is to provide the information upon which such adecision can be based.

Since a PIS is at the apex of a large

pyramidal decision-making hierarchy, it is asimportant to exclude irrelevant informationas it is to include necessary info rma tion. Tomaintain the advantages of hierarchy and

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decentralisation of decision-making, and toavoid swamping the top levels with extraneous data, it is necessary to filter information as it moves upwards through thehierarchy. The top needs the broad summaryvariables, not all the details. For example,a conventional MIS provides managers witha wealth of details on standard costs, inventory levels and a multitude of other factorswhich help him to control costs. The PIS,

on the other hand, contains much less detailsin this area, being concerned only withwhether costs are rising or falling (andwhether it is due to price or quantity effects).

The two information systems are notsubstitutes but complements. The PIS at theministry level motivates the use of, and inpart measures the success of the MIS at theenterprise or the holding company level. TheSengupta Committee only emphasises theMIS and ignores the PIS altogether. In fact,it recommends dismantling even the rudimentary PIS that already exists in the Planning Commiss ion. One would have expectedthem to suggest strengthening this systemalong wit h the installatio n of a compatibleMIS in various public enterprises.

One of the reasons given for abandoningthis information system contradicts some ofthe recommendations made earlier in thisReport. The Committee augues that a performance information system is notnecessary because the government can obtain specific information, when the needarises, from public enterprises. Those whoknow our public sector will agree thatgovernment requests for in for mat ion o f alltypes at odd times is a major source ofirritation, if not disguised harassment, for

enterprises. Further, in the absence of asystem of checks and cross-checks, there isno guarantee that public enterprises willalways supply reliable data. Some of these

mistakes may be intentional and some otherwise. However, the government would notknow the difference in any case.

ROLE OF TH E COMPT ROLLE R AN D

A U D I T O R C E N T R A L

In this section too, the now familiar pattern of the repor t is fai thfully repeated. Thatis, correct facts are stated but analysis and

policy recommendations somehow go awryin the transformation process from facts torecommendations. For example, the Committee correctly reports that public enterprises are subject to "two audits" regularly.One by the chartered accountants dealsmainly with questions of "regularity." ie,whether accounts are correctly maintained,expenditures and receipts accurately recorded. The supplementary audit by the Comptroller and Auditor General (C and AG)checks mainly the "propriety" of the transactions. C and AG also conducts a "performance audit" from time to time.

However, the Committee recommends

that the "performance audit" should be continued and supplementary audit is notnecessary for profitable non-core companies,once common accounting policies areevolved. This is exactly the opposite of whatthe logic dictates. As mentioned earlier, oneof the main reasons for poor performanceof public enterprises is the lack of clari ty ofgoals. The latter being a result of multipleprincipals emphasising multi ple goals, whichare often conflicting. The solution is,

therefore, reducing multiplicity of principals

and the conf lic ting nature of goals. Havin ga performance audit in addition to a memo

randum of understanding will be terriblyconfusing for public managers, They wouldnot know who they should please. If experience is any guide, they will please neither.

However, they will escape penalties by blaming the other principal in justifying theirfailure to each principal separately.

The recommendation that profit makingnon-core companies need not care about thepropriety of their transactions is extremelypuzzling. Propriety of transactions is oneaspect which makes a public enterprise truly different from a private one [Nitish De,

3987]. The distinction between core, non-

core and profit and loss making is meaningless in this context. Public enter prise mustcare about the propriety of their trans-actions, period.

REIATION WITH PARLIAMENT

This section (5.14-5.26) of the Reportrepeats much of what has been said earlier.Therefore, much of it does not require further comments. For example, we havealready commented on its recommendationto evolve a parliamentary conven tion of notasking questions on day to day operationsof the public enterprise.

The recommendation which does requiresome thought concerns the role of the Committee on Public Undertaking (COPU) ofthe Indian Parliament. The Sengupta Committee endorses the occasional "postmortem", "ex- post" studies of the workingof public enterprises by the COPU. This addition of yet another "principal" in themonito ring game can only confuse and confound the public enterprise managers.

I can understand the Committee's reluctance to appear "undemocratic" by suggesting the potentia l dangers of sti ll anotherperformance evaluation exercise. The Com

mittee failed miserably, however, in not eventryi ng to raise the quality of this parliamentary interface by asking some relevantquestions.

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There is a widespread perception thatCOPU enquiries are often used as witchhunts by interested parties. The Committeesshould have examined how many recommendations of the COP U have actually been im-plemented. Who are the people in the COPUstaff who do these studies? What relevant

experience do they have to question theworking of multi-crore mega enterprises?Only after these and other questions havebeen answered can one take the recommendation on COPU reports seriously.

The Report seems to get more muddledas one progresses through its pages. InSection V I , a very sketchy discussion oftechnology upgradation is undertaken. Itquotes a study that suggests that "a numberof public enterprises have not made sufficient efforts to absorb imported technologyor in some cases adaptation to the Indianenvironment." The Report then goes on immediately to discuss cures for this problem.

However, all its recommendations are toogeneral in their prescriptions and vague withregard to implementation. For example itrecommends, "All major projects should include technology adaptation programmesand for this purpose the government shouldconsider providing part of this expenditureas grant (para 6.3)". It is not clear what ismeant by "technology adaptation." Wherewill the money for this come from?

Ideally, one would have expected theCommittee to first discuss the causes for thelack of technology upgradation and, then,systematically discuss the cures in view of

the particular causes. Khanna (1984) hasshown that this is as much of a problem inthe private sector and there are very valideconomic reasons for it. On the one hand,the committee wants public enterprises to actlike private ones and generate financialsurpluses. On the other, it wants them tobehave differently. In the short run, at least,there may be a trade-off between these twoobjectives. Since public managers typicallyhave a short tenure, these considerations willbear heavily on their decisions. The Committee fails to enlighten us on how to resolve,this confli ct. In my view, an M OU would be

a useful vehicle to carry out this policy goal;however, no such linkages are provided in theReport to guide policy makers.

Furthermore, the Committee overlooksthe distinction between investment decisionand performance evaluation, mentionedearlier. For most public enterprises,, thetechnological choices are already predetermined at the investment decision stage. Theydo not have too many options. One has toseparate the "efficiency in investment decisions" from the "efficiency in operationaldecisions".

F I N A N C I A L V I A B I LI TY O F LO S S MA K I N G

UNITS

The most conspicuous thing about Section VII is the quick connection made bet

ween financial losses and efficiency. Theindictment of loss makers is alarming."Loss-making enterprises are a burden onthe public exchequer and, therefore, theycannot expect the same degree of autonomyas financially viable units." I wonder if it occurred to the Committee that lack of

autonomy may be the very cause for lossesto start with. Therefore, to restrict autonomyfurther may trap these enterprises in an eternal vicious cycle.

In addit ion , losses could be due to severalnon-commercial goals that the governmentmay have imposed on public enterprises, including lower output prices. Therefore, at thevery minim um, one would have expected theCommittee to tell us the performance ofthese loss makers in constant prices.

The Committee recommends capital.restructuring by converting debt into equity.This tantamounts to putting powder on one'sface to hide pimples. Generating profits in

this manner does not increase the overallwelfare of society. It is a transfer paymentwhich leads to money being transferred fromone party to another, leaving the overallsurplus at the same level. Since most of theinterest would have probably gone to thegovernment in any case, this restructuringdoes not increase the resources available tothe government. How does it matter whethergovernment takes their money as interest orprofit?

PRINCING IN PUBLIC ENTERPRISES

Pricing policies of public enterprises are

discussed at several places in the body of the-

Report. Section VI I I , however, is devotedexclusively to pricing issues. The problem.wit h this section is its purely administrativeapproach toward these issues. One expectedbetter from a Committee headed by aneconomist.

In para 8.3, the Committee recommends:

"Unless the public sector share of the marketis such that the concerned public enterpriseis the price leader, there is no point in thepublic sector alone charging a price lowerthan those of other producers!' The firstthing to note is that the Committee (impl icitly) ignores the distinction between outputand inputs markets. Public enterprises produce both final outputs as well as intermediate inputs. There are different considerations in deciding on pricing policies inthese two types of markets. Second, theCommittee never quite specifies what is themain objective of pricing policies. Is it purely

"financial" (i e, to generate profits alone)or one also wants to use them for improving resource allocation?

Even if the objective is purely financial,this recommendation is too general to beuseful. In many situations, such a policy maybe justified precisely because the concernedpublic enterprise is trying to capture a largeshare of the market to become a marketleader and curb the monopolistic exploitationof consumers by the current market leadersfrom the private sector. Therefore, the resultant poor financial performance in the shortrun will be more than compensated by the

enhanced social welfare in the long run.

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Further, if the concerned public enterpriseis a small part of the market and we forceit to behave like a purely private enterprise,then one has to ask a very basic question:what is the point in having that enterprisein the public sector? Would it not bepreferable to use the scarce public resourceselsewhere and simply collect taxes on the

' profits of the private enterprise? When I talkabout scarce resources, I am referring bothto resources invested in the enterprise as well

as resources required to monitor and control it.

More puzzling than all of this is the totalneglect of the allocative role of public enterprise pricing policies by the Committee.Public enterprises are an instrument ofpublic policy and, as such, their pricingpolicies are supposed to promote publicinterest, Financial surplus is one clement ofoverall social welfare. Another importantfactor affecting social welfare is the allocative efficiency of resources. The startingpoint of all discussions on "allocative efficiency" is the concept of "marginal cost pric

ing." It is curious that this concept was notmentioned even once in the Report. Thereare, admittedly, conceptual and practical difficulties associated with this concept, butthat is not an adequate justification for ignoring it altogether. Had the Committeecared to think about this aspect of pricing,it would have not written Section VIII in thiscavalier fashion.

For example, let us consider a case whereunderpricing is justified in terms of allocative efficiency. Suppose that a public enterprise is supplying intermediate inputs to aprivate enterprise which has a monopoly inthe product market. As a result of this

monopoly power, the private enterprise ischarging a higher price P0 and producinga lower output, Q 0 , compared to what it.would do if the market were competitive

(Figure 1). The government wants to correctthis distortion and has several choices. Itcould either nationalise the private firm,control its prices, break it up or use publicenterprise pricing policy to achieve the sameobjective. Faeh policy has its pros and cons,too numerous to discuss here.

However, let us further suppose that thegovernment decides (after considering otheroptions) to use public enterprise prices forachieving this objective. The argument, from

what is walled the "theory of second bestpricing", is that the public enterprise shouldset a price lower than its marginal cost ofproduction. This will lower the cost of pro-duction for the private enterprise and moveit closer toward the point of opt imum allocation as shown in Figure 1. How much shouldthe enterprise reduce the price of its products? The answer, in theory, is simple. Oneshould continue to depart from marginalcost so long as the benefit of doing so ismore than the cost of doing so. When thesetwo become equal, one should stop. Noticethat this may involve increasing the profitsof a private monopoly. This is the classictrade-off between equity and efficiency.

The point is that there are several theoretically sound reasons for lowering publicenterprise prices even when it may lead tosome financial losses. The preceding is butone example of the innumerable cases onecould cite.

The treatment of the important issue ofthe existing price preference system forpublic enterprises also smacks of ad hocreasoning. According to this system, a 10 percent price preference is to be given to publicenterprises vis-a-vis the private sector. Thatis, if a product similar to that from the

private sector can be supplied by a publicenterprise for a price difference of not morethan 10 per cent, then other public enterprises are obliged to purchase this product

from the public enterprise. (This preferenceis equal to 15 per cent where imports areinvolved.)

The Committee recommends that thissystem be abolished over 4 or 5 years andbe substituted by an explicit subsidy equal

to 10 per cent of the tender price. As usual,

he Committee gives no reason for theserecommendations.

One is left in the dark as to why a periodof 4 to 5 years has been chosen. What ismeant by "phased out"? Does it meanabolished for some immediately and later forothers? Or, reduce the percentage graduallyfrom ten to zero? Which enterprises shouldbe chosen for this phasing out?

Similarly, what is the relative advantageof having subsidies rather than price preferences? In terms of resource mobilisationboth have the same effect on the exchequer.To see other effects ofthis policy, let us con

sider a simple example. Suppose there aretwo public enterprises (a) and (b). Lnterprise(a) sells its output to (b). In the absence ofany constraints, the ideal pricing policy for

(a) would involve fixing the price equal toits marginal cost (MC) as shown in Figure2(a).

let us now suppose that the governmentenforces the price preference system. Thiscauses the marginal cost of production for(b) to increase from MCo to MCI, as shownin Figure 2(b). Comparing the two situationswe find the net loss to society is equal to thearea A BCD. If this loss is less than the benefits to society of maintaining employment

and operating public enter prise (a), thenprice preference is justified. One of thereasons for the higher costs of public enterprise (a) may be due to its location in abackward area, An economist's job is topoint out this trade-off and whether it is"worth it" or not, is a norma live judgmentfor decision makers.

Let us now consider the option of givinga subsidy and scrapping the price preferencesystem. The result will be a lower MC facing firm (a) and, hence, an expansion of production beyond the optimum quantity ofQQ* in Figure .V The net loss of this policywould equal area RST

Therefore, the choice between a subsidyand price preference will depend on whetherRST in Figure 3 is greater or smaller thanABCD in Figure 2(b). Admittedly, this is avery simplified picture. It is not intended todepict reality in its entirety, only to addressthe issues involved. From that point of view,it is clear that generalisations made by theCommittee are clearly too strong.

The last section of the Report discussesa few odds and ends. However a very disturbing comment is stuck in one of the recommendations: "Even though on paper theenterprises do enjoy complete autonomy in

these areas, in practice, however, interferencefrom the ministry or department of thegovernment does take place. We suggest thatsuitable convention be evolved to ensure such

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interferences are avoided." If this is true, thenwhat is the point of so many recommendations the Committee has made to ensuremore autonomy, including the formati on ofholding companies and MOUs? All thtsemay be fine on paper, but as the Committee admits, in reality the interference maycontinue unabated. Perhaps, the Committee should have spent more time on outlining a strategy to evolve these conventions fornon-interference. It is truly depressing tothink that, along with the Committee, wemay have been barking up the wrong tree.

Notes

[An earlier version of this paper was presented

at the National Seminar on the Management

of State Level Public Enterprises, Osmania

University, Hyderabad, March 5-6, 1987. I

would like to thank the participants of this

seminar and the seminars at the Centre for

Policy Research and the National Council forApplied Economic Research for their com

ments. Thanks are also due to K C Sethi and

Bagaram Tulpule for helpful comments. Part

of the research for this paper was supported

by the Centre for Studies in Public Enterprise

Management, Indian Institute of Management,

Calcutta.]

1 Organised jo in tl y by the standing Conference

of Public Enterprises (Scope) and the

Department of Public Enterprises.

2 Every third Rupee for the total investment

in this plan is expected to come from the

public sector.

3 A survey of a num ber of questio ns asked inparliament regarding the Sengupta Report

suggests the following. It appears that except

for three recommendations, all others have

been accepted. However, implementation of

these recommendations is a different story

altogether. None appear to have been fully

implemented. For details, see: Lok Sabha

(Unstarred question No 8202, April 29. 1986;

Starred question No 207, November 18,

1986), Rajya Sabha (Unstarred Question No

1251, November 17, 1986).

4 Careful analysis of this issue often reveals a

surprisingly large divergence between percep

tion and reality of public enterprise perfor

mance. For details, see: Trivedi (19860-

5 Defined by the Com mit tee in Para 2.3 of the

Report.

6 One can also add management of public

enterprise as a fourth category, though

management is subsumed under each of

these three categories.

7 Of course, wh ere the governm ent does not

administer prices, performance evaluation

should examine the pricing policy itself.

8 it would be an interesting research topic to

compare and contrast the recommendations

of the L K Jha Committee. Why is it that

two eminent policy makers examining the

same issue come up with such divergent

recommendations as these did in many cases?

This paper is not the right forum to answer

that question

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M-66

sengupta report on public enterprises: eloquent fuzziness at its best

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