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Administered Price Policy for Public Enterprises: Discussion That Never Took Place

Administered Price Policy for Public Enterprises: Discussion That Never Took Place

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Published by Prajapati Trivedi
This paper seeks to resuscitate the discussion on an important public policy document—the 'Discussion Paper on Administered Price Policy' placed in parliament by the union finance minister in August 1986, one of the purported objectives of which was to "initiate a more open approach to price setting by the government" The untimely expiration of the debate on the Discussion Paper has kept the government's administered price policy in a state of suspended animation and allowed the government to tinker with administered prices unfettered by any acceptable policy framework.
This paper seeks to resuscitate the discussion on an important public policy document—the 'Discussion Paper on Administered Price Policy' placed in parliament by the union finance minister in August 1986, one of the purported objectives of which was to "initiate a more open approach to price setting by the government" The untimely expiration of the debate on the Discussion Paper has kept the government's administered price policy in a state of suspended animation and allowed the government to tinker with administered prices unfettered by any acceptable policy framework.

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Published by: Prajapati Trivedi on Dec 26, 2012
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This paper seeks to resuscitate the discussion on an important public policy document—the 'Discussion Paper
 on Administered Price Policy' placed in parliament by the union finance minister in August 1986, one of the
 purported objectives of which was to "initiate a more open approach to price setting by the government" Theuntimely expiration of the debate on the Discussion Paper has kept the government's administered price policy
in a state of suspended animation and allowed the government to tinker with administered prices unfettered by
 any acceptable policy framework.
IT is part of the well known repository of conventional wisdom in public policy, thatif you want to make something public, simply mark it 'Top-Secret' It appears that theconverse is equally true: If you do not wantpublic policy to attract undue attention justpresent it for open public discussion. Thisphenomenon is precisely what appears tohave happened to 'A Discussion Paper onAdministered Price Policy', which was placedin the Indian parliament by the unionfinance minister on August 4,1986. The factthat this Discussion Paper deals with atechnical subject has also been a great helpin its march towards obscurity.One of the purported objectives of theDiscussion Paper was to "initiate a moreopen approach to price setting by thegovernment". It is fair to say that theadministered price policy is shrouded in asmuch, if not greater, mystery than it was atthe time of tabling of the Discussion Paperon the floor of the Indian parliament.The main purpose of this article is toresuscitate the discussion on this importantpublic policy document. The untimelyexpiration of the debate on the DiscussionPaper has kept India's administered pricepolicy in a state of suspended animation andallowed the government to tinker withadministered prices unfettered by any acceptable policy framework.The argument that is being made here isnot that there is
prima facie
grounds tosuspect a document that has not beendiscussed widely. There is nothing desirableabout a debate,
per se.
Indeed, quite oftendebates themselves are so superficial and off the point that it is difficult to say whetherit is always better to have a debate.However, once in a while, one comesacross a public policy document whichsmacks of being reasonable as well as judicious and one feels reassured about thegeneral thinking on the subject covered inthe document, notwithstanding one's disagreement over details. The L,K Jha Committee's report on public enterprises is onesuch example which readily comes to one'smind as an example of this category.In addition, the fact that the Jha C6m-mittee Report is not an official documentlike the Discussion Paper but contains onlythe recommendations of a committee of experts, goes to further heighten our discomfort with the Discussion Paper. In thecase of the Jha Committee Report, thegovernment had the option to accept orreject its recommendations and had to takeactive steps to do so. Since the Discussion
Paper appears to have been prepared by the
government policy-makers, however, it isreasonable to assume that the 'default'option would be the acceptance of itsprescriptions as official policy. In fact, theIndian government would have to take activesteps to change the policies suggested in theDiscussion Paper. And, there lies the rub.Clearly, this Discussion Paper is no JhaCommittee Report in substance or style andthe prospects of its adoption by default are,therefore, source of some discomfort.It is as difficult to fathom the 'real' purpose of this Discussion Paper as it is easyto determine that it is not in the same classas the Jha Committee Report. The Discussion Paper has a droll, dry professorialquality which exemplifies the great pit-fallof the ascendancy of unchecked nascenttechnocracy in the Indian government. It
appears to be a paper 'by' a technocrat and
also 'for' the 'technocrats'. It tends to forgetthat the vast majority of policy-makers andpractitioners do not have PhDs in economics.The fact that such a document was allowed to be tabled in the lower house of theparliament (which is not particularly wellknown for its technical expertise) shows justhow much intimidation these technocratshave been able to unleash on their politicalbosses. While the then finance minister maynot have understood much of the argumentsin the Discussion Paper, he still let it betabled in the parliament.The Discussion Paper is not only a trifletoo technical for the Indian parliamentariansin general, but it fails to satisfy any othercategory as well As we shall see in thefollowing paragraphs, the Discussion Paperalso appears to be too theoretical for practising managers and majority of the civilservants dealing with public enterprises.Furthermore, for academicians, however, itappears to be inadequate conceptually as
well as empirically.
Though it is never explicit, one gets theimpression that the paper appears to bedriven by an obsession to justify impendingincreases in administered prices.
1
Thus,naturally, it is selective in choosing only convenient facts and figures to justify whypublic enterprise prices ought to be increasedin general.Nothing highlights the problems with theDiscussion Paper better than paras 2through 10 of the document. They are supposed to tell us the "role of administeredprices" but end up discussing a very widerange of issues. This encyclopaedic approachof packing too much in only a few paragraphs is counterproductive and leaves the,reader confused about the true role of administered prices.These paragraphs attempt to discuss notonly the 'role of administered prices' butalso the ideological foundations of administered price policy, the objectives of thispolicy, the context in which it is operating,preconditions for its success and the role of the public sector in the Indian economy.Each one of the above mentioned items isa valid topic for discussion but when theyare clubbed together under a section entitled'Role of Administered Prices', the results aresomewhat confusing—our understanding of none of the topics is enhanced.
2
The authors of the Discussion Paperclearly want to appear to be 'pro-poor',whatever may be the actual consequencesarising out of their recommendation in thebody "of the Paper. Although, there isnothing wrong with making an 'ideological'or philosophical' statement, it must bemade explicitly. The authors could havebroken this section into several smallersections, and one of them could have dealtwith the ideology and philosophy behindadministered price policy.Being 'pro-poor' is perfectly acceptable solong as it only means being 'pro-poorpeople' and does not degenerate into being'pro-poor analysis'. Unfortunately, the Paperfalls into the latter trap. In para 2, it assertsthat the poorer sections of our society aregreatly dependent on a "progressive'' pricingEconomic and Political Weekly May 26, 1990
M-67
Administered Price Policy for PublicEnterprises
Discussion That Never Took Place
Prajapati Trivedi
 
policy. Does this statement mean that othersections do not deserve a 'progressive' pricing policy? In any case, what is this 'progressive' policy anyway? One has to be verywary of terms like progressive': they implydifferent things to different people.Economists (and I suspect authors of thePaper belong to this tribe), in particular,ought to know the ambiguity attached tothese terms better than anyone. For example,Adam Smith, who was once considered a'radical', is now viewed as a 'conservative'.
In paras 4 and 5, the authors seem to
imply that the ''wider interest' of equity andsocial justice can only be served, if essentialitems are subsidised and the market forcesof demand and supply are not allowed a freehand. This line of reasoning appears to glossover several issues. First, it is not clear whatthe authors want to suggest as the 'goal' of the price policy. Is the goal to 'subsidise' orto 'lower' prices? If latter is the goal (andseems reasonable to assume that it is), thenis subsidising the best way to achieve it?Further, the authors imply that the freeplay of market forces will not lead to lowerprices. Here again we need to consider twoissues in trying to assess the real problem.Is it the free play of market forces or the factthat markets do not work as they are supposed to, due to all kinds of distortions?Presumably, the authors remember the controversy surrounding the nationalisation of the wheat trade and the subsequent denationalisation. In many cases, the problem appears to be the existence of monopsonisticmiddlemen and not the market forces. Thusthe solution ought to be the elimination of middlemen and not the market forces.One also has to explain the inconvenientempirical evidence in this regard. For example, in 1983 the decontrol of cement pricesled to the glut of cement and extremely affordable prices. If one asked the consumersthey would say that their interests were bestserved during the period of decontrol, notwhen the price of cement was 'administered'.In the public enterprise literature, perversedistributional consequence of subsidisedprices is well established. Jones [1985] citesseveral examples from around the developing world to show how, often, subsidisedprices do not benefit the intended parties(but the middle men). In this context, Jones(1985) makes an important distinction whichthe authors of the Discussion Paper haveoverlooked. He differentiates between'Pareto-efficiency' and 'political-efficiency'.As all economists know, a 'Pareto-efficient'reallocation of resources is one which makessomeone better off without making anyoneworse off. Jones [1985] defines 'politicallyefficient' reallocation as one which makessomeone better off without making anyoneelse 'aware' that he
is
worse-off.No one can deny that transferring incomefrom one individual or segment to another,in the interest of equity and social justice,is a perfectly legitimate public policy goaland a prerogative of political power. Inaccomplishing this objective, however,politically efficient solutions are oftenpreferred oyer Pareto-efficient ones andmanipulation of public sector prices provided an excellent vehicle for achieving thelatter. A more thorough treatment of this important issue would have gone a long wayin making the Discussion Paper wholesome.Finally, the Discussion Paper highlightsa curious dichotomy in government thinking. At about the time the authors of thisPaper were suggesting that free play of market forces is not desirable, the government of India was actively propagating amove toward liberalisation. The underlyingassumption of the latter approach was thatfree play of market forces is good for theeconomy. Some references and an attemptat reconciling these two seemingly conflicting policy pronouncements would have been
enlightening.
Para 2 asserts that a "clear policy onadministered prices leads to a more stableeconomic environment." However, it doesnot tell us why the policy has not been statedclearly in the past? Perhaps, it was. If so,what was the policy? Where was it stated,and why is a new one required? By notanswering these questions, which come toone's mind naturally, the Paper leaves thereader unsure about its purpose and
contribution.
In discussing the role of the public enterprises in the Indian economy (paras 6through 8), the Discussion Paper does notmake any reference to the distinction between the central and state-level public enterprises (PEs). The figures quoted are forcentral PEs only. An explicit pronouncement on the role of state-level PEs, as wellas the reason for excluding them from thediscussion would have clarified the issues.Most people would agree that reforms in thepricing policies are much more urgentlyneeded in the public sectors of various statesof the union rather than at the centre.Therefore, it is important to know whetherthe principles discussed in the Paper alsoapply to the state-level PEs. This issue couldhave been covered in the section entitled.
'The Scope of the Paper', but, was not!
A great deal of confusion in the sectionentitled "Introduction" can be attributed tothe lack of discussion on two broader conceptual issues. The first one relates to theplace of pricing issues in the economics of public enterprises. The second, concerns therelative importance
of 
reforms in performance evaluation versus reforms of the pricing policies. Let us discuss each of thembefore proceeding.The economics of public enterprises canbe divided into the following three distinct,though interrelated, areas.
3
(a)
Investment Decision:
It deals with thequestion "Should we or should we not setup a particular public enterprise?" It alsodeals with issues related to expansion ordivestiture of an already existing PE.(b)
Pricing Decision:
It takes the investment decision as given. That is, it assumesthat the public enterprise already exists, anddeals with the question: "What price shouldbe charged?"(c)
Performance Evaluation:
Given theinvestment and pricing decision, it asks thequestion: "How well is the PE managementperforming their job?"As mentioned earlier, these are not watertight categories, and often the issues areintimately intertwined. Yet, they have emerged as separate areas of intellectual endeavourand, as a starting point, it is very useful toview them as such.By frequently mixing the 'pricing issues'with the 'performance evaluation issues', theDiscussion Paper is not able to do justiceto either. For example, in para 9, the Papersuggests that a "greater effort is required toensure that all possible avenues are exploredfor absorbing cost increases before finallydeciding on any price revision" From thisstatement it is not clear "who" should make"what" kind of effort in order to achieve thisend. It also raises the question whether theimplication is that such an effort has neverbeen made by the government of India. If not, then what are the reasons for it? Finally,if one cannot be sure of this 'effort', shouldone revise prices or not?Similarly, in para 3, the Paper suggeststhat "administered prices can play an important role in generating a constant pressureon every enterprise to improve efficiency,productivity and overall performance"However, it does not suggest, exactly, howthis goal would (could) be achieved. In fact,the above statement contradicts another onemade in para 9, where the Paper argues that"in a situation where all prices in theeconomy are changing, it is both unreasonable and counterproductive to delayprice revisions in the public sector''Within
a span of six paragraphs, the Paper suggests
that sluggish administered prices can be avehicle for increased as well as decreasedproductivity: however, the Paper does notsuggest any guidelines for determining whenthis point of inflection is arrived at.This kind of inconsistency has crept intothe Discussion Paper not ony because of theunnecessary mixing up of 'pricing' and 'performance' issues, but also because theauthors of the Paper have failed to disguisetheir singular lack of familiarity with issuesrelating to performance evaluation of PEs.Thus, in para 9, they repeat what must beconsidered the most hackneyed cliche in thisfield. They urge that "public enterprisesector must not only meet the wider socialobjectives assigned to it but it must also improve its capacity for surplus generation."it would be difficult to inter the vast areaof 'performance evaluation' of public enterprises, but it is worth raising some issues.For example, one wonders whether theauthors envisaged the possibility that theremight, indeed, be a trade-off involved inachieving wider social objectives and increasing surplus generation. More importantly,do the authors have a methodology or asystem in mind which can measure theachievement of social objectives? Islheir anacceptable definition of the vague' term'social objectives'?Para 8, again, illustrates the points made
M-68
Economic and Political Weekly May 26, 1990
 
above about the clarity of performanceevaluation issues. This para suggests thatPEs should run 'efficiently' and produce'reasonable' returns without ever definingwhat is 'efficiency' or 'reasonable' rate of return.
The same paragraph also emphasises the
need for resource generation in the SeventhPlan by saying that compared to the previousplan, this one relies more heavily on thepublic sector contributions to fund the Planoutlay, It argues that 50 per cent of the totaloutlay in the Seventh Plan is to come fromPEs as opposed to 30 per cent in the previousplan. The determination of these percentagesis one of the everlasting, though constantlyimpelling, mysteries of our planning process.The most widely held view is that this figureof 50 per cent was determined as a residualnumber. After determining what was available from other sources to finance the plan,the burden to raise the rest was laid squarely on the shoulders of PEs. If this hypothesisis not true, what were the assumptions onwhich the above percentages (from Table 1of the Discussion Paper) were calculated?Did the authors assume that administeredprices would remain constant or they wouldbe revised? If the latter was true, how muchwere these prices expected to change? Whatis the assumption regarding cost reductions?Are these assumptions based on a rigorousscientific study? Unfortunately, it is impossible to find answers to these pertinent questions either in the Paper under discussionor any other document.As mentioned earlier, some of the confusion in the Discussion Paper arises due tothe absence of any discussion regarding therelative roles and importance of reforms in'pricing policies' and 'performance evaluation systems'. The discussion on this topicinvolves two issues. First, what is the relativeimportance of these two reforms in termsof the potential benefits? Second, what isthe desirable sequence for introducing thesereforms?Figure 1 is very helpful in examining theseissues. When economists talk about efficiency, they usually have 'economic efficiency' in mind. In order for a public enterprise to be economically efficient, it has tobe both 'technically' as well as 'allocatively'efficient. Technical efficiency, simply stated,means that the public enterprise is producing a given level of output at the lowestpossible cost. If the marginal cost curve,MC
o
in Figure 1, represents the least-costway to produce various quantities of theoutput, then the divergence between MC.and MC
0
represents the degree of 'technicalinefficiency'. The main purpose of reformsin public enterprise performance evaluationsystems is to minimise this divergence between the two curves and, hence, reduce'technical' inefficiency'Allocative efficiency, on the other hand,is concerned with whether the 'right amount'of the good is produced and not whether thegood is being produced at the 'right-cost.'To be allocatively efficient, the marginal costof producing one extra unit should equal themarginal benefit associated with that unit.
4
This optimum point is given by Q
i
inFigure 1. The main concern of reforms inPE pricing policies is to fix a price equal toP
i
in order to induce the PEs to producethe optimum output equal to Q
i
.
Let us now compare the two sources of 
economic inefficiency. In order to make thiscomparison valid, let us assume a five percent inefficiency in both cases. In the caseof technical inefficiency, this would implythat the marginal cost of producing a givenquantity is higher by five per cent at eachlevel of output. In order to determine thewelfare cost of this type of inefficiency tosociety, we must know the counterfactualstory. That is, we must know compared towhat are we calculating this cost. Obviously,
if we assume the simultaneous existence of 
allocative as well as technical inefficiency,we will have a difficult time untangling theirseparate effects. Therefore, we shall assumethat the public enterprise price is beingallocatievely efficient. In other words, itsprice is always set at the intersection of theactual demand and marginal cost curves.Thus, we are comparing two situations:(a) a technically efficient scenario with theprice at P
i
and the output at Q
i
and (b)technically inefficient scenario with price atP
o
and output at Q
o
. The welfare analysisis summarised in Table 1. It shows that thewelfare loss associated with technical inefficiency is equal to the area BDECTo discuss the welfare loss associated witha.five per cent allocative inefficiency, we haveto, naturally, assume that the PE is technically efficient. A five per cent allocative inefficiency would translate to a price being fixed by the government at P
2
, which is fiveper cent lower than the optimum price of P
1
In other words, the error in fixing the"right" price is our proxy measure for thedegree of allocative inefficiency.
5
At this
price of P
2
, the equilibrium will be at out-
put level of Q. Therefore, our problem is tocompare the net welfare cost to the societyof moving from P, and
Q
1
to P
2
and Q
2
.Table 2 summarises the welfare analysisassociated with these points.Table 2 shows that the net loss associatedwith allocative inefficiency is equal to HDGClearly, this loss is smaller than the oneassociated with technical inefficiency(BDEC).
6
Therefore, one can conclude thatefforts at improving technical efficiency arelikely to yield much higher returns and henceshould be the starting point of ail reformEconomic and Political Weekly May 26, 1990
M-69

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