Administered Price Policy for Public Enterprises

Discussion That Never Took Place
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.
IT is part of the well known repository of conventional wisdom in public policy, that if you want to make something public, simply mark it 'Top-Secret' It appears that the converse is equally true: If you do not want public policy to attract undue attention just present it for open public discussion. This phenomenon is precisely what appears to have happened to 'A Discussion Paper on Administered Price Policy', which was placed in the Indian parliament by the union finance minister on August 4,1986. The fact that this Discussion Paper deals with a technical subject has also been a great help in its march towards obscurity. One of the purported objectives of the Discussion Paper was to "initiate a more open approach to price setting by the government". It is fair to say that the administered price policy is shrouded in as much, if not greater, mystery than it was at the time of tabling of the Discussion Paper on the floor of the Indian parliament. The main purpose of this article is to resuscitate the discussion on this important public policy document. The untimely expiration of the debate on the Discussion Paper has kept India'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. The argument that is being made here is not that there is prima facie grounds to suspect a document that has not been discussed widely. There is nothing desirable about a debate, per se. Indeed, quite often debates themselves are so superficial and off the point that it is difficult to say whether it is always better to have a debate. However, once in a while, one comes across a public policy document which smacks of being reasonable as well as judicious and one feels reassured about the general thinking on the subject covered in the document, notwithstanding one's disagreement over details. The L , K Jha Committee's report on public enterprises is one such example which readily comes to one's mind as an example of this category. In addition, the fact that the Jha C6mmittee Report is not an official document like the Discussion Paper but contains only the recommendations of a committee of experts, goes to further heighten our discomfort with the Discussion Paper. In the case of the Jha Committee Report, the government had the option to accept or reject its recommendations and had to take active steps to do so. Since the Discussion Paper appears to have been prepared by the government policy-makers, however, it is reasonable to assume that the 'default' option would be the acceptance of its prescriptions as official policy. In fact, the Indian government would have to take active steps to change the policies suggested in the Discussion Paper. And, there lies the rub. Clearly, this Discussion Paper is no Jha Committee Report in substance or style and the prospects of its adoption by default are, therefore, source of some discomfort. It is as difficult to fathom the 'real' purpose of this Discussion Paper as it is easy to determine that it is not in the same class as the Jha Committee Report. The Discussion Paper has a droll, dry professorial quality which exemplifies the great pit-fall of the ascendancy of unchecked nascent technocracy in the Indian government. It appears to be a paper 'by' a technocrat and also 'for' the 'technocrats'. It tends to forget that the vast majority of policy-makers and practitioners do not have PhDs in economics. The fact that such a document was allowed to be tabled in the lower house of the parliament (which is not particularly well known for its technical expertise) shows just how much intimidation these technocrats have been able to unleash on their political bosses. While the then finance minister may not have understood much of the arguments in the Discussion Paper, he still let it be tabled in the parliament. The Discussion Paper is not only a trifle too technical for the Indian parliamentarians in general, but it fails to satisfy any other category as w e l l As we shall see in the following paragraphs, the Discussion Paper also appears to be too theoretical for practising managers and majority of the civil servants dealing with public enterprises. Furthermore, for academicians, however, it appears to be inadequate conceptually as well as empirically. Though it is never explicit, one gets the impression that the paper appears to be driven by an obsession to justify impending increases in administered prices.1 Thus, naturally, it is selective in choosing only convenient facts and figures to justify why public enterprise prices ought to be increased in general. Nothing highlights the problems with the Discussion Paper better than paras 2 through 10 of the document. They are supposed to tell us the "role of administered prices" but end up discussing a very wide range of issues. This encyclopaedic approach of packing too much in only a few paragraphs is counterproductive and leaves the, reader confused about the true role of administered prices. These paragraphs attempt to discuss not only the 'role of administered prices' but also the ideological foundations of administered price policy, the objectives of this policy, 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 is a valid topic for discussion but when they are clubbed together under a section entitled 'Role of Administered Prices', the results are somewhat confusing—our understanding of none of the topics is enhanced.2 The authors of the Discussion Paper clearly want to appear to be 'pro-poor', whatever may be the actual consequences arising out of their recommendation in the body "of the Paper. Although, there is nothing wrong with making an 'ideological' or philosophical' statement, it must be made explicitly. The authors could have broken this section into several smaller sections, and one of them could have dealt with the ideology and philosophy behind administered price policy. Being 'pro-poor' is perfectly acceptable so long as it only means being 'pro-poor people' and does not degenerate into being 'pro-poor analysis'. Unfortunately, the Paper falls into the latter trap. In para 2, it asserts that the poorer sections of our society are greatly dependent on a "progressive'' pricing

Economic and Political Weekly May 26, 1990

policy. Does this statement mean that other sections do not deserve a 'progressive' pricing policy? In any case, what is this 'progressive' policy anyway? One has to be very wary of terms like progressive': they imply different things to different people. Economists (and I suspect authors of the Paper belong to this tribe), in particular, ought to know the ambiguity attached to these 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 and social justice can only be served, if essential items are subsidised and the market forces of demand and supply are not allowed a free hand. This line of reasoning appears to gloss over several issues. First, it is not clear what the authors want to suggest as the 'goal' of the price policy. Is the goal to 'subsidise' or to 'lower' prices? If latter is the goal (and seems reasonable to assume that it is), then is subsidising the best way to achieve it? Further, the authors imply that the free play of market forces will not lead to lower prices. Here again we need to consider two issues in trying to assess the real problem. Is it the free play of market forces or the fact that markets do not work as they are supposed to, due to all kinds of distortions? Presumably, the authors remember the controversy surrounding the nationalisation of the wheat trade and the subsequent denationalisation. In many cases, the problem appears to be the existence of monopsonistic middlemen and not the market forces. Thus the solution ought to be the elimination of middlemen and not the market forces. One also has to explain the inconvenient empirical evidence in this regard. For example, in 1983 the decontrol of cement prices led to the glut of cement and extremely affordable prices. If one asked the consumers they would say that their interests were best served during the period of decontrol, not when the price of cement was 'administered'. In the public enterprise literature, perverse distributional consequence of subsidised prices is well established. Jones [1985] cites several examples from around the developing world to show how, often, subsidised prices do not benefit the intended parties (but the middle men). In this context, Jones (1985) makes an important distinction which the authors of the Discussion Paper have overlooked. He differentiates between 'Pareto-efficiency' and 'political-efficiency'. As all economists know, a 'Pareto-efficient' reallocation of resources is one which makes someone better o f f without making anyone worse off. Jones [1985] defines 'politically efficient' reallocation as one which makes someone better off without making anyone else 'aware' that he is worse-off. No one can deny that transferring income from one individual or segment to another, in the interest of equity and social justice, is a perfectly legitimate public policy goal and a prerogative of political power. In accomplishing this objective, however, politically efficient solutions are often

preferred oyer Pareto-efficient ones and manipulation of public sector prices provided an excellent vehicle for achieving the latter. A more thorough treatment of this important issue would have gone a long way in making the Discussion Paper wholesome. Finally, the Discussion Paper highlights a curious dichotomy in government thinking. At about the time the authors of this Paper were suggesting that free play of market forces is not desirable, the government of India was actively propagating a move toward liberalisation. The underlying assumption of the latter approach was that free play of market forces is good for the economy. Some references and an attempt at reconciling these two seemingly conflicting policy pronouncements would have been enlightening. Para 2 asserts that a "clear policy on administered prices leads to a more stable economic environment." However, it does not tell us why the policy has not been stated clearly in the past? Perhaps, it was. If so, what was the policy? Where was it stated, and why is a new one required? By not answering these questions, which come to one's mind naturally, the Paper leaves the reader unsure about its purpose and contribution. In discussing the role of the public enterprises in the Indian economy (paras 6 through 8), the Discussion Paper does not make any reference to the distinction between the central and state-level public enterprises (PEs). The figures quoted are for central PEs only. An explicit pronouncement on the role of state-level PEs, as well as the reason for excluding them from the discussion would have clarified the issues. Most people would agree that reforms in the pricing policies are much more urgently needed in the public sectors of various states of the union rather than at the centre. Therefore, it is important to know whether the principles discussed in the Paper also apply to the state-level PEs. This issue could have been covered in the section entitled. 'The Scope of the Paper', but, was not! A great deal of confusion in the section entitled "Introduction" can be attributed to the lack of discussion on two broader conceptual issues. The first one relates to the place of pricing issues in the economics of public enterprises. The second, concerns the relative importance of reforms in performance evaluation versus reforms of the pricing policies. Let us discuss each of them before proceeding. The economics of public enterprises can be divided into the following three distinct, though interrelated, areas.3 (a) Investment Decision: It deals with the question "Should we or should we not set up a particular public enterprise?" It also deals with issues related to expansion or divestiture of an already existing PE. (b) Pricing Decision: It takes the investment decision as given. That is, it assumes that the public enterprise already exists, and deals with the question: "What price should be charged?"

(c) Performance Evaluation: Given the investment and pricing decision, it asks the question: "How well is the PE management performing their job?" As mentioned earlier, these are not watertight categories, and often the issues are intimately intertwined. Yet, they have emerged as separate areas of intellectual endeavour and, as a starting point, it is very useful to view them as such. By frequently mixing the 'pricing issues' with the 'performance evaluation issues', the Discussion Paper is not able to do justice to either. For example, in para 9, the Paper suggests that a "greater effort is required to ensure that all possible avenues are explored for absorbing cost increases before finally deciding on any price revision" From this statement it is not clear "who" should make "what" kind of effort in order to achieve this end. It also raises the question whether the implication is that such an effort has never been made by the government of India. If not, then what are the reasons for it? Finally, if one cannot be sure of this 'effort', should one revise prices or not? Similarly, in para 3, the Paper suggests that "administered prices can play an important role in generating a constant pressure on every enterprise to improve efficiency, productivity and overall performance" However, it does not suggest, exactly, how this goal would (could) be achieved. In fact, the above statement contradicts another one made in para 9, where the Paper argues that " i n a situation where all prices in the economy are changing, it is both unreasonable and counterproductive to delay price revisions in the public sector''Within a span of six paragraphs, the Paper suggests that sluggish administered prices can be a vehicle for increased as well as decreased productivity: however, the Paper does not suggest any guidelines for determining when this point of inflection is arrived at. This kind of inconsistency has crept into the Discussion Paper not ony because of the unnecessary mixing up of 'pricing' and 'performance' issues, but also because the authors of the Paper have failed to disguise their singular lack of familiarity with issues relating to performance evaluation of PEs. Thus, in para 9, they repeat what must be considered the most hackneyed cliche in this field. They urge that "public enterprise sector must not only meet the wider social objectives assigned to it but it must also improve its capacity for surplus generation." it would be difficult to inter the vast area of 'performance evaluation' of public enterprises, but it is worth raising some issues. For example, one wonders whether the authors envisaged the possibility that there might, indeed, be a trade-off involved in achieving wider social objectives and increasing surplus generation. More importantly, do the authors have a methodology or a system in mind which can measure the achievement of social objectives? Islheir an acceptable definition of the vague' term 'social objectives'? Para 8, again, illustrates the points made May 26, 1990

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above about the clarity of performance evaluation issues. This para suggests that PEs should run 'efficiently' and produce 'reasonable' returns without ever defining what is 'efficiency' or 'reasonable' rate of return. The same paragraph also emphasises the need for resource generation in the Seventh Plan by saying that compared to the previous plan, this one relies more heavily on the public sector contributions to fund the Plan outlay, It argues that 50 per cent of the total outlay in the Seventh Plan is to come from PEs as opposed to 30 per cent in the previous plan. The determination of these percentages is one of the everlasting, though constantly impelling, mysteries of our planning process. The most widely held view is that this figure of 50 per cent was determined as a residual number. After determining what was available from other sources to finance the plan, the burden to raise the rest was laid squarely on the shoulders of PEs. If this hypothesis is not true, what were the assumptions on which the above percentages (from Table 1 of the Discussion Paper) were calculated? Did the authors assume that administered prices would remain constant or they would be revised? If the latter was true, how much were these prices expected to change? What is the assumption regarding cost reductions? Are these assumptions based on a rigorous scientific study? Unfortunately, it is impossible to find answers to these pertinent questions either in the Paper under discussion or any other document. As mentioned earlier, some of the confusion in the Discussion Paper arises due to the absence of any discussion regarding the relative roles and importance of reforms in 'pricing policies' and 'performance evaluation systems'. The discussion on this topic involves two issues. First, what is the relative importance of these two reforms in terms of the potential benefits? Second, what is the desirable sequence for introducing these reforms? Figure 1 is very helpful in examining these issues. When economists talk about efficiency, they usually have 'economic efficiency' in mind. In order for a public enterprise to be economically efficient, it has to be both 'technically' as well as 'allocatively' efficient. Technical efficiency, simply stated, means that the public enterprise is producing a given level of output at the lowest possible cost. If the marginal cost curve, MCo in Figure 1, represents the least-cost way to produce various quantities of the output, then the divergence between M C . and M C 0 represents the degree of 'technical inefficiency'. The main purpose of reforms in public enterprise performance evaluation systems is to minimise this divergence between 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 the good is being produced at the 'right-cost.' To be allocatively efficient, the marginal cost of producing one extra unit should equal the Economic and Political Weekly

marginal benefit associated with that unit. 4 This optimum point is given by Q i in Figure 1. The main concern of reforms in PE pricing policies is to fix a price equal to Pi in order to induce the PEs to produce the optimum output equal to Q i . Let us now compare the two sources of economic inefficiency. In order to make this comparison valid, let us assume a five per cent inefficiency in both cases. In the case of technical inefficiency, this would imply that the marginal cost of producing a given quantity is higher by five per cent at each level of output. In order to determine the welfare cost of this type of inefficiency to society, we must know the counterfactual story. That is, we must know compared to what 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 their separate effects. Therefore, we shall assume that the public enterprise price is being allocatievely efficient. In other words, its price is always set at the intersection of the actual demand and marginal cost curves. Thus, we are comparing two situations: (a) a technically efficient scenario with the price at P i and the output at Q i and (b)

technically inefficient scenario with price at Po and output at Qo . The welfare analysis is summarised in Table 1. It shows that the welfare loss associated with technical inefficiency is equal to the area B D E C To discuss the welfare loss associated with a.five per cent allocative inefficiency, we have to, naturally, assume that the PE is technically efficient. A five per cent allocative inefficiency would translate to a price being fixed by the government at P 2 , which is five per cent lower than the optimum price of P 1 In other words, the error in fixing the "right" price is our proxy measure for the degree of allocative inefficiency.5 At this price of P 2 , the equilibrium will be at output level of Q. Therefore, our problem is to compare the net welfare cost to the society of moving from P, and Q 1 to P 2 and Q 2 . Table 2 summarises the welfare analysis associated with these points. Table 2 shows that the net loss associated with allocative inefficiency is equal to HDG Clearly, this loss is smaller than the one associated with technical inefficiency (BDEC). 6 Therefore, one can conclude that efforts at improving technical efficiency are likely to yield much higher returns and hence should be the starting point of ail reform M-69

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packages for improving public enterprises efficiency. This conclusion is further strengthened when one thinks about what the actual returns would be of eliminating allocative inefficiency starting from a situation where both types of inefficiencies exist (a much more probable scenario). In that case, one has to compare P 2 and Q 2 with P 0 and Q 0 . It turns out that the gain associated with fixing price at P0 rather than P1 is equal to HBK as opposed to H D I in the scenario discussed in Table 2. Not only are the potential pay-offs much larger in the case of reforms aimed at improving technical efficiency they also ought to come before pricing reforms in terms of sequencing. One can think of several arguments to support this idea. For example, in India, as in other countries, there is a limit to trie amount of resources that can be devoted to policy-making. To simultaneously start reforms in various public policy arenas may lead to spreading these resources very thinly. The end result may be failure on all fronts. Hence, a sequential approach seems more sensible. In addition, pricing reforms without concomitant reforms in the performance evaluation systems can be both 'illusory' as well as 'transient'. In order to explore this line of reasoning, we need to examine the context of these reforms. It is statistical reality that public enterprise deficits are a major cause of the third world debt crisis [Floyd, Grey and Short 1984]. This realisation has spurred many professionals to suggest that the solution to the deficit crisis lies in raising PE prices to eliminate their deficits. Traces of this kind of thinking can also be found in the Discussion Paper. When one examines this policy prescription further, however, one confronts real difficulties. First, the generation of surplus in PEs as a consequence of an increase in administered prices does not imply better performance The impression of improved performance is purely an 'illusion'. Since all the important or significant PEs are in the core sectors of the Indian economy, any increase in the prices of their outputs is likely to have a highly inflationary impact. Also, because the government is one of the major buyers of

PE products in the economy, an increase in inflation would involve greater expenditure on the part of the government. In short, the government appears to be collecting money from one of its pockets and putting, it right into the other. As mentioned earlier, financial profits generated by attempts at 'getting the price right1 are often not only 'illusory', as described above, they are also 'transient'. In PEs, the moment deficits are eliminated or surpluses generated as a result of price increases, there is often a tendency on the part of PEs to splurge. This tendency is often manifested in actions such as office renovations, hiring extra-workers when there is already surplus manpower, unnecessary trips abroad and other non-essential activities. Very soon, the enterprise is back to square one. The surplus is squeezed out by an increase in 'avoidable' costs and the enterprise is faced with another decision to increase prices. This vicious cycle can be more dangerous than the original deficits that prompted this cycle. Not only has the enterprise failed to control the deficits, but it also has become party to a net transfer of income from society at large to the public enterprise sector which is likely to exacerbate inequality. It would be difficult for this kind of vicious cycle to exist if a performance evaluation system that controls costs of production is in place, Therefore, it is, again, preferable to start reforms by putting such a system in place. To be fair, the Paper does argue for the introduction of such systems. However, it never states the reasons clearly and does not attempt to untangle the different issues. The introduction of Memoranda of Understanding (MOUs) in India embodies the kind of performance evaluation system that is being referred to here.7 A peat deal of difficulty in understanding the thrust of the Discussion Paper arises due to the absence of a clearly stated objective of the PE pricing policy. Even after reading the section entitled 'Role of Administered Prices', it is not clear whether the title of this section deals with "normative'' or "positive'' issues. Furthermore; it appears that the goals and objectives of the administered policy have been stated all over the body of the

Paper. It would have been infinitely better to have stated all the goals, cogently, at one place and then have discussed how to achieve them. At the very least, one can find the following goals of the pricing policy mentioned explicitly in the Paper: (a) Generate adequate internal resources (para 3). (b) Promote equity and social justice (para 4). (c) Provide basic necessities of life to the poorest sections at subsidised prices (para 5). (d) Provide a reasonable return to capital invested in public enterprises (para 8). (e) Control inflation (para 17). (f) Reduce the cost of basic goods so as to promote growth and employment in downstream industries (para 31). (g) Build pressure for reducing costs and increasing productivity (para 32). (h) Allocate resources so as to benefit the community (society) as a whole (para 33). (i) Reward efficiency (para 33). (j) Make transparent any areas of waste (para 33). There is absolutely nothing wrong with such a long list of objectives. If, in reality, the government intends to pursue all of them, then there is hardly any point in denying this reality. The issue here is how to achieve these objectives with the help of the pricing policy. The Discussion Paper never deals with this issue squarely. It mentions these objectives sporadically throughout the body of the Paper. This evasiveness makes one wonder whether the authors of this Paper were economists or non-economists, since the economists' methodology for dealing with this issue is fairly well-established. According to this methodology, the starting point for public sector pricing is the so-called 'Marginal Cost Pricing Rule'. By equating prices to M C , one can assure optimum allocation of society's scarce resources. If this pricing policy leads to a simultaneous achievement of the other goals listed above, fine and dandy. If it does not, then one must work out the trade-off between the conflicting objectives and see what is the welfare cost to the society for deviating from MC pricing policy to attain some other objective. The economists' job ought to be to highlight these choices. In the real-world, deviation from MC pricing is often the norm. Therefore, the job of professionals is to distinguish between legitimate versus illegitimate deviations from the MC pricing rule. Of course, the pursuit of an absolutely "good" or absolutely "bad" policy is futile The choice is always between imperfect possibilities. This notion has been so aptly captured by economists in the term "second-best" pricing options. To be sure, the economists' approach outlined above has had a battery of critics. However, no one has put up a more eloquent defence of this approach than Alfred Kahn and I quote him at length to rest our case for using the economist's framework lb the objection that economists tend to May 26, 1990

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overdo the importance of the allocation problem, the reply has to be that if the economist does not stress efficiency, no one else is likely to do so eithen While the other objectives with which those who set public enterprise prices are charged—distribution, regional balance, or whatever—are most unlikely to be forgotten, since each has its fervent advocate, efficiency very likely will be forgotten and, in fact, often has been... The economist dealing with public pricing may sometimes seem to be a rather strident advocate of some esoteric doctrine known as MC pricing who ignores everything that really matters. In fact, however, he is likely to be a lone voice for efficiency in a chorus of shouts for inefficiency in order to achieve this or that desired social or political goal. The stridency of his tone may also reflect his need to shout in order to be heard... The problem is not that efficiency is, to the economist, all that matters: it is, rather, that efficiency does matter, along with other things, and the best way we know to get efficiency is by setting price equal to M C . . . Finally, given the scarcity of resources, using them efficiently is simply a matter of common sense. Our quarrel is not with the lack of congruence between the Paper's approach and economists'. Rather, the Paper's approach is simply unclear. A quick reading of the initial sections seems to suggest that the most important goal for a pricing policy is to fight or control inflation. In fact, Section II entitled, 'Administered Prices and Inflation' creates .the impression that this is the main concern of the Paper. Yet, when one reads through this section, a highly confusing picture emerges. To start with, it is not clear why the authors have gone into such a lengthy discussion of inflation just to make the point that it is a result of a large number of complex factors and administered prices is one such factor. It is a fairly straightforward proposition, which is true for most countries and does not deserve so much space for bringing it to the readers1 attention. In fact, the length of this section contributes to the generation of contradictions. In para 7, the Paper suggests that the pricing policy of public enterprises has a much wider impact than their share in production. Yet, when the empirical evidence is examined, it turns out that the impact of prices is "much less destabilising than is generally believed" (para 30). Para 29 also claims that it is not true that "an increase in administered prices leads to an unusually high rate of inflation" Leaving aside the above conclusion regarding the relationship between administered prices and inflation, the technique used for arriving at the conclusion seems quite archaic by modern day standards of the economics profession. One would have liked the authors to perform a more sophisticated "causality" test to ascertain the relationship between inflation and administered prices. Major economic policies ought not to be based on primitive quantitative techniques. Economic and Political Weekly

While we are on the subject of quantitative techniques, it is worth pointing out the highly irritable presentation of facts in Table 1. It combines rupee amounts at different prices in the same table and thus makes comparisons difficult. The humour in Table 1 comes out if you read the following footnote at the bottom of this table: Targets are at 1979-80 prices for the Sixth Plan and 1984-35 prices for the Seventh Plan. Actuals are latest estimates and are in current prices. The authors might have made our lives easier by giving the figures in Table 1 at constant prices. The above examination of Section 11 entitled, Administered Prices and Inflation' suggests that the Discussion Paper is based on uncertain empirical foundations. Analogous scrutiny of Section I I I entitled, 'Policy Issues' suggests that the theoretical foundations of the Paper arc equally dubious. This section confirms, beyond doubt, the nagging suspicion one has all through previous sections that the authors of the Paper just do not understand the issues related to public enterprise performance evaluation. A glimpse at their insecurity (or lack of confidence) with this aspect of public enterprise policy is evident in Figure 5, where they use the terms like 'efficiency', 'productivity' and 'performance' interchangeably to cover all bases. Nowhere in the Paper do we find a clear distinction between these terms. It is not even clear if the authors of the Paper intend the words to be synonyms. In para 35, 'efficiency' is equated with 'capacity utilisation' The Paper argues that for units already working at close to full capacity utilisation, the scope for substantial improvements in efficiency may be limited. It seems to ignore the fact that it often makes economic sense not to produce at full capacity- Further, even if market conditions warrant producing at full-capacity, the real question is at "what cost" the full capacity output is being produced. Can the cost be decreased further by choosing a better factor proportion or by cutting down on the total factor cost? Para 36 reveals another very common pitfall to which many succumb. It is common place in the PE performance evaluation literature to make a distinction between Enterprise performance' and 'managerial performance'. The latter is 'enterprise performance' adjusted for all factors beyond management's control. If the, price of a product is being administered by the government, it then becomes an external factor and cannot be made to affect one's evaluation of managerial performance. For example, if from one year to another the only thing that happens is that the price of the PE output increases, then the consequent increase in profits cannot be taken as a reflection of increased managerial performance. In this situation Enterprise performance' has i m proved but not 'managerial performance'. Conversely, if administered prices are not

allowed to increase, 'fairness' to managers dictates that we do not blame them for the resulting losses. If we cannot legitimately blame them for these losses, we can hardly expect them to feel pressurised to act differently as suggested by para 36. The heart of the problem here lies in using pricing policy to achieve too many public policy objectives. It is a fundamental tenet of public policy formulation that there are limits to how. many objectives one can achieve with a given policy instrument. Usually, one requires as many policy instruments as there are public policy goals to be achieved. The paper suggests that when there is an increase in costs, inefficient units should be asked to absorb them through improved performance (para 36). This prescription seems to suggest that one should wait until costs increase in order to improve the performance of PEs. However, one would have thought that improvement in performance should be pursued regardless of cost increases. In fact, the paper itself says so in para 33. "The government is taking steps to achieve a reduction in operating and other real costs of public sector enterprises!' Unfortunately, the Paper does not specify that what the steps are, or whether yet another policy Paper will be presented by the government covering this topic. As we know, this kind of statement represents a time-worn ritual that has been regularly performed even since the inception of public enterprises in India. A bit more honesty would have brought in a breath of fresh air in this otherwise staid document. In Figure 5 of the Discussion Paper and the associated discussion, one is again struck by a similar lack of credibility. The left branch in the figure suggests that if one increases administered prices in order to absorb a rise in input costs, there would be an inflationary impact (para 38) on the economy. This reasoning contradicts the statement made earlier in para 24 (iii) that an increase in administered prices has "an overall deflationary effect on the economy as it tends to reduce the rate of growth in money supply!' The authors should have, at the very least, represented this argument by using another branch on the left side of the Figure 5. This additional branch would be only academically 'fair' thing to do unless one's objective was to distort the argument and give a one-sided picture. The arguments described on the right side of Figure 5 are equally suspect. For example, it is not clear that freezing administered prices when input prices are rising, would lead to losses in all public sector unit'. It would lead to losses only in some. Even then, it is conceivable that the public sector as a whole may continue to make profits and, hence, may not necessitate any net subsidy to this sector. Further, there is also a chance that an increase in non-administered prices may compensate for this freeze in the administered prices and, thereby, eliminate any need for subsidies. If one looks at the facts presented in

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Table 1 of the Discussion Paper, one finds that in the Sixth Plan, PEs contributed more than the targeted amount for the H a n outlay. It is conceivable that a freeze in administered prices may have still resulted in meetihg the plan targets, contrary to the arguments in para 40. The contention that higher budget deficits automatically would lead to inflation (para 40) ought to be viewed cautiously. First, we must know the magnitude of the increase in money supply that can be attributed to the freezing of administered prices. Some empirical evidence in this regard would have been very helpful. Even assuming that the increase in money supply is significant, one can only say that this factor would lead to an increase in aggregate demand, not inflation. Whether inflation occurs or not depends also on the behaviour of the aggregate supply, If there is a lot of slack in the economy, this increase in aggregate demand may be a welcome development. The authors' bias for financial profitability, once again, clouds their logic in para 41. They argue that "it is desirable that increases in tax revenues are used for financing development rather than for financing losses" They fail to distinguish a large number of cases in which the losses are a result of some development objective. For example, often PEs are set up in remote areas to promote regional development and, sometimes, their location sometimes causes them to become financially unviable. Therefore, financing their losses also tantamounts to financing development. The correct way to view this policy question is as follows: Once the government has decided that it wants to promote balanced regional development as a national policy, the question is how best to do so. The next step, among others, is idenfication of a particular region. Of course, politics plays a role in determining the answer to this question. In a democracy, this is inevitable and, perhaps, within limits, desirable. For us, the most relevant questions are: should the government set up an enterprise in the area most conducive for producing taxable surpluses and use the tax revenues for financing development activities? These activities may aim to generate employment, better work ethics, a higher standard of living, better education, hygiene, and other attributes of a more developed society. Or, should the government achieve these very objectives by setting up a large PE in this region? The answer to these questions is certainly not as clear-cut as the authors of the Paper would have us believe. As we move along, the theoretical discussions in the Paper become increasingly unsatisfactory. It seems the problem lies in the fact that these theoretical discussions are too little and unsatisfactory for professional economists but overwhelming for practising managers. A classic example is provided by para 43 which states that "Normally, it may be argued that any productive enterprise M-72

should price its products and services to cover long run marginal cost of production ( L R M C ) ' Now, economists will understand the statement (without necessarily agreeing) but, one can be pretty sure, the rest would have to take a course in economics to do so. First of all, L R M C is not an easy concept to start with. The Paper does not make it any easier by urging us simply 'trust' them that some government agency (BICP) is capable of calculating it. One would have preferred a more detailed discussion of components of L R M C . For instance, it would be interesting to find out how BICP (calculates the net replacement value of assets. What assumptions does it make regarding technological changes, physical deterioration rate (as opposed to accounting depreciation), rate of future inflation, etc? Above all, one would like to know how many objective, informed economists find BICP's approach acceptable? Since L R M C is such an important cornerstone of this Paper, the answers to these questions are critical for any meaningful discussion. Be that as it may, even the ascrtion that normally prices ought to be fixed equal to L R M C appears -too dogmatic and out of line with much of the theoretical literature on this topic. According to any stnadard work on PE pricing, fixing PE price at L R M C is a desirable policy only under a highly restrictive set of ideal circumstances. This pricing rule assumes, for example, that there are no 'externalities', absence of distortions in related markets and other such Utopian stories of the usual 'black-board' economics. We mortals know from first hand experience that this is not the 'normal' description of our world. Hence, price equal to L R M C , cannot be a 'normal' policy. Therefore, the bulk of the literature in PE pricing is devoted to figuring out 'optimal departures' from L R M C pricing in the 'Second Best' world in which we live. In fact, the Paper recognises these cases when it discusses the 'peak-load pricing' issue in

para 69. Here the dangers of uniform price based on L R M C leading to over investment in capacity is clearly recognised. In fact, charging a price different from L R M C at 'peak' as well as 'off-peak' may be the optimal solution in many cases. This multi-tier pricing is relevant not only for electricity and other utilities but also for a large number of other PEs in the transport sector as well. For the sake of clarity, it is worth illustrating this issue with the help of a simple example in Figure 2. Let us consider the optimum pricing policy for a hypothetical inter-island shipping Corporation owned by the government. It operates from the mainland and is in the process of deciding the price for its services between mainland and an island which is part of the Andaman and Nicobar islands archipelago. The demand curve D o u t represents the demand for the shpping services for exporting beer from the mainland to this island. D i n , on the other hand, represents the demand for shipping services by the inhabitants of the island for exporting copra to the mainland. The inter-island shipping PE has to determine not only how many trips to make but also what price to charge for the outbound and inbound trips. This problem illustrates a very commonplace problem of joint-costs in a large number of public enterprises. That is, the marginal cost of producing outbound and inbound trips cannot be isolated. A ship that goes out, has to come back. The only relevant concept is a marginal cost for the round-trip. Therefore, we are faced with the problem of deciding the optimum number of round trips as well as the respective prices for outbound and inbound trips? In order to do this, we need to know the marginal benefit of each round-trip. This is, of course, given by the vertical summation of the separate demand curves for the outbound and i n bound trips. Once we have the jointmarginal benefit curve given by the broken May 26, 1990

Economic and Political Weekly

lines in Figure 2, it is easy to determine the optimum number of trips. It would be at the intersection of joint-marginal-cost and joint marginal benefit at point Q. The prices for the outbound and inbound trips would be P 0 and P 1, respectively. Notice that neither price is equal to the joint L R M C . In para 44, the Paper makes another totally unrealistic (and simplistic) recommendation. It suggests that, " i n industries where the public sector has to compete with other producers, there is a strong case for allowing enterprises to set their own prices as far as possible!' This may be an acceptable policy provided that PEs are not burdened with any other non-market constraint. If you impose other non-commercial obligations on PEs and ask hem to compete with the private sector; the results are destined to be disappointing. Further, the Paper never clarifies what it means by competition. Is the car market in India competitive? Would the government allow Maruti to set any price the market can bear? There is always some competition in any commercial endeavour. The more relevant question is that of the degree of competition. Even duopolies and oligopolies compete with each other. But, then, they can also collude very easily while maintaining a facade of competition. Similarly, the authors of the Discussion Paper do not seem to have thought through the implication of their recommendation in para 48. They assert that "any unavoidable increase in prices of new materials and energy inputs should be allowed to be entirely passed on." The implication of this statement is that the management of PEs would have no incentive to change the factor mix, substituting less expensive inputs for more expensive ones. Granted, sometimes these substitution opportunities may not be present. Yet, by taking away the incentive to search for such opportunities for substitution, we may be overlooking opportunities that do exist. Paras 57 through 61 deal with situations where the actual cost of production in PEs is above normative levels. The authors do not think that this is the normal context, but give no reason for their assertion. It would be useful to have some sense of how many enterprises they suspect fall under this category. Their policy prescription is, once again, centred around achieving operational efficiency in PEs. They sugest that " i t should be mandatory for every public sector unit to set more efficient work norms with clearly set quarterly targets—along with the back up of appropriate incentive schemes'' At first blush, the above it can be compared to a policy which says it should be mandatory to be honest and hard working. In any case, it is a well known principle that those who live in glass houses should not threw stones at others. Unless the authors believe that public enterprise personnel come from a different stock in the country, one would like to know how successful Economic and Political Weekly

has the government been in instituting tor its employees "more efficient work norms, with clearly set quarterly targets—along with the hack up of appropriate incentive schemes". Of course, this is not an attempt to justify one wrong by quoting another. Our purpose is to suggest that these problems are, in fact, interrelated. Because the government has not had a culture of setting targets and rewarding or punishing achievement or failure, it is difficult to expect such attitudinal changes from their brethren in public enterprises. This bureaucratic culture has also influenced the way the government has managed its interface with PEs, The government, as the owner of PEs, has failed to clearly specify the objectives of PEs and institute an incentive linked to the performance of PEs on the basis of clearly specified objectives. Therefore, to break this vicious cycle of nonperformance oriented culture, charity must begin at home. The recent initiative by the government to enter into a Memorandum of Understanding (MOU) with 18 major PEs represents a valiant effort to break this vicious cycle. The Paper is silent on this policy initiative even though the M O U ball had been set in motion soon after the completion of the A r j u n Sengupta Committee Report at the end of 1984. Let us take this opportunity to highlight another flaw bedevilling most of our socalled expert committee reports, documents and policy paper. They rarely tend to acknowledge the work of the past committees and commissions on the same subject. It is difficult to speculate why. Perhaps they do not want to appear to disagree with other experts. Or, perhaps, maybe, they did not even bother to read what the previous expert committees have said on similar topics. We are not interested in past reports merely for the sake of comparison but to learn

from their knowledge and experience. One would, for example, like to know if other reports have suggested what this Paper is proposing. A n d , why were similar recommendations of previous committees not implemented? What is the 'marginal' contribution of this Paper? In regard to omissions, it is truly surprising to find no mention of 'price preference policy' in the Discussion Paper. For most practitioners, the first thought that comes to their mind in discussing pricing policies is the issue of 'price preference policy'. This policy mandates that a public enterprise should buy goods and services from another public entreprise even if the private enterprise can supply the same goods, as long as the PE price is not higher than 10 per cent compared to that of the private enterprise. It is not clear that the policy prescriptions in the Paper take this into account. Perhaps, the authors wish this issue to become a nonissue and fade away into oblivion. it makes one wonder what was the process involved in writing this Paper. In particular, did the authors bother to bounce their thoughts around in various circles before putting out this document? After reading through the whole document, one cannot help but fed that many compromises were made in order to get a document on this subject out in a hurry. Given the quantity and quality of India's experience and expertise in this field, we could have certainly done better than this Discussion Paper The major objective in writing this article is to initiate a discussion, and not to present a coherent set of alternative policy recommendations. The latter task is much more demanding than what one can hope from a journal article such as this. The preponderance of criticism levelled against the Discussion Paper in this article and the scarcity of applause for the valiant effort in writing It should be. however, viewed

May 26, 1990

in the proper perspective. It has never been easy for eocnomists to bring their theoretical apparatus to bear on practical problems. As Jacob Viner said years ago, "the list of handicaps of the economic theorist as a participant in public policy... is discouragingly long." Some of these handicaps arise from the practical difficulties associated with the use of economic theory in working out an appropriate public policy; others relate to the presentation of policy so that it carries conviction and obtains support: others again derive from the need to marry economic with non-economic consideration in making a policy politically acceptable. The Discussion Paper may not be unique in facing this common challenge, but it certainly fails to overcome these handicaps successfully. This failure may be unfortunate, but is not surprising. Oxenstierna said it centuries ago: "Do you not know, my son, with how little wisdom the world is governed?"

System embodied in the new MOUs, see, Trivedi (1989).

Basu, P K and Nove Alec, Public Enterprise Policy on Investment Pricing Returns, Asian and Pacific Development Administration Centre, Malaysia, 1979, Baumol, W J, and Bradford, W J 'Optimal Pricing for Public Enterprise', Quarterly Journal of Economics, November 1972, pp 519-544, Coase, R H, "The Theory of Public Uility Pricing and its Application', Bell Journal of Economics and Management Science, (Spring 1970). Gupta, K R, Pricing in Public Enterprise, Atlantic Publishers and Distributors, New Delhi 1978. Jones, Leroy P, 'Public Enterprise for Whom? Parverse Distributional Consequences of Public Operational Decisions', Economic Development and Cultural Change, 1985. Kahn, Alfred E, The Economics of Regulation Volume I: Principles, New York: John Wiley and Sons, 1970. Kumar, Lovraj, 'Pricing and Performance Evaluation in Public Enterprises', Public

[In writing this paper I have. Earlier versions of this paper were presented in the Advance Management Programme for Public Enterprise Managers, Indian Institute of Management, Calcutta, May 1989 and the Public Enterprise Workshop, Harvard Institute for International Development, Harward University, Cambridge, Massachusetts, July 1989. I am thankful to the participants of these programmes for useful comments and discussion without implicating them for the inadequacies of this paper. The latter are my sole responsibility.] 1 One can see that the government has been merrily raising administered prices. And, why not? Nobody seems to have objected to the tenor or contents of the Discussion Paper which the government put forward as a trial-balloon. 2 See, Mittal (1988) for a good discussion of objectives of pricing policies in public enterprises. It is also a good source of a recent bibliography on public enterprise pricing literature. 3 The title of Basu and Nove (1979) captures this distinction most directly. Almost all books on this subject deal with these three distinct areas. However, some make this distinction explicitly (eg, Ramanadham, 1974) others (e g, Gupta 1978; Srivastava, 1982) just mix up all these issues and hence end up engendering more confusion than clarity. 4 Of course; this is referred to as Marginal Cost Pricing. For other related concepts see a nice definitional summary by Kumar (1982). 5 Stylised facts suggest that for political reasons public enterprises in general tend to have their prices set below the marginal cost of production. Therefore a price which is five per cent lower than the optimum has been chosen for this illustration. 6 This comparison is much mote convincing. If one examines a simpler but an extreme case. See Appendix I for an example of such a case. 7 For details on the Performance Evaluation

Enterprise, Vol 1, No 2, 1980. Upsey, R G and Lancaster, Kelvin, 'The Genera] Theory of Second Best' Review of Economic Studies, February 1957, pp 11-13. Mittal, D K, Price Policy for Public Enterprises, Anmol Publications, New Delhi, 1988 Ramanadham, V V, Pricing and Investment in Public Enterprises, Oxford and lBH Publishing Co, New Delhi, 1974. Reed, P W, The Economics of Public Enterprises, New York: Crane Russal and Co, 1973, read pp 23-32. Srivastava, V K, Lal Price Policy for Public Undertakings in India, Kalyani Publishers, New Delhi, 1982. Trivedi, Prajapati, 'Performance Evaluation System for Memoranda of Understanding', Economic and Political Weekly, May 1989. Also reprinted in: Institute of Public Enterprise Journal, Hyderabad, June, 1989. Turvey, R, Economic Analysis and Public Enterprises, London, George Allen and Unwin, 1968. Turvey, R and Anderson, D, Electricity Economics, Baltimore, John Hopkins Press, 1977. Webb, Michael G, The Economics of Nationalised Industries: A Theoretical Approach, London, Thomas Nelson and Sons, 1973, Read pp 97-100.

Computerised Coal Distribution by
SINGARENI COLLIERIES (SSCL) has recently taken up computerisation of a number of its activities to improve overall efficiency. Marketing and distribution of coal being a sensitive and vulnerable area with scope for complaints, SCCL has chosen to introduce computerisation on a priority basis in the marketing department. The idea is to bring in total Objectivity' and 'neutrality' and to follow an 'open book system' in the supply and distribution of coal to the industrial consumers. While supply of coal to the core sectors tike power houses, major cement plants, railways and fertiliser plants is arranged as per the decisions of the Standing Linkage Committee, supply of coal to the non-core sector is made through a scientific and rational system. There are about 2,100 industries in Andhra Pradesh,. Tamil Nadu, Karnataka, Kerala and Maharashtra who regularly draw coal both by rail and road from SCCL. Coal is supplied to them as per the maximum permissible entitlement of each industry which is fixed on the basis of scientific norms. W i t h the installation of computers in the marketing department, data relating to all industrial consumers is fed into the computer. W i t h this the marketing department is able to compile and analyse the details of quantities and grades of coal drawn by different industries. For the first time, the norms by which coal is supplied to consumers is displayed on the notice board of the marketing department with a view to making the details known to all consumers. The grade of coal to which each

Singareni Collieries

category of industry is entitled, as decided by the technical committee,appointed by the government, is also indicated. The quantity of coal that each industry is entitled to per tonne of its finished product is also displayed on the notice borad. These are made public so that consumers are aware of the rules and conditions under which coal is supplied and they can point to any deviation from the norms. Sale notes are issued for supply of coal to the consumers on a 'first-come-first-served' basis. Daily, a computerised statement indicating the number of sale notes issued and the number of requests for issue of sale notes pending is displayed. The names of the consumers who have not been given sale notes and the reasons for the same are also displayed through a computerised statement. On par with the open book system that is being followed in the marketing department, the connected activities in the mining areas from where coal is issued to customers have also been computerised. A weekly computerised statement is prepared in which the name of the industrial consumer, the number of road lorries that he is entitled for, and the date when he would get coal and from which mines are indicated. These details are displayed in the mining areas where consumers submit their sale notes for drawal of coal so that they are aware that no queue jumping takes place. Mining areas follow a serial order and coal is issued on First-come-first-served' basis. The mining areas have to confine supplies to the grade specified in the sale note issued by the marketing department,

Economic and Political Weekly May 26, 1990