Discussion
Macroeconomic Fallacies
PRABHAT PATNAIK
I am grateful to A V Rajwade for his
comments (EPW, June 17) on my paper
‘On Some Common Macroeconomic
Fallacies’ (EPW, April 8). I feel however
that I should respond to his piece, even
at the risk of appearing churlish, if only
to clarify my position to interested readers.
I confine myself below to our points of
difference, and take them up seriatim.
Against my argument that “if the govern-
ment borrowed Rs 100 and spent it on a
power project then the bulk of it would
come back as operating surplus to BHEL
and other public sector enterprises”,
Rajwade says that “the ‘operating surplus’
would perhaps be 10/15 per cent of the
amount spent, hardly the bulk”.
In BHEL and other similar large public
enterprises, wages and salaries generally
constitute fixed costs. If BHEL revenue
goes up by Rs 100, then the only ‘leakage’
from this amount in the form of out-
payments would be for the purchase of
additional current material inputs from
other enterprises (over and above what-
ever decumulable excess inventories may
be currently held) for producing goods
worth Rs 100. Now, these other enter-
prises from whom BHEL would purchase
its additional current material inputs would
themselves generally be a part of the public
sector itself. In their case too, wages and
salaries are likely to be a fixed cost; and
their purchase of current material inputs
is also likely to be from some other public
sector units. It follows then that in a situ-
ation where unutilised capacity exists
within the public sector, the chain of
expenditures triggered by an initial pur-
chase of Rs 100 of power equipment from
BHEL would remain largely confined to
the public sector itself, i e, the bulk of
the extra savings, generated by Rs 100
of such extra investment through its
multiplier effects, would be within the
public sector itself, as I had claimed in
my paper.
This is quite separate from the argu-
ment, which I also subscribe to, that even
if the entire Rs 100 accrued as savings not
to the public but to the private sector, so
Economic and Political Weekly September 23, 2000
that the net indebtedness of the govern-
ment went up by Rs 100, in recessionary
conditions such as those prevailing in India
today this increase in net indebtedness
should not be a matter of worry. But when
there is not even an increase in net indebt-
edness of the government, to worry about
a fiscal deficit in the midst of a recession
represents sheer folly.1
Rajwade asks: “Would looking at all
public sector indebtedness together not
vitiate accountability of individual
elements therein even more?” Account-
ability becomes an issue only because we
are concerned with improving the overall
performance of the economy. If we choose
means of enforcing accountability
which actually lead to a worsening of the
performance of the economy, in the sense
of perpetuating recessionary conditions
in the midst of crying social needs, then
the very rationale of enforcing account-
ability gets lost. And closing our eyes
to the worsening performance for the
sake of enforcing accountability in a
particular manner is tantamount to an
inversion of reason.
Now, complete autonomy of public
enterprises is usually advocated in the
name of making the economy work better.
But if people go hungry in the midst of
massive food stocks, if the government
goes begging MNCs to set up power plants
even in the midst of massive unutilised
capacity in the domestic power equipment
sector, then the continuation of this absurd
irrationality cannot be justified on the
grounds that overcoming it would violate
complete autonomy of public enterprises!
Surely, in such situations we have to think
of other ways of enforcing accountability
than through complete autonomy.
Rajwade asks: if the government budget
is to be taken together with public enter-
prises for the purpose of calculating the
net indebtedness of the government, i e,
if indebtedness of one unit to another
within this domain is to be ignored as
being inconsequential, then where do we
draw the line in demarcating this domain?
Are state government enterprises to be
included? Is the Reserve Bank to be
included? And so on.
If the government borrows Rs 100
to increase expenditure in the budget,
then whether this Rs 100 generates an
equivalent amount of savings in the
private sector or in the public sector would
make a difference only for the following
possible reasons: first, the government
can influence the choice regarding the
form of holding wealth in the case of the
public sector in a way it cannot in the case
of the private sector (which can keep in
check the possible adverse consequences
of the liquidity overhang generated owing
to government borrowing); and secondly,
savings accruing to the public sector can
ease the pressure on the budget itself
(through for example making budgetary
contribution to the investment outlays of
such units correspondingly unnecessary).
In this case the savings accruing to such
units are almost equivalent to savings
accruing to the budget itself.
Clearly, therefore, where the boundaries
are drawn is not a juridical matter but
depends on the prevailing relationship
between the government and the concerned
units. If government-owned units are
completely autonomous then there is no
practical difference from this point of view
between government and private units,
i e, whether the savings accrue to the
private sector or the public sector. In short,
judgment has to be used for deciding
whether a particular borrowing constitutes
fiscal deficit or not. (I do not see the
relevance of discussing the status of the
RBI here since the multiplier effects of
government expenditure have nothing to
do with the RBI.) But the point is that since
the central government-owned units are
not completely autonomous and are finan-
cially linked with the budget, an increase
in the government’s indebtedness to them
is altogether different from what is im-
plied by the concept of a fiscal deficit.
Rajwade says: “One quite agrees that
disinvestment should not be seen merely
as a way to reduce the fiscal deficit...there
are strong arguments otherwise to
pursue the course.” Among these “strong
arguments” he mentions the need for
“economically more efficient use of the
assets” (“the return on capital employed
in public sector undertakings as a whole
is very low – 2 per cent”) and for elimi-
nating “a general atmosphere which
stifles innovation”.
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 My argument was not that “disinvest-
ment should not be merely seen as a way
to reduce the fiscal deficit”, but that dis-
investment does not reduce the fiscal deficit
except in a purely accounting sense, i e,
none of the baleful economic consequences
attributed to a fiscal deficit is removed if
the fiscal deficit is covered through dis-
investment. I would like anyone to show
me otherwise.
I would also like anyone to show me
how, on the basis of the definition of
‘efficiency’ given in standard neo-classi-
cal economic theory, an economy under-
going liberalisation or privatisation expe-
riences an improvement in ‘efficiency’. I
had argued earlier in the pages of this
journal (October 25, 1997) that the claims
of ‘efficiency’ gains in a liberalised
economy are necessarily based on the
assumption that there is full employment
of resources in the post-liberalisation
scenario. This is palpably not the case.
Now, Rajwade has come up with a
definition of ‘efficiency’ (of asset use)
which makes it identical with the rate of
return. This is completely untenable. If two
different sectors, producing two different
sets of products (or product-mixes even
when they operate in the same broad product
group), pursuing very different price poli-
cies, facing very different demand condi-
tions, and having very different sets of
social obligations, earn very different rates
of return, then this fact can scarcely be
taken as an indicator of their respective
‘efficiencies’ according to the tenets of
any strand of economic theory. One may
wish the assets currently under the public
sector to earn higher rates of return, but
it is illegitimate to drag in the concept of
‘efficiency’ for saying so.
The ‘rate of return criterion’ for
privatisation becomes particularly objec-
tionable, given the totality of the circum-
stances within which it is being advocated.
First, we illegitimately emphasise the need
for reining in the fiscal deficit even in the
midst of a recession. Next, we illegiti-
mately define our fiscal deficit, by looking
only at budgetary transactions, so that even
when the net indebtedness of the govern-
ment sector as a whole would not go up,
we still worry about a fiscal deficit arising
only from budgetary transactions. (Or
putting it differently, even when what the
government spends with its right hand
would accrue to its left hand, we keep our
eyes focused exclusively on the right hand.)
As a result, even in the midst of unutilised
capacity in the public sector units, the
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government feels compelled to contract its
expenditure for reining in the fiscal deficit,
while begging MNCs to bring in the same
equipment which we could have produced
but are not producing for lack of demand.
And when public sector units, starved of
orders owing to such irrational policies,
show low rates of return, we wish to
privatise them ‘for a song’ (see below) and
in the process undermine our own tech-
nological and productive capacity! Like
the brahmin in the story who abandoned
his goat, thinking it was a dog because
three cheats had told him so, we are willing
to destroy whatever national capabilities
we have built up over decades because
the Bretton Woods institutions have suc-
cessfully persuaded us to believe in what
Joan Robinson had called the “humbug
of finance”.2
But let us for a moment ignore even this:
Let us suppose there is no demand con-
straint faced by public sector units. Even
then two important considerations intrude:
First, if earning a higher rate of return on
public sector assets (whether under public
sector ownership or after privatisation),
entails measures which have major dis-
tributive implications, then a higher rate
of return per se cannot be lauded. It has
to be specifically justified (and identifying
a higher rate of return with ‘efficiency’
which is considered per se desirable
actually obfuscates the issue). The current
agitation in Andhra Pradesh over power
tariff hike illustrates the point. Secondly,
there is a difference between returns
accruing to the private and the government
sectors, namely, there is less scope in
principle for social control over the end
use of resources belonging to the private
sector. If the privatisation of public sector
assets on the rate of return criterion is
questionable, when the higher rate of
return is earned, say, through mass
retrenchment, it becomes doubly so if the
higher rate so earned is stashed away in
Swiss Banks.
Finally, a word about innovativeness.
Such instances of innovativeness as one
comes across in post-independence India
(from fertilisers to heavy electricals to
offshore oil exploration) have occurred
largely in the public sector. This is quite
apart from the fact that the public sector
has been largely responsible for building
up the basic technological capability in the
country. By contrast, the private large-
scale sector (when we are talking about
privatisation it is only the private large-
scale sector which is relevant) has been
Economic and Political Weekly
singularly uninnovative. To use the lack
of innovativeness of the public sector as
an argument for privatisation therefore
seems ironical.
Finally, I come to the question of sale
prices of public sector assets. There are
actually two separate questions here which
need to be distinguished: First, what should
be the sale price of a public enterprise?
Second, when is the sale of a public
enterprise for retiring government dent
worthwhile?
Taking the first question first, we can
approach it from two different sides. The
value of an enterprise can be seen on the
one hand as the present discounted value
of the expected future stream of earnings
at some suitable interest rate r. Let me
denote this value (calculated for the pro-
spective buyer with the highest such value)
as P. On the other hand, one can look at
the enterprise as possessing a set of assets
(including land) which have some current
market value. Let me call it V. In real life
P and V would not be identical. The sale
price of an enterprise therefore should be
max (P, V). Let me call it S. (It follows
that even if an enterprise earns a zero rate
of return, its sale price should not be zero.)
Now, there is plenty of evidence that the
actual sale price of public enterprises (or
of public enterprise equity) has been way
below what would correspond to S. I
referred to the CAG’s strictures on the
subject, to which Rajwade’s response is:
“One does not know the expertise of the
CAG in taking a view on stock prices”.
The point is that no such expertise is needed.
As long as we know the value of the assets
(the estimation of which requires very little
expertise), we get the net worth of a
company simply by subtracting its debt
(which would be known) from the value
of assets. If the company is being sold off
(wholly or partially) for an amount that is
far below this figure (or, in the case of
partial sale, some corresponding figure),
then the charge of a ‘rip-off’ would be
valid. The CAG’s strictures, based
precisely on such calculations, validate
such a charge.
Let us now move to the second question.
Let the interest rate on public debt be i,
which is not necessarily the same as r. Let
the present value of the future stream of
profits expected by the government, dis-
counted at the rate i, be D. The selling of
public enterprises to retire government
debt would be worthwhile from a fiscal
point of view if (ignoring considerations
of risks) S > D.
September 23, 2000
 But this does not mean that in all cases
where S > D the public enterprise should
be sold off for retiring government debt.
The government must also be concerned
with what happens to output and employ-
ment. If for instance a prospective buyer
of BHEL wants to convert its property
into an amusement park, then the govern-
ment should be unwilling to sell it even
though S would exceed D. If an enterprise
is to be kept running as an enterprise,
and this is to be a stipulation in the sale
of it, then its sale would be worthwhile
from a fiscal point of view if P > D. Since
i would be less than r, a necessary
Economic and Political Weekly September 23, 2000
condition for this is that the sale price in
such a case should be higher than the current
market value calculated by applying r to the
expected stream of returns under govern-
ment control (which would roughly be
the same as the returns expected by the
government).
Now, the only case where we can have
some idea of market value is if a part of
PSU equity is already quoted in the market.
Privatisation through further sale of equity
would be legitimate from a fiscal point of
view if this further equity fetches a price
higher than its current market value. The
GAIL privatisation example, one of the few
of this genre we have, shows precisely the
opposite.
My purpose in saying all this is not
necessarily to allege corruption but to make
a structural point, namely, the very prices at
which the private sector appears willing to
buy PSUs are such that they invalidate even
the fiscal case for privatisation. EPW
Note
1 The complete argument is developed in my
V P Chintan memorial lecture, ‘The Humbug
of Finance’, Frontline, February 4, which can
also be accessed at www:macroscan.com.
2 Joan Robinson, Economic Philosophy.
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