Why Public Sector Companies Have Made Losses Of More Than Rs 1 Lakh Crore

Buried in the inside pages of the Economic Survey of 2015-2016, released on 26 February 2016, is a very interesting data point.

The accumulated losses of sick public sector enterprises as of 31 March 2014, stood at Rs 1.04 lakh crore. This essentially means that the Government of India has pumped a lot of money into these companies over the years to keep them going.

The Survey does not point out whether the accumulated loss number of Rs 1.04 lakh crore takes the time value of money into account. What is the time value of money? Let’s say 10 years back the public sector enterprises made a loss of Rs 2,000 crore. The government took on this loss and compensated them for it. The value of the Rs 2,000 crore the government handed over to these loss making enterprises, ten years later, would be much greater than Rs 2,000 crore. (This example is for illustrative purpose only).

The loss number of Rs 1.04 lakh crore probably does not take the time value of money into account. If it had, the loss number would have been much higher. The question is, why have the public sector enterprises lost so much money over the years?

Charles Wheelan has the answer in Naked Economics - Undressing the Dismal Science. He gives the example of Hindustan Fertilizer Corporation. He writes, “By 1991, the Hindustan Fertilizer Corporation had been up and running for twelve years. Every day, twelve hundred employees reported to work with the avowed goal of producing fertilizer. There was just one small complication. The plant had never actually produced any saleable fertilizer. None. Government bureaucrats ran the plant using public funds; the machinery that was installed never worked properly.”

Further, the workers came in every day and the government kept paying their salaries. Wheelan writes, “The entire enterprise was an industrial charade. It limped along because there was no mechanism to force it to shut down. When the government is bankrolling the business, there is no need to produce something and then sell it for more than what it cost to make.”

If the government keeps making up for the losses of any company, what incentive do the management and the employees have to turn it around? None. A good comparison here are the public sector banks, in which the government has infused Rs 1.02 lakh crore of capital between 2009 and September 2015.

There is another point that needs to be made here. Up until the 1990s when the government ran most businesses in the country, the smartest lot either left the country or worked for the government.

As the economy opened up from 1991 onwards, people started looking at other options as the number of jobs offered by the private sector in sectors as diverse as banking to telecom exploded. The private sector also offered extra incentives to their best performers. The government meanwhile continued to follow a uniform pay scale.

Wheelan writes, “This uniform pay scale creates a set of incentives the economists refer to as adverse selection.” What does the term mean in this context? The most talented professionals who earlier worked for the government now had the option of working for the private sector where their pay was closely linked to their productivity, unlike in the government.

On the flip side, as Wheelan puts it, “for the least talented, the incentives are just the opposite.” They know that working for the government would mean a fixed salary and regular increments over the years, which will not really depend on their performance.

Hence, those who have ended up working for the government over the last couple of decades were definitely not the best of the lot.

The fact that the government has been ready to bailout loss-making public sector enterprises, and the best people don’t work for them anymore, has led to a situation where losses have just kept piling up.

In sectors where the private sector has been allowed entry, it has flourished and government companies have had to take a backseat. As the Economic Survey points out-

The Indian aviation and telecommunication sectors of today are unrecognizably different from what they were 20 years ago, with enormous benefits for the citizens. Public sector companies now account for a small share of the overall size of these sectors.

Despite the public sector enterprises being a small insignificant part of many sectors and with many of these companies making losses, the government continues to operate them and take on their losses. A major reason remains the fear of taking on the trade unions.

In fact, many of these loss making companies own large tracts of land which can be a huge revenue spinner for the government. As the Economic Survey points out-

Most public sector firms occupy relatively large tracts of land in desirable locations. Parts of this land can be converted into land banks and made into vehicles for promoting the ‘Make in India’ and Smart City campaigns. If the land is in dense urban areas, it could be used to develop eco-systems to nurture start-ups and if located in smaller towns and cities, it could be used to develop sites for industrial clusters.

Let’s hope the government shuts down these loss-making companies and starts selling the large tracts of land that they own.

This article was first published here.