The Hindu Business Line : Unleashing the power of private initiative

The reforms of 1991 can be considered a tipping point, heralding a surge in the growth of private investment activity hitherto crowded out by state intervention. There has since been a dramatic improvement in industrial productivity and competitiveness.

Sumit Majumdar

Firms do not operate in a vacuum. Instead, they operate within the contours of a lush institutional and competitive environment where the actions of the State and other competitors have significant impact on their behaviour and on the subsequent performance.

In many nations, the State has played a significant role in defining the contours within which business and entrepreneurial activity could be conducted. In so comprehensively defining the institutional topography, the State has played a role that has overwhelmingly subsumed the activities of individuals, and by a process of aggregation, that of the market, in defining not just the context within which firms do business but has also provided the bulk of the transactions that are reflected in the economic accounts of a nation.

One way that the role of the State has manifested itself is in its investment activities. The State has been a substantial investor in the economic activities of a country and has operated several very significant businesses that make up the industrial structure of an economy. In funding the activities of running businesses, the State operates in exactly the same capital market that private businesses operate in.

Smaller role for Private enterprise

It is axiomatic that the enhancement of the relative role of the State, as an acquirer of funds from the capital market, and as investor in businesses and infrastructure projects, has the impact of reducing the role of private enterprise in an economy. What the consequences of such crowding out are in affecting the performance of an economy is known. The State sector is assumed to be generally less productive, pro-active and innovative than the private sector.

Conjectures have been aired suggesting that the holding back of the enormous economic potential of India, by destroying the elan vital associated with private entrepreneurial initiative, is principally due to the role of State enterprises becoming substitutes for private sector enterprises. Consequently, private sector enterprises and initiatives have atrophied and withered.

An understanding of the crowding out phenomenon helps assess the potential trajectories along which an economy has evolved as a result of entrepreneurial activity. The notion of crowding out deals with understanding the evolutionary imprint of competition for a variety of resources, one of which is the basic financial resources that enable firms of various types to commence and progress in their operations.

The History

The reasoning behind the enhancement of the role of the State in Indian industry was, broadly, to bring about rapid industrial development and correct historical patterns of lopsidedness. Such policies were initially laudable, given the times in the 1950s when almost all Western European countries had similar active policies in place and even in the US there was an active planning movement that presumed its denizens, such as Mr Robert McNamara, could dictate the contours of national economic development.

Yet, as Mr Sharad Marathe, former Industries Secretary, has written, though there was a sense that by the 1960s the logic of State intervention in India was losing its charm and legitimacy, the system that had been created had taken on a life of its own.

Throughout the 1960s and the 1970s, such systemic life resulted in a substantial increase in the share of government companies and the emasculation of entrepreneurial initiative within the Indian economy.

As Mr Hayek has also described such a system: “This division in the disposition of resources would then simply have the effect that neither the entrepreneur nor the central authority would be in a position to plan…To assume that it is possible to create conditions for full competition without making those who are responsible for the decisions pay for the mistakes seems to be pure illusion. It will be at best a system of quasi-competition where the person really responsible will not be the entrepreneur, but the one who approves his decisions and where in consequence all the difficulties will arise in connection with freedom of initiative and the assessment of responsibility which are usually associated with bureaucracy.”

Tipping point

The reforms of 1991 were meant to alter the system. A number of reforms have set off an epidemic of entrepreneurship in India. Specifically, the role of the central planning authority, taking decisions about what quantities of resources were to be made available to entrepreneurs, in what combinations they were to be used and, yet, hold the entrepreneur for eventual outcomes, were constrained by the specific policies implemented during the reforms process. The reforms of 1991 can thus be considered a tipping point. A question is what impact has this had?

In the past, there was a significant growth in the share of government companies in India that crowded out the entry and growth of private enterprise.

This took place at least over a 30-year period, from the mid- to late-1950s to the late 1980s and early 1990s. Correspondingly, the amount of private equity capital invested in firms declined until the late 1980s and early 1990s.

The figure shows the post-1991 upsurge when there was a growth of private investment activity. From a low base in 1991, within the first decade or so after the reforms, the amount of capital raised has risen six times, while government firms’ capital raising has remained stagnant.

Related to these features of Indian industry was that just a relatively small number of government companies absorbed a great deal of the corporate sector equity investment in India, significantly skewing the capital structure of industry and leading to a situation where a relatively extremely small proportion of government companies accounted for most of the equity capital.

Reversal of trend

The significant growth in the share of government companies in India that effectively crowded out the entry and growth of private enterprises had a significantly negative effect on India’s industrial competitiveness, and that trend has been reversed with the significant resurgence in private enterprise in India.

After the introduction of major reforms in 1991, there has been a crowding in by private enterprises, displacing the government companies from their key position as holders of a very large portion of equity capital, with private companies increasing their financial scale by also substantially augmenting the level of equity invested per company.

These have had a dramatic and significant impact on India’s industrial productivity. The relationships between the presence of private firms in India’s corporate sector and also the amount of paid-up capital per private firm and the productivity measure are strongly significant and positive.

As a consequence, the competitiveness of Indian industry has been sharply enhanced.

So what?

An allied question on the above theme relates to an evaluation of the contagiousness of the entrepreneurship process across industry sectors and geographies and how far this could be a self-sustaining process.

If that were to be the case, then the crowding in of private enterprise in India will comprehensively marginalise the role of government companies and make the process of privatisation unnecessary.

The competitive process of entrepreneurship would have had its way in altering the industrial structure of India.

(The author is Professor of Technology Strategy, University of Texas at Dallas. He can be contacted at majumdar@utdallas.edu)