The economics of bottomless pits

We don't know how government ownership affect the behaviour of privately owned firms

Many Indian economists are unaware, because they have not been taught, that until the Second World War economics focused mainly on the behaviour of firms under different degrees and kinds of competition. 

What was not factored in in those theories was the presence of firms with access to tax payers’ money because in those days in Europe and America the notion of government-owned companies did not quite exist.

But now it does and we need to ask: how has government ownership affected and influenced the behaviour of privately-owned firms? Is there any theory to describe this? What is the economic theory of mixed economies?

Before government ownership came along, firms had to compete on a level playing field. Your fate depended on minimising your mistakes. Most theories of competition flowed from this basic premise.

This led to an entire body of economic theory that analysed firm level strategies for maximising output, profits and later as shareholder numbers grew after WW2, achieving the best combinations of the two that kept returns at the minimum acceptable level. The strategy was called ‘satisficing’. 

While privately-owned firms, even with a large shareholder body, adopted this strategy, government-owned firms with just one owner in most cases — the government itself — gradually departed from both maximising and satisficing.

Losses mounted and the government became an undemanding provider of investible funds. It now provides working capital also. 

Money? No worries

The result is that state ownership, which was intended to keep the worst aspects of capitalism at bay, has ended up having exactly the opposite effect by forcing labour intensive economies to prematurely adopt technology intensive, labour displacing strategies.

This is exactly what Karl Marx had predicted and it has happened because, as I said above, of the presence of players with no cash worries. They distort the entire working of the market for the products in question. 

Air India (AI) and its private sector competitors are a perfect example of this. The latter adopt labour displacing technologies at faster pace than they would otherwise have done. 

Thus, AI has around 350 people per aircraft. The private airlines have around 150. Except when AI charges full fares — which are debited to its owner, can you believe it! — it has no chance of surviving. Yet it does, year after year. 

It is exactly the same in every manufacturing or service industry where there is a large public sector presence — oil and gas, banking, telecom, you name it. 

The consequence, in a supply-constrained economy, is that the economy performs far below is potential level of output. The best way to see this is to ask what would have happened to agriculture if a quarter of its output was from government-owned farms.

Everyone knows the answer but has any Indian economist tried to disprove, via algebra and geometry so that it can be taught in colleges, the Left’s claim that government ownership is beneficial? 

Intellectual battles have to be fought with intellect, not moans and groans. Left ideas — adopted in democracies because the voting poor outnumber the non-voting rich — are bad enough in politics because they emphasise distribution and re-distribution; in economics they cause absolute havoc.

Three distortions

Since, as we have seen, these government-owned entities need endless funds the overall level of taxation, ceteris paribus, is also higher. This causes its own distortions. 

The government may just as well pour tax revenues funds down the drain. The effect would be exactly the same, given below.

One, the incremental capital output ratio which gives us a rough idea of the extra investment capital necessary to produce one extra unit of production, increases. In India, although the government will not admit it because it indicates inefficiency, it is well above 5. 

Second, the marginal efficiency of capital, or the net rate of return required from an extra unit of capital, goes down. Expectations about future costs and demand matter a lot for it to be above the rate of interest. If taxes are high, the net rate of return is adversely affected and investment stays below potential.

Indian economists have been so busy calculating political metrics such as poverty lines and inequality that they have completely neglected industrial economics. I doubt it is even taught these days. 

After 26 years of the removal of industrial licensing, we should have had at least two dozen Ph Ds on its effect on different industries. No such luck.