Real versus financial resources

Hindsight is more accurate than foresight, but essentially worthless

That the government's, hopefully tentative, decision to merge the Infrastructure Development Finance Company (IDFC) with the State Bank of India (SBI) or make it a subsidiary is inane has been expressed quite widely by the financial newspapers (Business Standard editorial 22nd March as an example).

The proposal is illustrative of the general point, which should be a cause of anxiety among economists; the so called 'second generation of reforms' may turn out to be no more than a series of purposeless financial changes without any impact on our well-being.

Keynes, according to Steindl believed that "the only real economic constraints which limit our policy options are scarcities of real resources "" of labour, skills, machines, factories, land, raw materials, exhaustible resources.

If we cannot make use of them this must be due to institutions superstition or our own stupidity." (the late Josef Steindl of the Austrian Institute of Economic Research published by Latzera 1983, published in English by Macmillan in 'Keynes's Relevance Today' 1985). Steindl was driving home the point that financial orthodoxy about balanced budgets and sound finance could hinder a rational use of available material resources.

It is this inability to deploy real resources that is the cause of frustration between IDFC and the bureaucrats. As far as the bureaucrats are concerned they have sanctioned money to IDFC which is not translated into projects.

But for IDFC the underlying problem is not the magnitude of funds made available but the bureaucracy's rules that ensure projects cannot be implemented quickly enough. There is no lack of will or skills to implement projects, but rather the requirement that public funds cannot be disbursed outside a strict criteria that has been often reiterated to managers of public funds.

The problem is that no compromise is permitted about the 'norms of appraisal'. Projects have to meet standards of economic viability which apply to any projects requiring the disbursement of public funds.

Since it is common practice for authorities to use the benefit of hindsight in the evaluation of these projects, no rational system of appraisal can be applied beforehand. It is therefore common sense for the appraisers to adopt a conservative criterion in evaluation to the point where orthodoxy prevails over uncertainty.

Therein lies the ultimate difficulty, and it is one that has plagued the public sector for all these many years. The predicament lies not in the structure of IDFC but in the fact that the government and state-owned banks and institutions have contributed 75 per cent of the paid-up capital of IDFC and that the government therefore insists on the same degree of scrutiny in the use of these funds as it does for any government project.

In an earlier article 'Vision and Reality of Public Sector Management: The Indian Experience', written by me after my brief sojourn as chairman of STC and published in a book edited by Maurice Scott and Deepak Lal, Essays in honour of Ian Little (OUP 1990), I have extensively analysed the incompatibility of applying the government's financial criteria to the management of public sector units.

If it is an imperative that the use of government funds requires the application of the same principles as would apply to profit-making institutions, there can be no scope for extensive use of government funds to overcome the under-utilisation of real resources.

Merely passing the buck from the government itself to government-owned public sector units will not do the trick. The present dispute with IDFC is merely an illustration of the obverse side of the problem outlined in my paper.

For the normal difficulty public sector units have faced is the requirement to explain losses incurred in carrying out activities even when they have been urged to do so precisely by bureaucrats and ministers, who stand ready to condemn failure or impropriety caused by their own initiatives.

IDFC has avoided this particular trap only to fall into the other jaw of the dilemma, in that they have avoided implementing risky projects but now stand accused of not doing enough. IDFC has successfully made profits but they now are charged with failing to enhance and expedite the flow of credit into the infrastructural development of the country.

The government uses every facile and banal argument to show that in their budgets they have made large provision to increase the funds available for infrastructure; but in the use of these funds there will be seen to have been no change in criteria.

The ultimate test is simply to ensure that the lenders do not partake of any risk that could jeopardise the proper repayment of loans. IDFC has proved very successful at achieving this result; it has been successful in attaining very respectable returns from its investments; but that is not enough for politicians and their administrative stooges who now choose to assess the outcome within different parameters.

What government bureaucrats want is for public sector managers not to act merely within the narrow criteria that has been set for them. They are expected to take risks, not as regards the success of their enterprises but regarding their own careers.

Thus if they get round the criteria by bending the norms and succeed they will be rewarded as heroes and if they fail they must find "all the voyage of their life is bound in shallows and miseries" (vide Brutus in 'Julius Caesar') which take the form of enquiries instituted by a host of government agencies.

It is a dismal economic system. For it requires ordinary men to behave like heroes. In my previously referred to article I had quoted a couplet from Brecht that runs as follows "Unhappy the Land that has no heroes", to which the reply was "No, unhappy the Land that needs heroes".

It seems that IDFC is one more painful example of the immense damage that is done to the economy through government expectations that in the application of public funds foresight should be as good as hindsight .

For the simple lesson that emerges from this controversy between IDFC and the government is that even after fifty years of public fund management we have learnt nothing. We have developed no system for enabling the public sector to take risks. We have developed no system that will enable us to pay financial costs for social gain.

This is somewhat surprising as the academic norms for calculating social accounts have been extensively developed. But they have never been made operational; indeed public sector managers would be given very short shrift if they were to pass projects that on social accounting standards were beneficial but from the financial point of view disastrous loss makers.

The consequence that has emerged is that public or semi-public funds are regarded as only to be used when projects are both socially and financially viable.

This compromise cannot be faulted but it does not lead to the maximum use of real resources. The fact that we need infrastructure, particularly a viable power sector, is not a matter of any doubt, but the painful financial obstacles faced in developing a system have been explicitly stated by IDFC's chief policy maker Urjit Patel in his Business Standard articles. But when the Government of India is your ultimate master, the reward for developing such expertise is the threat of premature retirement.

sjmulji@aol.com