Friday, December 06, 2013

Privatising Khaki enterprises?

My article for the online magazine Viewpoint, Issue No. 180, December 6, 2013. The article can be accessed here.  

The advent of the right-wing PML-N government in Pakistan coincides with increased calls for privatization. Experts rush in to remind the government that privatization policies are a condition for aid and loans from international financial institutions (IFIs).Lest we forget, Prime Minister Mian Nawaz Sharif also promised increased privatization during his election campaign. Over the last two decades these same experts have been ‘advising' all sorts of governments. Now they advise Nawaz Sharif to take a bold step and to go all the way to privatize state owned enterprises.

A full throttle privatization agenda was recently announced by the federal cabinet. The rationale is financial loss. A frequently quoted figure is Rs. 500 billion per year spent by the government to subsidize state owned enterprises (SOEs). They argue that SOEs are a fiscal burden, and the sooner we are rid of them the better. Freed up resources can then be used elsewhere.

I will not get into the merits or demerits of the fiscal burden argument. Much is wrong with the SOEs as well as the state itself. Both require a lot of fixing. One of the main arguments against fixing SOEs is that they are used as employment bureaus (every past government has stuffed SOEs with loyal party workers), and that even if this government turns them around there is no guarantee that the next government will not put the effort to waste. In my opinion this argument highlights the lack of an institutional/constitutional arrangement that can prevent or restrict political parties from using SOEs to distribute patronage. The argument does not oppose state intervention in the economy but finds the misuse of SOEs burdensome for the state. It is crucial that we understand this last point.

Economic theory opposes state intervention in the economy on the basis of efficiency.
The argument is simple. Market determined prices of goods and services send firms the right signals for resource allocation. Since the only motive of a privately owned firm is the maximization of profit, resource allocation will reflect this goal. They argue that society as a whole will be better off if state intervention in the production of goods and services is at a minimum. The ideal scenario is no state intervention at all.

An important aspect of this argument is that it doesn't really matter whether states are involved in a profit making activity because their profits are an outcome of special market arrangements under which production and pricing of goods and services takes place. Profits are a manifestation of the market power that the state's activity may enjoy in the sphere of production. From the perspective of economic theory, this distorts the signals that market determined prices are supposed to send to the firms, which in turn misallocates resources and leaves society worse off.

Two very crucial points need some reckoning here. First, state intervention is not restricted to the SOEs. Businesses run by the Pakistan military [which runs the biggest business empire in Pakistan] are also a part of the state, as are WAPDA, PIA, and DISCOs etc. However, nobody asks whether the presence of Fauji Fertilizer in the fertilizer market distorts signals necessary to efficient resource allocation. Another example is the military's presence in the country’s real estate market. Circumstantial evidence suggests that the military's several housing societies help to create real estate bubbles - an event that inflates residential land prices.
Many of our IFI-trained experts do not like to highlight this aspect of the state's economic activity. The usual argument provided to justify the businesses of the military is that they are profit making entities that pay taxes therefore are not a burden on the state and in fact contribute to the national economy in a positive way. In the same breath they argue that these businesses are run for the welfare of retired military personnel and that their corporate style management does not allow for misuse as employment bureaus and keep the military's involvement at bay.
This is a faulty argument.

As stated earlier, economic theory argues that the profitability of a state-run business is based on its special status in the market (a monopoly or monopolistic power). Or it could be because the market is structured in a way that it benefits the state run businesses. Hence, economic theory advances a rationale for privatization even when SOEs are making profits [and the government wants to privatize profit making institutions as well, for instance, PTCL]. Corporate- style management and governance of military businesses does not hide the fact that these are essentially state run businesses.

The armed forces are subservient to the state (and the executive), so any business activity undertaken by them clearly falls under the ambit of the state. For example, the Fauji Foundation (FF) owns several businesses run for the welfare of ex-servicemen of the armed forces. FF is governed by a Committee of Administration (CoA) and a Board of Directors (BoD). The former is responsible for major investment and disinvestment and makes other important financial decisions. The latter takes care of the daily affairs of the foundation. The CoA consists of the Secretary of Defense as its chairman, the managing director of FF, the Chief of General Staff, Pakistan Army (PA), the Adjutant General PA, the Quartermaster General PA, the Chief Of Logistics Staff, PA, the Deputy Chief of the Naval Staff (training and Personnel), and the Deputy Chief of the Air Staff (Administration). With the exception of the first two members in the list all other members of the foundation's CoA are serving military officers. The Army Welfare Trust has a similar governance structure. How is this different from a senior bureaucrat lording over the affairs of any other SOE? If in these two instances, SOEs are one and the same (which they are), why do experts call for the privatization of only those SOEs that are managed by elected or unelected civilians?

The argument made here is not new. Ayesha Siddiqa discussed the businesses of the military in much greater detail in her book Military Inc. Revisiting this argument is important when calls for privatization gain strength in the country. Again, the welfare argument supporting the running of these businesses is at best weak if not entirely disingenuous. This is so because the employment bureau type management of other SOEs can also be justified on the basis of welfare provision, fiscal burden notwithstanding. Yet, one never sees our energetic experts making arguments along these lines. Experts rarely question the military's presence in the economic sphere in the first place.

The second point that requires reckoning is the performance of our much championed private sector. Again, the degree to which the private sector depends on the state for success is seldom highlighted. From agricultural price support to input subsidies for the industrial sector, the private sector would do poorly if they were left to the vagaries of market forces. In this limited space attention should be given to the racket that the state runs for private businesses in the name of tax codes.

Replete with concessions, holidays, and exemptions, the tax structure seems only to benefit the private sector. Tax expenditure is the amount of revenue forgone due to various tax exemptions. The Economic Survey of Pakistan reports tax expenditures since the fiscal year 2001. Since then a little over Rs. 1000 billion have been forgone due to various concession, rebates, and exemptions. On the average this amounts to Rs 100 billion of lost revenue every year. Some analysts say that this figure is underreported and the actual annual number might be 5 times as much. It is probably safe to say that the correct number lies somewhere in between. It is important to note this fact because it puts in perspective the fiscal burden number (Rs 500 billion) that I mentioned in the beginning of this article. It is obvious where the state needs to put its focus if it wants to address its fiscal burden.

In the last instance arguments for privatization can only be defended on ideological and political grounds. And if the battle is ideological and political then we need to pick sides and prepare ourselves for a long fight.

The writer is a PhD candidate at the New School for Social Research and a Research Fellow at IBA, Karachi. The views are his own. and @alifdaru

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