Private, Reporting for Duty!

"Government is selling India! Government is selling all our prized assets! Government is selling the country." 

Such statements from the opposition were not unexpected post the 1st Feb 2021 Union Budget with the push of BPCL, Air India etc disinvestments and further information of four PSBs up for sale being released by the Finance Minister. A working class raised in Nehruvian Socialism and a society fairly broken from spirit of entrepreneurship of ancient Bhaarat, naturally might resonate with such headlines and comments. The ghost of privatization is difficult to shake off for some but then what do we stand to achieve with it? Is it all bad or all good or is it somewhere in between? Is there a sweet-spot that one can aim for between the poles of Privatization (broadly, Capitalism) and State Ownership (i.e. Socialism)?

To answer these questions, one needs to ponder over the question, "What is any government's core job?". A government is supposed to provide for its people economically and socially while ensuring internal & external safety and security. When one says 'provide', one has to acknowledge that for anything the government has to give to Raam, it has to take something from Shyam. For anything it has to give to Laxman, it has to take from Raam and for anything it has to give to Shyam, it has to take from Laxman. This something can be a direct cash transfer as done through Kisan Samman Nidhi, it can be good roads/public infrastructure, it can be having a good night's sleep with a robust law & order system, it can be security from foreign/local terrorists so on so forth. Put simply, to provide or to spend money on welfare, infrastructure and security, government needs taxes. For the government to earn enough taxes to cover rising annual expenditure, it has two levers it can employ:

a) Raise Tax Rates (from 5% to 10% to 20% so on so forth)

b) Raise the Tax base (i.e. the number of individuals or corporations paying taxes as well as the taxable income of the concerned individuals or corporations or put simply, the net income)

There is a limit to which tax rates can be raised comfortably; beyond a certain point, tax evasion from the citizens and corporations starts getting indirectly encouraged. Though there are studies in behavioral finance which have researched and presented their analysis on the optimal tax rate for different levels of economic development, predicting the optimal tax rate is an extremely cumbersome task without much to gain out of it. As a general rule of thumb, anything above 20% starts nudging citizenry and corporations, especially in cases of an incompetent government, towards tax evasion. Since independence, our country has fallen into this trap where we have focused on excessive taxation on those earning well resulting in tax rates well above 50% for roughly three decades. This is an immensely counterproductive tactic to employ which results in citizenry discontent and weakening of the country's economic health. Sound economics suggests that the second lever, i.e. raising the tax base, is a much stable and sustainable taxation policy. This can be demonstrated by considering a basic mathematical demonstration of the area of a triangle:

A = 0.5 * base (b) * height (h)

If we consider base (b) as the tax base (Rs. amount of taxable income) and height (h) as the average tax rate, A can be termed as the total government tax collection (ignoring 0.5 as a constant as it will cancel out when we compare). Naturally, if the tax base is increased, the average tax rates are going to go down for the same level of government tax income.

The whole push of privatization is in pursuit of this tax base - the higher the tax base, the lower would be the average tax rates we all end up paying. Now, how does privatization fit into raising of the tax base? One would wonder that whether a company is owned by the state or by the private investor, it would be paying taxes and so would its employees. This is where the point on net income comes in not to forget, the up-front sale value of the government business being sold. When the state (i.e. the government at centre or the state) runs a business - that of coal mining, of airline operations, of oil exploration/production/refining, banks etc - it has to rely on the administrative set-up (or babudom) to take business decisions. Leaders of these businesses and the mid-management might not be the best experts to handle these businesses. The government ends up owning so many assets as primary shareholder, that managing those assets gets highly inefficient. Imagine any regular middle class family of six people (two earning members, two retired senior citizens and two kids) owning four cars - can each of this car be used optimally or would some of these cars always stay underutilized in the family's garage? These cars would continue to incur maintenance expenses unnecessarily as well as the avoidable purchase expenditure made on them by the family.

All in all, when a state-owned business earns Rs. 1000/- in revenues and generates 10% pre-tax profit, it has Rs. 100/- as pre-tax income which at 20% tax rate implies Rs. 20/- tax revenues to the government. When the same business is run by field experts who are not limited by inefficient reservation policies, labour policies and performance appraisal policies of the government (which regularly plague state-run businesses), then that business tends to earn higher revenues (say Rs. 1100/-) and improve its expense management as well. Experts are able to deliver the same output with a lesser workforce and plant/property/equipment. This means it is able to provide higher margins as well (say 12%) which at same average tax rate (i.e. 20%), means Rs. 26.4/- tax revenues to the government (Rs. 1100 * 12% * 20%), a good 32% (Rs. 26.4/ Rs. 20 - 1) more as compared to a state-owned business. 

The exception to this demonstration generally comes when a state-owned business (or set of businesses) is (are) a monopoly in its (their) field - possibly what we see with state-owned petroleum refiners or LIC given its monopoly; the moment that advantage goes, inefficiency rules the roost as seen with PSBs or state-owned power discoms or even BSNL/MTNL or Air India. That is where the next plus point of privatization comes in - when the market is open to experts competing against each other, any product or service is subject to competitive pricing taking it closer to its true market price that benefits consumers as well as enterprises. Imagine a case where you have to urgently travel via rickshaw from your home to the railway station or bus stand but there is only one rickshaw available, that too not metered - you are forced to shell out whatever the rickshaw driver quotes even if you know it is too high. However, when there are multiple rickshaw drivers competing for your attention (as tends to happen when one goes for Ola or Uber), the pricing is more closer to being called fair. In short, efficient businesses are able to compete better and provide better solutions to the consumer because if they don't, their profits will be hit. Imagine more and more businesses running this efficiently and competing in a free-market economy, that means higher and higher tax revenues (i.e. tax base) for the government. As mentioned earlier in the blog, a larger tax base provides the government with a much greater room in the future to reduce tax rates as it did across the past few years and recently, even the corporate tax rate - because more and more companies are eventually complying with taxation laws, more and more individuals are filing & paying income taxes - the number of taxpayers as well as the amount of tax is going up. When both these sub-components of the tax base sees a rise, the tax base has nowhere else to go but wider/be larger - down comes the triangle's height! This height does not only represent income taxes but is applicable to say fuel taxes as well; if the government has enough tax revenues from other sources, it would be less dependent on fuel taxes. (I have written at length on this tax height/rate taking the example of crude oil in a blog published in Sep 2017: Petro Prices: Perturbed by or Perpective of?)

Does this all mean that privatization has no pitfalls and that there is nothing to guard against? No; privatization does bring in greater competition, a more cut-throat environment of survival and as with pricing of a rickshaw service or a product, the pricing of an employee's service as well. Pay is not guaranteed and more often than not, is a function of performance and so is the continuity of employment. With that at stake, an employee is more susceptible to exploitation by the employer and that is where safeguards kick in. This is where the onus is on every employee to not allow himself/herself to be exploited. A businessman would be willing to put in 12-15 hours a day in his business for he seeks the growth. The businessman is willing to put his health, physical or mental, on the line to gain later on as the business grows. This is a businessman's choice; the similar choice is available to the employee too - if an employee seeks the high growth that comes with greater effort & sacrifice, he/she better well put in those efforts especially if there are other prospective employees or current employees who are willing to put in those extra efforts. If these extra efforts are not acceptable, the employee has to learn to accept a lesser pay and flatter promotion trajectory as well. The mentality to enjoy the benefits and growth that capitalism offers but experience the laid-back workplace relaxation that socialism allows, that mentality is not sustainable - there is a fun economics professor story on this.

This is what privatization brings to the table - it increases market competitiveness, bolsters profitable growth that leads to higher employment for the citizenry and higher tax revenues to the government. Higher tax revenues to the government, in the hands of a responsible leadership, translates to better infrastructure and security for the nation. It leads to opening up of further opportunities for sustainable growth that multiplies and keeps coming back to us, the people. Indirectly, it also reduces the reserved jobs in the country encouraging meritocracy. To gain all this, every employed individual has to simply accept the dynamics at work and figure out where he/she fits in. It is my personal experience that this is workable even in a corporate set-up like ours that values hours spent at office as a vital performance metric. There can be initial few years of greater struggle but if one prioritizes one's needs & wants, one can plan & adjust to the demands of privatized corporate set-ups. I have made peace with a lesser pay and flatter growth trajectory in return for a stable working schedule where I can balance my work with my off-work interests. So is the case with western work-setups where qualitative delivery is all that matters. We'll take time to change our mindsets, but it has to begin and move from somewhere! The answer can't be halting privatization.

The government has no business being in business!

With a pinch of salt and accounting for exceptions - that is the sweet spot! A base of free-market economics interspersed with precise, minimal & targeted socialist welfare interventions designed to make themselves redundant in the long-run!

The only task of the government is to provide & ensure a fair, competitive, adequately equipped, transparent and well-networked (roads, rail, sea, air, information/digital) environment for businesses, individuals and consumers to function - market dynamics of supply-demand takes care of the rest. In such an efficient environment, any government can then hope to collect optimal well-distributed taxes (direct on income or indirect on expenditure on commodities like fuel or services like hotel dining) just as a honey-bee collects honey, without damaging the flower as envisioned in Chanakya's Arthashastra.

I'll end the write-up with a thought provoking quote:

When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that is the beginning of the end of any nation.

Bhaarat has gone to the brink with Nehruvian Socialism and is looking to come back from that point - do we take a part in a meritocratic rise or condemn it further to its doom?

Jai Hind!