India has long been an intrusive state even when it came to business and the economy

It is fashionable to criticise [Jawaharlal] Nehru these days for much of what ails India. Nevertheless, it is important to remember that those were the days when the propaganda surrounding the Soviet Union was very strong. Even the Americans fell for it.

For many years, the most widely used economics textbook all over the world was written by the American economist Paul Samuelson. Samuelson, in different editions of his textbook, maintained for a very long period of time that, in the years to come, the Soviet economy would grow bigger than that of the United States.
As Daniel Acemoglu and James A Robinson write in Why Nations Fail: The Origins of Power, Prosperity and Poverty:

“The most widely used university textbook in economics, written by Nobel Prize-winner Paul Samuelson, repeatedly predicted the coming economic dominance of the Soviet Union. In the 1961 edition, Samuelson predicted that Soviet national income would overtake that of the United States possibly by 1984, but probably by 1997. In the 1980 edition, there was little change in the analysis, though the two dates were delayed to 2002 and 2012.”

Of course nothing of this sort happened, and the Soviet Union broke up in December 1991. But those were the days, and the narrative framed around the success of the Soviet style of economics, driven by its Five-Year Plans, was very popular. Samuelson was not the only one to be seduced by it. In fact, an entire generation was.

The trouble, as Acemoglu and Robinson point out, was:

“In reality, what got implemented in [the] Soviet Union had little to do with the Five-Year Plans, which were frequently revised and written or simply ignored. The development of industry took place on the basis of commands by Stalin and the Politburo, who changed their minds frequently and often completely revised their previous decisions.” 

Closer to home, Jawaharlal Nehru was also a great fan of the Soviet style of economic development.

So, India had its own set of Five-Year Plans. The Second Five-Year Plan (1956-1961) put into practice the idea of economic growth driven by public sector enterprises. The idea was that the government running businesses would ensure that Indians could control their own well-being.

As Shashi Tharoor puts it in India: From Midnight to Millennium:

“The logic behind this approach [was]… the conviction that items vital for the economic well-being of Indians must remain in Indian hands – not the hands of Indians seeking to profit from such activity, but the disinterested hands of the state, that father and mother [emphasis added] to all Indians. It was sustained by the assumption that the public sector was a good in itself; that, even if it was not efficient or productive or competitive, it employed large numbers of Indians, gave them a stake in worshipping at Nehru’s ‘new temples of modern India’…In this kind of thinking, performance was not a relevant criterion for judging the utility of the public sector.”

The lack of a performance criterion also led to a situation where public sector enterprises were set up but never got around to producing what they were meant to. Take the case of Hindustan Fertilizers Ltd.

Charles Wheelan talks about the company in his book Naked Economics: Undressing the Dismal Science. As he writes:

“By 1991, the Hindustan Fertilizer Corporation had been up and running for twelve years. Every day, twelve hundred employees reported to work with the avowed goal of producing fertiliser. There was just one small complication. The plant had never actually produced any saleable fertiliser. None. Government bureaucrats ran the plant using public funds; the machinery that was installed never worked properly.”

The fertiliser factory was set up at a cost of $1.2 billion and over a period of seven years, but it produced no fertiliser. Nevertheless, there was a canteen, an accounts department and a personnel department. Apart from this, promotions, pay rises and audits also happened.

It was totally surreal. Nehru’s public sector system as it evolved ensured that workers came in every day and the government kept paying their salaries. As Wheelan writes:

“The entire enterprise was an industrial charade. It limped along because there was no mechanism to force it to shut down. When the government is bankrolling the business, there is no need to produce something and then sell it for more than what it cost to make.” [Emphasis added.]

In fact, even in factories which produced something, productivity was horrible, to say the least. Productivity is essentially output per unit of input. Take the case of Steel Authority of India Ltd. (SAIL). The government’s main steel producer employed 2.47 lakh people to produce six million tonnes of steel in 1986. In comparison, the Pohan Steel Company of South Korea employed just 10,000 individuals to produce 14 million tonnes, or two and half times the steel produced by SAIL, during the same year.

Given this, it wasn’t surprising that the public sector enterprises worked in a very inefficient way. In 1992-1993, of the 237 public sector enterprises in operation, 104 were loss-incurring. The losses amounted to Rs 4,000 crore in total. If we were to adjust this for the consumer price inflation that has prevailed between then and now, it amounts to a little over Rs 19,300 crore as of March 2015.

As mentioned earlier, the losses of the 77 loss-incurring public sector enterprises in 2014-2015 stood at around Rs 27,360 crore. This means that, between 1992-1993 and 2014-2015, the losses of the public sector enterprises had gone up by close to 42 per cent.

The irony is that, unlike many other things, free India did not inherit public sector enterprises from the British when they left India in 1947.

When the First Five-Year Plan was launched in 1951, there were just five public sector enterprises. Yes, you read that right—there were just five public sector enterprises in 1951! The total investments of these companies added up to just a minuscule Rs 2.9 crore. By 1985, the number of public sector enterprises was around 200. They had a total paid-up capital of more than Rs 17,562 crore. All of this had been contributed by the government.

The question to ask is: How did the number of public sector enterprises jump from five in 1951 to 200 in 1985? The Nehru-Mahalanobis model of economic growth did not have much role for private enterprise in it. One reason for this was the assumption that the private companies would have neither the money nor the risk appetite in setting up companies in sectors like steel, which would have long gestation periods.

Hence, the government would have to set up public sector enterprises. But, over a period of time, the logic changed and went way beyond what it was originally meant to be. As Dwijendra Tripathi writes in The Oxford History of Indian Business:

“As the socialistic rhetoric became shriller, public sector enterprises intruded into the consumer-oriented sectors as well, such as drugs, hotels and goods-processing industries, with the avowed objective of ensuring easier availability of vital articles of mass consumption.”

A good example of this is Modern Food Industries, which was set up in the mid-1960s to make and sell bread. The company was finally sold by the Atal Bihari Vajpayee government to Hindustan Lever Ltd (now Hindustan Unilever Ltd) in January 2000.

Other than the government getting into consumer-oriented industries, it also started taking over sick private companies, in order to ensure that jobs were not lost. These were largely cotton mills.

Close to where I live in Central Mumbai, there is the National Bicycle Corporation of India. The company was established in 1939 by the Birla Group. A few decades later, the company started to incur losses, and it was taken over by the government in 1974. It was nationalised in 1980.

Furthermore, when the British left India, a few British-owned firms continued to operate in India. But, over the years, they found it difficult to continue to operate, primarily because of the web of regulation that the Indian government had built around private enterprise. These firms were also taken over by the Indian government.

These included some of the biggest firms of the pre-Independence era, such as Andrew Yule and Co., Bird Hilgers and Co., Balmer Lawrie and Co., Jessop and Co., Braithwaite and Co., Richardson Cruddas, Mazagon Docks, Hooghly Docking and Engineering Company, and Smith Stanistreet Pharmaceuticals. As Tripathi writes: “Producing heavy and light engineering goods, transportation equipment and drugs, their continuance was considered vital for the nation-building programmes.”

These reasons essentially ensured that the government was running all kinds of businesses.

As Tripathi writes:

“In the process, the public sector emerged by the mid-1980s as a vast conglomerate of heterogeneous industries – a virtual leviathan dominating almost every major contour of the nation’s business. The wide range of products and activities of the enterprises falling in this sector included manufacturing of steel, mining of coal and minerals, extraction and refining of crude, manufacturing of heavy machinery and machine-building equipment, machine tools and instruments, heavy electronic equipment for thermal and hydel stations, transportation equipment, telecommunication equipment, ships, submarines, fertilizers, drugs and pharmaceuticals.”

And there was more.

“The consumer items produced by the public sector undertakings included textiles, bread, newsprint, paper, footwear and contraceptives. The public sector also operated in the area of air, sea, river and road transport, large-scale trading and construction services, and the hospitality industry…The list would be larger if we include the banks, financial institutions, and insurance companies.”

Given the wide array of businesses that the government chose to operate in, it isn’t surprising that it ended up creating a mess by the mid-1980s. The situation has only got worse since then. One possible explanation for this might lie in the fact that, earlier, the smartest lot used to work for the government. If you were to look at the engineers who worked for public sector enterprises throughout the 1970s, 1980s and 1990s, most of them had passed out of Regional Engineering Colleges (RECs) located in different parts of the country.

After the economy opened up, from 1991 onwards, people started looking at other options, as the number of jobs offered by the private sector in sectors as diverse as banking and telecommunications exploded.

The private sector also offered extra incentives to their best performers.

The government meanwhile continued following a uniform pay scale. As Wheelan writes: “This uniform pay scale creates a set of incentives the economists refer to as adverse selection.” What does the term mean in this context? The most talented professionals who had earlier worked for the government now had the option of working for the private sector, where their pay was closely linked to their productivity, unlike with the government.

On the flip side, as Wheelan puts it, “for the least talented, the incentives are just the opposite”. They know that working for the government would mean a fixed salary and regular increments over the years, which would not “really” depend on their performance. Hence, those who have ended up working for the government over the last couple of decades were definitely not the best of the lot.

But this is more of a short-term reason. Over the longer term, other factors were at work as well. After Indira Gandhi became Prime Minister in 1966, the socialistic instincts of the government increased dramatically. In 1969, 14 banks were nationalised. After 1969, 131 public sector enterprises were set up. The trouble was that the bureaucrats who ran the government had no experience in running businesses. The bureaucratic system which India had inherited from the British and with which it more or less continued was not trained to manage profit-making businesses. It still isn’t.

This reason is of immense importance, given that even though the public sector enterprises were run by trained and capable individuals in many cases, the real decision-making was carried out by the bureaucrats (read IAS officers), who had absolutely no experience in running businesses. This is something that continues to hold good even today. Having said that, there are honourable exceptions, like Jagdish Khattar, who did a fantastic job of running Maruti Suzuki Ltd.
Furthermore, as the government got into the consumer-oriented sectors, it found out that it could not compete with the much nimbler private sector companies already operating in these sectors. Take the case of Scooters India Ltd., a company set up in the early seventies, which could never really take on Bajaj Auto. The company, based out of Lucknow in Uttar Pradesh, is still around, and made a profit of a little over Rs 11 crore in 2014-2015.

The point being made is that the government couldn’t really compete in the consumer-oriented sectors. This became even more obvious after the economy was opened up in 1991 and the private sector was allowed into many sectors it wasn’t previously allowed into. As TN Ninan writes in The Turn of the Tortoise:

“The last quarter century’s experience has shown that when the private sector is asked to provide telecom services, run airlines and airports, build and run ports, undertake banking, distribute electricity and even undertake water supply, the result is usually (though not always, for there is no shortage of private banks and airlines that have failed) a substantial improvement on what the government was doing until then.”

The fact that the government has been ready to bail out the loss-incurring public sector enterprises and that the best people don’t work for it anymore has led to a situation wherein the losses have just kept piling up. In fact, in sectors where the private sector has been allowed entry, it has flourished, and the government companies have had to take a back seat.

Excerpted with permission from India’s Big Government: The Intrusive State and How It’s Hurting Us, Vivek Kaul, Equitymaster Agora Research.

Vivek Kaul is an author and a columnist based in Mumbai. This is his fourth book.