Economists and policy-makers alike look at the public sector with distrustful eyes. Government departments, public sector undertakings including utilities are included in the definition of the public sector. Public sector has been thought of as a synonym for corruption, red-tape and poor service quality. This near fanatic identification of the public sector with inefficiency has been attributed either to the Washington Consensus propagated by the World Bank and the IMFor the 1970s Reaganomics/Thatcherism that bestrode the Atlantic.The confluence of various factors culminating with the fall of the Soviet Union discredited the model of economic development propounded by them. This attitude towards the public sector in practice and policy advice is not supported by economic theory or pragmatic policy.
Public Sector Investment and Economic Theory
Economic theory identifies at least 2 clear instances of public sector involvement in economic activities. This includes instances of externalities and infant industry. An example of the former is pollution caused by an industry located upstream, which adversely impacts the livelihood of fishermen located downstream. Similarly if the scientific and technological development of an economy is quite low that certain industries cannot be set up in those environments then economic theory sees a role for government. Protection of those industries by imposing high tariff lines would encourage domestic productionvis-a vis foreign production. In the mid-half of the previous century it was thought that certain sectors especially infrastructure especially roads, power, ports etc require huge investments that require the governments to step in as private sector was not in a position to raise the necessary capital for the said purpose. Apart from the above instances, where public sector investment is required for optimal economic development an entire branch of economics, namely macroeconomics was born out of the need for maintaining economic growth and employment by public investment, especially during times of a downturn in the economic cycle. Now, if the above are the reasons provided for the need for public sector investment, then what are the reasons against it?
One of the main arguments is that in an economy the supply of investible funds is limited and if the public sector were to expropriate them then very little would be left for the private sector. This in turn leads to a high demand for the limited investible capital leading in turn to an increase in the cost of capital which is interest rates. The high levels of interest rates in turn discourage investment and reduces the economic growth in the economy. Another argument given is the agency reason which says that there are very few incentives for the government to take optimal decisions. Since governments are animated by politics and interests, economic and business logic take a backseat. In addition there is a tendency for governments to resort to pork barreling. The latter occurs especially in democracies with parliamentary systems of government which uses the first past the post system. This refers to the tendency of certain governments to increase public spending in certain local areas that are dear to the representative or minister in charge as they are politically closer to these constituencies. This is a phenomenon that we can identify with in our state and country. In such instances the first steps themselves are taken in the wrong direction. Industries that require certain raw materials are located far from areas that produce these raw materials based on nothing other than political expediency.
Public Sector Investment in Practice
These strong theoretical arguments however did not prevent the decline in preference and a reduction in support of the public sector from the late 1980s onwards.Evidence, however existed to demonstrate the importance of public investment. We look at some examples of public sector led growth across continents.The foremost example of a success story of state-led economic development is that of South Korea. South Korea focused on both industrial production and the building of infrastructure since 1961 to increase their economic growth rates in the Korean economy. The less known but more recent example is that of Ethiopia. Ethiopiahas seen the 3rd highest GDP growth in the world clocking rates upward of 5% since the early 1990s and with per-capita income growth averaging upwards of 8% in the 2004-14 period. This period also saw sectoral shifts in the economy from agricultural sector to services sector. The main strategy followed by Ethiopia during this period has been termed Agricultural Development Led Industrialisation. Similarly,Bolivia with its deft public management of the commodity sector combined with public investment has helped keep the economic growth buoyant in that country where others in the region has faltered. Moreover in the period between 2005 and 2014 public investment increased from 6% to 13%.
The importance of public investment to buoy up economic growth in times of a downturn is clearly seen from the experience of China during the 2008 Global Financial Crisis. By increasing public investment by more than RMB 4 trillion helped keep the economic growth in China to more than 10% per annum. Belatedly even advanced economies like the US resorted to public investment like the TARP to shore up the fortunes of the economy. Hence, there is a need to evaluate the positives and negatives of public investment on a case-by-case basis. A downright rejection of public investment or extolling the virtues of public investment without being cautious about the political angles of public sector investment may not be right.
Public Sector Investment in India
In an economy like ours, with widespread regional inequalities in development the role of the public sector in economic development cannot be wished away. The private sector is incentivized by profit and areas like the North east the ability of the private sector to garner profits in general is often limited. There may be isolated sectors like telecom sector where the private sector can still play a decisive role. The Total Government Expenditure which is a proxy for the size of the public sector in the country is at about 15% of GDP. There has also been a recognition in India’s policy making circles about the importance of pubic investments as the Government of India has realized the problems of a trough in the private investment in the economy and had planned a concerted investment especially in the Indian Railways in the previous budget and the Economic Survey.
It would be interesting to observe how the channelizing of the investments fared and how the upcoming Budget and Economic Survey which will be tabled in February 2016 recalibrates the need for public investment in the economy. This assumes significance in the context of an anticipated trough in India’s economy with a downward revision of the future growth rates.
