The Indian Economy Blog

What are the perils of the government being in business? When the state is in the business of running businesses, perverse incentives take hold. That is the question that Rahul Gaitonde asks and responds that India’s biggest problem today is an interventionist state.

He studies the role of the government in the telecommunications sector and its decision to not unbundled the public sector firms’, BSNL and MTNL, infrastructure for use by private sector firms. He quotes the Economic Times report where the minister for IT, Mr Maran claims that “[i]f the state is not in the business of telecom, then their infrastructure can be shared and given to private players but in this case, the state is in the business and they are not in a social service segment,”

Gaitonde writes:

Maran’s quote says it all. If the state is not running telecom companies for “social service”, or it put it more correctly, “social benefit”, then what are they running it for? If profit is the only motive, then the company should be privatized, fully, and right away. Think about it: If there is no “larger good” for running BSNL and MTNL, their motives are just like any other private company. Why, then, should they be at such a huge advantage compared to a private player? First, they have access to tremendous funds (taxpayers’ money) which are not the result of revenue earned by the company. That’s what’s enabled them to build up this vast copper wire “last mile” network in the first place. Second, the parent ministry frames policy for the sector. This is almost always designed to protect the state-owned enterprises in the sector, which is but natural. But is it fair?

The question of fairness (or equity) is a normative one and the answer is necessarily subjective. However, the question of whether the policy is economically efficient lends itself to positive analysis. Economic efficiency requires that resources are allocated efficiently so as to maximize social welfare. The literature on telecommunications policy is unequivocal in concluding that the telecommunications market is contestable and therefore a competitive market will achieve efficient outcomes. If the government, for whatever reasons, were to introduce distortions in the marketplace that reduce competition, however, then the outcome will lead to welfare losses.

Giatonde outlines a solution which starts off with privatization of BSNL and MTNL. For the details please refer to his article. My contention is that privatization while necessary, is not sufficient to promote competition. For true competition to emerge, the firms that enjoy an advantage due to their legacy networks which were built under a protected marketplace must be suitably handicapped so that they don’t continue to dominate the field even if they are not the most efficient. Part of that handicapping process would involve unbundling the legacy infrastructure of the incumbents so that the private sector entrants do not have to duplicate the last mile infrastructure.

There are other questions such as should “unviable” markets (such as poor rural populations) be served, and if so how should it be funded, and who should serve those markets, which are not so easily answered as the politicians and bureaucrats would have us believe. But that is an entirely different kettle of fish.

The bottom line is simple: when the government is both a referee (policy maker) and a player (in business), then it can make up “heads I win, tails you lose” sort of rules for the game, and while it can “win” the game, the economy loses. For too long the government has won at the expense of the people. It is time for the government to get out of the game.