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Strategic Human Resource Management in Higher Education

Introduction Identifying the basic structure of a human resources office in a higher education setting, and the role of a manager in this office is important as it helps identify industry-wide standards and best practices. While reading the resources for the week, think about internal and external challenges affecting talent management in educational organizations. Initial Post Instructions Visit CUPA-HR (College & University Professional Association for Human Resources) and consider joining as a student for a waived fee. Which aspects of HRM do you feel are most important for the employee, supervisor, and HRM professional to be responsible for?  Why? What is the role of HRM in higher education? What are the challenges and emerging trends impacting the management of talent in educational organizations? Minimum of one library resource and an additional resource for initial post Writing Requirements In addition to one initial post, respond to at least two peers. Initial Post Length: minimum of 350 words Secondary Post Length: minimum of 200-word discussion post Using APA format, provide at least two citations with corresponding references page and use appropriate in-text citation(s) referring to the academic concept for the initial post.

The role of the state in an economy

Role of the state in society

Under any type of economic system, the purpose of economic activity is to satisfy the material needs of that society. People receive income, spend, save and invest. Hence decisions must be made about the allocation of resources among various products to determine the type of goods to be produced with available resources. Further decisions must be made on the extent to which decisions must be made on the extent to which output will be used for immediate consumption or for use in future production or the rate of overall real capital accumulation as a whole.

The economy has to decide the particular techniques of production to be selected. Decision regulating the distribution of output of society among its various members must also be determined. There are three general ways in which the problems can be solved.

  1. Decisions may be made by some form of authority designated as a government, which is able to enforce its decisions upon the members of the society. (Centrally planned economy).
  2. Decisions may be made automatically through the operations of the market mechanism (market economy)/capital.
  3. The decisions may be made through the interaction and co-ordination between market mechanism and government authority (mixed economy).

Role of government in a capitalist economy

  • Provide law and order.
  • Promote equality in income and wealth distribution in use of taxation and expenditure.
  • Protect the interest of the working class and common man by enacting labour laws and social security legislation.
  • Provision of public goods such as defense, bridges, park, education, health etc.
  • To ensure economic efficiency by proper allocation of resources, through competitive environment.
  • To solve the problem of expenditures caused by private activities.
  • To undertake risk investments which cannot be taken by private activities?
  • Help in economic growth and development.

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Role of government in a mixed economy

  • Resource allocation through public expenditure, price controls and income.
  • Consumer protection from monopolies.
  • Provision of public goods and services.
  • Distribution of income and wealth
  • Optimal diversion of resources
  • Development of private sector through subsidies, tax concession, and tax holidays etc.
  • Undertake development projects.

The case for public sector production in Kenya

When Kenya became independent, it was felt that independence will be incomplete without economic self-reliance and social justice. Heavy investment was therefore made in Public Enterprises (PE) to;

  1. Build infrastructure
  2. Promote rapid economic growth and industrialization
  3. Secure balanced regional development
  4. Create job opportunities, where persons belonging to socially disadvantaged communities could have their due share.
  5. Prevent concentration of economic power
  6. Reduce disparities in income and wealth.

THE MEANING OF PUBLIC ENTERPRISE(P.E).

Public enterprise is an activity of a business character, managed and owned, 51% or more by the government – either central, or local providing goods or services for a price.

The definition has two dimensions, namely, public ownership and business enterprise.

Public ownership implies that major decisions would rest on distinctive social criteria to the exclusion of any personal interests. Also, the surplus would not accrue to a private group or individuals. Finally it involves social accountability i.e. whether the PE has provided to the nation the maximum economic and social profitability and that no group or persons have secured private gains.

TYPE OF OWNERSHIP

A PE can be owned by the central or local government. There are so many government companies and statutory corporations other than banks, financial institutions, insurance companies etc. There are several autonomous entities. There are also numerous municipal and city corporations and local bodies undertake economic activities like supply of water, power and transport.

  • Indirect ownership

For an activity to become PE, the government should not only own it but also manage it. The ownership with the government must be 51 percent or more. In some cases, this ownership may not be indirect e.g. The government owns Air-India Ltd, which in turn owns hotel corporation of India Ltd. If the majority ownership is through more than one public financial institution, public sector, bank etc, the unit would be considered a deemed government company. There are many cases where 55 percent or more of equity of an enterprise is held in this way.

  • Ownership without management

It is possible that the government may have ownership without having management with it, if the unit is given on lease or management is handed over to a non-government body.

  • Management without ownership

It is a unit being managed by the government without owning it. In the past, many private enterprises were under government control based on the provision of industries without acquisition of ownership rights by the government. Here the unit is no a PE.

Business Enterprise

It implies that the government expects a return on the capital invested, and the goods and services are made available for a price, which may be adjusted from time to time to cover cost of inputs.

A PE need not earn profit but should at least cover full cost of its input over a period of time. It is possible that in the short-run a PE may not be able to cover its cost and may incur losses. But so long as the intention is not to suffer a loss, it is a business activity.

It may be noted that the business character is more likely to be found in areas of economic activity such as agriculture, mining, manufacturing, utilities, construction, commerce, communication, banking, insurance, financing and consultancy services. On the other hand, public administration, national defenseetc generally do not lend themselves to the business idea, and hence cannot be considered PEs. The enterprise or business dimension of PE emphasis financial viability and cost-price equation.

CLASSIFICATION OF PUBLIC ENTERPRISES

  1. Classification based on legal definition; joint stock company, public or statutory corporation, department enterprise, co-operative society
  2. Based on ownership; fully-owned by the government, owned by the government through one of its companies or corporation, owned jointly with a foreign party, owned jointly with individual
  3. Sectorial classification; enterprises under construction, enterprises producing and selling goods, enterprises rendering commercial services, promotional and development enterprises
  4. Based on level of role in industry
  5. Complete presence
  6. Partial- but substantial presence
  7. Partial and small presence
  8. Based on origination
  9. Inherited from colonial past
  10. Acquisition of domestic or private capital
  11. State entrepreneurship
  12. Takeover of sick units

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FORMS OF PUBLIC ENTERPRISES

Departmental Organization

It was, at one point of time, the prominent form of organization of the public enterprises for two reasons. First, it was easy for a government to create an enterprise within the organizational framework of one of its already existing departments. Secondly, in the initial stages of developmental planning, the number of such enterprises with commercial functions was small.

The major characteristics of Departmental enterprises are

(a) The enterprise is financed by annual appropriation from the treasury and all or major share of its revenues are paid into the treasury.

(b) The enterprise is subject to budget accounting and audit controls applicable to other government activities.

(c) The permanent staffs of the enterprise are civil servants, the method by which they are recruited and the conditions of service under which they are employed are ordinarily the same as for other civil servants.

(d) The enterprise is generally organized as a major sub-division of one of the central government departments and is subject to direct control of the need of the department.

(e) Wherever this applies in the legal system of the country concerned, the enterprise possesses the sovereign immunity of the state and cannot be sued without the consent of the government.

Public Corporation

It is an autonomous form of the organization “clothed with the power of the government, but possessed with the flexibility and initiative of private enterprise”.

Public Corporation may be understood in general terms as an autonomous commercial organization established at government’s insistence outside the framework of government department and company legislation.

1. It is wholly owned by the State.

2. It is generally created by, or pursuant to, a special law defining its powers, duties, and immunities and prescribing the form of the management its relationship to established departments and ministries.

3. As a corporate body it is a separate entity for legal purposes and can sue and be sued, enter into contract and acquire property in its own name.

4. Except for appropriations to provide capital or to cover losses, a public corporation is usually independently financed.

5. It is generally exempted from most regulatory and propitiatory statues applicable to expenditure of public funds.

6. It is ordinarily not subject to budget accounting and audit laws and procedure applicable to no corporate agencies.

7. In majority of cases, employees of public corporations are not civil servants and they are recruited and remunerated under terms and conditions, which the corporation itself determines.

8. It may not be wholly owned by the State.

9. Every public corporation need not be the result of a special enactment.

10. Some of the restrictive regulations applicable to government departments’ expenditures and the audit system can also be imposed on public corporations.

11. Some of the employees of public corporations, especially at the top level, may be from the civil services.

Government Company

The joint stock company is another organizational form of public enterprises. The ‘company form’ which may also be called a ‘government company’ is described in many countries as an enterprise registered under the Companies Act of the land in which the government and/or public enterprises hold at least 51 per cent of equity capital.

Advantages of Government Companies are as follows.

1. A government company is far easier to constitute than a public corporation, which requires specific legislation, while only seven signatories of the memorandum and articles of association are required to get a company, registered under the Companies Act in India.

2. The company form enables the government to diversify its ownership in the company by either selling or buying equity shares. It can easily transfer the company to private sector by simply reducing its share capital to less than 50 per cent.

3. The creation of a company form of public enterprise suggests the government’s will to allow the public enterprise to work under the same set of law as those applying to private sector enterprise.

4. The company form of organization of public enterprise gives certain conveniences to government as far as its relationship with the enterprise is concerned.

Joint Enterprise

State participation in an economic activity along with the private sector has led to the creation of a specific type of organizational form, which is known as joint enterprise.

Public sector undertakings:

Factors responsible for the emergence of Joint Enterprises

1. Government’s will to set up joint enterprises with private sector may be in either of the following situations:

(a) Lack of initiative to participate in the private enterprises which can be secured by government’s participation; or

(b) Government wants to conserve its limited resources and invite private capital so that the government can extend its coverage to more fields in the public sector.

2. The government’s decision to enter into partial ownership of a going private enterprise may occur in the following situations:

(a) For conversion of loans of the private sector into equity capital

(b) For regulating the monopolistic operations or public interest potentials of a private enterprise;

(c) For overcoming the ‘sickness’ or ‘mismanagement’ of a private enterprise

(d) For governing profit in case of a private enterprise;

(e) For continuation of previous management, in case of nationalization of private enterprise; and

(f) For limiting cost compensation, in case of nationalization of foreign private enterprise. There has been a progressive increase in the number of joint enterprises the world over, especially in the wake of privatization wave.

Development Corporation

It is difficult to exactly define ‘Development Corporation’. On the basis of empirical evidence world over, especially in the developing countries, it may signify an autonomous agency in the public sector, primarily to promote, rather than to operate, economic activities through a system of subsidizing. The promotional activity of a Development Corporation is as follows.

(1) It promotes an activity which otherwise might not come into existence.

(2) It accelerates an activity which otherwise would materialize at a slow pace in small outputs and in a sect orally unbalanced manner.

(3) It promotes a desired pattern of economic activity, meaning thereby the expansion of desired sector of activity, promotion of units of desired sizes, attainment of desired balance of payments, development of certain economic activity in the desired region, etc.

Summary

The chapter has emphasized the role of the state, the need for public sector production in an economy, distinguished the type of ownership of public enterprise and has shown the various types of classification of public sector enterprise.

Question

  1. Discuss the role of government in a capitalist system
  2. Distinguish between a public company an public corporation and give examples of each

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CHAPTER TWO

RATIONALE, OBJECTIVES AND IMPORTANCE OF PUBLIC ENTERPRISES

Learning objectives

After you have read chapter you should be able to:-

  1. Rationale of public enterprises
  2. Objectives of public enterprises

Rationale

The need to have public undertakings can be justified on a number of grounds.

1. An economy cannot sustain itself and grow unless it is healthy in terms of production potential which should increase with the passage in time with the advent of industrialization, and therefore more rapid rate of economic growth. It was essential that the economy should be able to sustain its increasing productive capacity. This implies development of different economy sectors in harmony with each other, which is a proper sectorial balance. However, the nature of market mechanism is such that all economic activities are guided by economic rationalization which in the case of provision of productive services means profitability. Market mechanism would refuse to create and run the productive services which could not yield adequate commercial profits. It is found that there are some means of production like social overheads, the creation and maintenance of which does not ensure adequate commercial returns. Such social overheads however, are necessary for the development of external economic and therefore help towards unleashing the productive forces of that economy. Their development lowers the cost-price level and stimulates economic growth.

In this way, social overheads formed the first category whose creation and maintenance as public undertakings was theoretically justified. The public authorities could maintain these overheads at a loss and meet the loss from their tax revenues. In some cases it might be possible to collect some revenue by way of fees and the like, but in general the social overheads would be non-profitable undertakings.

2. Most of social overheads and other basic and key industries need huge amounts of investment. Private enterprises is either not able to raise the necessary funds or is not ready to bear such large risks. In such a case, even if these enterprises could possibly be profitable, the government has to step in to establish them. Cases of very long-term projects also come in this category. A society is expected to have an eternal life. It can and should take a very long-term view of the costs and benefits of a project, but a private enterprise will have only a limited time horizon before it.

Public authorities can invest in a project which would yield benefits to the economy for 400 years, but it is difficult to think of a private enterprise making an investment on the basis of such a long projection.

3. These days, most governments of underdeveloped countries consider it their duty to help in economic growth. Such a policy, in its turn, entails a number of responsibilities and some of these results in the governments going in for various types of public enterprises.

In an underdeveloped country, additionally we find that there is all round shortage of capital. It becomes the task of the authorities to assure the responsibility of filling the gap and thereby removing the specific shortages. In the same connection, one may mention the role of basic and key industries, the development of key industries provides an impetus and a necessary base for the general economic development in diverse areas. A proper and well-coordinated development of these basic and key industries necessitates a planning of the part of the economy so that over time, the economy acquires greater resiliency and sensitivity instead of getting saddled with greater shortages. It is not very likely that private sector which moves solely on the basis of profit motive will find it always convenient to establish these industries in time and in adequate measure. Under such circumstances it falls to the public sector to see these programmes through. Furthermore, provision of such gaps, and also creation of certain basic inputs like human skills through education and training will provide the necessary infrastructure to the economy without which it cannot grow. Actually once such an infrastructure is provided, even private enterprises would find it easier and more profitable to expand at a rapid rate.

4. Economic growth is intimately connected with and dependent upon the economic surplus which the economy is able to create and the way it is utilized. A number of public sectors undertakings directly add to the capital assets of the economy in the form of roads, bridges, factories, etc. They contribute to the production power of economy. Such an addition to the capital stock of the country might also take place through the utilization and exploitation of resources which were hitherto going to waste, or they might result from the change in the allocation of the productive resources. Here again, public undertakings can help the economy a lot in diverting its productive resources into their lines wherein will accelerate the growth process later through a provision of an infrastructure, basic and key industries, etc.

5. The final choice of a project in the interest of the economy as a whole should depend on the SMB relative to SMC instead of the private MC and MB. There are a number of services the supply of which creates lots of externalities. Such externalities may be adding to SB or SC or both. If SB > SC in the case of any service, then its production should be taken. But it is possible that while on grounds of social benefits some projects are established on grounds of commercial profitability they are not. Under such circumstances these projects can be taken up by the authorities in the public sector.

6. Case of merit goods such as education, medical, etc. If left to private hands, the very demand for such services will be limited on account of their high prices. But it is generally believed that the supply of such services should be adequate and should be available at low or zero prices so as to encourage their consumption. In case of education, the government may not only provide it free, it may even insist that all the children up to a certain age must attend schools. Similarly, persons suffering from certain ailments may be forced to go to hospitals. Medical check-ups may be compulsory and general medical may be provided free or at subsidized rates. Street lighting, removal of garbage, etc, may come under category of services provided by government and then charge a fee at full or subsidized rates.

Such merit goods are expected to enhance the general welfare of the community and should therefore be provided through public enterprises either along with private enterprises or in place of it.

7. The overall economic policy of a country may also dictate the view of public undertakings. In some sectors, there are some industries like electricity generation where there are economics of scale. If such a service is provided by large number of firms competing with each other, it would not be possible to reap these economies. On the other hand, if the supply of such a service lies in the hands of a monopoly, it may not be looked at favourism because quite often they exhibit a tendency to exploit the situation to their advantage. It also causes a concentration of economic power in some private hands. Accordingly authorities think it more desirable to have a public monopoly of such services in order to reap the economies of scale and also to avoid concentration of economic power into private hands.

8. Effective economic control of the economy is sought to be brought in the hands of the state. The authorities plan to have a strategic control over the working of the whole economy through controlling certain key sectors e.g. government might rationalize foreign trade but because its intention is to displace the private sector as such, but because through it a whole spectrum of industries can be made to be the official line.

Similarly, the authorities can own industries like steel, cement, chemicals, electronic products, railways, car ways, etc.

9. In the case of some natural resources like forests, mines, etc, the commercial interests of private enterprises often come into conflict with those of private. Individuals are likely to make a quick profit by over-extracting the resources; but if it is the governments they can be expected to follow a well-defined systematic policy of tapping the resources, and safeguard the long-term interests of the economy.

10. There are some projects which by their nature have to be in private hands. Similarly depending on the socio-political structure of the country some defense industries certain research and development organizations etc. can be okay in the public sector.

11. Private ownership of the mean of production leads to concentration of economic power in a few hands and accentuates disparities in income and wealth

12. Private ownership is based on exploitation of workers, if unorganized. Only public ownership ensures that workers get the full value of their efforts.

13. Public enterprise takes a wider view of it responsibility as against the narrow view of profit maximization. Eg public enterprise takes seriously its obligation to the employees, the neighborhood, the customers and the environment. Private enterprises claim that they are also socially responsible, but in most cases this is more a show.

14. Private enterprise leads to wasteful and undesirable multiplication of services and products. Proliferation of models and brands confuses the public through highly persuasive and cost advertisement, often unnecessarily adding to the price paid by the consumers.

15. Public utilities like water, electricity, railways and postal services should be under public control to avoid exploitation. Although there are methods of control over private monopolies, the experience has shown that they are evaded and avoided in numerous ways through economic and political clout of private enterprises.

16. Public enterprises can be used as an instrument of redistribution. The objective of reduction of disparities in income and wealth can be achieved through public enterprise.

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ECONOMIC OBJECTIVES

  1. Immediately after independence, public enterprise had to be set in as private enterprise found it difficult to raise adequate resources for basic and heavy Industries. Eg steel mills, heavy engineering and heavy electric plants, air craft, buildings etc
  2. Private enterprise was also found to be less willing to take risk in new an untried areas of activities, eg oil exploration
  3. Private enterprise with a short time horizon is unwilling to invest in ventures involving slow and low returns in project of high strategic value.
  4. Public enterprises are used to encourage, stimulate or monitor competition
  5. Public enterprises help in averting unemployment and saving the useful production capacity.
  6. Where resources are irreplaceable, private profit maximization could lead to wrong results
  7. Financial administration can be better ensured through public eEnterprise. It helps in better collection of taxes on income, sales and customer duties. The private enterprise is often found to use its tricky devices to evade and avoid various types of taxes, causing much loss to the exchequer.

Ways in which public enterprises help in economic development

  1. Provision of finance and developmental support for industry. Through public sector financial institutions eg development bank, insurance company
  2. Finance for agriculture
  3. Provision of technical assistance eg national industrial development corporation, Kenya industrial estate
  4. Support to agriculture eg national seeds corporation, Food Corporation, Kenya national cereal board.
  5. Development support eg ICDC, KMC, forestry development corporation

IDEOLOGICAL AND SOCIAL OBJECTIVES OF PUBLIC ENTERPRISES

Public institutions of which PE forms a part, can help in securing social justice for many people. Market can only serve those who are part of the market system. A vast number of people live on the edges of a subsistence economy. The government needs credible programmes of direct government intervention focusing on the needs of those people.

PEs in general view has a large content of equity. Some PEs have been established for this purpose.

Some important social objectives intended to be achieved through PEs are considered below;

  1. Avoidance of concentration of wealth and means of production

PE helps to promote the rational objectives as laid down in the constitution may greatly affect this constitutional objective

  1. Reduction of disparities in income by treating the labour generously and by putting a low level ceiling on the salaries and benefits at the top level, PE has helped in reduction of disparities in income over a large area of employment.
  2. Help the under privileged

This is inform of marginalized society, physically handicapped persons, ex-servicemen and dependents of those killed in action etc.

Development of Backward Areas

One of the aims of national planning is to ensure that the areas which are lagging behind industrially are provided greater opportunity for growth and employment. The areas in which central PEs are located become direct beneficiaries and stand to gain in terms of increased employment opportunities, growth of small scale and ancillary industries, development of industrial facilities etc.

5 Private ownership is based on exploitation of workers if unorganized. Only public ownership ensures that workers get the full value of their efforts.

  1. PE takes a wider view of its responsibilities as against the narrow view of profit maximization. e.g. a PE takes seriously its obligations to the employees, the neighborhood, the customers and the environment.
  2. Private enterprise leads to wasteful and undesirable multiplication of services and products. Proliferation of model and brands confuses the public through highly persuasive and costly advertisement, often unnecessary adding to the price paid by the customers.
  3. Public utilities like gas, electricity, railways, and postal services should be under public ownership as their goods and services being non-tradable give rise to monopoly, which should be under public control to avoid exploitation.
  4. Private enterprise serves private but not social ends. Profits and resources of PEs go to the exchequer as for public purpose as directed by the government.
  5. PE can be used as an instrument of redistribution.
  6. The social objectives of continuing with loss-incurring services or facilities cannot be provided by a profit-seeking enterprise e.g. railway lines or bus services essential for a rural community may be avoided or depleted by private enterprise. Similarly, private sector banks are found averse to open rural branches or help the needy and deserving borrowers or small means.

SOME SPECIFIC OBJECTIVES

Revival of sick private enterprises

A large number of private companies in textile industry, engineering and other business units are nationalized to avoid large unemployment and to save the useful production capacity of the sinking private sector units.

To provide fair treatment to labour

One of the main objectives of PE is to act as model employer. The working conditions and welfare arrangements should in fact serve as models.

Control over commanding heights of the economy

The PE should control the basic and strategic sectors of the economy through which it is possible to command and control the whole economy.

Control over the commanding in a poor country where it is extremely difficult to mobilize adequate resources for development.

Augment revenue of the state

PEs are meant to supplement the revenue of the country in a big way by appropriate pricing policies, and by mopping up profits which otherwise may go to the private sector. In a developing economy the PE constitute a ready and increasingly important source for financing investment either for the expansion of the enterprise which yield these surplus or elsewhere in the economy.

Helps achieve socialist pattern of society

Adoption of socialist pattern of society would necessitate that the government assumes direct responsibility for the future development of industries over a wide range.

Provide a model to aid competition with private enterprise.

PE may serve as a model of efficiency to private enterprise.

Enhance production of essential goods

In some areas, the effort of private sector enterprises is not adequate to meet the requirements of some essential goods e.g. cement industry was created to increase the cement supply for the growing demand, public universities, public hospitals etc

Achieve economic self-reliance

This can be achieved through production and technology up-gradation effort.

Summary

The chapter has discussed in details the rationale of public enterprises and economic, social and development objectives of public enterprises

Question

  1. State and explain any four rationale of public enterprise
  2. Explain how public enterprises are involved in economic growth and development

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CHAPTER THREE

MANAGEMENT ISSUE

Learning objectives

After you have read chapter you should be able to:-

  1. Explain principal-Agent problem
  2. Explain the principles of government-public enterprise relationship
  3. Explain the problems of public enterprises
  4. Discuss the performance of public enterprises

Principal-Agent problem

PEs has a close and continuous relationship with the government. The government has to oversee their working and control their operations because they are instruments of its economic and social policies and because of their great importance to the national economy. It is also argued that a closer control is necessary as the PE manager is neither inspired by personal gains nor gnawed by the final sanction of insolvency of his enterprise.

The government relationship with PEs is determined not only by the fact that the government is the sole or the majority shareholder but also by the fact that the government has to ensure that policies of PEs are compatible with the national priorities and objectives. Some enterprises operate in a sensitive area and require close and constant direction and supervision by the government.

The government – PE relationship is affected by many factors taken together, of which the personality of the chief executive and his equation with the minister and the secretary to his minister is perhaps the most crucial. Further, the government feels more concerned about enterprises which are in deficit because parliament takes more interest in them, and also because a deficit may indicate less efficiency.

Nature of relationship

The government – PE relationship has many facets. They manifest themselves more in the form of advice, persuasion or simple communication of the government’s view point, rather than issuance of directions or orders.

The basic problem is to what extent the government should be involved in matters of policy, public interest, and operational efficiency of PEs. The government –PE relationship is quite intimate, yet the necessary distance has to be maintained in those matters where autonomy has been granted. If public enterpriseis not allowed to benefit from their autonomy there would be no point in establishing them as autonomy units, with high-powered board and their own independent staff.

Formal powers of the government are laid down in the articles of Association of the government companies, and for the statutory corporations in the incorporating statues and the rules made there under. However, the Articles, or the statutes do not generally impose any particular duty or responsibility regarding public interest, such duties get manifested through government control.

The public interest involving those matters which the enterprise might not have regarded for, if it concern itself with its commercial success only. Such matters include not using monopoly power to exploit consumers, taking into account the requirements of development, for example employment of socially disadvantage groups.

It must be noted that the public interest need not necessarily conflict with business principles. What is good for the enterprise e.g. generation of resources is also good for the nation. Commercial efficiency is after all in the public interest. But what is important is that once the public interest has been stated and accepted, the enterprise must set out to operate commercially i.e. efficiently, within that context.

Autonomous PEs should be endowed with the maximum authority, consistent with their responsibilities.

Principles of Government – PE Relationship

  1. The government should be concerned with securing that PEs operates in the public interest. For this purpose, it should decide the broad policies to be pursued by PEs, including their financial and economic obligations.
  2. The government should seek to ensure the efficiency of PEs by exercising a broad oversight over them, but should not become involved in their management.
  3. The PEs should be left as free as possible to carry out the policies required of them as efficiently as possible.
  4. There should be a clear demarcation of responsibilities between the minister and PEs.
  5. The method of government control should be mainly strategic rather than tactical; PEs can have a clear idea of what the government requires of them if they are not subject to frequent, ad hoc, tactical controls.
  6. The government and PEs should be publicly accountable. It means that responsibility for actions, successes and failures should be publicly identifiable.
  7. The measure of management should not be purely commercial success or social achievement, but should be efficiency with which the enterprise carries out the joint commercial/special duties given to it. The efficiency is of two factors; success in giving customers a mix of goods and services they want and success in minimizing the cost of doing so.
  8. The ultimate sanction for bad management may be dismissal or non-reappointment in post, but improvement of management should be the first objective.
  9. Proper and fruitful exercise of government control depends on the attitudes and ability of both the minister and his secretariat and the PE and its officials.

Some problems of public undertakings

Public enterprises are not free from difficulties. They have to work under certain limitations such that performance wise their rating is sufficiently low.

1. Objectives

There is lack of clear-cut objectives. Public enterprises are expected to help and guide the economy in numerous ways. However, any given public enterprise can be expected to have only limited objectives in view, such as creation of an investigable surplus for authorities or for expansion, providing infrastructure and the like. In many cases, a public enterprise is not clear as to what objective(s) it is expected to pursue. At some time, it might be accused of not pursuing one particular objective and at another time, some different objective, or it may be expected to pursue various objectives in general which could be contradictory and mutually exclusive. In such a situation, the enterprise could not simultaneously achieve a high degree of efficiency w.r.t all of them.

2. Pricing policy

Pricing policy adopted by an enterprise may be designed to subsidize the consumer of its goods or services even when the overall economic policy of the country does not dictate so or the case may be that in order to cover its general inefficient working, the enterprise might be charging monopoly prices in the name of rationalizing them or ensuring a fair rate of return on invested capital. The problem gets further aggravated on account of government intervention. Some enterprises are forced to procure their inputs from specified sources only. The authorities often intervene in matters of wage rates and prices of inputs and outputs. Hedged by price regulations such enterprises are left with no scope for improving their profitability.

3. Spillover Effects

Public enterprises are interrelated with each other and private enterprises through input-output relations. They have a demand for each other’s product and depend on mutual demand supply relations. The result is that an inefficient working of an enterprise tends to spread its effects on to other enterprises also. When supplies from one enterprise is delayed, are highly priced and of inferior quality, or suffer from any such defects, a chain activities takes place and quite a few other industries including public enterprises suffer. Since most of the key and basic industries are in the public sector, their inefficient working causes much larger damage than would otherwise be the case.

4. Incentives and Penalties

Public enterprises, even when they are companies or corporations, are not in a position to devise a high grade system of punishment and incentives. Management personnel in public enterprises do not have any incentives to take initiative and try out new and better ideas. On the other hand, they are liable to explain their action if they deviate from the set practice even if the result of the initiative is good. The result is management personnel think it best to play safe and work any within the practice.

5. Top Heavy Management

Public enterprises are burdened with inefficient and expensive management. The appointments to top positions are not always made on grounds of merit and efficient only. These top positions are generally transferable from one concern to the other. The number of managers is so heavy.

6. Red Tapism

Bureaucratic delays and the need to have specific sanctions of funds even when allocations have been made from the ministry of finance every time a non-routine expenditure is to be made, causing ascelation of costs and inefficiency.

7. Cost consciousness

The unions, if they have enough of bargaining strength, are able to force higher wages with no link with production.

8. Professionalism

There has been a lack of professionalism in the management, though this deficiency is being removed gradually through the public enterprises selection board.

9. Gestation Period

Public enterprises have large long gestation periods.

10. Over Regulation

The entire machinery of public sector enterprises is so entangled in rules, regulations and audit orientation that they mostly end up in under-utilized production capacity. This tendency is strengthened by delays in surplus of essential inputs for which recourse to non-recognized methods of replenishment is not allowed.

11. Social Burden

Expenses incurred on creation and maintenance of townships for the workers and other employees, the infrastructure and welfare facilities provided for them is also expenditure on creation and maintenance of per capita facilities are termed social burdens of the undertaking under consideration.

PERFORMANCE OF PUBLIC ENTERPRISES

The performance of public sector undertakings can be assessed on the basis of a number of criteria including the objectives they are expected to achieve. These objectives reflect not only social needs but also ideas regarding democracy, social justice and dispersion of economic power.

1. Performance base on Control of Commanding heights of the economy

Currently, the entire private sector of the economy is refined within the framework of supplies demands and pricing policy framework laid down by the public sector.

2. Industrialization

Public sector has greatly helped the country in its industrialization by assuming the responsibility for providing infrastructure and establishing basic and key industries.

3. Performance base on Generating Addition Employment

By themselves public sector undertakings employs a larger number of persons. They also have multiplier effect on the growth of employment through the growth of ancillary industries, distribution and marketing customers, etc. The main problem, however, lies in the fact that they themselves have very low productivity. They are overstuffed, poor and supply management, uncertain production schedules and procedurals complexities.

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4. Performance base on Regional Disparities

Public enterprises have not been able to reduce the disparities completely. This is because the number of public enterprises is not enough to provide adequate stimulus to economic activity in the private sector in the marginalized areas.

5. Performance base on Quality of product.

Products of some enterprises are of very high standard and can even compete in International markets while that of others is quite poor. Coupled with inefficient attention to technologies upgrading, product quality has suffered.

6. Performance base on Capacity utilization

There is continued underutilization of their productive capacity. This is because of:-

  • power shortage, fluctuations and failures
  • industrial dishonest
  • lack of balancing of equipment
  • equipment breakdown
  • inadequacy of demand
  • inadequacy and poor quality of raw materials
  • design deficiencies

7. Performance base on Profitability

With the absorption of huge public funds public enterprises are legitimately expected to yield a good conduct of investible surplus. Amongst other reasons, the important causes for public sector losses are the following:-

(a) A large proportion of public sector undertakings are subject to administered prices. They cannot adopt a pricing policy which would reflect the cost of production. They are expected to bear a part of the social burden for the benefit of certain sections of the society or certain areas of the country.

(b) The technology adopted in a number of undertakings is highly capital intensive. This works against profitability operations unless the scale of output is quite large

(c) They are over-stressed; and they are not permitted to remove surplus employees or adjust their emoluments in line with their productions

(d) They are denied professional management and entrepreneurial skills. They are not able to take timely and appropriate decisions in many fields like changing the quality and design of the product, or altering the marketing strategy, etc.

(f) Most of them are burdened with a number of social obligations in the form of providing housing, primary education, health care, etc, to their employees.

(g) Government policies ensure that no financially problem that is ever closed down and no effective system of reward and payment can be instituted in it.

Measures to improve profitability

  1. Approval of captive power plants in power – intensive power sensitive enterprises so as to free them from the fluctuations in power supply
  2. Quick settlement of wage agreement falling due with a view of improving the labour relations climate
  3. Expeditions action in filling up vacancies in the top management cadre
  4. Continuous monitoring of project implementation and operation efficiency
  5. Adoption of stable prices policy whereby public enterprises are not able to revise their prices very frequently and unless their labour input costs go up
  6. Providing a long secure tenure to the top executive with the necessary operational autonomy and accountability for failure or credit for success.

8 Performance based on market capitalization

Capitalization is the number of shares outstanding multiplied by the closing share price on a particular date. The share value reflects the public perception of the present and expected health of a company. The fact of numerous built-in handicaps due to the majority government ownership in these companies is also not lost sight of by the market.

Market capitalization of P.Es has been on decline for years. The market value of the shares of P.E. has been less than the net worth which reflects poor market confidence in these companies.

Many P.Es are sitting on a pile of wealth and their share prices would move up as soon as the government’s controlling equity is sold out.

9 Performance base on Value Added

The contribution of a manufacturing firm can also be measured in terms of value addition. It is calculated by deducting the cost of direct materials and fuel used for production from the value of production. The balance is contribution towards four factors, namely, wages and salary, interest, rent and profit. The value added has also declined indicating contribution to the economy by P.Es has been going down.

10 Performance base on Contribution to central Exchequer/budgetary support.

P.Es have been making minimum contribution to argument resources of the government through payment of dividends, corporate tax, excess, customs and other duties, thereby financing the needs for planned development of the country.

11 Performance base on Resource mobilization by P.E/Resource generation

This includes contribution to finance the plan expenditure for the government and their own plan outlays. It also includes extra budgetary and budgetary support from the government.

12 Performance base on Non-Financial Contribution

Three important dimensions of this contribution namely:

Development of backward areas, Employment for socially-disadvantaged communities and Creation and maintenance of social overheads are considered below.

For ensuring a balanced regional development P.Es are consciously established in many backward regions which meant that much extra financial cost for the enterprise. The regions benefit in many ways including increased employment, development of roads, communication and other facilities. They also provide vital job opportunities to a large number of locals and help the all-round development of many backward regions in the country. Rural Electrification is an example.

P.Es contributes to national integration through bringing persons together from various regions, religions, costs and languages.

13 Economic and social development of the country. (Support to agriculture, spread of rival banking, eradication of poverty and disease are examples).

14. Performance base on Efficiency

Efficiency is the ratio of results accrued to the means used. It is the shortest path or the cheapest means towards the desired goal. It is not just doing things the right way but also implies doing the right thing to become effective. Efficiency is basically an input output relationship. For various inputs, standards of output to be secured are laid down and compared with the actual performance. The deviators from the normal should be measured to permit suitable action, where necessary. Even for positive deviations, actions may be needed to see whether the target sets are too low and require an upward revision.

Test of Efficiency in Public Enterprise

  1. Financial ratios

Percentage of sales to capital employed – it shows the overall productivity or effectiveness of the resources available to the firm.

  1. The percentage of cost of sales to sales – It indicates the profit or loss per value of sales
  2. Liquidity ratio = shows the liquid asset as a ratio of current liability
  3. Total factor Productivity

Productivity can be measured either with respect to a given factor of production or with respect to all factors of production. Labour productivity is the number of output per unit of labour. Similarly is the capital productivity. Total productivity is the net output per composite unit of total factor input combining both labour as well as capital inputs.

In the context of the growth of national economy, it is the index of total factor productivity that represents the most appropriate method for evaluating the overall performance of P.Es in relation to that of the private enterprises. Total factor productivity index is the most comprehensive indicator of the trends in the overall efficiency of resource utilization by the equivalence units over a specified time period – net output (VA).

Avoidance of waste as an index of efficiency wastes can be inform of volume of discarded scrap unit losses of energy, labour turn-over and absenteeism and loss of goodwill that may arise from employees, customers and to the local community – or underutilization of capacity, loss of the savings, loss of supplies.

Levels of Evaluation of Efficiency

Management of a public enterprise/Management evaluation.

The aim is to ensure whether within the constraints of various resources, the management has secured the most optimum utilization of resources at its disposal. The test here is that the P.E has done as well s it could be expected to perform in the circumstances in which it was placed. This evaluation would be with reference to various physical, financial and other qualitative parameters seen in advance.

The evaluation of enterprise.

The enterprise may not be able to raise the price of products or service to absorb various increased input costs due to wider consideration – leading to poor performance or P.E performance may improve due to monopoly profits. It is able to secure due to one extraneous reason. The extraneous factors affecting performance may be formal and visible e.g. issue of presidential directives or other formal communications to the P.E. or they may be informal, Political and ad hoc in nature.

Society i.e. how society reacts to whatever has been covered by the enterprise. Is it helping in the redistribution of income, increased access to service or product, reduced price etc. This evaluation prompts reforms in the working of a given enterprise so as to be conducive to more socially acceptance partners of results than have been realized. E.g. pricing that subsidizes rice consumption, technology that wastefully emphasizes capital rather than labour as an input.

Comparative advantaged of P.E.

Here we consider whatever the function of a P.E. would be more efficiently performed by the private sector.

Social Efficiency

An enterprise producing goods and services involving social cost such as generation of pollution, neglect of things like labour welfare, import substitution, preservation of natural resources, and inadequate attention to supply and Demand to other national and social priorities and values cannot be considered efficient even with high productivity and profits. The efficiency thus becomes a relationship between inputs and the total contribution.

Business Ethics and Efficiency

P.E should provide high level of business morality. In a mixed economy, P.E. has to show competitive performance consistent with a high level of morality. They should be free from corruption.

Measurement of efficiency of a public sector

An Industry’s efficiency is made up of two factors – its success in giving its customer the goods and services they want and its success in minimizing the cost of doing so

The process in assessing the efficiency of a monopolistic industry is whether its consumers are getting what they want, whether the costs are properly allocated between then, and whether the industry is using the least quantity of real resources for any given level of output.

If a firm in an industry which is highly competitive succeeds in selling its products, makes profits which satisfy its shareholders, continues to expand and to attract such capital as it requires, given conditions of employment to its staff which make them compete and has management which commands the respect of all parts, that firm may be said to be efficient.

Competition is the governing factor. The consumers have to be attracted in competition with other concerns. The capital has to be attained on the investment merits of the concern in competition with other concerns making demands on the capital markets. Labour has to be recruited and retained into the face of competition from other concerns within the same industry or from other industries.

N/B: Even when profits are made by an enterprise, that does not necessarily indicates that the firm’s resources are being used in the most efficient way and the further one move from a strongly competitive situation toward monopoly the less reliable tests become.

A monopoly may succeed in making profit and yet be failing to give customers a good or as cheap a service as they would get it if the undertaking were conducted with the efficiency found elsewhere.

The electricity industry does not compete on equal terms in the capital market because in common with other nationalized industries, it has been given the benefit raising money under treasury guarantee on the national credit.

Competition for staff is limited. At the initial recruitment the industry most compete with all other employers. But once a man has settled down in an industry and has specialized in some aspects of its work, his special knowledge and experience can be sold only to the Electricity Authority. Formerly he had a choice of several hundred employers in the industry. Today if he wishes to increase his range of potential employers he must leave the industry to do so.

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Summary

The chapter has reviewed issues relating to principle-agent relationship, problems of public enterprises, and their performances criteria.

Question

  1. Discuss principal-agent relationship of public enterprise
  2. Explain any five Criteria that can be applied to measure the performance of public enterprise

CHAPTER FOUR

PRICING POLICIES, RULES AND PRACTICES

Learning objectives

After you have read chapter you should be able to:-

  1. Explain principles of determining pricing policy
  2. Explain the various pricing rule that can be adopted by the public enterprises
  3. Explain pricing practices used by the public enterprises
  4. Show ways in which government intervene in price fixation of public eneterprises

Pricing Policy

Pricing policy for public enterprise is a difficult task, the main reason being that the public enterprises are not necessarily for earning profit and pricing policy doesn’t have to be uniform for all the public undertakings. A number of factors have to be taken into account before the pricing of a public undertaking is decided.

1. Objective or objectives before the public enterprise.

Like a private enterprise, it may aim at getting maximum profit, or it may have a policy of contributing to the distributive justice in the economy by reducing the inequalities of income and wealth. Similarly it may have a specific purpose of encouraging the consumption of the services it is producing or the objective may be to fill in the supply gap of some essential inputs for other industries or to contribute to the building up of the infrastructure of the economy for accelerating its economic growth.

2. Opportunities which it has in implementing the price policy.

Such opportunities are conditioned, amongst other things by three sets of circumstances

(a) Market Structure

If public enterprise is one among many others operating in a competitive set up, then its rice cannot effectively differ from the market price. If the public enterprise is the dominant one in the market (monopoly) then it is much easier to adopt a price of its choice in conformity with its objectives. If the private enterprises are acting in a kind of combination, then again any price level which is significantly different from theirs will be thwarted by their action.

(b) Its own working

it is assumed that in terms of organization and hence efficiency a public enterprise will be at par with private enterprises. Internal inefficiency of the enterprises can make the selection of an appropriate price policy difficult.

(c) Sensitivity of the enterprise to changing political and social demands.

For effective results, the political and social atmosphere should be such as let the public enterprise choose and adhere to its price policy consistent with its chosen objectives. Thus depending upon the opportunities and changes therein, the pricing may or may not be in full conformity with its objectives.

3. Capacity to identify the beneficiaries of the public service that it provides.

If individual beneficiaries can be identified, only then can a public undertaking decide to levy a price for its services, otherwise not. It is however, not maintained that a price will always be charged if the beneficiaries can be identified. It may still be decided to supply the service free of cost, as a matter of policy. Still another variance in the formation of price policy is the decision of the authorities as to whether the service so supplied would compulsorily form a part of consumption of the people or it would be left to their voluntary decisions, e.g. street lighting, sanitation, education, etc. may be compulsory made of the consumption of every eligible citizen or resident of a locality.

Principles of determining pricing policy

1. General Taxation Principle

There is a category of public services which would be supplied free and when would be financed through the general public revenues. In this category it includes such public enterprise as providing pure public goods or those coming close to this description/ the closer these goods to the pure public goods, the lesser will be the possibility of identifying the individual beneficiaries and charging them for a service. (Goods are provide free of charge). In some cases, some services may be supplied free as a matter of convenience and policy, even when the beneficiaries can be identified e.g. the users of a road/bridge can be identified, but it may not be thought desirable to collect a fee from those who use the road. The cost of collection may be very high compared with the revenue collected. The system may cause a lot of inconvenience, delay and hardship and therefore a loss of welfare and efficiency to the society. It may be better to finance the road out of general revenues or by collecting the funds indirectly through a tax on vehicles or petrol taxation.

2. Compulsory cost of service principle

Here the beneficiaries are identified and even the amount of service which each is consuming is determined and they are made to pay for the service e.g. provision of street lighting may be assumed to benefit the locality as a whole and the residents may be taxed on the basis of the household or the size of the family or some similar race. It is possible that the rate of fee so levied or may not be able to meet the full cost of the service and a part of it may be financed through general taxation.

3. Voluntary Price Principle

The consumers of the public service are free to choose the consumption of the public service by paying the price determined by the public enterprise. The question to be answered is: How should such a public enterprise fix its price? It will depend on the factors discussed above e.g. monopoly – cannot constrained by the pricing policy of its competitors. If it charges a high price, it has no danger of being competed out from the market.

Pricing policy with regard to the consumption of its product by the public.

If the consumption of such a service is believed to contribute to the welfare of the society, the policy would be to encourage its consumption. The decision will be to set a low price in this case, possibly even below the cost of production. However, the choice of actual price will also depend on the elasticity of demand. E.g. assume that the demand for the good in question is highly elastic. In such a case a very low or zero prices may bring about an excessive and wasteful demand consumption of the commodity. Under such circumstances, the problem has to be solved through some additional measures. E.g. the supply of the good per individual or family up to a certain amount may be allowed free or at a very low rate and beyond that a higher rate may be charged, e.g. every family consumes 200 litters of water per person per day. So much water may be supplied at a normal rate even free and quantities of water consumed beyond that could be billed at rates at which water could be consumed only for genuine needs. Supplying water through unmetered connections and charging for it at flat rate per household will only encourage a waste.

Demand for goods and services like water, medical services etc have a low elasticity of demand up to a certain extent. Assuming this is a socially desirable consumption, it shall be permitted though excess consumption can be billed at higher rates.

On the other hand, the elasticity of demand is very low so that irrespective of the price, the amount of demand does not vary much, then the price can be kept very low or even zero since in that case the danger of wastage is not there.

If the policy is to discourage the consumption of the product or service being supplied by the enterprise, then the policy should be to set a high price for the service. If the elasticity of demand is high this would act as a strong deterrent against consumption of this item. Ordinarily, it should also be a source of profit to the authorities. But if it is found that the elasticity of demand for the product is low, even a higher price would not reduce its demand significantly, and then additional measures also would have to be adopted.

Fixing so high a price in this case might mean a loss of welfare to those who have to purchase the good (drug addicts), since they might have to reduce their expenditure on other useful items like the education of their children, food, etc. In such a case, therefore, a reasonably high price couple with some form of rationing would be helpful. Alternatively, there can be those goods (such as electricity for domestic use) whose consumption is sought to be restricted on grounds of inadequate supply but not below certain standards. In these cases, again the rates can be low up to specified quantity of consumption and may rise steeply beyond these limits.

The third category is of those goods whose consumption is to be neither encouraged nor discouraged as a matter of policy. The price useful is not to be used with the objective of regulating the consumption of the service. In this area, there has been a controversy as to whether the price should be equal or unequal to the marginal cost of production.

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PRICING RULES

DIFFERENT PRICING RULES IN PUBLIC SECTOR ENTERPRISES

While every private enterprise unit always aims at maximizing profit, in the case of public sector enterprise often they are expected to help attain various social-economic objectives. This means their pricing is not always governed by the consideration of maximizing profits. Depending upon the social-political and economic objectives different pricing policies are recommended for public enterprises. Some of the important pricing policies recommended for public enterprises are as follows

  1. No profit, no loss concept
  2. Marginal cost pricing
  3. Average cost pricing
  4. Policy of making maximum profit
  5. Policy of charging discriminatory prices

1 NO PROFIT, NO LOSS POLICY

It implies that the public sector enterprise following this principle should neither make profit after meeting all charges on capital and current account nor suffer any losses. The idea behind this principle is that some enterprises are not meant to make maximum profit but are meant to serve public interest or public welfare without at the same time subsidizing the commodities or services in question

2 MARGINAL COSTING

It is a wealth maximum pricing rule. Public enterprise should determine the prices of their product on the principle that the price equals marginal cost of the commodity in question. The argument in favour of this principle is that it ensures the optimum output and at the same time ensures maximum welfare under given conditions

But the principle of marginal cost for public enterprise is criticized on the following grounds. Which marginal cost principle is to be followed? Long-term or short-term. If it is the long-term, marginal cost will be equal to average cost, if on the other hand it is the short-term marginal cost that would result in frequent changes in price of a commodity causing frequent fluctuations in conditions of supply and demand.

Advantages of Marginal Costing

– The price of a product or service should reflect its true cost otherwise it could either result in excess demand for the scarce resources, or, if over-priced, full use of the available resources will not be possible. The true cost is the marginal cost i.e. the cost of producing an additional unit of output.

If the consumer is willing to pay for extra output, welfare is enhanced if that output is made available to the consumer. On the other hand if the consumers are not willing to pay a price which would cover the cost of the additional output, such production and sale should not be allowed in the interest of maximizing the welfare. Under the marginal cost rule, the resources would get allocated to an enterprise whose output is of greater value than that of the other enterprise. The allocation of resources in the economy would thus be most optimum and efficient.

Limitations of MC

It is extremely difficult to measure MC in practice.

It is difficult to implement such a policy if firms are price takers.

Profits accrue if there are diseconomies of scale which may not be the relevant objective for public sector output especially those with a social dimension.

Losses could occur if the industry experiences enormous of scale.

It can result in complex tariff structures since there are two marginal costs i.e. the long-run costs (LRMC) and the short-run marginal cost (SRMC). Since both are only equal at optimal capacity, it is sometimes difficult to know which of the price could be set equal to.

3. AVERAGE COST PRICING/BREAK-EVEN/NO PROFIT/NO LOSS.

It is argued that public enterprises being for the public good should cover their cost of production in full, including the cost of capital employed, but should not aim at profit making. This is one of the important ways by which public enterprises should distinguish it from private enterprises which aims at maximizing the profit.

In many public sector enterprises, the principle of average cost pricing is widely followed. There are two main arguments in favour of this principle. In the first place it is easy to administer. And secondly, full costs(fixed as well as operation costs) are covered under the principle of average cost pricing so that community is spared the burden of additional taxation to support the industry as would be the case if the principle of marginal cost pricing is adopted. Also nobody is required to apply more than the cost of production under this principle and therefore there is no exploitation of consumers or discrimination.. Another advantage is that average cost pricing by covering all costs of production would ensure economic viability of a public enterprise and because it has not to beg for subsidy from the government, it might also ensure its autonomous status. Above all it provides simplicity in calculation and administration.

4 POLICY OF MAKING MAXIMUM PROFIT

In developing countries capital is scarce and therefore it is reasonable to expect that investment in public enterprise earn maximum profits so that additional funds would be available for investment or expansion of the existing units that would mean acceleration of the growth rate of the economy.

5 POLICY OF DISCRIMINATORY PRICES

Since public enterprises have to fulfill certain social-cultural and political objectives in case of certain public enterprises policy of charging discriminatory prices is advocated and is also followed. Eg, to stimulate agricultural growth in backward areas charging lower rate for electricity than what is charged for urban industries appears quite reasonable. Also charging lower are for agricultural inputs in the case of small and marginal farmers would appear justified due to their different capacity to bear burden. The urban sector banks and financial institutions in India have been following policy of charging lower rate of interest( about 4 percent) in the case of producers from poorer sections of the community, while charging anywhere up to 15 percent in the case of big farmers and industries. Sometimes even free loans of free distribution of seeds may have to be undertaken in case of food-affected poor sections of the community.

Various form of multipart pricing has captured much interest as methods of financing services that are subject to decreasing cost. Such forms of pricing can among other things being shown to be agreeable in principle to the users of the service. Suppose initially that price is set at Ac. At this rate of output, the value people place on additional output exceeds the cost they must bear for that output. It will be conceptually possible for all users of the service to agree to a system of lower marginal prices for blocks or units of output beyond those provided under AC pricing. Indeed, multipart pricing is widely used. Numerous services are financed by levying both a change that is independent of consumption. Golf course often levies both a flat annual fee and a per-unit fee for each round of golf. Telephone services are financed by applying a fixed installation charge, recurring but fixed equipment fee, and a price that varies directly with the amount of service consumed. Although the specific form of multipart pricing may differ from case to case, all forms create a divergence between the average price of a service and the marginal price. Justifiable in off-peak periods since capacity is fixed and supplies capacity is available

PRICING PRACTICES

The pricing practices of public enterprises can be considered under the following categories.

1. Enterprises operating in a competitive market:

In a fully competitive situation, prices will be dictated by the market forces of demand and supply. However, where the competition is contemplated, PEs should neither be given any hidden concessions or facilities nor be burdened with unremunerated responsibilities from which the private sector is exempt.

Sometimes the enterprise may be the product leader in the market and its price may set the tone for other manufacturers. The efficiency of an enterprise in such a case would keep the prices down, both in the public and private sectors.

2. Subsidized Price.

Public enterprises operating in basic and key areas of the economy should keep their prices low because this would yield indirect benefit to the society. The gap between the cost and the realization is met by the government in the form of consumer’s subsidy.

Another reason given for the prices is that higher prices in strategic areas like power, steel and railway freight would have an inflationary impact on the whole economy e.g. power cost though industrial costs or agricultural produce.

3. Cost-Plus Price

The enterprises are provided with a certain percentage of profit on their cost of production. This is a method of using public enterprises to raise revenue for the government. This is possible where the market is dominated by a single producer (monopoly) and the consumers of the produce are capable of paying. It is also applicable where government has made substantial investment and wants to secure an adequate return of the capital invested which can be used in financing the country’s development (ploughing back profit.). The objective is to cover whatever costs are incurred, plus (ie to which is added) a certain percentage by way of reason able return on investment in the project. It is utilized in telephone industry. The advantage in the case of this principle is that reasonable return on investment is assured and that helps additional capital formation which might be used for further expansion of industry or for starting new industrial units in public sector.

4. Administered or retention price

In order to reconcile the interest of consumers as well as producers a system of retention price on the basis of cost of production has been adopted in the case of certain products like fertilizers and petroleum products. This system ensures uniform sale price to the consumers. Administered prices are determined by taking into account the cost of production of more efficient units which account for a large percentage of total output, based on certain norms of consumption of raw materials, energy and capacity utilization.

GOVERNMENT INTERVENTION IN PRICE FIXATION

Public enterprises have enormous impact on the economy on account of their size and because they provide many basic goods and services that directly or indirectly enter into the costs of production of all other industries. If the corporations pricing policies have their output provided at a price below the cost of supply excess demand would be created. Higher prices that provide for a return regarded in by enterprise as satisfactory would add to the cost of living and might be inflationary.

Government intervention affects the enterprises pricing policies and their ability to cover costs in the following ways:

Under the different versions of prices and incomes policy that successive government has followed, the freedom of the enterprises to increase their prices has been restricted.

Price rises, if allowed by the government, had at time been delayed.

Government has influenced the enterprise decisions on inputs. This affect the costs and the prices they need to charge.

Government had restricted the enterprise’s scope to buy cheaper inputs abroad.

Some Guidelines for Pricing Policy:

1. Prices should cover the necessary operating costs and the replacement of assets plus a contribution to the cost of public services and to the expansion of the public enterprise sector.

2. They should be so set that surplus generation is maximum in respect of amenity goods and lowest in respect of basic consumer goods and key investment inputs.

3. Prices are part of a price system and not individual items. Intervention in respect of price levels and relationships should be systematic and not piecemeal.

4. To procure the resources for the public sector and the government through the appropriate price policy, the whole sector’s requirement including the relationship between prices, taxes and domestic borrowing must be thoroughly explored.

5. Cross-subsidization between high and low surplus generating products should be organized in such a way as to minimize distortions in production and investment and also undesired shifts in consumption.

6 Exceptions from the general sectorial guidelines for some enterprises or products may be made as necessary. But these should be kept simple and coherent and the exceptions should not swamp the guidelines.

Financial Targets In Respect of Each Sector must be set up in order to plan pricing guidelines and to estimate in advance the effect of price changes and evaluate in retrospect the results of such changes.

7 Detailed financial analysis should be made of the claims of public enterprises for the imposed prices in accordance with the broad national goals.

8 Taxation is not a public function. Sale or excise taxes should be substituted for the fiscal monopoly element in the prices. This will rationalize fiscal policy and allow a more rigorous examination of an enterprises productive or trading efficiency.

9 Consumer should pay the true cost of the provision of goods and services if it can be identified.

10 Cross-Subsidization between profitable and unprofitable services within the industry might be permitted in some circumstances e.g. KPLC could use a surplus earned by consumer in urban areas to subsidize loss-making rural services.

11 Below-Cost prices could be charged when there was a surplus capacity and reduction in price would stimulate demand.

12 Differentiated prices might be charged when demand fluctuated and was heavier at certain times some that price were higher at peak times and lower at the off-peak e.g. Charges for a telephone call of the same duration and over the same distance were lower after business hours.

13 Multi-tariff could be introduced listing charges that were related to the volume of goods transported or purchased and customers could be offered relevant charges.

Summary

The chapter has been able to explain clearly the various factors considered by the public enterprise in determining its price, the principles used to decide the price to be charge, the various pricing rule used by the public sector enterprises and various form of government intervention in the price determination.

Question

  1. Explain the reasons why marginal costing is the most ideal social pricing
  2. What factors are considered when an enterprise is to determine its price policy

CHAPTER FIVE

PUBLIC ENTERPRISE REFORMS

Learning objectives

After you have read chapter you should be able to:-

  1. Explain the reasons for public enterprise reforms
  2. Explain various forms of reform of public enterprise

REFORMS OF PUBLIC ENTERPRISES

Remedy for Problems of Public Enterprises

It entails – changing the relationship between government and public enterprises, regulating the public enterprises, and instituting some controls.

For years, many public enterprises have continued to be a big drain on the national exchequer. The reasons for this are many fold and vary from case to case. However, two factors are common in almost all cases. First is the impact of economic reforms and denial of a level playing field to public enterprises.

Second is management failure, mostly because of an inadequate top management, frequent changes of the chief executives long intervals between one chief executive leaving and successor taking over.

Micro-level Reasons of reform

  1. There is much ideological fight against the public sector. The government have been emphasizing on the market – oriented economic policies.
  2. All over the world public enterprises have not been able to perform well commercially due to overloading of undefined and vague social objectives. There has also been an excessive political and bureaucratic intervention.
  3. Public enterprises do not get the required guidance from the government due to the incompetence and short-range perspective of the government. E.g. government does not provide stance and competent board of directors to its enterprises. This naturally affects public enterprise performance.
  4. Losses have hastened thinking about reforms. The losses may be due to:Wrong investment decisions with respect to location and technology, operational inefficiencies which are traceable to the government’s own voice in the working of public enterprise and the wrong pricing policies public enterprises are asked to pursue. These may require close government intervention and control.

Due to the liberalization measures competition from private enterprise is constantly inclosing, compelling public enterprises to be competitive for their survival.

5 Failure of public enterprise to meet the customer’s needs effectively.

The aims of public enterprise reforms are to:

  1. Enhancing the role of the private sector in the economy by shifting more of the responsibility for production and delivery of goods and services from the public to the private sector, to create a more level playing field by eliminating preferential treatment, including monopoly powers, and to enhance the private sector to enter the areas of activity of the public enterprise on all equitable basis.
  2. Reducing the demand of the public enterprise on the exchequer so as to improve the use of government’s scarce resources and to enhance the returns on those resources by achieving greater efficiency in both private and public enterprises through greater responsiveness to market signals and commercial criteria.
  3. Reducing the role and rationalizing the operations of the public enterprise sector.
  4. Improve the regulatory environment by seeking more economically rational means of regulatory, thereby reducing conflicts of interest between the regulatory and commercial functions of public enterprises that are consistent with government policy.
  5. Broaden the base of ownership and enhancing capital market development.

The primary objectives of the public enterprises reform programmer appear to be:

  1. To enhance the efficiency and performance of public enterprise sector

6 To bring about financial discipline, managerial and financial autonomy, appropriate incentives and accountability all aimed at having the public enterprises operating on commercial principles.

FORM OF REFORMS

RESTRUCTURING

It include the following

Restructuring corporate Governance:

This includes:

  1. Greater autonomy to public enterprise boards i.e. power to take all strategic decisions with the government exercising its rights as the majority shareholder only through its representatives on the board.
  2. The government’s role to be limited to written directives on brand policy matters.
  3. Professionalizing the boards through appointment of experts from outside the government as non-executive directors based on selection on the public enterprise selection board.
  4. Appointment of the Chief executive and functional directors to be made for a minimum of five years.
  5. Autonomy to price products and services on par with the private sector, the government being free to establish price regulatory mechanism for a any industrial sector as a whole.
  6. Restructuring the workforce
  7. For better sales realization, workforce has to be trimmed. Surplus manpower drains the profitability. The government has used voluntary retirement Schemes (golden handshake) of public enterprises.

Financial Restructuring

  1. Government should provide additional equity to rise up the paid-up capital.
  2. Writing off the accumulated losses/loans and interest waiver
  3. Conversion of loans to equity
  4. Government loans
  5. Government acting as a guarantee for loans.

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All above are aimed at enhancing the sales

Technological Restructuring

  1. The government may bring a foreign joint venture partner for public enterprise to gain understanding of the latest technologies and management practices.
  2. Transforming a part of an existing public enterprise into a new separate government company for the purpose of privatizing that particular unit.

Regulation

  1. Regulation has to be instituted to ensure that the market conditions necessary for efficiency evolve and where they do not, regulatory intervention is made to provide the best possible balance of marketization.
  2. If left alone, the utilities cannot be relied upon to treat their customers fairly and to provide the required services in an efficient and economic manner. The regulatory body protect the interest of the consumers or users, where enabling the companies to receive sufficient returns, if they operate efficiently.

Regulatory Mechanisms

The efficient solution would be for government to require the enterprise to produce at P = MC and then to cover the enterprise losses with a subsidy.

More commonly, monopolies are regulated on the basis of rate of return. The regulatory body sets a price that permits the monopoly a fair rate of return on investment. This may or may not make price and MC reasonably close to each other. In some cases it is possible to both permit the monopoly to make an acceptable rate of return and achieve marginal efficiency even through the monopoly faces declining costs.

Regulation on quality of service provided, technical compatibility, Location, relating to registration, relating to assets, liabilities and profit margins, preparation of financial statements and auditors report, constitution of an investment committee and investments of funds, Legal exclusion of potential competitor leading to monopoly, purchase of raw materials.

Deregulation/Liberalization

Liberalization involves greater role for the market forces to the functioning of institutions. It is Lack of government intervention. It is assumed that the market is more effective than the government in achieving economic and social goals. It may take the form of;

  1. Abolition of the requirements of industrial licensing (Licensing).
  2. Doing away with all controls and restrictions on raising capital within the country and outside the country. (Financing capital requirements).
  3. Removal of Limits of foreign investments.
  4. Globalization

It means world economic integration through free movement across national border of financial capital represented by investment in capital markets and money marketsPhysical capital represented by plant and machinery, Technology, Labour.

Kenya economy should be open to foreign financing investment Imports of capital equipment, technology and personnel, in almost all sectors.

Globalization brings new ideas, innovations and Leads to increase in incomes, competition.

PRIVATISATION

Privatization means transfer of ownership of state assets from the public bodies to private enterprise or provision of services from public to private enterprise. The aims of the privatization programmes are political and economic. The relative importance of the reasons for privatization differs from country to country but basically they are;

  1. Failure of nationalized industries in general to meet consumers’ needs effectively
  2. The wish to reduce the power of the state and its role in the economy.
  3. Belief that an enterprise based economy would allow for greater flexibility and a better response to consumers demand.
  4. Determination to create capital – owning democracies.

Thus government privatize to;

  1. Reduce the size of public sectors of industry.
  2. Increase competition in the market.
  3. Improve efficiency among suppliers of goods and services.
  4. Extend share ownership in companies by investors with small amounts of savings.
  5. Ease the pressure on central governments’ budget.

The expectation is that as state monopolies are broken up and a competitive environment established, privatized firms will have to improve their efficiency, cut costs and reduce prices or keep them below the level up to which they would have otherwise risen. Firms that are not competitive will unlike state enterprises go out of business. Privatized companies that are profitable or have profit potential will attract investors and enable shareholders with small amounts of capital and employees to acquire shareholdings. Private funding of industry reduces claims on public finance. The help to the government comes on both sides of the budget. On the expenditure sides, the state no longer has to support loss – making nationalized industries and provide them with capital, thereby increasing the public sector borrowing requirement on the revenue side, proceeds from the sale of state assets increase governments resources enabling them to increase public spending or cut taxation or both.

Opponents of privatization argue that; privatization of natural monopolies merely substitutes private for state monopoly; that the social service elements in provision of services by profit – driven companies will disappear and measures to cut costs will lead to unemployment.

MECHANISM OF PRIVATISATION

How state – owned enterprises are privatized depends on a variety of factors such as whether, the country is developed, developing or emerging from a centrally – planned economic system; the relative size of public sector of industry, the sophistication of the national capital market and the financial framework. The state of international capital market is also important. It may reach a saturation level if a large number of privatization share offers are made concurrently and national governments restrict the extent of foreign investment that may be allowed. Timing and local legislation are therefore important factors. Also important to a decision on the choice of privatization method is the native and size of privatization.

On offer may be;

  1. A minority share – holding in a country.
  2. A controlling stake in a company.
  3. A state – owned company already operating in competitive international markets.
  4. A whole nationalized industry.
  5. Potentially the whole of the economy.

Depending on the circumstances the transfer from state to private ownership may be by wears of;

    • Public Offering

Shares are offered to the general public and can be traded subsequently on the stock exchange. This method is only appropriate for privatization of large enterprises.

    • Placing

Brokers acting on behalf of a government arrange for the purchase of shares by placing them with a group of investors or one large investor who may wish to hold or gradually a sell off the stock.

    • Trade sale.

A state enterprise is sold to a private sector company or consortium. A trade sale is likely to be on the basis of a tender and financial markets are bypassed.

    • Management/worker’s buy – out

A state owned undertaking may be sold to employees because it is loss – making or faces closure and companies in the private sectors are not interested in buying it. There may however be a possibility of turning it around to round to run on a profitable basis. Management/worker buys – out can save jobs. It may be attractive proposition to government for reasons other than financial.

    • Auction.

In cases of smaller properties owned by the state, sales by auction may be a relatively simple way to privatize but the practicality of this depends on there being a sufficient number of bidders with adequate funds to purchase.

    • Grant of statutory right of purchase.

People may be granted by law the right to purchase specified state property, provided they meet certain requirements.

THE CASE OF PRIVATISATION

  1. Privatization which involves the sales of state – owned assets provide the government with a short – term source of revenue which can be used to finance development expenditure such as infrastructure development.
  2. It helps to reduce public spending and the public sector borrowing requirement. This is especially so if the state can sell – loss – making enterprises and public spending on subsidies fall. The public sector borrowing (PSBR) may also fall if private ownership returns industries to profitability since corporation tax revenue will increase and the state may earn higher dividend income from any share it still possesses in the privatized company.
  3. Privatization increases competition thereby increasing a locative efficiency where the organization has ran with prices higher than marginal cost. Competition could force an organization to be more cost – conscious, making it easier for changes in work practices to be introduced and enforced both at an operational level and in the management of the organization.
  4. Where privatization results in the breaking of state monopoly, so that a number of competing firms are able to operate, consumer choice may be enhanced. Competing firms are more likely to respond to consumer demand and quality of service should be improved and innovation encouraged in both products and the means of their production and distribution.
  5. Privatization can change the organization culture in that the often – borrow vision of directorate and management and supply orientation of the organization can be replaced by a mean more commercially aware enterprise. Restraints can be removed in financing and market of products diversification. Links with other companies through joint ventures can be developed. It makes it more difficult for political interference since politicians who used parastatals for their own ends cannot easily do so with private enterprises.
  6. It has a role in promoting an enterprise culture through extending share ownership to individual and employees who did not own shares previously. It is therefore conducive to hand work and accepting responsibility.

THE CASE AGAINST PRIVATISATION

  1. It may increase monopoly abuse, by transferring socially owned and accountancies public monopolies into regulated and less accountancies private monopoly. This monopoly may arise because utilities tend to be natural monopolies and there have been economic and technological arguments for keeping them as single suppliers. The monopolies may exploit consumers by charging excessively high prices and producing poor quality commodities.
  2. In the absence of a market for the shares of nationalized industry it may be difficult to determine the appropriate issue price for shares. This may lead to over subscription or under subscription. It has been argued that state owned asset have often been sold off too cheaply.
  3. Increased privatization of public sectors enterprises can lead to greater difficulty in planning the whole economy because unanticipated actions by the private sector can undermine the targets of a development plan such as delocalization of industries.
  4. Privatization of certain sectors like health and education may lead to those very goods being provided in inadequate qualities and at prices that are too high for lower income consumers.
  5. The private sector may lack entrepreneurship skills and capital to develop certain establishments which require heavy capital investments like airways, ports and harbors.
  6. It would imply greater control by multinational corporations with their related problems of transfer pricing and repatriation of process.
  7. Public private partnership

Public–private partnership (PPP) describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies.

PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. In some types of PPP, the cost of using the service is borne exclusively by the users of the service and not by the taxpayer. In other types (notably the private finance initiative), capital investment is made by the private sector on the weakness of a contract with government to provide agreed services and the cost of providing the service is borne wholly or in part by the government. Government contributions to a PPP may also be in kind (notably the transfer of existing assets). In projects that are aimed at creating public goods like in the infrastructure sector, the government may provide a capital subsidy in the form of a one-time grant, so as to make it more attractive to the private investors. In some other cases, the government may support the project by providing revenue subsidies, including tax breaks or by removing guaranteed annual revenues for a fixed time period.

PPPs are organized along a continuum between public and private nodes and needs as they integrate normative, albeit separate and distinct, functions of society—the market and the commons. A common challenge for PPPs is allowing for these fluctuations and reinforcing the intended partnership without diminishing either sector. Multisectoral, or collaborative, partnering is experienced on a continuum of private to public in varying degrees of implementation according to the need, time restraints, and the issue at hand. Even though these partnerships are now common, it is normal for both private and public sectors to be critical of the other’s approach and methods. It is at the merger of these sectors that we see how a unified partnership has immediate impact in the development of communities and the provision of public services. Example of ppp is:

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Health public-private partnerships

A health services PPP can be described as a long-term contract (typically 15–30 years) between a public-sector authority and one or more private sector companies operating as a legal entity. The government provides the strength of its purchasing power, outlines goals for an optimal health system, and empowers private enterprise to innovate, build, maintain and/or manage delivery of agreed-upon services over the term of the contract. The private sector receives payment for its services and assumes substantial financial, technical and operational risk while benefitting from the upside potential of shared cost savings.

The private entity is made up of any combination of participants who have a vested interested in working together to provide core competencies in operations, technology, funding and technical expertise. The opportunity for multi-sector market participants includes hospital providers and physician groups, technology companies, pharmaceutical and medical device companies, private health insurers, facilities managers and construction firms. Funding sources could include banks, private equity firms, philanthropists and pension fund managers.

For more than two decades public-private partnerships have been used to finance health infrastructure. Now governments are increasingly looking to the PPP-model to solve larger problems in healthcare delivery. There is not a country in the world where healthcare is financed entirely by the government. While the provision of health is widely recognized as the responsibility of government, private capital and expertise are increasingly viewed as welcome sources to induce efficiency and innovation. As PPPs move from financing infrastructure to managing care delivery, there is an opportunity to reduce overall cost of healthcare.

Summary

The chapter has explained the rationales for the public enterprise reforms, the reform strageies of restructuring, privatization, public-private partnership and liberalization

Question

  1. Giving specific examples in Kenya Justify the need for reforms of public enterprise.
  2. Explain the following reforms strategies; restructuring, privatization and public-private partnership

CHAPTER SIX

INVESTMENT CRITERIA

Learning objectives

After you have read chapter you should be able to:-

  1. Explain the steps involved in project evaluation in public sector
  2. Explain the various project evaluation techniques

Project Appraisal

Governments at all levels allocate a considerable portion of their revenue for expenditure on such public capital projects as transportation systems, airports and power generating plants. Other expenditures would involve, improving public health programs and education projects. The benefits from this expenditure accrue to society or a portion of the society for a long period of time.

Project evaluation like all issues in allocation economics involves determination of the ways in which the most efficient use can be made of scarce resources. In its simplest form, the issue is how to determine the composition of the budget of a given size and how to allocate a total of given funds among alternative projects. To determine allocation between two alternative projects, expenditure evaluation involves evaluation of all costs involved and evaluation of all benefits to be derived from public funds.

It is worth noting that where a project is purely private, consideration before investing includes:

  • The expected rate of return on the project that would reflect the net results of private costs (money spent on all resources)
  • Private revenues (sale of the goods and services produced by the capital assets).
  • Degree of risk involved in the project.

However, tabulating the private costs and revenues or benefits does not necessarily exhaust all the costs and benefits associated with the proposal. For example wherever a private investor decides to start a manufacturing plant, he only considers such items as the initial costs of construction, annual maintenance and service cost and the money value of the plan output. What his analysis would not consider, unless forced by the regulations, is the noise and air pollution imposed upon nearby area residents. Even social benefits accruing from such a plant (e.g. increased employment opportunities to residents of that area) would not be considered.

However in the benefit-cost analysis in a public sector, social benefits and costs are captured in the analysis. Please note that, despite the differences that exist in cost-benefit analysis, both approaches (private and public) are analytically the same. It involves the comparison of the stream of benefits expected from a project measured against the stream of expected cost to obtain the expected net worth of the project.

The major problems confronting Benefit Cost Analysis (BCA) from the public or social point of views are:

  1. The identification of all costs and benefits associated with a given project and
  2. Quantifying these costs and benefits in terms of the common unit, shillings.

TYPES OF PUBLIC PROJECTS

Public projects can be divisible or lump sum. In divisible groups all projects can be reduced or increased. If budget is fixed, i.e. given specific amount of money to spend, the planner must determine Cost (C) and Benefits (B) involved or derived from each project.

COST-BENEFIT ANALYSIS

Cost-benefit analysis represents a practical technique for determining the relative merits of alternative government projects over time. Use of cost-benefit analysis can attribute to efficiency by making sure that new projects for which marginal socialcost exceed marginal social benefit are not considered for approval. Cost-benefit analysis if done well, provides essential information to be used by government authorities and citizens in making choices among alternative govenmnent projects.

Essentially, there are three steps involved in a cost-benefit analysis:

  1. Enumerate all costs and benefits of the proposed project
  2. Evaluate all costs and benefits in monetary term
  3. Discount future benefits and costs. This allows future benefits and cost to be reduced to their present values, so that they can be compared with the amount of budget authority necessary to finance the project

ENUMERATING BENEFITS AND COSTS

TYPES OF BENEFITS AND COSTS:-

Benefits and cost may be real or pecuniary. Real benefits and costs may be; Direct or indirect; Tangible or intangible; Inside or outside; Intermediate or final

REAL VERSUS PECUNIARY

Real benefits are the benefits derived by the final consumer of the public project. They reflect an addition to the community welfare and they are weighted against the real cost of withdrawing resources from alternative uses.

Pecuniary benefits and cost – occur as a result of changes in relative prices which occur as the economy adjusts itself to the provision of public goods and services. As a result of changing economic situation resulting from provision of public goods, some members of society may gain while others may lose.

But this doesn’t reflect net gain or loss to society as a whole. The reason why society is left the same (no net gain or loss) is because one group’s loss is another group’s gain but since all groups belong to society there is a tradeoff.

Consider the following case study to illustrate pecuniary benefits and costs:

Consider a case where a road is constructed through a given district. The demand for construction workers in that district will increase leading to increased wages for construction workers in the area, while those to whom higher taxes have been imposed in order to construct the road will lose.

Where the road opens new markets for certain products or raw materials or labour etc. Producers of these products will experience a higher demand leading to increase in price and earnings while those who paid the taxes will suffer reduced incomes.

Note in both cases, society considered as a whole will remain indifferent because gain of construction of road will be offset by loses incurred.

Welfare of society as a whole will remain uncharged but some individuals will benefits while others lose.

DIRECT VERSUS INDIRECT BENEFITS AND COSTS

Direct benefits and costs are those which are closely associated with projects objectives while indirect benefits and costs are in the nature of byproducts.

The objectives of any development project are given under or by the intent of the legislative body which proposes it. For example: – An irrigation scheme has the provision of water for farming as its main objective.

Rural health project can be designed to reduce death rates among children. It may also provide for family planning programme.

While there are many direct benefits and costs there may also be certain silent features in the projects that can provide indirect benefits e.g. an irrigation scheme can also be used or modified to generate electricity and provide clean water for drinking. If provision for water for farming was the main objective of the legislator the eventual provision of electricity and clean water for drinking are indirect benefit.

Direct costs to the project would involve costs incurred in purchasing and installing pipes. Indirect costs would be destruction of wildlife and diversion of water.

A good education system will train and provide skills which will be used to improve the earning of participants. But, in addition to those direct benefits there may be other indirect benefits e.g. reduction in crime rate and the provision of expert’s services such as doctor’s services lawyer’s services etc.

TANGIBLE VERSUS INTANGIBLE BENEFITS AND COSTS

Tangible benefits and costs are those that can be valued in the market whereas others, which cannot are referred to as “intangible”. The distinction is thus synonymous with that between benefits from private and social goods or between costs, which are internalized, and costs, which are external.

INTERMEDIATE VERSUS FINAL

Development projects may be intermediate or final. Final projects are those, which provide services directly to consumer, and they involve also the provision of a final product.

Intermediate projects are developed for the purpose of using them in further generation of other benefits. For example provision of road itself may be a social good and it enters as an intermediate good into the production of a final output which is a private good (the transported product ready for sale).

INSIDE VERSUS OUTSIDE

Another distinction is between benefits and costs which accrue inside the jurisdiction in which the project is undertaken and others which accrue outside. For example where a river basin is developed or drained so as to control flooding in a given district the benefits are derived within that district.

However where these benefits are extended to other districts through which the river flows, the benefits can be said to be externalized.

Evaluating Benefits and Costs

After all costs and benefits have been satisfactorily enumerated, the next step is to evaluate these costs and benefits in monetary terms. Evaluating output requires an estimate of the demand for increased production and calculation of consumer surplus. When the output of particular progrms is not sold in markets, the problem of valuation is difficult. Surrogate measures of the willingness of beneficiaries to apply for output that are not sold must be obtained. For example, although the benefits of many public health progrms are consumed collectively, the value of these benefits may be reflected in increased earnings of those whose health is improved by the project. An estimate of such increased earnings, over time, may be a good reflection of the value of the benefit for the project. Similarly, the benefits of an education program may be measured by an estimate of the increased earnings accruing, over time, to former students.

An additional problem occurs with outputs and inputs that are marketable This results when any output attributable to a project is sold in monopolistic markets, when external effects are generated by production of the output, or when distortions due to subsidies or taxes are present. but whose pries do not reflect their true social value. Under such conditions, prices must be adjusted to reflect the actual marginal social cost or benefit. For example, if the prices of increased agricultural output of an irrigation project reflect the support of government agricultural policy, then the prices must be adjusted downward to reflect the actual marginal social benefit of the output to consumers. If the prices of inputs used are distorted upward from actual marginal social cost by the monopolistic power of sellers, then downward adjustment must be made in the input prices.

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Discounting Future benefits

The choice of an appropriate discount rate is of crucial importance here. The need to discount stems from the existence of positive interest rates in the economy. Positive interest rates imply that a $ of benefit in the future will be worth less than an equivalent of present benefits, because it takes less than a $ of resources invested today to produce a $ of resources tomorrow, when interests are positive.

Choosing the social rate of discount

The social rate of discount reflects the return that can be earned on resources employed in alternative private use. This is the opportunity cost of funds invested by the government in a project. To avoid losses in well-being, resources should not be transferred from the private sector to government use if those resources can earn a higher social return in the private sector.

Setting the discount rate equal to the social opportunity cost of funds ensures that misallocations do not occur. The social opportunity cost depends on the rate at which savers and investors are willing to give up either consumption or investment to finance the government project. For example, if the rate of interest in the economy is 10%, a government project must yield at least that much to justify the transfer of funds from private to government use.

Ranking Projects

Projects are usually ranked according to the present value of their discounted net benefits(B-C) or according to the ration of the present value of benefits to the present value of costs. All projects with positive net benefits are considered for approval. Similarly, all projects with benefit-cost ratios in excess of a value of 1 are considered for approval.

Net Benefit Criteria: B – C

Benefit- Cost Ratio: B/C

CAPITAL BUDGETING TECHNIQUES

It involves the entire of planning the expenditure of firms whose returns are expected to extend beyond one year.

Examples of capital outlays are:

  • Expenditure on plant and equipment
  • Expenditure on acquisition and improvement of land.

The optimal capital budgeting is the level of investment that maximizes the present value of the project. Factors that affect capital budgeting include: Availability of funds, Rate of return on investment, Rate of interest at which funds are borrowed, Degree of risk involved in venture, Useful life of the assets and Degree of competitive in the market.

The following are the methods of capital budgeting:-

    1. Net present value of the project (NPV)
    2. Internal rate of return method (IRR)
    3. Payback period method (P/B)
    4. Return on investment method
    5. Expected rate of return method.

NET PRESENT VALUE AS A METHOD OF CAPITAL BUDGETING

Most investor would consider the NPV of a project before investing. This method takes into consideration the time value of money and profitability of a project.

Formula NPV = n Rt – C

t= 1 (1+r) t

Where – Rt is the annual income stream for n years

  • C is the initial cost
  • R is the discounting rate.

Decision to invest or not:-

Where NPV>O accept the project. If you are required to choose one project from many projects using this method, choose the project with highest NPV.

Where NPV=0 for private projects reject the project. But if the project is a government one the project may be invested into depending on its usefulness to the society.

Where NPV<0 public project selection decision should consider public interest and how essential the project is. If the project is an essential (e.g. eradicating polio), the government would subsidize the difference in cost.

Numerical Example 1

Table 3

PROJECT A

Year Cash Flows PVIF PV

At 10%

1 500 0.91 455

2 400 0.83 332

3 300 0.75 225

4 100 0.68 68

5 10 0.62 6

6 10 0.56 6

Total Present Value 1092.00

Assuming initial cost = 1000

NPV = n Rt- C = 1092 – 1000 = 92

t=1 (1 +r) t

PROJECT B

Year Cash flows PVIF PV

At 10%

1 100 0.91 91

2 200 0.83 166

3 300 0.75 225

4 400 0.68 272

5 500 0.62 310

6 600 0.56 336

Total Present Value 1400

Less initial cost 1000

NPV 400

Based on NPV method we should select project B because it has the highest NPV.

INTERNAL RATE OF RETURN (IRR) AS A METHOD OF CAPITAL BUDGETING.

Internal rate of return is the rate of interest which equates present value of the expected future cash flows or receipts from a project with the costs.

Formula

NPV = n Rt – C = 0

t=1 (1 +r) t

or

NPV = n Rt – n Rt – C = 0

t=1 (1 +r)t t=1 (1 +r)t

Formula 2 applies where we have streams of costs. The internal rate of return corresponds to the r in the formula. Based on the method, we accept a project when

  1. IRR > K (K here would represent the rate at which the investor borrowed loan. It may also represent the rate of return that the investor has forgone by not investing his funds in other assets.) e.g. on treasury bonds; on savings.

So in this case we could say that the resources that are invested in the project will give the investor a better return that he would have received by investing them elsewhere (for equal risks). Or another conclusion would be; he should invest since the rate of return on investment exceeds the rate at which he’s paying a loan.

  1. When IRR=K the decision maker is indifferent as to whether he invests in the project or not. In the case of a public project, the nature of investment would be considered. If the project has public support accepts it.
  2. If IRR>K, then by the same argument the opportunity cost of investing in the project elsewhere, which in this case are greater than the net benefits received from the project. In that case it would not be worthwhile investing resources in the public sector project.

According to the method, when there are many mutually exclusive projects to choose from, the projects are ranked in terms of their internal rates of return and that project with the highest IRR is chosen, provided that its IRR>K.

Pay-back period

It measures how long it takes to recover original invested amount from cashflows of an earning asset.

Where annual incomes are uniform over the year, pay-back period is calculated as;

PBP = C where C = Initial Cost

R R = Annual Income which is uniform

Where annual incomes are not uniform over the years, pay-back period is calculated as follows;

PBP = Complete Period + Balance after complete periods

Cashflow of the next period

P.T.O

Return on investment (ROI)

Rate of return on investments is calculated as;

ROI = Net Income = Gross Income – Expenses

Total Assets Total Assets

Expenses include here all expenses and taxes.

Summary

The chapter has been able to explain the steps involved in public sector project evaluation. It has also discussed the various project evaluation techniques

Question

  1. Discuss the various criteria that can be applied to evaluate a public sector project
  2. How does the social rate of discount used affect the number of projects that can be approved and their ranking in cost-benefit analysis.

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KENYAN EXPERIENCE

ON PUBLIC PRIVATE PARTNERSHIP (PPPs)

THE CASE FOR PPPs

Like many other developing countries, Kenya faces significant financing gaps in infrastructure and utilities to attain country’s vision 2030. For example electricity and power generation visa vispower consumption has a spare capacity of only 4%.Transport has financing gap of US$0.14billion per annum. The factors that contributed to the adoption of ppp gap are:

  1. Reduction of demand for Government resources to enable it to finance certain functions such as security, education and health.
  2. Inability of state corporations to mobilize adequate resources to fulfill their national mandates.
  3. Diminishing external resources in form of loans and grants whichthe Government had accessed earlier to finance infrastructure services –donors mainly supporting privatized utilities due to perceived operational efficiencies from private sector operations which enhance project sustainability.
  4. Lessons from other countries which have succeeded to improve infrastructure services through public private partnerships.
  5. Existence of PPPs which allow for private sector investments in strategic operations without sale of assets.
  6. With private sector managing maintenance and support services such as cleaning and security services, the Government professionals can concentrate on frontline service delivery.

LEGAL FOUNDATIONS FOR PPPs IN KENYA

There are two pieces of legislation that provide some foundationfor PPP arrangements.

  1. The Privatization Act 2005 which defines privatization as a transaction that result in a transfer, other than a public entity of; (a) Assets of a public entity including the shares in a state corporation (b) Operational control of assets of a public entity ©Operations previously performed by a public entity.
  2. The second is the Public Procurement & Disposal (PPDA) Act 2005 which defines public private partnership as an agreement between procuring entity and a private party under which: (a) the private party undertakes to perform a public function or provide a service on behalf of a procuring entity (b) the private party receives a benefit for performing this function, either by way of (i) compensation from a public fund (ii) charges or fees (iii) combination of compensation and charges.

•Section 64(4) of the PPD Act states that the Public Procurement Oversight Authority shall issue detailed guidelines for concessioning or PPPs.

KEY PROVISIONS OF THE GUIDELINES ON PPPs

  1. The Government appointed a steering committee of 13 members whose functions among others are: (i)establishing PPP standards, guidelines and procedures (ii) Serving as a resource center for best PPP practices in Kenya (iii) providing final approval/disapproval for PPP projects, after ensuring that there has been quality analysis of the PPP project to aid decision making and testing the PPP project for affordability, risk allocation and value for money.
  2. A procuring entity may enter into a PPP whereby a private party performs part of a procuring entity’s service delivery or administrative functions and assumes the associated risks, provided that in doing so the procedures strictly adhere to the guidelines. In return the private party may receive a fee according to predefined performance criteria, which may be from service tariffs or user charges or from government budget.
  3. The guidelines identifies the following PPP arrangements which can be entered into; A service contract, a concession, a lease, a BOT, a BOO or any other scheme as may be prescribed by the PPP steering committee.
  4. The guidelines also provide for unsolicited bids.

PPPs IN THE TRANSPORT SECTOR

•In December 2006 the Governments of Kenya and Ugandan jointly concessionedthe Kenya-Uganda railways. Since then the operational performance has not improved with the concessioningdue to absence of a strong rail operator.

•The concessionaire has effectively defaulted on payments of concession fees, agreed investments and improvements in cargo haulage.

•The two governments have given notice of terminating the concession.

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•The Government took a decision to replace the current driving license with second Generation Driving License.

•The Government settled for BOT scheme for a period of five years. There will be revenue sharing in the concession period. Upon expiry of the concession the production of drivers’license will revert to the Government.

•Firms were invited to bid and 4 firms submitted bids. A firm has been qualified and is awaiting necessary sanctioning before signing of the contract.

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•The Government advertised the tolling of a section of the Northern corridor in year 2007. The concessionaire was to add an extra lane a distance of 107km,maintain the section then charge a toll to recoup his investments. The response was not encouraging as only one firm returned the bids. It should be noted that the then there was no PPP framework in place. Negotiations with the party that responded are going on guided by the now established PPP framework

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LESSONS LEARNED

•Adequate capacity needs to be in place in Ministries for structuring of deals and negotiating deals to protect the public sector interest.

•Public and political acceptance of benefits of public private partnerships is needed.

•PPPs are not a panacea. They represent a claim on public resources that needs to be understood and assessed by the Government. They are often complex and long term and mistakes can be costly.

•Treatment of unsolicited bids is now clear under the released guidelines on PPPs.

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