Private Sector and Public Sector

India runs a mixed economy, which means that privately owned businesses and government owned businesses operate side by side. This chapter looks at how the public sector is organised, how its role has changed over the years, and how global enterprises and joint ventures fit into the picture. If you are revising the whole syllabus, you can find the rest of our Class 11 Business Studies notes alongside this one.

Introduction

There are all kinds of business organisations in our country: small or large, industrial or trading, privately owned or government owned. These organisations affect our daily economic life and so become a part of the Indian economy.

Since the Indian economy is made up of both privately owned and government owned business enterprises, it is known as a mixed economy. The Government of India has chosen a mixed economy in which both private and government enterprises are allowed to operate. The economy can therefore be classified into two sectors: the private sector and the public sector.

The public sector consists of various organisations owned and managed by the government. These organisations may be partly or wholly owned by the central or state government. They may be part of a ministry or come into existence through a Special Act of Parliament. Through these enterprises, the government takes part in the economic activities of the country.

Industrial Policy Resolutions

In its industrial policy resolutions, from time to time, the government defines the areas of activity in which the private sector and the public sector are allowed to operate.

In the Industrial Policy Resolution of 1948, the Government of India set out its approach to developing the industrial sector. The roles of the private and public sectors were clearly defined, and through various Acts and regulations the government oversaw the economic activities of both.

The Industrial Policy Resolution of 1956 laid down certain objectives for the public sector so as to accelerate the rate of growth and industrialisation. The public sector was given a great deal of importance, but at the same time the mutual dependence of the public and private sectors was emphasised.

Forms of Organising Public Sector Enterprises

The government's participation in the business and economic life of the country needs some kind of organisational framework to function. The government has a major role in forming the public sector, but it acts through its offices and employees, who take decisions on its behalf.

For this purpose, public enterprises were formed to take part in the economic activities of the country. They are expected to contribute to economic development in today's liberalised, competitive world. These enterprises are owned by the public and are accountable to the public through Parliament. They are characterised by public ownership, the use of public funds and public accountability.

A public enterprise may take a particular form of organisation depending on the nature of its operations and its relationship with the government. Whatever the form, any organisation in the public sector should ensure sound performance, productivity and quality standards.

The three forms of organisation that a public enterprise may take are:

• Departmental undertaking
• Statutory corporation
• Government company

Departmental Undertakings

This is the oldest and most traditional form of organising public enterprises. Such enterprises are set up as departments of a ministry and are treated as a part or an extension of the ministry itself. The government functions through these departments, and their activities are an integral part of the working of the government.

They are not set up as autonomous or independent institutions, and so are not separate legal entities. They act through the officers of the government, and their employees are government employees. These undertakings may be under the central or the state government, and the rules of the central or state government apply to them.

Features

• The funding comes directly from the government treasury as an annual appropriation from the budget, and the revenue they earn is also paid into the treasury.
• They are subject to the accounting and audit controls that apply to other government activities.
• The employees are government servants whose recruitment and service conditions are the same as those of other government employees. They are usually headed by Indian Administrative Service (IAS) officers and civil servants, who can be transferred from one ministry to another.
• Such an undertaking is generally a major subdivision of a government department and is under the direct control of the ministry.
• They are accountable to the ministry, since their management is directly under the concerned ministry.

Merits

• They allow Parliament to exercise effective control over their operations.
• They ensure a high degree of public accountability.
• The revenue earned goes directly to the treasury and is therefore a source of income for the government.
• Where national security is concerned, this form is most suitable, as it is under the direct control and supervision of the concerned ministry.

Limitations

• Departmental undertakings lack the flexibility that is essential for the smooth running of a business.
• The heads of such undertakings cannot take independent decisions without the approval of the concerned ministry, which causes delays where prompt decisions are needed.
• They are unable to take advantage of business opportunities, because an over cautious and conservative approach does not allow risky ventures.
• There is red tape in day to day operations, and no action can be taken unless it passes through the proper channels of authority.
• There is often political interference through the ministry.
• These organisations can be insensitive to consumer needs and may not provide adequate service.

Statutory Corporations

Statutory corporations are public enterprises brought into existence by a Special Act of Parliament. The Act defines their powers and functions, the rules governing their employees, and their relationship with government departments.

A statutory corporation is a corporate body created by the legislature with defined powers and functions. It is financially independent and has clear control over a specified area or a particular type of commercial activity. It is a corporate person and can act in its own name. A statutory corporation therefore combines the power of the government with much of the operating flexibility of private enterprise.

Features

• It is set up under an Act of Parliament and is governed by the provisions of that Act, which defines its objects, powers and privileges.
• It is wholly owned by the state. The government has the ultimate financial responsibility and the power to take its profits, and it must also bear any losses.
• It is a body corporate and can sue and be sued, enter into contracts and acquire property in its own name.
• It is usually independently financed. It obtains funds by borrowing from the government or the public and through revenue from the sale of goods and services, and it can use its own revenue.
• It is not subject to the same accounting and audit procedures that apply to government departments, and it is not tied to the central budget.
• Its employees are not government or civil servants and are not governed by government rules. Their service conditions are governed by the Act itself, though some officers may be taken from government departments on deputation to head these organisations.

Merits

• They enjoy independence and a high degree of operational flexibility, free from undesirable government control.
• Since their funds do not come from the central budget, the government generally does not interfere in their financial matters.
• Being autonomous, they frame their own policies and procedures within the powers given by the Act, though the Act may reserve a few matters for the approval of a particular ministry.
• A statutory corporation is a valuable instrument for economic development, as it has the power of the government combined with the initiative of private enterprise.

Limitations

• In reality, a statutory corporation does not enjoy as much flexibility as it appears to, because its actions are still subject to many rules and regulations.
• Government and political interference tends to appear in major decisions or where large funds are involved.
• Where there is dealing with the public, corruption can creep in.
• The government often appoints advisers to the corporation's board, which limits its freedom in entering contracts and taking decisions. Any disagreement is referred to the government for a final decision, which further delays action.

Government Company

A government company is established under the Companies Act, 2013 and is registered and governed by the provisions of that Act. These companies are set up for purely business purposes and, in true spirit, compete with companies in the private sector.

According to Section 2(45) of the Companies Act, 2013, a government company means any company in which not less than 51 per cent of the paid up capital is held by the central government, or by any state government, or partly by the central government and partly by one or more state governments, and includes a company that is a subsidiary of a government company.

All provisions of the Act apply to government companies unless otherwise specified. A government company may be formed as a private limited company or a public limited company, and certain provisions apply to the appointment and retirement of directors and other managerial personnel. The shares of the company are purchased in the name of the President of India. Since the government is the major shareholder and controls the management, these are known as government companies.

Features

• It is an organisation created under the Companies Act, 2013 or an earlier company law.
• The company can file a suit against a third party in a court of law and can be sued.
• It can enter into contracts and acquire property in its own name.
• Its management is regulated by the provisions of the Companies Act, like any other public limited company.
• Its employees are appointed according to its own rules contained in the Memorandum and Articles of Association, the main documents that state the company's objects, rules and regulations.
• These companies are exempt from the ordinary government accounting and audit rules. An auditor is appointed by the Central Government, and the annual report is presented in Parliament or the state legislature.
• A government company obtains its funds from government shareholding and other private shareholders, and it is also allowed to raise funds from the capital market.

Merits

• A government company can be set up simply by meeting the requirements of the Companies Act; a separate Act of Parliament is not needed.
• It has a separate legal entity, apart from the government.
• It enjoys autonomy in management decisions and acts according to business prudence.
• By providing goods and services at reasonable prices, these companies can steady the market and curb unhealthy business practices.

Limitations

• Where the government is the only shareholder, many provisions of the Companies Act have little relevance.
• It can evade the constitutional responsibility that a government financed company should have, as it is not answerable directly to Parliament.
• With the government as the sole shareholder, management and administration rest with the government, which defeats the main purpose of registering it like other companies.

Changing Role of the Public Sector

At the time of Independence, it was expected that public sector enterprises would help achieve certain objectives of the economy, either by taking part in business directly or by acting as a catalyst. The public sector would build up infrastructure for other sectors and invest in key areas.

The private sector was unwilling to invest in projects that needed heavy investment and had long gestation periods, so the government took it upon itself to develop infrastructure and provide essential goods and services. The early Five Year Plans gave a lot of importance to the public sector.

In the period after the 1990s, the new economic policies emphasised liberalisation, privatisation and globalisation, and the role of the public sector was redefined. It was expected to compete actively in the market rather than play a passive role, and it was held accountable for losses and returns on investment. A unit making continuous losses could be referred to the Board for Industrial and Financial Reconstruction (BIFR) for a complete overhaul or shut down. Various committees were set up to study inefficient units and suggest ways to improve their efficiency and profitability.

Development of infrastructure

The development of infrastructure is a prerequisite for industrialisation in any country. In the pre Independence period, basic infrastructure was not developed, so industrialisation progressed very slowly. It cannot be sustained without adequate transport and communication, fuel and energy, and basic and heavy industries.

The private sector showed no initiative to invest in heavy industries and did not have the trained people or finance to set them up quickly. Only the government could mobilise huge capital, coordinate industrial construction and train technicians and workers. Rail, road, sea and air transport were the responsibility of the government, and their expansion added to the pace of industrialisation. Public sector enterprises were meant to invest in certain spheres:

• To provide infrastructure to the core sector, which needs huge capital, complex technology and large organisations, such as steel plants, power generation, civil aviation, railways, petroleum, state trading and coal.
• To give a lead in investment where the private sector was not moving in the desired direction, such as fertilisers, pharmaceuticals, petrochemicals, newsprint, and medium and heavy engineering.
• To give direction to future investment in areas such as hotels, project management, consultancy, textiles and automobiles.

Regional balance

The government is responsible for developing all regions in a balanced way and removing regional disparities. Before Independence, most industrial progress was limited to a few areas such as the port towns. After 1951, the Five Year Plans paid special attention to regions that were lagging behind, and public sector industries were deliberately set up there.

Four major steel plants were set up in backward areas to speed up economic development, provide employment and develop ancillary industries. This was achieved to some extent, but there is scope for much more. The government therefore had to locate new enterprises in backward areas and, at the same time, prevent private units from crowding into already advanced areas.

Economies of scale

Where large scale industries need a huge capital outlay, the public sector stepped in to take advantage of economies of scale. Electric power plants, natural gas, petroleum and telephone industries are examples of large scale public sector units. These units needed a larger base to work economically, which was possible only with government resources and mass scale production.

Check over the concentration of economic power

The public sector acts as a check on the private sector. In the private sector, only a few industrial houses are willing to invest in heavy industries, so wealth can get concentrated in a few hands and monopolistic practices are encouraged, leading to inequalities of income that harm society. The public sector can set up large industries needing heavy investment so that the income and benefits are shared by a large number of employees and workers. This prevents the concentration of wealth and economic power in the private sector.

Import substitution

During the Second and Third Five Year Plans, India aimed to be self reliant in many areas. Foreign exchange was scarce, and importing the heavy machinery needed for a strong industrial base was difficult. Public sector companies in heavy engineering that would help with import substitution were set up. At the same time, public sector companies such as STC and MMTC played an important role in expanding the country's exports.

Government policy towards the public sector since 1991

In its new industrial policy of 1991, the Government of India introduced four major reforms in the public sector. The main elements were:

• To restructure and revive potentially viable public sector units (PSUs).
• To close down PSUs that could not be revived.
• To bring down the government's equity in all non strategic PSUs to 26 per cent or lower, if necessary.
• To fully protect the interests of workers.

Reduction in the industries reserved for the public sector, from 17 to 8 and then to 3

In the 1956 resolution, 17 industries were reserved for the public sector. In 1991, only 8 were reserved, restricted to areas such as atomic energy, arms, communication, mining and railways. In 2001, only three industries were reserved exclusively for the public sector: atomic energy, arms and rail transport. This meant the private sector could enter all other areas, and the public sector would have to compete with it.

The public sector has played a vital role in developing the economy, but the private sector is also capable of contributing substantially to nation building. Both sectors therefore need to be seen as mutually complementary parts of the national economy. Private sector units also have to take on greater public responsibility, while the public sector needs to achieve more in a highly competitive market.

Disinvestment of shares of selected public sector enterprises

Disinvestment means selling equity shares to the private sector and the public. The aim was to raise resources and to encourage wider participation of the general public and workers in the ownership of these enterprises. The government decided to withdraw from the industrial sector and reduce its equity in all undertakings. It was expected that this would improve managerial performance and financial discipline, though much remains to be done in this area.

Policy on sick units, the same as for the private sector

All public sector units were referred to the Board for Industrial and Financial Reconstruction to decide whether a sick unit should be restructured or closed. The Board has considered revival and rehabilitation for some units and winding up for others, and there is a lot of resentment among workers of units that are to be closed.

A National Renewal Fund was set up to retrain or redeploy retrenched labour and to compensate employees seeking voluntary retirement. Many sick enterprises cannot be revived because they have piled up huge losses, and with public finances under pressure neither the central nor the state government can sustain them for long. In such cases the only option is to close the undertaking after providing a safety net for its workers. The National Renewal Fund has not been enough to meet the cost of the Voluntary Separation Scheme or the Voluntary Retirement Scheme.

Memorandum of Understanding

Performance is to be improved through a Memorandum of Understanding (MoU) system, under which managements are given greater autonomy but are held accountable for specified results. Public sector units were given clear targets and the freedom to achieve them. The MoU is signed between a public sector unit and its administrative ministry, and it defines their relationship and the unit's autonomy.

Global Enterprises

Multinational corporations (MNCs), as we can see around us, are giant corporations that operate in a number of countries. They are characterised by their huge size, a large number of products, advanced technology, marketing strategies and a network of operations across the world.

Global enterprises are huge industrial organisations that extend their industrial and marketing operations through a network of branches in several countries. Their branches are also called Majority Owned Foreign Affiliates (MOFA). They operate in several areas, produce many products, and spread their business strategy across many countries.

They do not aim to maximise profit from one or two products but spread their branches widely, and they have an impact on the international economy. MNCs can exercise huge influence on the world economy because of their capital, technology and goodwill, which lets them sell products in many countries. Some may be a little exploitative and focus on consumer goods and luxury items that are not always desirable for developing countries.

Huge capital resources

These enterprises have huge financial resources and can raise funds from many sources. They may issue equity shares, debentures or bonds to the public. They can also borrow from financial institutions and international banks, and they enjoy credibility in the capital market, so even investors and banks in the host country are willing to invest in them. Because of this financial strength, they can survive in all circumstances.

Foreign collaboration

Global enterprises usually enter into agreements with Indian companies for the sale of technology, the production of goods, the use of brand names, and so on. These MNCs may collaborate with public and private sector companies, and the agreements often contain restrictive clauses on the transfer of technology, pricing, dividend payments and control by foreign technicians. Big industrial houses that want to diversify and expand have gained through such collaborations in terms of patents, resources and foreign exchange, but these collaborations have also encouraged monopolies and the concentration of power in a few hands.

Advanced technology

These enterprises have superior methods of production and can meet international standards and quality specifications. This helps the industrial progress of the country in which they operate, as they use local resources and raw materials well. Computerisation and many other inventions have come through the technology provided by MNCs.

Product innovation

These enterprises have highly sophisticated research and development departments that develop new products and better designs of existing ones. Such research needs huge investment, which only global enterprises can afford.

Marketing strategies

The marketing strategies of global companies are far more effective than those of other companies, and they use aggressive strategies to raise sales quickly. They have a reliable and up to date market information system, and their advertising and sales promotion are usually very effective. As their brands are already well known, selling their products is not a problem.

Expansion of market territory

Their operations extend beyond the boundaries of their own countries, their international image builds up, and their market territory expands until they become international brands. They operate through a network of subsidiaries, branches and affiliates in host countries, and their giant size gives them a dominant position in the market.

Centralised control

They have their headquarters in their home country and control all their branches and subsidiaries. However, this control is limited to the broad policy framework of the parent company, and there is no interference in day to day operations.

Joint Ventures

Meaning

When two businesses agree to join together for a common purpose and mutual benefit, it gives rise to a joint venture. Businesses of any size can use joint ventures to build long term relationships or to work together on short term projects. A joint venture can be flexible according to the parties' requirements, which should be clearly stated in a joint venture agreement to avoid conflict later.

A joint venture may also result from an agreement between two businesses in different countries, in which case the provisions of both governments have to be followed. In a broad sense, a joint venture is the pooling of resources and expertise by two or more businesses to achieve a particular goal, with the risks and rewards shared. The reasons often include business expansion, new product development or entry into new markets, especially in another country.

It is becoming common for companies to form joint ventures and strategic alliances, often because of complementary strengths such as distribution channels, technology or finance. Here, two or more parent companies agree to share capital, technology, people, risks and rewards in a new entity under shared control. In India, joint venture companies are a popular way of doing business. There are no separate laws for them, and companies incorporated in India are treated the same as domestic companies.

A joint venture company can be formed in any of the following ways:

1. Two parties (individuals or companies) incorporate a company in India. The business of one party is transferred to the new company, and in return shares are issued to that party, while the other party subscribes for shares in cash.
2. The two parties subscribe to the shares of the joint venture company in an agreed proportion, in cash, and start a new business.
3. A promoter shareholder of an existing Indian company and another party, which may be an individual or a company, collaborate to carry on the business of that company jointly. The other party may be a resident or a non resident and may take up shares through payment in cash.

All joint ventures in India that involve a foreign partner or a Non Resident Indian (NRI) require government approval. Depending on the case, approval is obtained from the Reserve Bank of India or the Foreign Investment Promotion Board (FIPB):

• If the joint venture is covered under the automatic route, the approval of the Reserve Bank of India is required.
• In other special cases not covered by the automatic route, special approval of the FIPB is required.

A joint venture must be based on a memorandum of understanding signed by both parties, setting out the basis of the agreement. The terms should be discussed and negotiated thoroughly to avoid legal complications later, keeping in mind the cultural and legal background of the parties. The agreement should also state that all necessary approvals and licences will be obtained within a set period.

Increased resources and capacity

Joining hands with another business adds to existing resources and capacity, letting the joint venture grow and expand more quickly and efficiently. The new business pools financial and human resources and can face market challenges and seize new opportunities.

Access to new markets and distribution networks

When a business enters a joint venture with a partner from another country, it opens up a large, growing market. It can also use the partner's established distribution channels, such as retail outlets in local markets, which would otherwise be very expensive to set up.

Access to technology

Technology is a major reason for many businesses to enter joint ventures. Advanced production techniques that give better quality products save time, energy and investment, as the business does not have to develop its own technology. Technology also improves efficiency and effectiveness, which reduces costs.

Innovation

Markets are becoming more demanding in terms of new and innovative products. Joint ventures let a business offer something new and creative for the same market, and foreign partners in particular can bring innovative products because of new ideas and technology.

Low cost of production

When international corporations invest in India, they benefit greatly from the lower cost of production and can get quality products for their global needs. India is becoming an important global source and is very competitive in many products. The reasons include low cost raw materials and labour, a technically qualified workforce, management professionals, and skilled people in many fields such as lawyers, chartered accountants, engineers and scientists. The international partner thus gets products of the required quality and specification at a much lower cost than at home.

Established brand name

When two businesses enter a joint venture, one party can benefit from the other's goodwill, which is already established in the market. If the joint venture is with an Indian company, the Indian partner does not have to spend time or money building a brand name or a distribution system, as there is a ready market waiting for the product. A lot of investment is saved in the process.

Why it still matters

The ideas in this chapter are not just history. India is still deciding, right now, which businesses the government should own and which it should hand over to private owners.

In February 2021 the government announced a New Public Sector Enterprise Policy. It named just four strategic sectors in which the government will keep only a bare minimum of public sector companies: atomic energy, space and defence; transport and telecommunication; power, petroleum, coal and other minerals; and banking, insurance and financial services. In every other, non strategic sector, public sector enterprises are to be privatised where possible, or else closed. This is the same story the notes tell about the list of reserved industries shrinking from 17 in 1956 to just 3 by 2001, only carried into the present day.

A live example of privatisation is Air India. Founded long ago by the Tata group, it had been a government owned airline for decades. On 27 January 2022 the government handed Air India back to the Tata group. It was the country's first big privatisation since 2003 and 2004, and a clear case of a government company passing into private hands.

Disinvestment, which the notes describe as selling shares of a public sector enterprise, also happened on a record scale. In May 2022 the government sold a small slice, about 3.5 per cent, of the Life Insurance Corporation of India (LIC) through a public share sale. This raised more than 20,000 crore rupees while the government still kept around 96.5 per cent ownership. It was the largest share sale India had ever seen at the time, and a real world version of the disinvestment idea in your syllabus.

So when you read about departmental undertakings, statutory corporations, government companies and disinvestment, you are reading about decisions that are still being argued over in Parliament and reported in the news. You can explore how these choices shape the wider Indian economy on the Learnacy Hub, and browse more study notes and explainers to connect the theory to today's headlines.

Sources

1. Department of Investment and Public Asset Management (DIPAM), New Public Sector Enterprise Policy for Atmanirbhar Bharat, notified 4 February 2021
2. Tata group newsroom, Tata group completes the acquisition of Air India, 27 January 2022
3. Business Today, Air India formally handed over to the Tata group, 27 January 2022
4. Business Standard, Government made Rs 31,106 crore in FY23 through disinvestment (LIC share sale), DIPAM report

Key takeaways

• India has a mixed economy with both private and public sectors operating together.
• The public sector consists of organisations owned and managed by the government.
• The government defines the areas of activity for the private and public sectors through industrial policy resolutions.
• Public sector enterprises are formed to contribute to economic development and are accountable to the public through Parliament.
• There are three forms of organisation for public enterprises: departmental undertakings, statutory corporations, and government companies.

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