SOME ISSUES WITH RESPECT TO THE RELATIW EFFICIENCY

OF PUBLIC ENTERPRISES

bY T. TAMBUNAN

Faculty of Economics, Christian University of Indonesiu Center for Development Planning, Erasmus University Rotterdam

Introduction

In recent years there has been a shift in the literature on the economics of public enterprises from welfare economics perspective to an examination of the performance of publicly owned firms. Notably there has been a growing interest in the relative efficiency of public enterprises and efforts have been made to identifjl the possible causes of differences in the relative efficiency between the public and private enterprises.

The aim of this short paper is to discuss some issues with respect to the economic performance, i.e. efficiency, of the public enterprises.

1 Some Measurement Problems: a Discussion on Methodology

Undoubtedly, there is a need to assess the relative performance of public enterprises, especially in relation to the problems of govern- ment deficit and the aim to increase economic efficiency in these days

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in many developed as well as less developed countries. But, despite this no generally acceptable criteria of appropriate measurement has been found yet. There seemed to be a general agreement that profit maximization, the yardstick of success of private enterprise, is not acceptable as the measurement of performance of public enterprises, especially in countries where these enterprises have many other social than only economic or political objectives (Mandi, 19781.’ However, some authors felt that profitability should be used as the measurement of performance of public enterprise. The reason they gave is as Maniatis (19701, for example, puts in this own words that the profitability norm is an “objective and dependable test as i t is based on the measurement of a one-dimensional effect encompassing the entire spectrum of the determinants of efficiency” (p. 228-229). Other analysts on the economic efficiency of public enterprise provide a somewhat different perspective in this respect. For instance, Schloss (1970) proposed that social cost benefit analysis should be used to assess the performance of public enterprise, whereas Khera (1963) argued that economical use of resources (‘economic efficiency’) and methods of management finctioning are two of a number of essential aspects according to which public enterprise should be measured. In addition, some authors suggest that the performance of public enterprises can be measured against a range of criteria in terms of financial, commercial, economic or social.2

After reading their works, it can be concluded that the shortcom- ing of most of the measurements proposed by the above authors is inherent in their approach. They have tried to find a single or a few measurements to be applicable to all types of public enterprises. But, as stated by Mandi (1978): T h i s approach was not suitable because there were various types of public enterprises, performing various functions and they need to be measured differently” (p. 56). In other words, different sets of criteria should be used to measure different types of public enterprises.

With respect to this problem of measuring performance of differ- ent types of public enterprises, there has been a growing consensus or agreement that the concept of productivity is more acceptable or suitable to be used for this purpose. By productivity it means the ratio

1 See also, for example, Galbraith (1964). 2 There is an extensive literature which has examined the proporties of more alternative indicators. See, for example, Bishop and Thompson (1992), Marchand et al. (1984), Perelman and Pestieau (19881, Rees (19891, and Windle (1991).

SOME ISSUES WITH RESPECT TO THE EFFICIENCY OF PUBLIC ENTERPRISES 463

between the quantity of goods and services produced and the quantity of (or costs of) production resources consumed. This concept is not tied to the concept of profitability. Thus, as a simple example, an enter- prise can have high productivity but, at the same time, has some losses due to providing social or other ‘non-business oriented’ serv- ices.

Recently, in relation to this concept of productivity or efficiency many authors have constructed a production frontier or used a stochastic production frontier approach to compute ’technical’ or pro- ductive efficiency in dice^.^ The frontier (‘best practice’) production function posits an outer boundary in output surface over a given range of observed inputs. In other words, this production function gives the maximum obtainable outputs given available inputs and production technologies (Cakmak and Zaim, 1992).

2 The Comparative Performance of Public and Private Enterprise: Some Evidence

With respect to the relative economic performance of public enterprises, the most obvious question is whether output per man (productivity), or cost per unit of product or profitability, within the public enterprise sector has been growing faster or slower than within the private sector? Numerous comparative studies of the perform- ance of public and private enterprises have been made in a number of mainly developed countries, either for those who are engaged in the same activities or in dkerent businesses.

A growing body of evidence shows that when the public and private enterprises are compared in terms of the cost of producing similar outputs, or of other measures (alternative ratios to the pro- ductivity measurement) of efficiency, the private sector outperforms the public sector. Pryke (19831, for example, found that most public enterprises in the United Kingdom have performed relatively poorly in terms of their competitive position. They have used labour and capital inefficiently and have been less profitable. They have poor management and low productivity, In most cases the public activities in the country have been losing money over a long period. Borcherding et a1 (1982) presents a table summarizing a large

3 See for example, Farrell(1957), Forsund F.R. et al. (19801, Cakmak and Zaim (1992), Jondrow et al. (1982). Lee and Tyler (1978), Fare et al. (1985a) and Fare et al. (1985b).

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number of studies up to 1980 that compare the production costs of public and private enterprises which shows that the former enter- prises have generally higher unit cost stuctures than the latter ones. However, a similar table listing a large number of empirical studies presented by Pestieau and Tulkens (1990) shows that in some cases i t has been found no significant differences in unit cost structures between the two groups of enterprises. Similarly, a number of com- parative analyses of public and private firms in the USA shows that in terms of rates of return or cost per unit of output the public seetor was not widely different from the private sector. Even in some activi- ties there was no evidence that private firm costs were lower than that of public firms (Yunker, 1975, and Millward, 1980).

Davies (1971)' presents some data on the relative costs of public versus private Australia's trunk airlines.6 He compared the efficiency of these two airlines by using three productivity measures: tons of freight and mail carried per employee, passengers carried per em- ployee, and revenue earned per employee. The result shows that the private airline company was more efficient than the public one. Based on this finding, he concludes that substitution of private production for public production would certainly reduce costs of production sig- nificantly. He claimed that one important reason that the public enterprise performanced inefficiently was probably due to the fact that the pricing, routing, and service levels required by the govern- ment were not necessarily the most efficient ones.8

Wallace and Junk (1970) studied the electric utility costs by mode of ownership in the United States. They computed both operat- ing costs on a per kilowatt hour basis and capacity costs on a kilowatt basis for eight regions of the country for municipal (publicly) and investor (privately) owned utilities. They come with some results showing that the municipal generating systems have both higher operating costs and higher investment costs than private firms have. Some authors such as Dean (19751, Meyer (19751, Gunderson (1979), and Marks (1980) argue that the municipal utilities could have higher costs because they are smaller than the investor-owned utilities, given the fact that the optimum scale of operation for an electric company is fairly large.

4 See also Davies (1977,1980). 5 6

See also Forsyth and Hocking (1980). See also Spann (1977) and Funkhouser and MacAvoy (1979).

SOME ISSUES WITH RESPECT M THE EFFICIENCY OF PUBLIC ENTERPRISES 466

In terms of profitability, Millward (1980) has found (by using data on gross trading profits and taking this variable as a percentage of net fixed assets at current replacement cost) in the United King- dom that the rates of return in the private sector have been well above the public sector during the all post-war period.

Finally, Caves et a1 (1980b) compared the productivity growth rates between Canadian and American (USA) railroads; both are public owned companies. They found a distinctly better performance, in terms of greater growth rates, for the substantially less regulated Canadian companies. They conclude that the important explanation for the superior economic performance of the two Canadian railroads must ultimately lie in the area of organizational design and control. More specifically, regulation in general, and direct price regulation in particular, has a strong bearing on how production is organized. They show that as the Canadian railroads were deregulated the marketing organizations of those companies were radically altered. Moreover, the Canadian railroads have much more elaborate 'costing' systems than those of their U.S. counterparts. There is also an indication that computer-based systems for operating and financial management are better integrated in the Canadian railroads than in their US. coun- terparts.

3 Some Reasons for Bad Management

The relevant question here is: "Why is the public enterprise recorded so dismal ?" The proximate explanation is that the activities in the public enterprises have been badly run (mismanagement). Many public enterprises are slow in adapting changes in the market. They have failed to rationalize their pattern of operations. Maybe more important differences in individual motivations between the private firms, whose managers or employees can secure direct mon- etary rewards from cost-savings or increasing productivity, and the bureaucratic agency (public firms) are also as one of important ex- planatory factors for the inefficiency in the public ~ e c t o r . ~

The public enterprises have long been 'too big' in activities but 'too small' in management capacity. They are also too bureaucratic while their private counterparts are run by indivuals with high entre-

7 (19751, Buchanan (1977) and Rowley (1977).

See, for example, Turvey (1968), Wallace and Junk (1970), Yunker

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preneurship. Moreover, the public enterprises are subject to a wide range of statutory and administrative controls, as well as to less formal modes of intervention.

Amongst these factors mentioned above, maybe the most likely explanation for the poor performance of the public enterprise activi- ties is that they are public ownership. I t could have had harmful effect by inducing the belief that the activities should act as social services rather than profit maximization oriented undertakings, and take the ‘national interest’ rather than the ‘economic goals’ into account.* Though, it is maybe untrue that public ownership has caused managers to believe that the activities they undertake are more social services rather than business orientation. Due to all these factors, the managers in the public enterprises are not forced to observe the financial discipline, the need which all private undertak- ings have from time to time, to raise money from the market.e

Public ownership provides a comfortable life and destroys the commercial ethic. Indeed, a significant part of the problem is that politicians can influence the objectives of public enterprises and, in particular, less compelling noncommercial objectives are substituted for economic and financial objectives. Such as Alchian (19651, Niskanen (1971) and Posner (1984) argue that political interference in decision making and bureaucratic failure are probably the princi- pal sources of inefficiency associated with public ownership. Further- more, public enterprises either do not heve to borrow on the private capital market, or if they do government guarantees or backing results in their being favorably treated relative to private enterprises. It also allows public sector unions to exploit their power to interrupt the supply of essential goods and services to secure pay and condi- tions that are out of line with those in the private sector.

So, all the factors mentioned above create a condition or situa- tion which leads public enterprises to perform badly in terms of productive efficiency, that is to have higher production costs a t a given level of output than comparable enterprises in the private sector. lo

8 Caves et al. (1982) and Gratwick (1982) argue that the improvement of economic performance of a firm must come about through the improvement of effectiveness of management encouraged by its full accountability for profits. 9 See, for example, Funkhouser and MacAvoy (19791, Pommerehne and h e y (1977). 10 See, for instance, Polanyi (1972,1974), Pier et al. (1974), Pescatrice and Trapani (19801, Millward et al. (1983) and Hemming and Mansoor (1988).

SOME ISSUES WITH RESPECT "0 THE EFFICIENCY OF PUBLIC ENTERPRISES 467

4 Some Conclusions

From many studies in wich some of them have been discussed in this short paper, it appears that there is still a need to improve not only the data base for comparing public and private firms but also the methodology of measuring differences in the performance between these two sectors.

This study shows that there is no systematic evidence that public enterprises are less efficient than their private counterparts. Although, i t is still difficult to identifj., for instance, separate compo- nents of cost effectiveness as well as to make a 'good' productivity comparison between the two sectors.

The important questions in this respect include: "if a private firm, having higher productivity or efficiency than a public firm, puts itself into (external) conditions that generally facing the public firm only, for example, getting high subsidized credit from the government instead of lending money from capital market at much higher market rate of interest, would then the efficiency in using capital of the private firm be still higher than that of the public firm?" And, "is unskilled management in the public sector the most responsible factor for its inefficiency rather than because of 'too many' services provided by the government ?"

All studies discussed in this paper are not dealt explicitly with theses questions. In Section 2 of this paper, a number of factors has been suggested as the possible explanations for the public firms being inefficient. However, i t is still not clear enough: "what are the 'direct' and what are the 'indirect' responsible factors ?" But, this shortcom- ing can be overcome by carrying out 'field' surveys. In other words, there is still a need for more case studies aiming to answer this particular question rather than empirical studies using published data only.

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