Privatisation and Outsourcing as Ways to Enhance Effectiveness of Public Services

Q & A with Santhakumar V

Q: There are successful cases of privatisation and outsourcing in India, such as telephone services, Air India, and passport services. Are privatisation and outsourcing desirable for improving the effectiveness of public services?

A: Let us understand the differences in the role of private agents in all three cases mentioned. In telephone services, private providers (like Airtel) are allowed to provide services by the public sector organisation (BSNL) with a regulator (Telecom Regulatory Authority of India — TRAI); Air India, a public-sector organisation, was sold to a private/corporate company; and in the case of passport services, specific activities that are part of issuing passports are outsourced to Tata Consultancy Services (TCS), a private sector organisation, while the sovereign and fiduciary functions, like verification, granting and issuing of passports rest with government officials (Ministry of External Affairs – MEA). The last one is an example of outsourcing and the former two are examples of privatisation.

There are economic reasons for the success of privatisation or outsourcing in these cases. In the case of Air India, the service is a typical private good (like hotels) hence, there is no ‘economic’ need for government intervention. Technology has changed the telephony system (from landlines to mobiles). In the past, the need for landlines could have created a monopoly in telephone services which would have become socially harmful if it were controlled by a private company. Today, mobile phones (and the redundance of landlines) has reduced the chances of monopoly and so multiple private firms can provide this service. Only certain activities as part of the issue of passports are outsourced to TCS and such outsourcing is not new. Historically, the construction of roads was carried out by private contractors though the design and financing remained with the government.

Q: Are there cases where privatisation has failed in India?

A: Yes. Though there were attempts to privatise electricity utilities, these have not been successful in most cases. In one case, the private company which bought the utility returned it to the government. The inclination to privatise electricity utilities has declined in India.

Q: What may be the reason for the failure of privatisation of electricity utilities?

A: In most cities/areas, considering the need for investments in landlines, it is efficient to have only one electricity utility. If it is a private company, it can become a socially harmful monopoly, which has to be avoided. One way is for the government to regulate private companies (through a regulator). This has not worked well in India. Let us take an example. The regulator may have to ensure a minimum return for the capital invested by the private company. This may require a periodical revision of the tariff for electricity (considering the increase in costs). However, the government (which appoints the regulator) may not want such a tariff revision. This may lead to losses for the private company. The other way is to give the license to operate as a monopoly to a private company through competition. The idea is that when multiple companies compete, this competition will force them to quote low prices. This competition at the time of awarding the license may reduce the harmful effects of a monopoly later.

When two parties enter into a contract, both become vulnerable. For example, the company makes investments expecting that it can charge a particular price (and get a specific return), if the government in the future does not allow them to increase charges based on contract conditions (say due to political reasons), the company cannot stop operation (since its losses will increase if it does so). When the government signs a contract, it also becomes vulnerable because if the company threatens to stop operations, it has to find a new service provider and the gap in the provision of such a service can be costly. Hence, both parties may try to be ‘excessively’ vigilant. This is not a hypothetical situation. Whenever expressions of interest are invited for the privatisation of electricity utilities in India, only two to three companies have shown interest, and hence, the expected benefits of competition have not been realised.

Q: Are there cases where privatisation has been attempted (though it is not ideal in India)? What are the implications?

A: To some extent, the privatisation of airports has been attempted. There may be only one airport in a city. Hence, it can become a regional monopoly. If it is controlled fully by a private company, it may decide the fees (landing charges) to maximise its revenue, and this may not maximise consumer welfare. However, the justification for privatisation is that the governments do not have enough money to create new (or to expand existing) airports. To some extent, this is the case with toll roads also.

Q: Are there cases where privatisation has not been attempted (due to the perception that it is not appropriate)?

A: Though there is talk about the privatisation of water supply, it is not attempted in most contexts, which is the right thing to do. The problems which we have discussed in the context of electricity supply will manifest in severe forms in the case of water supply. This may also be the case with sewerage, waste collection, etc.

Q: Is access to service (like poor people may not be able to buy water from a private utility) a consideration in the decision on whether a public service can be privatised or not?

A: Theoretically, a service can be privatised but the government has to pay (through different ways) to ensure that all people get the service. This payment can be made directly to consumers or to the company which provides the service at subsidised rates to specific sets of consumers. Hence, reduced access need not be a theoretical reason against privatisation. However, it can be a practical challenge in many developing countries. As mentioned in the case of electricity utilities, governments in these countries may not have enough money to pay the poorer consumers or the service provider to ensure that these consumers benefit from the service. Instead, it may try to influence the regulator to not increase the tariff, which may discourage private players and reduce the scope and viability of privatisation.

Q: Instead of full privatisation, can there be more outsourcing? Since the involvement of TCS is useful in passport services, such a strategy should be useful in many others.

A: The situations where outsourcing is useful also depend on the context. There are multiple reasons. For example, governments may want to give school education for all children. Instead of starting government schools, it can outsource this responsibility to private schools by paying them money. But there can be ‘perverse’ incentives for private schools depending on the mode of payment of money.

Let us consider the following ways of paying money and their implications:

Providing teachers’ salaries — private managers may appoint teachers by taking bribes or side payments.
Meeting the cost of education per child — difficulty in assessing the cost of private schools as part of RTE.
Meeting the cost based on student achievement – not all students will get admission.
Lump sum grant — the possibility of saving costs by appointing teachers who are willing to accept a lower salary

These cases demonstrate that the complexities/difficulties will increase if the actual work or practices of the private agency cannot be monitored easily. Hence, the difficulty in monitoring could be a consideration in whether an activity can be outsourced or not.

Let us consider the example of outsourcing fire control services. A private company may sign a contract with the government to provide this service for a specific price and scope of service. Suppose there is a fire which requires more effort on the part of the private company, which has not been envisaged in the existing contract, a new contract cannot be signed before providing the service. This is a difficult situation for both the company and the government. Hence, the emergency nature of service, unpredictability of the need for (quantum of) service, etc, can be factors that may determine whether a specific service can be outsourced or not.

Whether to outsource or not is an issue that confronts not only governments but also private companies. For-profit private companies may carry out certain activities with permanent employees and may outsource certain other activities. One can see gardening, transport, housekeeping, etc., outsourced by IT companies whereas the software development is carried out by employees. This is not merely due to the ‘high-tech’ nature of software development. Each software developer may have some intrinsic knowledge that cannot be monitored easily by a supervisor; the experience of working on a series of projects gets accumulated and such accumulated experience is useful for the company, it may be problematic when the person who works only on a small part of the project leaves; if people move in and out frequently, they may take with them some important information that is valuable to the company; and all these may determine whether a specific activity can be outsourced or not in a private company. Such considerations matter in global outsourcing projects too.

When a bank in the US outsources its back-office operations to a BPO in Bengaluru, it may have three options: (a) to give the contract to the lowest bidder; (b) to have part-ownership of the company which gets the outsourcing contract; © entrust the back-office operations to a fully owned subsidiary which operates in Bengaluru. Though the last option is costlier, some banks follow this route. A costly route, such as this, may ensure greater control over the organisation which gets the outsourcing contract. This may be needed to ensure that the customer data is not leaked to competitors, the quality of service is not diluted, and so on. Hence, getting work done by employees or their subsidiaries is a practice used by private companies too.

In summary, there are conditions that make it imperative for the government to provide certain public services. The privatisation and outsourcing of all public services are not desirable and depend on many factors some of which have been discussed.