Why government should not run a business

Very often, Nepali politicians can be heard proudly promising to revive the sick or shut down state-owned enterprises (SOEs). These promises are often backed by the people who believe that these enterprises fare better than their private counterparts. This is nothing but an infatuation many people have towards SOEs. The reason sick or shut down enterprises are in their current state is because of the government.

In a bid to increase domestic production and reduce trade deficits, the Nepali government has decided to revitalize nine sick industries—Janakpur Cigarette Factory, Agricultural Tools Factory, Gorkhali Rubber Industry, Nepal Orind Magnesite, Nepal Metal Company, Biratnagar Jute Mill, Birgunj Sugar Factory, Hetauda Textile Industry and Butwal Yarn Factory. But this is not going to fare any better than pouring water into sand. SOEs in Nepal have never performed well, despite the government back-up and support. In contrast, the private sector has been performing exceptionally well. The recent Yellow Book, published by the Ministry of Finance, shows that out of 42 SOEs currently in existence, 19 are operating in loss, and a majority of such losses are in the industrial sector where the private sector’s revenue grew by eight percent compared to the previous fiscal year.

By the end of the fiscal year 2077/78, the losses incurred by the government-owned industries have reached NRs 18 billion which is equivalent to the annual minimum salary of more than one hundred thousand workers. Yet, the government does not stop reinvigorating the idea of operating such industries. Let’s assume the government goes ahead with its plan to revive these industries. This act itself is going to suck in a substantial amount of capital. But what happens to the investment after that? Will these industries actually prosper? Will these industries show any kind of innovation? Will these industries be able to compete with the private sector on a level playing field? Studies paint a bleak picture for SOEs and most of them recommend that the government keep itself out of doing business.

There are many reasons why SOEs fail.  One of them is because there is a lack of ownership. In a privately owned and operated enterprise, the owner will work to better their industry’s value. They will consistently work to further innovate their product/s or management style resulting in operational efficiency. In the case of an SOE, the ownership lies in the hands of the masses. The bureaucratic efficiency while making decisions and an incentive to innovate is lacking in an SOE resulting in a slump in operational efficiency. The owner (the government) and the managers of SoEs do not have to depend on shareholders for capital, unlike the private enterprises where this relationship fosters accountability. SOEs also do not have to depend on customers for business and profits, again, unlike the private enterprises where this relationship fosters doing good business. The majority of the SOEs operate in sectors where there is a high barrier to entry for other players resulting in a lack of competition which in turn discourages innovation. Once these SOEs are introduced to competition, they rarely perform well.

Our cement industries tell a powerful tale. Prior to opening this sector up for private investments, the government operated three cement industries that were fulfilling the demand of the country. However, after allowing private investments in this sector, state-operated cement industries were not able to compete alongside them. In the last fiscal year alone, the two state-owned cement industries that are currently in operation—Hetauda Cement Factory and Udaypur Cement Factory—reported a loss of NRs 170 million and NRs. 300 million respectively. On the contrary, Shivam Cement—a privately operated cement industry alone—made a profit of NRs 1.4 billion. A study conducted by Nepal Rastra Bank also shows that the government-owned cement industries are neither efficient nor profitable. The study discloses that the net profit margin of locally owned cement industries is 10.42 percent and that for cement industries with Foreign Direct Investment is 10.17 percent while the same for SOEs is negative.

Governments should not be doing business and the Nepali government must learn from its own experiences. Nobel Prize Awardee Professor Milton Friedman famously said: “If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand.”

Governments are better suited to deliver public services and play the role of facilitators when it comes to business. To achieve the objective of increasing production and decreasing the trade deficit, the government can work towards improving the business environment and reducing the bureaucratic red tape that discourages investors from setting up new industries. Entry restrictions, complex and arcane legislation, high taxes and regulations, and difficulty in repatriating (among many) are some of the major reasons behind Nepal’s poor production and high dependence on imports. Reforms in these areas would enhance Nepal’s business environment which would, in turn, foster competition which would again result in the production of more and better goods for domestic consumption as well as export.

This article was originally published in Nepal Live Today by Prakash Maharjan on June 27, 2022.