Nepal | April 03, 2020

Reviving PEs: Forget it, it’s sunk cost

Rupak D Sharma

Should the government yield to the temptation to ‘make corrections’ by throwing money in public enterprises that previously failed to compete in the open market or consider the past investment a sunk cost and finance other meaningful projects?

Illustration: Ratna Sagar Shrestha/THT

When my son was around four, I had bought him a pair of kurta pyjama. I made the purchase as it was made of high quality fabric and was on sale for half its tag price. In technical terms, the purchase had maximised my acquisition utility (read utility as happiness or satisfaction) because of its high quality and my transaction utility because it was on sale.

But the problem was that my son wouldn’t wear it. I tried to convince him saying it would look good on him; even provided incentive – chocolates – that he put it on at least once; and, out of desperation, shouted at him saying I didn’t have a plant at home to grow cash for unnecessary spending. But he wouldn’t wear it.

Many of us indulge in impulsive shopping when goods are on sale. This tends to make us happy. Then we realise some of the purchases were unnecessary or even ridiculous. And when goods end up somewhere in the back of the closet or in the store room, we tend to regret. That’s what happened to me after I bought the kurta pyjama.

If you talk to economists about this problem, they’d tell you there is no use regretting, because it’s a sunk cost, meaning the money paid for the good is gone and you would not get it back; and “ignoring sunk cost is perfectly rational, even required”. Remember the saying don’t cry over spilt milk?

But it’s hard to ignore the sunk cost, isn’t it, because money has been spent. And that’s what is happening with public enterprises (PEs) in Nepal, many of which were set-up through foreign governments’ assistance.

Ministers of every new government make announcements to use taxpayers’ money to revive state-owned enterprises that have been shut down. We’ve heard Baburam Bhattarai, former prime minister and finance minister, and Nabindra Raj Joshi, former industry minister, floating ideas of resuming operation of Hetauda Textile Mill.

Recently, the industry minister also expressed interest to resume operation of two closed state-owned sugar factories. And talks about breathing life into closed enterprises like Gorakhkali Tyre Factory, Bhrikuti Paper Factory and Biratnagar Jute Mill have also made rounds in the past.

The genesis of failure of most of these state-owned enterprises is same: they fail to upgrade machinery and equipment, which prevents them from competing with relatively cheaper goods and erodes their competitiveness.

These problems cause losses to soar. Add to that problems of inefficient management, overstaffing which raises overhead cost, lack of expertise, ineffective marketing strategies and political meddling, and a perfect recipe for the downfall of the state-owned enterprises is created.

Yet ministers and bureaucrats fail to recognise these weaknesses inherent in many Nepali public enterprises and talk about injecting money to revive companies that have failed. This is because too much of investment has gone into these enterprises and it is difficult to let go. But again the more we invest, the more difficult it would be to quit. This is what behavioural economists have found.

So, should the government yield to the temptation to “make corrections” by throwing money in companies that previously failed to compete in the open market or consider the past investment a sunk cost and finance other meaningful projects?

The government’s gross investment in 37 public enterprises topped Rs 312.1 billion as of last fiscal year, the latest report of the Finance Ministry shows. But they extended dividend of only Rs7.8 billion, of which 89.9 per cent came from one company – Nepal Telecom. If you exclude the telecom company, the combined cumulative loss of remaining 36 public enterprises stands at Rs 48.5 billion.

It is quite surprising that Janak Education Materials, which has near-monopoly in supply of textbooks to community schools, and Dairy Development Corporation, whose milk and dairy products are quite popular among households, booked a combined net loss of over half a billion rupees in the last fiscal year. Something is wrong isn’t it?

My intention here is not to question the intention or integrity of ministers and bureaucrats trying to promote public enterprises. I’m just saying, whatever good intentions, states usually do not have the particular talent or information to spot enterprises that can succeed in future.

Well, they can choose at random, but their intuitive thinking may turn out to be an extreme prediction or simply the result of overconfidence.

So, is it worth taking such a big risk with taxpayers’ money instead of letting the private sector run those businesses? The government should ponder on this question as the latest Finance Ministry report has indicated opening more public enterprises.

Coming back to kurta pyjama, I still have it somewhere in the store room. My son has outgrown that dress and my grandchild, if I have one, probably won’t wear it because it would be too old by then and perhaps out of fashion.

I regret not selling it earlier when it was in good condition to recoup some cost. I also regret spending money on the dress without consulting my son.


A version of this article appears in print on June 01, 2018 of The Himalayan Times.


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