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Anne Auer
Kelley School of Business

Nandini Gupta
Kelley School of Business

Last modified: Monday, March 7, 2011

Empirical evidence confirms that lawmakers facing local pressure obstruct national progress

IU Kelley School research sheds light on the privatization of firms in India and has implications for countries worldwide

March 7, 2011

BLOOMINGTON, Ind. -- In a new twist on the "all politics is local" theory, first-of-its-kind empirical research from the Indiana University Kelley School of Business demonstrates how lawmakers knowingly and willingly obstruct desperately needed national progress to please local constituents -- and often, keep themselves in office.

The study, which analyzes firm-level data from India and accounts for all privatizations undertaken there until 2009, reveals that government officials in hotly contested elections thwart sales of firms in their home regions. Conversely, those who face insignificant or insurmountable election challenges generally advance such potential deals. These findings have global ramifications because they shed light on a spectrum of legislative priorities that pit local interests against national gains.

"For years, economists have demonstrated the far-reaching national benefits of privatization: improvements in efficiency, long-term employment gains, added resources for human services and financial market development -- and politicians are acutely aware of this," said Nandini Gupta, associate professor of finance at the Kelley School and co-author of the study.

"However, those contending with challenges from opposition parties won't risk alienating local voters who mistakenly equate privatization with widespread layoffs, reduced wages or long-term economic calamity," Gupta added.

The authors further show that no government-owned firm located in the home state of a top-ranked Indian minister ever has been privatized, epitomizing a deeply entrenched "not in my backyard" mentality.

Implications for India

According to Gupta, privatization issues are particularly salient in India, where approximately five percent of GDP is concentrated in just 240 state-owned companies, which employ 2 million workers in a country of 1 billion. These businesses are more varied than those in fully developed countries, encompassing typical sectors such as heavy industry but also small-scale operations including computer manufacturers and bakeries -- firms most economists would argue don't need government support.

"A wide array of state-owned firms was justified in India's post-independence era when the country lacked an entrepreneurial class," Gupta said. "This logic no longer holds."

According to Gupta, the data showed that privatization of firms did not lead to widespread unemployment as was often feared. This was due in part to a tendency by the government to sell primarily firms that that were profitable -- and ultimately able to take on more workers.

Further, she argues much of India persistently lacks basic infrastructure and critical human services, such as roads, clean water and health care. Privatizing even a small portion of firms would free up much-needed capital for improvements in this sphere.

Implications beyond India

The authors focused on India partially because of its large and diverse population and robust, multi-party democracy. Thus, Gupta argues the findings are relevant for nations around the world, especially given the lasting fallout from the economic crisis.

She points to the United States, which has seen new government takeovers (such as General Motors) and heated discussion about how to pay for legislative priorities, such as health care for all Americans and transportation improvements. She hopes her study will serve to inform others navigating the thorny landscape of privatization and other political issues that set local and national interests in opposition (such as earmarks).

"More than anything, this work demonstrates that voice matters," Gupta said. "Small, organized groups can extract a huge amount of benefits for themselves unless those in opposition rise up to meet the challenge."

Gupta co-authored the study, "The Decision to Privatize: Finance and Politics," with Serdar Dinc, visiting economist at the Federal Reserve Bank of Chicago. The work appeared in the Journal of Finance.