India's power sector reforms: Who reaped the benefits?

The cornerstone of India´s power sector reforms is the 2003 National Electricity Act that limited state intervention in the power sector. This column analyses the effects of the Act on Indian manufacturing firms. It finds that political clout of firms played a key role in the distribution of gains from the reforms in terms of improved electricity supply.

In the past decades, India has made several efforts to bridge the wide gap between the demand and supply of electricity. In 1991, power generation by the private sector was allowed, and in 1998, a system of independent regulatory commissions was created. The most important reform, however, is the 2003 National Electricity Act. Designed to introduce market forces in the power sector, the Act called for renewed privatisation and deregulation efforts (Mathavan 2008, Sharma, Nair, and Balasubramanian 2005). Barriers to entry were lowered for private power generators looking to supply electricity to both commercial and residential end-users; for example, captive generation (when a private power plant is built to supply energy to just one user or small group of users) was officially permitted by law. In addition to this increase in competition in pricing and power provision, Indian policymakers also looked to phase out inefficient cross-subsidies (Bhattacharya and Patel 2007)1. The intention of the electricity reforms was to equalise prices for industrial and agricultural consumers; historically, government officials have charged some large businesses higher electricity rates and then used the earnings to reward rural electoral constituencies with cheap or even free electricity. In all, the Act was envisioned as an important step towards decreasing state interference in the electricity market and improving public goods provision for all citizens of India.

Who reaped the benefits from the 2003 reforms? We analysed panel data on the quality of power supply to Indian manufacturing firms in 2002 and 2005, that is, before and after the reform legislation was passed (Szakonyi and Urpelainen 2014).

Analysing the effects of the National Electricity Act 2003 on the manufacturing industry

The National Electricity Act was enacted in 2003, and we used panel data from the World Bank´s 2002 and 2005 Enterprise Surveys to investigate what types of firms benefited from improved power supply2. The survey includes 1,094 firms and is a representative sample of all firms in the manufacturing sector. The firms operate in a dozen different areas of manufacturing (for example, roughly a quarter operate in the textiles industry, with slightly less working in machinery production) and are located in 18 of India’s 28 states and seven Union Territories. Just as importantly, the World Bank was unable to survey only a relative small percentage of firms in both 2002 and 2005; this low level of attrition allows us to more comprehensively analyse change over time within our firm sample.

The main outcome measure was a survey question on a 0-10 scale concerning the perception of firms of power quality, with higher values indicating better supply. We verified that this comprehensive measure was strongly associated with objective components, such as the annual number of power outages. We examined the change from 2002 to 2005. To measure political clout, we relied primarily on a survey question concerning the perceived need to bribe prior to the reform, and participation in a business association with lobbying functions. Firms that were not compelled to pay bribes before the reform were assumed to be politically more influential, while firms that could lobby through a business association were assumed to have better access to politicians (Schneider 2009)³.

We find that political clout played an important role in the distribution of the gains from reform. While the quality of power supply increased overall, the benefits were distributed unevenly across manufacturing firms. Most importantly, firms with political clout benefited more than their less influential counterparts. Firms that had been extorted for bribes in 2002 reaped less of the gains from improvements in access to energy brought about by the passage of the 2003 Act. Similarly, experience of lobbying through business associations significantly improved firms’ chances of benefitting from the liberalising reforms. The magnitude of both effects is noteworthy: for example, less vulnerable firms on average could see twice the improvement in their power quality between 2002 and 2005 than their extorted counterparts. We interpret our results as offering strong evidence that politics continues to enter bargaining over power distribution to firms, even when governments reduce their role in the marketplace.

We also conducted numerous additional tests to scrutinise the robustness of the result. Most importantly, we divided the states in the sample between those that were in a good position to implement reforms, and those that were not. Since lobbying for free electricity by the agricultural sector is known to be a key impediment to power sector reform in India, we used pre-reform agricultural tariffs as an indicator of the power of the key opponents of reform. Lower agricultural tariffs are found in states with strong lobbies that undermine the implementation of the Act, whereas higher agricultural tariffs are found in states that are in a good position to undertake power sector reforms. As expected, we found that political clout was a stronger determinant of benefits in states that were able to implement the reforms, thanks to a low level of opposition by the farming lobby. Since reforms made more progress in states with low levels of opposition, these states had greater surplus to divide among firms, and political clout became a critical factor in the division of this surplus.

Implications for power sector reform in India

This research has numerous implications for our understanding of the obstacles policymakers face during liberalising reform. First, even when reforms are designed to limit state intervention in a given market, politics continues to play a key role in creation of winners and losers from the legislative changes. The relationships between firms and the State pre-reform significantly affect the distribution of potential benefits. This finding is critical for policymakers, in that even well-meaning attempts to promote market competition can result in greater inequality between politically-connected firms and those that are not.

One possible solution to the persistence of political favouritism is the strengthening of independent bodies to oversee the reform process. Removing the decision-making power about who wins and who loses from politically-inclined actors (such as corrupt bureaucrats) would be a huge step forward towards leveling access for all individuals and firms to essential public goods. Only non-partisan agencies can effectively ensure that the gains from reform do not fall vulnerable to the whims of political predation. India already has a Central Electricity Regulatory Commission and states have also created their own commissions, building on the 1998 Electricity Regulatory Commissions Act. Similar to the work of Dubash and Rao (2008), our results suggest that India could benefit from strengthening the independence of these agencies. Further improvements in the quality of electricity supply are critical for improving India´s industrial growth prospects, and improved regulatory governance is a move in the right direction.

Notes:

Cross-subsidisation involves charging industrial users higher electricity tariffs and using the difference in prices to subsidise agricultural or domestic consumers.
Overall, the survey data shows that the quality of power supply improved significantly.
We also used several additional measures as robustness checks with similar results.