- Impact Of Government Intervention In India - Free Essays on Economics Impact Of Government Intervention In India

Essay Writing Service

Impact Of Government Intervention In India

In this study the impact of government intervention toward governance and performance of Indonesian state-owned enterprises was investigated, using 114 of total 141 enterprises from year 2006 to 2009 (456 observations) as sample. The study is cross-sectional to estimate how issues of intellectual property assignment, soft budget constraint and political embeddedness affect the economic performance of enterprises. Form of SOEs, number of ownership, government loan, capital injection, number of government officer seat in board of commissioners, as well as government assignment are assigned as government intervention proxies. On the other hand the firm performance is represented by ROA and ROE. The result shows that government ownership, government loan and government assignment have adverse impact to SOEs performance, on the other hand number of government officer on Board of Commissioner is the only intervention with favorable impact. The impact from the rest of government actions are unclear and need to be tested further. Finally, the paper concludes that the government intervention could be either good or bad depend on some other factors. The possibilities of the reasons are discussed

Keywords: Government Intervention, Performance, Indonesia, State-Owned Enterprises


The importance of government intervention to the economy has become endless debate among the economist. In fact there is no single nation, even the most extreme among the pros and cons, pursues the pure economy with full or without government intervention. The difference is just the degree. The role of government in transition economies is undeniably critical, which is one of the common ways is through state owned enterprises (SOEs).

Get Help With Your Essay

If you need assistance with writing your essay, our professional essay writing service is here to help!

Find out more

It is widely known that SOEs throughout the globe have been suspected as ill-governed business entities signified by such as high level of corruption, lack of transparency, as well as severe inefficient. Many market based economist believe that the main reason of such weaknesses is government intervention. Therefore they actively promote liberalization trough privatization of SOEs. In many cases, it can be one of requirements stipulated by the donor institution such as IMF or World Bank in granting financial help to troubling developing countries.

However, it may be not true for all cases. Some countries, such as Singapore and china, are example where government intervention doesn’t mean harm SOEs performance. Manageable government intervention toward SOEs can lead to excellent performance.

This paper aims to: 1) investigate the level of government intervention in Indonesian SOEs; 2) examine the relationship between the level of government intervention and the performance of state owned enterprises. The paper unfolds as follows. In Section 2 description of government intervention in Indonesian SOEs are presented. In Section 3 the theoretical review are described. Variables and hypothesis will be discussed in section 4, meanwhile section 5 will describe data and methodology. Section 6 contains a discussion of result and findings, and final section will conclude the paper.

2. Literature Review in Government Intervention

In developing countries government play three roles simultaneously; first, as an economic player that supply and demand for particular services and good [1], secondly as regulator that posses the sole role to produce, to enact, as well as to enforce regulations [2], and last but not least act as the owner of state-controlled enterprises that produce some goods and services..

Previous studies have identified some benefits of possessing connection to state such as improving the legitimacy of firm [2], getting access to government controlled resources [3], being able to affect regulation formulation [4]. Some other advantages are having opportunity over privileged treatment [5][6], and from favor of having asymmetric information state policies [7].

There are three main issue of government intervention are elaborated in this paper. They are intellectual property aspect through control and ownership, budget constraint aspect, and political embeddedness issue. Each aspect is elaborated in the following paragraphs.

2.1. Intellectual Property Aspect

First, In broader scope, some ownership-related issues have been addressed by previous researcher. Those issues are state-private, dispersed-concentrated, and domestic-foreign. Those previous researches mainly investigated the relationship between ownership structures with the performance. Nonetheless, most of those researches have been conducted to test hypothesis in private-owned firms. SOEs are a business institution belongs to a society as whole therefore the benefits of it should bring benefits to the society. The problem is if everyone owns it that means no one actually own as a result no one has incentive to utilize the resources effectively and efficiently. Therefore many economists suggest assigning property right by lowering the government control and ownership [8].

The problem believed related to ownership is principle-agent problem that arises when managers act not on shareholder’s interest. The deviating management goal often hinders the shareholders goal in maximizing their share value. Previous study reveals that efficient information and structure of incentive as a result of the existence of private ownership is believed to able to reduce agency problem [9]. Also argued in [10] that another reason why full private or semi private enterprises are said to have less agency problem is because those firms have better both external and internal governance mechanisms. External mechanisms include market for labor/manager and capital along with all regulation and their discipline and enforcement on them. In the other hand, internal governance mechanism consists of managerial ownership, reward system, and board composition. Meanwhile both mechanism are not exist for the case of SOEs [8]. Furthermore, agency problem in the SOEs sector is worse than their peer in the private sector since there are two agency relationships as a breakdown of owner – manager, they are owners-to-politicians and politicians-to-managers [12]. However if the portion of share owned by public is dispersed big number of individual of investors and or there is no adequate provisions of protection toward minority shareholders case of partial privatized in the SOEs may not make significant difference [13].

2.2. Budget Constraint

The template is used Another government involvement in economic activity especially in the context of SOEs is in the issue of soft budget constraint. As described in [14]:

”The softening of the budget constraint appears when the strict relationship between expenditure and earnings has been relaxed, because excess expenditures over earnings will be paid by some other institution, typically by the state. A further condition of softening is that the decision maker expects such external financial assistance with high probability and this probability is built into his behavior”.

It is also pointed out in that government in transition economies often exploit SOEs to produce public goods and services n financing the resulting social burdens on SOEs through subsidies and loan policy [15].

From several previous research, causes of soft budget constraint can be categorized into some, such as decentralized [16], paternalism [14], and public ownership in socialist economies [17], monopolistic market [18], policy burden [19]. In the context of Indonesian SOEs, two latter causes are relevant. Some particular industries have been still monopolized by one or more SOEs not because of the real competitiveness but just because the government has not liberalized the market yet, for instance seaport, airport, and defense industry. Monopoly also can rise when the industry is not lucrative enough to attract investment from private player. Normally those sectors do not give normal profit to be sustainable in the industry. Consequently, it is related to third causes, when the government wants to execute some economy or political program that may not be done unless having to involve SOE, in this case the SOEs have to shoulder political burden.

It is said in [20] soft budget constraint will cause the firm become less responsive to price, technological changes, and unfavorable external condition. They all are root causes of organizational slack. In addition, another consequence of soft budget constraints is that SOEs may not efficient in utilizing their finance resources since capital market cannot discipline SOEs. to format your paper and style the text. All margins, column widths, line spaces, and text fonts are prescribed; please do not alter them. You may note peculiarities. For example, the head margin in this template measures proportionately more than is customary. This measurement and others are deliberate, using specifications that anticipate your paper as one part of the entire proceedings, and not as an independent document. Please do not revise any of the current designations.

2.3 Political Embeddedness

As mentioned earlier the relationship between the state and the SOEs is more than just ownership matter. Its position as the regulator in the same time causes the situation, so-called political embeddedness that refers to ‘technical, bureaucratic, or emotional ties to the state and its actors. It includes wide-ranging and intricate association; official and unofficial, personal and organizational ties to the state [21].

Given existence of principle-agent problem mentioned earlier, one way utilized by the shareholder to ensure the management work on owner-based interest is through supervisory board. However, it has been quiet common for the case of SOEs that the members of supervisory board mostly have been selected among bureaucrats from any departments or politicians from any political parties. As stated previously, the presence more official or politician may just deteriorates the existing agency problem because in many circumstances actually there is nothing wrong with the policy, instead the politician misbehavior. In another word, SOEs might be ideal place of rent seeking activities from the member of board of commissioner.

From positive side, existence of supervisory member that represent any associated department can become an effective tool to pursue “check and balance” in managerial process in the company [22]. However, in the transition economy amid the absence of law enforcement toward misbehavior, the existence of more supervisory member will exacerbate the agency problem because of self-interested maximizing politicians or bureaucrats.

3. Government Intervention in Indonesian State-Owned Enterprises

Established with a strong legal base, namely, on the article 33 of the county’s constitution SOEs have been playing a considerably important role in Indonesian economic development reign. Operating in almost all fields of business, ranging from finance, banking, mining, transportation, high-tech technology to agro-industry, the enterprises have been contributing in several ways. More than 800 thousands workers have been employed across the SOEs. It accounted for % of employment. Then, more than IDR 150 billions of taxes and IDR 28,6 billions of dividend, both combined represented 3,8 % of Indonesian GDP, were paid to the state budget in year 2009. This amount has not been included community development fund allocated from firms’ profit for alleviating the poverty.

However, mentioned contributions do not mean that the ISOEs are in sound governance and performance. Even though Indonesian SOEs is big in term of size, they are mostly weak in term of competitiveness. By employing more than IDR 2.000 billion total assets and IDR 525 billion total equity in year 2009, Indonesian SOEs proceeded only IDR 78 billion net income. It means SOEs accounted for less than 4% of ROA and 15 % of ROE. Compared to their competitors in each industry sector, SOEs has been outperformed. Further inquiry found that 20 SOEs accounted dominantly for almost 90% of the total in term of both net income and total assets. In addition, among those SOEs there are dozens of SOE suffering with huge loss in their financial statement. Revealed facts strengthen public stereotype toward SOEs as inefficient, bureaucratic, less responsive, lack of skillful management, lack of transparency institution.

Even though all firms are regarded as state-owned firm, the degree of government involvement to the firms is different one with another. It can be seen from the types and the level of government actions imposed to each firm.

Assuming that the form of enterprises and number of state ownership can be used to measure the level of government intervention, in year 2009 Indonesian SOEs comprises 14 government agencies, 111 limited company, 16 listing company. Meanwhile in term of ownership Indonesian SOEs consist of 112 wholly owned, 29 partially owned (not including 19 firms with state ownership less than 50% excluded from this study). Looking at the trend, the number of listing company has been increasing from 12 firms in year 2006 to 16 firms in year 2009. Even the number is supposed to be higher if privatization program was done well for during period of time.

For many reason, there are many SOEs ended up with financial difficulties but at the same time unable or unwilling to find external financial resources. At such condition, government usually comes to rescue the troubling enterprises by endowing with capital injection or low-soft government loan. Government steadily poured the almost-bankrupt SOEs with additional capital injection in cash as much as IDR 1,9 trillions per year on average since 2005 to 2010 (accumulatively IDR 9.9 trillion at the end of year 2010). Some SOEs obtained non-cash capital injection, for instance in form of fixed assets transferred from associated ministries that purchased it by using annual the state budget. The latter case is not always advantageous to receiving SOEs, even it is frequently harmful since the transferred assets may be either not needed or not fit.

Moreover, to meet SOEs’ need on working capital and capital expenditure, government also has been providing soft loan in the sense at very low rate and less rigid requirement in comparison with commercial credit rate. In the context of Indonesian SOEs, loan mainly consists of Investment Fund and Subsidiary Loan Agreement (SLA). The two types of loan principally are two step loan; foreign donor to government and then government to SOEs. The outstanding balance at the end of year 2008 is approximately IDR 49.8 trillion to 85 SOEs. Part of that amount, which is around IDR 15.5 trillion or 31%, (31 SOEs) was default at that time.

Another type of government intervention is to assign some government programs to SOEs. The program is so called public service obligation (PSO). Around 10 SOEs has been involved to execute government assignment in availing food, fertilizer, energy, and transportation. In turn government transfer hundreds trillions as compensation to the SOEs which is including in it is cost of the program (acknowledge as subsidy for society) plus some percentage of margin for the SOEs. For instance in year 2009 government allocated almost IDR 180 trillion for delivering public service obligation program (PSO) with SOEs as the executor.

*Identify applicable sponsor(s) here. (dispensable)4. Variables and Hypothesis

To address the issue of intellectual property assignment/ownership control, two variables are employed. They are form of SOEs (FORM) and number of government ownership (OWNERSHIP). In term of form, SOEs are categorized into three groups of enterprises. Those are public agency, company limited, and listing company limited. The main difference among them is the primary goal and form of ownership. Public agency is the firm which its ownership has not been divided into a number of shares. Its main activity is to avail public goods or services as a part of government program. The second form of SOEs form is company limited which is the ownership of the firm has been divided into a number of shares. Although there is still possibility that the firms will become vehicle of government program, however, the main goals of firms are profit maximization. The only different with the last form of SOEs is the shares have been tradeable in capital market. In another hand, the way of strengthening property right also can be done through releasing state ownership and control. It is conducted by inviting other parties such as employee, management, local government, or even public to posses SOEs’s share.

It has been elaborated by some economist that a source of inefficiencies is state control over the firms. It is said that the government is more likely to distract the resources of the firm to attain its own political or socio-economic goals [23]. In addition, government control over enterprises is also suspected to have association with the absence of incentive and lack of monitoring for managers to perform better [24]. Moreover, different forms of state ownership are also associated with the level of government officials’ involvement in the process of corporate governance and it is likely to have different performance [25].

Form transformation and privatization can be regarded as one way of defining property right. Property right theory suggests that the clearer (more direct and unattenuated) the property rights to be defined, the better the way of utilizing the assets (governance) will be [26].

Hypothesis 1a : Form transformation from public agency to company limited and listing company limited will provide negative impact toward SOEs performance;

Hypothesis 1b : Form transformation from public agency to company limited and listing company limited will provide positive impact toward SOEs performance;

Hypothesis 2a : Decreasing number of state-ownership on SOEs will give negative impact toward SOEs performance;

Hypothesis 2b : Decreasing number of state-ownership on SOEs will give positive impact toward SOEs performance;

With regard to soft budget constraint aspect, this study employed two independent variable, namely capital injection (CAPITAL) and government debt (GOVLOAN). In most cases, if SOEs are facing severe financial hardship the state will interfere either by providing loan or capital injection as last resort sources. In contrast to the case commercial bank loan that requires some rigid requirement in obtaining credit and of course with market rate, the government frequently releases many requirements so that the SOEs will be easier to get loan at subsidized interest rate. This government loan present financial benefit to SOEs, mainly because of lower interest rate, no collateral required and lower transaction cost. In case of capital injection the advantages enjoyed by SOEs are even bigger than government loan. Nonetheless, both types of government actions can creates disincentive for managers to govern the firm properly and efficiently including in finding needed financial resources. This may also hinder sound development of capital or financial market. Therefore following hypotheses are set:

Hypothesis 3a : Government intervention to SOEs in form of government loan will give negative impact toward SOEs performance;

Hypothesis 3b : Government intervention to SOEs in form of government loan will give positive impact toward SOEs performance;

Hypothesis 4a : Government intervention to SOEs in form of capital injection will provide negative impact toward SOEs performance;

Hypothesis 4b : Government intervention to SOEs in form of capital injection will provide positive impact toward SOEs performance;

In this paper, the issue of political embeddedness is examined by employing two variables; involvement of SOEs in executing public service obligation (PSO) and number of government officers seating in the board of commissioner (OFFICERS). PSO is government program to avail the basic need of the people such as electricity, food, medicine, fuel, transportation and soon. Doing so will provide SOEs both benefit as well as cost. The appointed SOEs will financially benefit from captive revenue plus certain percentage of profit given over each particular government assignment. Nevertheless, it also implicitly grants some cost SOEs. SOEs that heavily rely on government assignment as the main source of revenue will be more likely to have unproven competitiveness compared to their private owned peers. In the long run, it also will harm financially. Moreover, too much business transaction with government and its bureaucrats may induce political rent seeking activities that undermine SOEs competitiveness.

With regard to composition of board of commissioner, most of Indonesian SOEs have active or retired officers as well politicians from ruling political parties. It also derives both benefit and cost to SOEs simultaneously. The presence official on the board can be source of legitimacy and facilitator in passing government policy to SOEs and in delivering message from SOEs in effort of influencing the policymakers that ultimately benefit SOEs [4]. Even more, this also can provide SOEs access to resources (such as government project) controlled by department or ministry which is the officials work.

On the other hand, Public choice theory states that politician will maximize their interest in gaining more votes so that the firm with less political intervention will be more likely in increasing search for better governance [27]. In addition, as representative of the government, acting officials usually will act on the basis of government interest that is probably not in line with firm objective. Additionally, as argued in [28] the presences of politician exacerbate the agency problem. This means that the presence of officials on the BOC may be perceived with significant costs for the firm. The summation of benefit wrapped and cost burdened will be net impact of political embeddedness.

Hypothesis 5a: Public service obligation will give negative impact toward SOEs

Hypothesis 5b: Public service obligation will give positive impact toward SOEs

Hypothesis 6a: Number of active or retired officers as well as politician on BOC will result negative impact toward SOEs

Hypothesis 6b: Number of active or retired officers as well as politician on BOC will result positive impact toward SOEs

As dependent variable, this study employs Return on Assets (ROA) and Return on Equity (ROE) as performance measures. Thanks to its simplicity in calculating as well as its explanatory power both measures were used in previous numerous researches, including for Indonesian SOEs [29]. For control variable, equity is selected as the only variable to represent the size of SOEs.

4. Data and Methodology

Financial data were collected from annual report of 114 SOEs (of total 141 SOEs) for year 2006-2009 (456 observations). This sample covers almost 97% of population both in term of assets and sales.

The way in giving score for independent variable as follows:

SOEs is scored 1, 2, and 3 if their form is public agency, company limited, and listed company limited consecutively;

Ownership (OWNERS) is represented in percentage of state ownership, range from 0 to 1;

Capital injection (CAPINJ) and government loan (GOVLOAN) are dummy variables. If the SOE did NOT get additional injection in form of cash or noncash capital as well as debt to capital conversion (including debt haircut) within last five years score 0 is given and 1 otherwise for CAPINJ. Meanwhile if there is NO government long term loan balance in the SOEs’ balance sheet score 0 is provided and 1 otherwise for GOVLOAN;

Number of officers or politician (OFFBOC) who seat on board of commissioners is expressed in the number as it is;

PSO is also dummy variable which is SOEs that conduct government assignment is valued 1 and 0 otherwise;

Equity value has been transformed into ln value to reduce the possibility of multicoliniarity problem;

Type of industry which the SOEs operate is also valued using dummy variable, 0 for good production/manufacture and 1 for service provider.

Once all data have been identified and inputted, those independent variables are tested to examine the relationship toward dependent variable using ordinary least square method. The regression equations are written as follows:

ROE = α0 + α1FORM + α2GOVLOAN + α3OFFBOC + α4PSO + α5CAPINJ + α6OWNERS + α7log.EQUITY + α8CORE (1)

ROA = β0 + β1FORM + β2GOVLOAN + β3OFFBOC + β4PSO + β5CAPINJ + β6OWNERS + β7log.EQUITY + β8CORE (2)

5. Result and Findings

Table 1 shows the descriptive statistic and correlation. Average ROE of ISOEs, 0,085, is relatively low compared to their private competitor. Meanwhile, average number of government officer and politician on board of commissioner is 3.32. Furthermore, mean of state ownership on SOEs that is 92%, partly because this study doesn’t include SOEs with state-minority ownership, less than 50%, but mainly it shows that majority of SOEs are still wholly-owned by the state. With respect to form, most SOEs are in form of limited corporations. In term of core business which SOEs operate, there were more SOEs doing business in service industry compared to manufacture industry. The rest of variables are dummy variable so that the means just show the relative proportion over the observation. For instance, mean of PSO is 0.12 meaning the percentage of SOE executing special government program is around 12% of population.

Table1: Descriptive statistics and correlations for ROE as dependent variable

Table 2:

From table 2, regression run for testing the relationship between government intervention and ROE shows that using 307 observations (after omitting some outliers) roughly 57% variability of dependent variable, ROE, can be explained by all combined independent variable, this score is acceptably high. Employing Variance In¬‚ation Factor (VIF) and Tolerance statistic critical scores that may signal problem with multicollinearity has not been approached by both scores [30].

Find out how UKEssays.com can help you!

Our academic experts are ready and waiting to assist with any writing project you may have. From simple essay plans, through to full dissertations, you can guarantee we have a service perfectly matched to your needs.

View our services

Looking at the significance, except GOVLOAN and CAPINJ, the rest of independent variables have statistically significant effect toward ROE. Although FORM and PSO are not significant at 5% confidential level, however, both variables are quite significant at 10% confidential levels. Therefore, in this paper both variables are still considered as significant.

Table 2: cooefficients, t statistic, & colinearity for ROE as dependent variable

From the second equation, which is the only difference from table 1 is that the former uses ROA as dependent variable instead of ROE. The result displayed on the table 3 shows almost similar figure. The ROA score is considerably low at 3.2%. What makes slightly difference is the number of valid observation after taking out the outliers. With regard to correlation, there is no sharp correlation among variables. It support argument that multicollinearity problem is negligible.

Table 3: Descriptive statistics and correlations for ROA as dependent variable

The second regression results moderately high r square, 0.450. A couple outliers were identified until reaching valid observation is 270. After considering F score, Tolerance and VIF score the model is judged statistically fit. Among predetermined independent variable only CORE was not significant.

Table 3: cooefficients, t statistic, & colinearity for ROA as dependent variable

From the result of two different equation of regression discussed above, the impact of each aspect of government intervention can be summarized as follows:

Table 4: cooefficients, t statistic, & colinearity for ROA as dependent variable

Independent Variable

Dependent Variable










Negative (insignificant)



Negative (insignificant)













Negative (insignificant)

Overall, comparison of the result from two different tests provide strong support for Hypotheses 2b, 5a, 6a, and reject Hypotheses 2a, 5b, and 6b. However some hypotheses are left with unclear answer due to the mixed up result.

6. Discussions

From the finding described earlier form has positive impact over ROE, meaning that reducing the government control signified by transformation of SOEs form is more likely to give good impact of SOEs the performance. However, the opposite result was found for second equation which is ROA as dependent variable. The possible reason is SOEs with less control from the government will have more flexibility in raising capital either through equity capitalization (for instance, through initial public offering) or by leveraging debt. SOEs with less government control seem to finance their project using more debt rather than equity. As a result it will keep their equity low so that it can push their ROE higher. Interestingly, when performance measured by using ROA the opposite result prevails. This paper argue SOEs with less government control become less conservative in selecting project in the way that fund obtained from debt/loan have been invested in the project with low return.

Not surprisingly, both equations show consistent results regarding the impact of ownership toward performance. The result show more number of government ownership will lead to poorer performance. The presence of other shareholders other than government is expected to be able to enhance governance of the firm through improvement in monitoring, transparency, responsibility, and so on. This is especially for the case of Indonesian privatized SOEs as finding of previous research [31].

With respect to capital injection, the result is mixed up. This variable is statistically significant in relation to ROA but insignificant in the case of ROE with different direction of impact. This finding need to be further investigated by employing other performance variable or by applying qualitative approach. Similarly, the impact of government loan over performance is also indecisive. It is because only one test, which ROA as dependent variable, demonstrates significant result. However, both tests show the same negative impact of such kind of government interference. It can be conclude that the cost of obtaining and optimizing government loan exceed the financial benefit that may be able to reaped. Even possible financial benefit from low interest and low transaction cost of loan acquirement may be offset by illegal transfer paid to rent seeker in bureaucracy. This finding reinforces the previous research conclusion which is soft budget constraint will create conducive environment for spoiled managerial behavior [20]. This managers have no incentive to run the firm efficiently, reluctant to compete fairly which will severely harm the firm competitiveness in the long run.

Interestingly, the findings with respect to number of government officers occupy seats on board of commissioner appears to be different from common belief that suspect that the presence of officer on board of commissioners is likely to worsen the situation and pe

Most Used Categories

EssayHub’s Community of Professional Tutors & Editors
Tutoring Service, EssayHub
Professional Essay Writers for Hire
Essay Writing Service, EssayPro
Professional Custom
Professional Custom Essay Writing Services
In need of qualified essay help online or professional assistance with your research paper?
Browsing the web for a reliable custom writing service to give you a hand with college assignment?
Out of time and require quick and moreover effective support with your term paper or dissertation?