[Solved] Explain the meaning of investment in an economy in terms of capital formation. Discuss the factors to be considered while designing a concession agreement between a public entity and a private entity. (UPSC GS-3 mains 2020)

In economics, an investment is the purchase of goods that are not consumed today but are used in the production of goods or services in the future and thus is considered to be a form of saving and part of the investment and capital formation.

The concession agreement between a public entity and a private entity is multifaceted, as the public sector wants to maximize its revenue, enabling services while operating in remote areas at minimum costs.

On the other hand, the private entity has to design the services keeping in mind the profit motive. This paper presents the factors that must be considered while designing a concession agreement between a public entity and a private entity, with special reference to India.

  • Essentially, it involves expenditure of money or financial capital for the sake of future returns, in contrast to consumption, which is spending money on present goods and services.
  • An asset is a resource that is expected to provide benefit to its owner over time. It can be tangible, intangible or both. Examples include property, vehicles, goods, rights and equity.
  • Investment in an economy can play important role in the growth of output. It was defined in two ways. First, investment are those goods that are not consumed immediately and can be used for more than one period of time.
  • Second, investment are those goods that are purchased with the purpose of resale or using them in other productive capacities. Investment in an economy takes place when national income is greater than consumption expenditures.

Capital formation is the process of investing in capital for further productive investment. Assets that are meant to be used in the production of other goods and services for a period of more than one year.

  • Investment usually refers to Gross fixed capital formation (GFCF) which is a macroeconomic aggregate.
  • The World Bank while tracking gross capital formation estimates changes in inventories. GFCF takes account of expenditure on plant, machinery, equipment, buildings and infrastructure.
  • The important factor is the assets which come into existence because of a production process.
  • For instance, an investment which leads to capital formation in agriculture improves the stock of equipment, tools and productivity of natural resources making possible for farmers to optimize the use of their resources more productively, especially land and labour.

Human capital and its significance:

Human Capital is a measure of the skills, education, capacity and attributes of labour which influence their productive capacity and earning potential. Investment in human capital is needed for technological growth, improving productivity, creating social innovations, etc.

Steps taken by the government:

  • Health: Ayushman Bharat Yojana aims at making interventions in primary, secondary and tertiary care systems, to address healthcare holistically.
  • Skills: Skill India Mission launched to fulfill the growing need in India for skilled manpower across sectors.
  • Education: Samagra Siksha Abhiyan, which subsumed the three erstwhile schemes of Sarva Shiksha Abhiyan (SSA), Rashtriya Madhyamik Shiksha Abhiyan (RMSA) and Teacher Education (TE) aims to provide equal opportunities for schooling and equitable learning outcomes.
  • Employment: Increase in wages of rural employment scheme MNREGA to boost rural domestic demand and improve livelihood opportunities for the poor.

Way ahead

  • Investment in SHE (Skill, Education and Health): There is a need to increase government spending in these areas to create a healthier, smarter and competitive workforce.
  • Industrial training: Incentives should be provided to job creating sectors like IT, BPOs, diamond, textiles industry, leather industry, etc for on the job training and skilling of workers.
  • Use of technology: With rising internet penetration, government should collaborate with industry leaders to create online tutorials in local regional languages to impart knowledge and skills to all.
  • Reviving agriculture sector: Rural youth should be promoted to adapt to new methodologies of farming which are in high demand. For ex: organic farming, aquaponics, drip irrigation techniques, etc.
  • Promoting labour-intensive sectors such as gems and jewellery, textiles and garments and leather goods.
  • Investment in infrastructure: Good transport, communication, availability of mobile phones and the internet are very important for the development of human capital in any developing economy.

A concession agreement is an agreement between a government body or a public entity and a private party to operate and manage a limited number of operations within an already existing government-owned facility.

The success of the concession agreement is vital to both parties because the agency avoids the risk of having to invest in the capital improvements that could be required in order to operate from building, the concessionaire or operator makes guaranteed revenue over a agreed-upon time period.

Factors to be considered while designing a concession agreement between a public entity and a private entity

  • It include costs
  • income, revenue and investment opportunities
  • Risks associated with market segment such as competition, regulation and economic/political risks
  • funding options like self-funding including build-operate-transfer (BOT) model
  • Public private partnership (PPP) model
  • retirement or refinancing of debt
  • sources of financing such as budgetary allocation
  • credit to developers resulting in a value capture mechanism to repay the financial institution

Further reading..

A concession agreement, which diversifies  investment, is a contract that gives a company the right to use resources for a specified purpose and operate a particular business granted by a government with specified terms.

The factors to be acknowledged for its reciprocity and win-win attribution number provisions related to public assets, ease of investments made and managed by the private entity, time period, risk sharing, genuine risk transfer, output-based modalities, performance-linked payments, conformance with performance standards, benefits allowed because of comparative advantage, effective contract enforcement, focus on service delivery, monitoring mechanism and arrangement, resource use rationalization, the imposition of standards and conditions arising out of new guidelines or orders and others.

These agreements should be based on best international practices, and make certain that policies and regulatory frameworks would address the complexities and balance the diverse interests of all stakeholders in various sectors.

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