Atanu Dey On India's Development

The Evils of Competition

The principle that exposure to economics should convey is that of the spontaneous coordination which the market achieves. — James M. Buchanan

The last time I was out having lunch with my economics guru, I pondered the question that is foremost in the minds of most Indians. “What,” I asked the great guru, “explains the shoddy quality of goods and services that one finds in India generally?”

“That I can tell you in one word: competition.”

“How so?” I said. “Isn’t competition supposed to ensure lowest prices, and highest quality instead?”

“Certainly. But you have to remember that a market has two sides to it. There is the supply side. And then there is the demand side. It is the competition in the supply side that ensures high quality and low prices. But if for some reason, there are barriers to entry in the supply side of the market, then you have a problem.

“Here is how it works. Suppose you restrict the entry of firms into the market by decree such as done in the “License Permit Quota Control Raj.” Suppose this leads to low quantities supplied relative to the demand. Then on the demand side, there is competition for the limited quantity supplied. So the quality goes to hell in a hand basket and the price goes up.”

I sort of realized the problem. But I needed a ‘fer-instance.’ “For instance?” I asked.

“Competition in the demand side is what drives out quality and pushes up the price. You do recall that not too long ago, the telephone system was the sole preserve of the government. No private sector firm could enter the market. What was the result? If you wanted a phone, you had to wait for years on end, sometimes as long as eight or ten years. Given the enormous waiting lines, the public sector firms supplying telephony were assured customers who would be willing to put up with shoddy phone service because the demand far exceeded the supply even at the exorbitant prices being charged.

“In those bad old days, you had competition on the demand side. Compare that to today. The competition has shifted to the supply side of the telecommunications market. Now private firms compete with each other to provide phone service. The years of waiting time has been entirely eliminated and now you can get phone service in a matter of hours.”

“Are there any other examples?” I asked.

“Lots and lots. Whenever you see shoddy services or crappy goods, ask yourself where the competition is. You will invariably notice that the competition is on the demand side. Train service? Government monopoly and therefore poor quality. Air transportation? Used to be shoddy but now it is much better because there is at least limited competition.

“Excess supply of goods and services is rarely a problem in over-populated underdeveloped economies; it is always excess demand.”

“So what was the reason for not allowing entry into the markets? Why restrict entry on the supply side in the first place?” I said.

“Greed. If you restrict entry, you have monopoly power. That allows you to collect monopoly rents. Here is how it works. Suppose you want to collect the monopoly rents from, say, the two-wheeler market. You decree that for a firm to manufacture two-wheelers, it has to obtain a license. How much will a manufacturer of two-wheelers be willing to pay for a license to produce and sell them? Almost as much as they will make by charging a high price in a non-competitive marketplace.”

“Who gets these monopoly-like rents? I have not heard of any rule that seeks a hugh license fees from manufacturing licenses,” I said.

“Well, you don’t have to have an explicit rule. You just have discretionary powers as to who you hand them out to. For instance, as the Minister for Two-wheelers (assume there is one), you will hand it out to the firm that pays you a lot of black money and also fills up the coffers of your political party. Corruption of the political process is a handy by-product of the license quota permit control raj.”

“Damn,” I said. “That explains to things in one shot. First, why we have lousy quality high price goods and services. Next it explains why it is so hard to get rid of the license permit quota control raj. Is there a way out?”

“Yes, there is. But it won’t happen till the last politician is strangled with the entrails of the last bureaucrat.”

  • http://corelations.blogspot.com/ Aseem Asthana

    This is a good writeup. Makes for interesting reading and the toughts are well placed. Just one grouse though. The title is a misnomer to the main idea of the writeup.

    Competition is NOT the cause of evils you seek to confront. It is lack of the same on the supply side. The article itself has the following line,

    “It is the competition in the supply side that ensures high quality and low prices”

  • Ad

    Hi,
    something that is not directly related to the scene of competition we are talkin here (or it may be). The current scene in US is of mergers of 2 or 3 big cos. and formation of a very very big corporation. Well even the big cos. throughout the world are way too big than our Indian companies(public or pvt).
    Ex- IBM with revenues more than 80 billion
    Wipro/Infosys/TCS with little more than 1 billion each.
    well this is the scene in all other sectors.
    I think the size difference is also a factor for quality and service, even if we have competition, too many competitors in the market also leads to providing poor quality to provide low cost goods.
    Can we see merger of Infosys + Wipro or something like that in Indian market to provide better goods and services and be competitive??

  • http://sajshirazi.blogspot.com/ Shirazi

    Congratulation for being the best. You deserved it.

  • http://sajshirazi.blogspot.com/ Shirazi

    Congratulation for being the best. You deserved it.

  • http://www.deeshaa.org Atanu Dey

    Ad,

    The more competition on the supply side, the greater is the quality and lower is the price. When firms become too large relative to the market, competition goes down. And prices go up and quality comes down. That is an empirical truth.

    The greater the “competition” on the demand side, the quality of the supply will be lower and prices higher. That is again an empirical fact.

    So the merger of Wipro and Infosys would tend to reduce quality and increase price because it will reduce competition.

    Aseem,

    The title of the post was deliberately provocative. What I left unsaid in the title was that it is “competition” on the demand side which is undesirable, just as competition on the supply side is highly desireable.

  • Ad

    Well what u said is right but I am talking about other economics funda of “economies of scale”, “large scale production” …
    So what do u say about the present PM’s idea of merging 100s of banks into 4-5 big banks to make them competitive internationally and so they can provide high standard of services in domestic market also? is that a bad idea because it will reduce competition??

  • http://ramdhanyk.com Ramdhan Yadav Kotamaraja

    Why THE EDUCATED and THE SOCIALLY RESPONSIBLE usually always talk about decimating politicians. Think about it, there can be no democracy with out politics and politicans. I really believe that instead of talking about impossibility of “The last politician strangled with the entrails of the last bureaucrat.”, lets talk about something that is possible to do.

    Lets talk about THE EDUCATED and THE SOCIALLY RESPONSIBLE getting into politics and reshaping the political arena for good. Lets talk about building a future generation of socially respobsible heros who have guts to take up politics as career and clean up the murky political waters.

    If this sounds like a impossible task, then there is no right to criticize the existing political system and politicians.

  • http://ramdhanyk.com Ramdhan Yadav Kotamaraja

    Why THE EDUCATED and THE SOCIALLY RESPONSIBLE usually always talk about decimating politicians. Think about it, there can be no democracy with out politics and politicans. I really believe that instead of talking about impossibility of “The last politician strangled with the entrails of the last bureaucrat.”, lets talk about something that is possible to do.

    Lets talk about THE EDUCATED and THE SOCIALLY RESPONSIBLE getting into politics and reshaping the political arena for good. Lets talk about building a future generation of socially respobsible heros who have guts to take up politics as career and clean up the murky political waters.

    If this sounds like a impossible task, then there is no right to criticize the existing political system and politicians.

  • Srinivas R Thota

    competition : also explains the outsourcing that is happening to India in recent years .

    Consider the demand side as MNCs seeking the supply side as HRs ( Human Resource).

    MNCs are after cheap labor ( easily available in countries like India ,China , Brazil )
    to increase their productivity . Also because of the barriers that they have in using this resource in developed countries.( Labor laws , Less younger population etc )

    So in countries like India competition on supply side ( HR competition [cheap+high qualty] ) gives much advantage to the demand side (MNCs)

    Srinivas R Thota

  • DP Chalasani

    The title of the article is misleading. That said, I believe that the article is an excellent insight into the basic economic problems which India faced and is still facing.

    A very important question which I have been asking myself is…How did the economic planners of our country during the 50′s 60′s and 70′s come up with these kind of policies? Where these policies the best solutions to the problems they faced then?

    We must also realize that a huge section of our population lies outside the “economic system”.How can a free market enterprise system benefit them.

    I hope you explore the theme of your article further. Thank you,

    Dp Chalasani

  • http://www.deeshaa.org Atanu Dey

    Ad,

    Sure scale economies matter and the costs come down. But competition in the market is about prices. So imagine that there is only one producer due to consolidation of a number of smaller producers. The costs may come down but now the firm will have market power and can therefore charge prices much higher than costs and thus lead to social losses.

    Monopoly is not a good idea. Oligopoly (a market in which there are a few large firms) is fine because they can keep each other in check while being efficient producers. So yes, if hundreds of small banks were to merge and we are left with a small set of large PRIVATE banks (and not one large PUBLIC sector bank), then economies of scale will obtain without the problem of pricing above cost.

  • http://tarunsblog.blogspot.com TTG

    Yawn. Made a mistake by wandering by the site again…
    I wonder how long before you stop stating the obvious, and attempt to present a solution on your site? yes, for the nth time, Socialism is at the root of India’s position in the world as of 1991. And obviously, Socialism benefitted the political class the most, and naturally removing those licensing controls is analogous to asking somebody to take a pay cut. For this your get an award? Or are you just trying to pander to the lowest IQ, instead of actually bothering to come up with some solutions? Note-to-self: Set alarm for 50 years hence, when Deeshaa.org will have finally quit hammering the obvious point that Socialism ruined modern India.