Atanu Dey On India's Development

The Congested-shortage Economy

| 18 Comments

I.
The drive to the airport last week in Mumbai was no different from most drives in Mumbai. It was congested and progress was excruciatingly slow much of the way. The line at the security check was long. Only two of the five machines scanning the carry-on bags were working and progress was slow. That was the cause of the congestion at the security check. When the boarding time came — and went — I asked at the gate when will boarding start. At the check-in counter, I had been told that the flight was on time. Now I was told that the flight had not landed and was circling overhead — because of congestion at the airport. It’s a repeating pattern and it tells an interesting story.

Earlier that day I had stepped on to the streets outside our Peninsula Corporate Park offices in Lower Parel in Mumbai. The sidewalks — 3-foot wide to begin with – are congested with shops spilling on to them, forcing people on to the road where they compete with bicycles, trucks, buses, cars, 2-wheelers, cows and dogs. The roads are dug up for various reasons ranging from laying of pipes and cables, to building of some fly-over to help ease the congestion. Progress is at a slow walking pace for all: fat cats in Mercs and BMWs, the commoners in dilapidated black-and-yellow taxis, yuppies in Suzukis and Hundais Hyundais.

II.
It’s always congested. There’s never enough capacity. The local trains in Mumbai run at 300 percent capacity. The long distance trains aren’t as bad if you can afford air conditioned class but the unreserved compartments are unbelievably congested. Even in the upper classes of the railways, reservations have to be made weeks or months in advance. Too often trains run late because the system is congested and one unfortunate delay propagates through the system affecting dozens of trains.

Congestion appears to be the defining characteristic of much of daily living. Prices are high, quantities limited, and quality is poor. Those features are normally associated with unregulated monopolies. A moment’s reflection is sufficient to see that much of what we suffer from in India can be explained by what is known about monopolies.

Monopolies are generally not good, even when there are justifications for their existence. The owners of a monopoly always have the temptation to restrict quantity in order to raise prices, and thus get super-normal profits. Monopolies make a simple offer: take it or leave it. “Don’t like what we have? Tough luck.” Monopolies have market power — they can set the prices and quantities and do so to maximize profits and don’t really care about the welfare consequences of their actions.

Nobody likes competition but in a competitive marketplace, no one has the kind of power that monopolists have. In a competitive market, no one has the luxury of setting prices. All are “price takers” — they take what they can get.

III.
Monopolies exist for a variety of reasons such as scale economies and technological advantages. I call them “natural reasons.” Then there is one “unnatural reason” — where a monopoly is created by government fiat. The government legally restricts the production and sales of goods and services to one firm, which is generally a government firm.

The fun in being a monopolist lies in the control that one has. One controls the price and therefore can set the profit-maximizing quantity knowing what the demand patterns are like. The steeper the demand curve, the greater the wedge between the cost and the price, which means greater profits. The more essential some good or service is, the steeper is the demand curve. So it makes sense to be a monopolist for a good or service that has no close substitutes.

It’s good to be a monopolists, just like it is good to be a dictator.

As a monopolist, you control how much you will produce and at which price it will be sold, and you produce the quality that suits you, not the customer. You dictate, you rule. You reign. It’s your raj. It’s a license-control-permit-quota raj.

IV.
Talking of raj, the supreme example of a monopolist is the government. If you don’t like the government, you have no option other than migrating. Sure, you can vote this government out of the office – but then you are replacing one monopoly with another. The new monopolist has the same incentives to screw you over as the previous one.

Markets are magical things. Competitive markets are amazing things. Magically, competitive markets solve the most astonishing problems that no human agency can solve: they discover prices, determine the quantity to be produced, how productive resources are to be allocated, etc., and in some sense maximize social welfare. Monopolies leave much to be desired in terms of social welfare. They are good for the monopoly but not for others.

Of course, there are real world conditions under which markets fail to grind out the social welfare maximizing outcome. These failures are as well-known as the mechanisms for fixing them. But generally, even an imperfectly competitive market’s welfare implications trump that of a monopoly.

No firm in a competitive marketplace can make economic profits. For profit, one has to be a monopoly. That is why it makes sense to become a monopolist. How much would you be willing to pay to become a monopolist? Well, that depends, doesn’t it on how much profit you will be able to make as the monopolist?

V.
One important bit about markets before we move ahead. Well-functioning markets have one characteristic: there are no persistent shortages. There may be acute episodic shortages but they disappear soon enough. You never have to queue up to buy some commodity in them. In response to demand, the price goes up or down, signaling to producers whether to expand or contract their production.

You have to engineer shortages that persist for years and decades. Careful planning is required to keep production low so that a rationing mechanism can be put in place for distributing the production. Monopolists can and do keep quantities artificially low – and somehow or the other, the government is involved in this. The implications of this are profoundly interesting.

Suppose you could make $10 billion a year profit as a monopolist. And suppose you are reasonably certain that your tenure will be around 10 years. That’s $100 billion in profits. You would be willing to pay say $10- or $30- or $70 billion or anything less than $100. In actuality, you may get the monopoly for much less than that provided you don’t have too many competitors for the monopoly.

The lure of monopoly profits induces competition. It is competition for “the market” because once you get control of the market, there is no competition in the market. Competition for the market is a substitute for competition in the market.

The government is a supreme monopolist, as I mentioned before. Whoever (or whichever group) is the government stands to gain immense amounts of profits. The greater the profits, the greater is the competition for being the government.

VI.
There are legitimate reasons for why we need a government. In one word, government is necessary for solving the coordination problem. Without defining it here, let’s just say that there are some things that only something like a government can ensure – such as external security, internal law and order, some form of central bank, some legislative functions, etc. But that’s a very limited set of activities.

The government is not required for a whole host of other things. Private parties can and indeed do produce goods and services, from shoes and ships and sealing wax and whatever. A competitive private sector can produce practically all the stuff that we need – transportation, food, clothes, entertainment, education, . . . the list goes on. And they can do it efficiently and effectively.

Firms that cannot compete in the competitive market, go out of business. In the competitive market, shortages disappear because the incentive to remove the shortage is that one can make some profits – and that is self-limiting because they all rush in and soon the shortage disappears.

When the government decides to become the monopolist-supplier of some good or service, suddenly shortages become an enduring fact of nature. Recall that only by restricting quantities can the monopolist make profits. If a monopolist were to produce the output quantity that a competitive market would have produced, then the price would also be that of the competitive market, and there would be no profits and it would not be worth being a monopolist.

VII.
So there it is. India is a congested shortage economy because it is profitable to be a monopolist. The government is the supreme monopolist. The larger the government, the more the profits. And that’s why the government runs airlines, railways, schools, bakeries, hotels, steel, coal, . . . wherever you see shortage and congestion, think of the government.

Is that all there is to it – shortages? Unfortunately no. There’s something worse. Corruption. Corruption is a function of how big the government is. That is the core thesis of this post.

Suppose the government were only into legislation, law enforcement and security. More specifically, say it was not into running a million schools, or in the business of granting licenses to firms to run schools and colleges. Then being an official in the government would not be all that attractive. But since there are licenses required, and the quantity is limited, getting the licenses induces competition for the market for education. Competition in the market is limited by limiting the licenses. So education becomes a very lucrative business.

Note, private providers of education in a competitive market would not make any profits, the quantity will not be limited, the quality will not be poor, and there will be no shortages.

VIII.
The only reason for what we have in education today – lousy quality, low quantity, and high prices – is because of government control. And we have government control because the government extracts rents (the super-normal profits) from the firms that provide education.

Continuing with the education theme for just a little bit more, here’s the scary part. The lousy education sector is going to become worse. I was at a roundtable meeting at the Observer Research Foundation in Mumbai a couple of weeks ago. One member of the Planning Commission who was instrumental in the new draft bill for the creation of an apex body called the NCHER – National Commission for Higher Education and Research – made a presentation. It was the stuff of nightmares.

The AICTE and UGC are regulatory bodies that have brought ruin to the country’s education system. Now they are going to be replaced by NCHER which is essentially AICTE and UGC on steroids with two solid-fuel rocket boosters strapped on the sides and supercharged with high octane aviation fuel turbo charged nuclear nanotechnology quantum super collider super cooled magneto-spherical resonating chamber horror.

IX.
The more control the government has, the more money it makes. Auctioning of the radio spectrum gets one say Rs 26,000 crores (or about US$ 5 billion.) That is a pretty penny. It makes sense to become the telecom minister. So you can afford to spend US$ 1 billion in making sure that you get to be the telecom minister.

Anyway, the problem of corruption is simply ingrained in this democracy (which I call the cargo-cult democracy – google for more). Becoming a minister is a sure-fire way of getting billions of dollars in overseas accounts.

The larger the government grows, the larger is the reward for being in it. The nation becomes poor because of the shortages and congestion. But those in the government make money because they engineer the shortages. Prices rise, poverty deepens.

And that deepening of poverty is the reason that the government says that it needs to expand. It enlarges itself to provide NREGA or some such mumble-thousand crores scheme, for instance. Of that, it siphons off 50 percent. That’s about US$ 30 billion every year. Nice pot of change, if you can get your paws on it.

X.
Lee Kuan Yew said last year that Singapore became rich but its leaders did not. Indian politicians can make a similar claim: India did not become rich, its leaders did.

There is more but this has been a long post. I have not gone into the details of the linkage between multi-billion dollar corruption of India, the reason the democratic setup of the country will not allow good people to become leaders, why the middle-class is ignorant and apathetic, why the Congress party is a close substitute for the colonial British rulers, and so on.

XI.
I argue that when the Congress party inherited the government of India from the British, Nehru and his descendants found the conditions very good. They did not dismantle the institutions that the British had used to control the Indian economy for the purposes of extracting all they could out of India. They kept the economy in shackles. As time went on, they tightened their grip on the economy to the point that it was dying.

Fortunately, PV Narasimha Rao was not as crooked as the Nehru-Gandhi family. He freed the economy a bit from the chains that the GA-ndhi-Nehru-Hangers-on had forged for India. It is called “liberalization” – the freeing of something.

It is hard to fathom how people can hold the GANDH in such esteem as to actually vote for them. But then one must remember that half the population is absolutely illiterate and probably the large majority is totally ignorant of the truth – since the government controls what the people are told.

I think the chances are fairly low that India will actually get out of the hole that the Congress party and the Family has dug for India. From where I am, I see the stranglehold of the government only increasing. As the body thrashes more in desperate need for air, they will increase the pressure so that the body passes into a coma. Then they will eat the dead.

There is only one hope. That the people realize what horrors that party has committed against India and Indians, and what further horrors they have in store for India. If we have to save India, the only hope is public education.

  • hUmDiNgEr

    Bang on as usual.
    However, I think you should have talked about personal level game theoretic decisions that we Indian take. People being poor and illiterate makes it difficult for us to achieve a better collective outcome.
    btw, it’s Hyundai, it seems you missed the “y”.

  • Jay

    >>…It is hard to fathom how people can hold the GANDH in such esteem as to actually vote for them….

    Atanu, gr8 post indeed…just a li’l typo IMO…I guess u intend refer to GANDHIs, not GANDH, the one-and-only true family in saaddaa Bharatvarsh :P that has sacrificed soooooo much for this gr8 country of ours…we the lesser mortals are indeed humbled!

  • TiredProf

    “You have to engineer shortages that persist for years and decades.”

    What was “engineered” was relentless male drive to procreate, because, without a male heir giving you your last drink of water, you would rot in everlasting hell, won’t you?

    Stop blaming the government. Has any other government scaled up primary education by a factor of 4+ in 40 years, in a population where finding school teachers is itself difficult?

    That’s why, before proceeding to solve other resource problems, China turned off the tap first.

  • Kaffir

    =>
    What was “engineered” was relentless male drive to procreate, because, without a male heir giving you your last drink of water, you would rot in everlasting hell, won’t you?
    [..]

    That’s why, before proceeding to solve other resource problems, China turned off the tap first.
    =>

    I guess that’s why feminists and activists who otherwise are very vocal about family planning, suddenly turn mute when it comes to Indian Muslims. With the freedom to marry more than one woman and have numerous kids, is it the Muslims who are driving up the population, or Hindus? Which communal and regressive elements are against a Uniform Civil Code in India?

  • ProSense

    @TiredProf: The male drive to procreate is certainly not created by religion. It’s pretty darn uniform across religions.

    @Kaffir: There is far larger diversity in family size across Hindu families than between the typical Hindu and typical Muslim family. Any attempt to address the procreation crisis that creates differential forces or treatment is doomed. The fact is, everyone’s tube must be tied after one child, unless we are resigned to all go up in smoke within another 20 years.

  • Ravi

    I wonder what China is waiting for?

  • Ravi

    To elaborate on my earlier comment: The only thing that will make Indian politicians wake up is China kicking their ass really hard. The last time they kicked (1962) wasn’t hard enough. I hope they do a better job next time.

  • Oldtimer

    >>There is far larger diversity in family size across Hindu families than between the typical Hindu and typical Muslim family.

    What’s that supposed to prove?

    There was this paper in the leftwing EPW 5 or 6 years ago, based on a study that compared Hindu and Muslim population growth rates keeping major social indicators (education, income etc) equal. Even within comparable socioeconomic groups, Muslim fertility rates were consistently higher than Hindu rates.

    >>Any attempt to address the procreation crisis that creates differential forces or treatment is doomed.

    Any method that takes an ostrich stance to the influence of faith and fundamentalism on Muslim population growth is even more doomed.

  • ProSense

    @Oldtimer

    “What’s that supposed to prove?”

    So you agree? I am proving nothing. I am suggesting that if there is, in some wildest dream-world, some hope of reining in Indian birth rates, it must be based on equality of the law for all, regardless of historic or current fertility. (But anyway this debate is useless. One-child policy will never happen in India. Neither will there be a single law for all citizens.)

    “Any method that takes an ostrich stance to the influence of faith and fundamentalism on Muslim population growth is even more doomed.”

    I am not advocating the ostrich stance. You may well believe, and justifiably so, that Muslim fertility is larger than Hindu fertility. You may even convince me with genuine data. Fine. That does not change the above statement. You think anyone has a chance selectively tying Muslim tubes? Remember Sanjiv Gandhi? He got castrated for touching Hindu genitalia!

    Anyway, it seems you and I at least agree that population pressure is an important cause of shortages. Rapid population growth even destroys the ability of the population to scale its productivity with its own size, because there are not enough educators and trainers. Atanu is extremely anti Congress, but I suspect he would be in a similar position against any other party, had it been dominant for 50 years. It’s the incumbency curse, because any political incumbent in India will be seen as progressively f***ing things up. This is unavoidable, because no matter how hard you swim the population tide will make you go backward.

  • Optimist

    “I think the chances are fairly low that India will actually get out of the hole that the Congress party and the Family has dug for India. From where I am, I see the stranglehold of the government only increasing. As the body thrashes more in desperate need for air, they will increase the pressure so that the body passes into a coma. Then they will eat the dead.”

    I wish to be optimist, but I am afraid I have to agree with your pessimistic portrayal of the past, present and future. There is no redemption from the dynasty in sight. Their money-power will ensure that.

    Who will show the way out ? Who will allow the masses to get educated and what education will reveal the truth to masses ? The so called educated themselves are blissfully unaware or unconcerned.

    Yet, hope comes from the fact that change is inevitable and certain. Having been at the bottom for so long, we can hope to raise. Let us hope this will happen soon.

  • ProSense

    @Optimist: Hope is not a strategy. You ask “who will allow the masses to get educated” etc. It’s not (only) the question of allowing them. As in a sustained chain reaction, there needs to be enough people able and willing to teach the next generation in a society. This ability to raise the intellectual level of the next generation must survive and thrive at all scales, from families to villages to towns to states to countries. Education (not necessarily pedantic, but a matter of wisdom with the ways of the world) must come up from within each social group, not imposed from the outside. A population that grows faster than this teaching ability can be scaled up is inherently doomed. For a while one can keep up appearances of progress by consuming and importing foreign technology at a breakneck pace, as we have been doing with heavy machinery, cars, freeway construction, mobile phones, computers, etc. The illusion of progress sloughs off all over the place. E.g., if you lose even one screw holding down the circuit board of your mobile phone, try locating the exact same screw in any Indian city without cannibalizing another phone. Consider the millions of PCs used by our celebrated IT industry: even their plastic front bezels are not made in India, leave along the power supply, circuit boards, or chips. Eventually the world (economy) will ask: What value do you produce on your own out of all these toys? I am afraid Bangalore and Hyderabad software houses cannot provide enough justification for all the toys we have been gorging on. Never before has a generation been given so much and achieved so little with it.

  • http://ketanpanchal.blogspot.com/ Ketan

    Atanu,

    A very insightful post!

    Reading it, for the first time ever I felt it was truly possible for our country to not be doomed like this, only if market would have been kept freer. There would have been competition to sell, & not to buy.

    But is it possible that at the time India got free, people virtually did not have purchasing power? A prerequisite for any businessman would be assurance that once capital is invested, & production starts, people would have money to buy it. Would (foreign, who’d have the capital) entrepreneurs of that time have had such confidence in poor Indian citizens? Moreover, after WW-II, would many western investors want to take risk in a virgin market?

    I think for a few sectors it was inevitable that government take control as no profits could have been made there. Take education for example. At a time (post-independence) when majority of farmers were famine-struck, why would they send their children to schools (taking them away from farm work) & in addition also pay for (privately owned & manageds) school’s profit & payment of staff’s salaries? Same would hold true of so many things targeted at rural population, like healthcare, postal service, etc. Probably it would not have been possible to leave rural population at the mercy of free market till agriculture became an income generator (as against means for mere satisfying hunger) – something that must have required green revolution (if indeed something like this happened).

    But yes, once substantial proportion of rural population had developed some purchasing power, free market should’ve been introduced.

    Possibly, the reason this was not done was to keep collecting tax from urban (purportedly more prosperous than villagers) so that villagers could be made to survive through subsidies, etc. And once the government would tax the urban dwellers on pretext of providing rails, roads, transport, education, healthcare, etc., it could have not asked them to pay private players also for provision of the same.

    But as you rightly pointed out, the government did not give up license-quota-Raj policy even when it was possible to do, & that was purely guided by ulterior motives you have mentioned.

  • TiredProf

    @Ketan

    “only if market would have been kept freer. There would have been competition to sell, and not to buy.”

    A free market does not necessarily make people do inconvenient but valuable things. Consider “hands-off” parenting where there is no compulsion to go to school or do homework. How do you give incentives for education? Atanu discusses some plausible measures toward this end, but I doubt these can result in “competition to sell and not to buy”. That would happen if there is an oversupply of education, which in turn can happen if there is a sufficient number of qualified educators. As it turns out, the per-capita availability of qualified educators has been on a decline for as far long back as I can remember. I can’t see a buyer’s market in Indian education ever again, unless, for some reason, (say) 20 million qualified educators suddenly decide to immigrate into India from outside. That is really the magnitude of the jolt we need to set this floundering ship right. I am in the tertiary engineering education sector; I should know.

  • Sriram

    @TiredProf:
    Do you think the current valuations are inverted and that educators should be paid higher than the work force (say, current IT folks) who get benefited from an educator? I think the idiom : Those who can’t do, teach, is cynical and demeaning.

    However one may love a profession, its the economics which lure the best to a profession. Of course there are but a few exceptions as usual.

    btw: i am not a teacher

  • Harish Rao

    Point taken. The current problems of the nation is basically due to the country moving from a supply driven economy (license raj) to a demand driven economy (a different license raj post liberalization plus crony capitalism). Apply this same fundamental of engineered shortages to any urban transport network and you would immediately find the reason for high real estate prices as well as poor transport system.

    But I was just skeptical on whether free markets would be able to solve the education problem, especially in rural areas. it would be a big task to open up those markets and expect the private sector to offer those services.

  • JAYADEV J

    If you haven’t signed an NDA for that meeting, please tell us what the NCHER bureaucrat told you that spooked you so. How is it going to get worse than what we have now? (non-functional public schools, Rte on private schools, no competition, very limited availability in higher education etc)

    • Atanu_Dey

      The presentation that the NCHER bureaucrat made was about how the government was going to take greater control of college education. The government would dictate what was to be taught by whom to whom and who was allowed to be admitted to college and what quotas would be set for which caste and religious groups and how much was to be paid to teachers and who was to be a teacher based on which caste and religion and how the government would decide who gets to run colleges and how quotas will be met in all aspects of education . . .

      In short, more of the same things that have brought India’s education to its knees will be implemented so that the system collapses totally.

    • http://www.deeshaa.org Atanu Dey

      The presentation that the NCHER bureaucrat made was about how the government was going to take greater control of college education. The government would dictate what was to be taught by whom to whom and who was allowed to be admitted to college and what quotas would be set for which caste and religious groups and how much was to be paid to teachers and who was to be a teacher based on which caste and religion and how the government would decide who gets to run colleges and how quotas will be met in all aspects of education . . .

      In short, more of the same things that have brought India’s education to its knees will be implemented so that the system collapses totally.