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Boycotting Chinese goods: Impractical and harms the national interest

The plan to boycott Chinese imports is neither practical nor is it in the Indian national interest.

By Anupam Manur (@anupammanur)

boycott

There has been many nationalist calls for boycotting Chinese goods as a retaliation against China for blocking India’s bid at the UN to designate Jaish-e-Mohammed chief Masood Azhar as a terrorist, following the Uri attacks and the subsequent surgical strikes carried out by the Indian army. Presumably, India is tired and frustrated of China tacitly supporting Pakistan and thus, the clarion call is for consumers to boycott all Chinese products en masse, so as to hurt the Chinese economy, especially at a time when it is reeling. This has obtained mass support from not only the ordinary citizens, but is being backed by influential MPs and others from the political class.

Such a move is neither practically feasible in order to obtain the desired result, nor will it be in our national interest to do so. Let us examine the feasibility angle first.

India is the biggest importer of Chinese consumer goods and the trade deficit of India with China is one of the biggest between two significant trading partners. India imports almost seven times more from China than it exports to it. The range of goods that we import from China is massive: consumer durables such as electronic products, mobile phones, plastic items, industrial goods, vehicles, solar cells, essential pharmaceutical products, including tuberculosis and leprosy drugs, antibiotics, among many others.

Impractical, at best. Impossible, in reality

Even if we wanted to, it is nearly impossible to keep China out of our daily lives. There’s a little bit of China in every product we consume. Ironically, the laptops and mobile phones that we use to forward the message to boycott Chinese goods are made in China itself. The modern day production process is complex and interconnected. Every good that we use has different components from various countries. Take the mobile phones: it will have some rare earth elements from China, uses the labour and land from China, has investment and capital from the US or an European country, has entrepreneurship from Japan or Korea, and it finally, might use software made in India. Thus, it is impossible to isolate any country and boycott its products.

It is also important to understand that this kind of consumer boycott movements is hardly new or unique. It has been tried and it has failed many times in the world previously. China itself tried to boycott all Japanese products in the early 1930s to protest against Japanese colonisation. The US consumer forums tried to boycott French goods in 2003 to protest against France declining to send troops to Iraq post 9/11. Ghanians boycotted European goods; Jamaicans boycotted goods made from Trinidad and Tobago; Russians boycotted European agricultural products, etc. The list goes on. The only common thing between all these various events is that none of the boycotts were successful in their mission. It all failed and dissipated within a few weeks and the reason for that is always simple: economics. To understand why the boycott movements started, we have to understand why the countries imported these goods in the first place. We have to realise why India is so heavily dependent on China for imports.

Comparative Advantage

Why does India rely so heavily on China for its imports? The answer lies in practical economics. China can produce many of these goods cheaper and more efficiently than India can. Thus, the average consumer, who is price conscious, does not really care whether the products are made in China or in Eritrea, as long as he gets the best goods for the cheapest price. The only practical way to boycott Chinese goods is to deploy an import-substitution method and produce alternatives at home, which is far from ideal. If we as a nation would want to boycott Chinese goods, we would be traveling back in time to the autarkic nation that we were post-independence and this would effectively harm overall social welfare. We tried import substitution methods in the 1960s and 1970s and our rate of economic growth was low and stagnant for a long period. Basic economic theory tells us that each nation will produce the goods that it has a comparative advantage in and then trade it for goods with other countries.

If India were to try and make all the products that we currently import from China at home, it would involve a considerable reallocation of our resources from productive to unproductive uses. Immediately, the range of products available as a choice to the consumer would diminish, the quality of the products would be worse and the prices would be higher. The welfare gains from trade would be wiped out and the cost of all the products would become considerably higher and the retailer and the consumer who relied on cheaper imports would suffer.

What is India’s national interest?

The important thing here is to distinguish what is in India’s national interest. If we define our national interest as the greatest good (higher income) for the greatest number of people, then import substitution would just not work. Imported products allows consumers from all income levels the ability to consume these products at lower prices and retailers to maximise on their sales.

How do you respond to the Chinese actions in the UN, then? It is a political problem and largely needs a political resolution. If we were to impose trade sanctions against each country that has mildly annoyed India in the geopolitical realm, we would be left with no one to trade with. The US has traditionally given monetary aid to Pakistan despite Pakistan’s unwillingness to curb home grown terrorism. Can we afford to not trade with the US? Saudi Arabia and other middle Eastern economies fund Pakistan’s terrorism directly or indirectly. Can we afford to stop importing oil from these countries?

Harming one’s own citizen’s in order to extract revenge on another country seems to be an ill-advised move. Each citizen can take a call on what they want to buy or not. If Chinese made plastic diyas during Deepavali is not to your liking, don’t purchase it. But, that’s no reason to call for a universal boycott on Chinese imports.

Finally, is this dependence on China for imports good? Perhaps not. As of now, we do not have a comparative advantage in producing the goods that we import from China. However, with the right policies, we can produce some of these items or contribute a greater amount in the global production value chain. For that, we need to improve our productivity, free up labour laws, reform land acquisition policies, fix our credit system, and so on.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

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Structural Reforms: What are they and how do you go about it?

BY Anupam Manur (@anupammanur)

No democratically elected government with a limited term of office would want to risk negative popularity in the short term for potential benefit in the future, for which they might not be able to take credit.

The microeconomist’s universal answer to all questions is demand and supply and the macroeconomist’s version is structural reforms. So goes the joke. Kaushik Basu, Chief Economist of the World Bank, in fact tweeted something similar: “Structural reform is safe advice. No one knows what it means. If economy grows: I told you. If it stalls: You didn’t do structural reform.”

So, what exactly constitutes structural reforms? From the political angle, The Economist looks at structural reforms as changes to the way the government works. From an economic viewpoint: it is about making markets work efficiently in the various sectors of the economy. An IMF paper[i] describes structural reforms as: “They typically concern policies geared towards raising productivity by improving the technical efficiency of markets and institutional structures, and by reducing or removing impediments to the efficient allocation of resources”. In fact, changes in the Ease of Doing Business rankings, published anually by the World Bank, signifies the various structural reforms undertaken in any country.

Structural reforms gained popularity from the IMF and World Bank. The two global institutions would attach preconditions to the loans that they provided to countries. These conditions were known as Structural Adjustment Programmes (SAP). Only upon initiating these reforms would a country be eligible to get loans from the IMF or World Bank. These reforms included:

  1. Trade liberalisation: Removing barriers to trade, decreasing tariffs and quotas, exchange rate liberalisation, and minismising the government’s involvement in trade.
  2. Balancing budgets: Governments had to impose strict austerity measures to reduce the fiscal deficit and create a roadmap for repayment of the loan, which involved raising taxes and cutting down expenditure.
  3. Reigning in inflation by imposing tighter monetary policy conditions and removing government’s influence in the central bank’s functioning.
  4. Removing many state controls on production, subsidies, price controls, etc.
  5. Encouraging investment by removing regulatory hurdles. This applied to both domestic and international (FDI) investment. This also involved market deregulation in most sectors of the economy.
  6. Improving overall governance structures, reducing corruption, etc
  7. Privatization and divestment of large public sector units.

Much of the Fund’s current work still revolves around the same issues. In the latest Article IV IMF staff consultation with member countries, their recommendations for most of the countries bordered around the same issues: initiate structural reforms: the United States has to reform its primary education, while France has to balance its budget and urgently carry out labour market reforms; Japan needs structural reforms to inspire more migration to mitigate the demographic crisis, and Brazil need to reduce the fiscal deficit, inflation, corruption in the government, undertake financial market reforms, and so on.

Most empirical analysis does bear out the fact that structural reforms matter to increasing productivity and GDP growth. However, there are a lot of conditions under which structural reforms work. Most countries try to undertake structural reforms when they are in crisis – either out of their own volition in order to fix the broken systems or by command from the IMF and World Bank. The success of the reforms depend upon a number of factors, such as the initial conditions, strength of existing institutions, speed of reforms and the sequencing of the reforms. After the disintegration of the USSR, for example, many countries undertook structural reforms in order to move to a market based economy. Each country followed a different approach and the ensuing results very varied. The Central and Eastern European countries fared far better than the former Soviet Union countries.

There are two important political economy factors at play that determine the success of structural reforms. The first is the time lag between the implementation of the reforms and the eventual positive effects of the same. Most empirical research shows that there is a considerable lag before the positive effects are played out in the economy, be it in terms of increased growth, reduced inflation, increased employment or higher trade. In between, however, it is not uncommon to see short term pain and a dip in growth. This explains why most countries are still reluctant about implementing big reforms. No democratically elected government with a limited term of office would want to risk negative popularity in the short term for potential benefit in the future, which they might not be able to take credit for.

Closely related is the second political economy factor of managing the winners and the losers. Every big reform will create multiple winners and losers. Economists such as Roland suggests that a gradual approach to reforms would allow an opportunity to giving compensating tranfers to losers from reforms to buy their acceptance.

The former Swedish Finance Minister, Anders Borg, has written an insightful article on the ways to tackle this particular problem. One of his biggest advice: front loading. “When structural reforms are implemented close to an election, the short-term impact will dominate the debate, and the more nebulous long-term gains will be written off as uncertain forecasts.” Thus, this should be done early enough after a government is formed to allow for some of the positive effects to come through before the next election.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

[i] “Structural Reforms And Macroeconomic Performance: Initial Considerations For The Fund”, IMF Staff Reports, November 2015.

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Karnataka vs. Cab-Aggregators (Part II)

By Anupam Manur (@anupammanur)

uber-ola-1024x576

In order to obtain a licence, cab-aggregators have to replace their present efficient technology with an outdated one. The requirements to obtain the licence are archaic and simply untenable. 

In yet another blow to cab aggregator companies in Karnataka, the State Transport Department issued a statement asking cab aggregator companies which have not obtained the necessary licences to stop operations immediately. “Web-based aggregators had to obtain licences to operate cabs and taxis. But many aggregator companies have not obtained licences, but are operating such cabs. This is a gross violation under sec-93 r/w 193 of the Motor Vehicles Act. Hence, companies which have not obtained licences from the concerned authority should stop operations with immediate effect otherwise strict action will be taken against such operators,” the statement said.

It does feel a bit retrograde to ask companies to stop functioning for not having obtained the appropriate licence. It does remind one of the pre-1991 days. However, the immediate counterbalancing reaction would be to wonder why would the cab companies refuse to obtain a licence. What exactly is preventing them from getting a licence, which can keep them in business in their largest market – Bangalore. So, I wanted to know what does it entail to obtain a licence to continue as a cab aggregator.

This particular section (sec-93 r/w 193) of the Motor Vehicles Act specifies that “No person shall engage himself as an agent or a canvasser, in the sale of tickets for travel by public service vehicles or in otherwise soliciting customers for such vehicles, without a licence from the proper authorities”. This bit seems more relevant for KSRTC ticketing agents and not on-demand cab aggregators operating over a mobile app.

For further clarity, one needs to look at the The Karnataka on-demand Transportation Technology Aggregators Rules, 20 I 6, which was released on 2nd April 2016. It starts off by quoting the original section 93 that a licence is required to operate as a cab aggregator and then goes on to specify the requirements for obtaining the licence.

The requirements are specified for the aggregator company, the driver, and the vehicle. The company has to pay a licensing fee of Rs.50,000; keep a security deposit of Rs.2,50,000; have a minimum of 100 cabs in their fleet, has facilities for monitoring the vehicles via GPS, etc. The driver should have a driver’s licence, minimum driving experience of two years, be a resident of Karnataka for a minimum period of two years and have a working knowledge of Kannada among other things.

All of these requirements seems fairly reasonable and should not act as an impediment for Ola or Uber to obtain a licence. It also seems that the regulators have understood how cab aggregators work, until of course, they get to the specification for the vehicle. When describing the requirements of the vehicles, the Act goes back to the classic 1970s Licensing Raj days. All cabs should be fitted with an yellow coloured display board with words “Taxi” visible both from the front and the rear. The board shall be capable of being illuminated during the night hours. The driver’s licence and photo should be displayed clearly in the vehicle. As of now, the app takes care of that.

The part of the Act that betrays the fact that the regulators temporarily time travelled to the 1970s is the demand for every vehicle to have a meter which displays the fare along with a printer that can provide a printed copy of the final amount to be paid along with the breakdown of the fare. While specifying this, they truly embraced red-tapism, in all its glory, and specified the font size for the bill to be printed in, print width, print speed, resolution, among other things. They have also given extremely detailed specifications of the GPS/GPRS capable vehicle tracking unit (including temperature range and humidity of the device).

Some of the specifications for vehicles operating under cab-aggregators.

Some of the specifications for vehicles operating under cab-aggregators.

Asking an app-based cab aggregator company to install a bill printing device in the car, a large display monitor that shows the route, fare, and other details, to have a taxi sign on top, etc seems to be retrospective in nature, since all of this is done more efficiently by the respective apps. By demanding Uber and Ola to obtain licences by adhering to these specifications is forcing them to replace their more efficient technology with an outdated one.  By doing so, the regulators are only betraying their ignorance of how a cab-aggregator functions. I would strongly urge them to download the Ola app today, take a ride, understand how it works and then come up with regulations that wouldn’t throttle the businesses.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

(Part I was regarding limiting Surge Pricing and my article on that can be found here).

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A Ban on Surge Pricing will Create Shortages

By Anupam Manur (@anupammanur)

Instead of a price ceiling on cab prices, the government should look at all the ways in which it can increase the travel options within the city.

Karnataka’s Transport Minister Ramalinga Reddy recently unveiled a new policy to regulate cab aggregator services such as Uber and Ola. While Karnataka previously had a policy to regulate regular taxis as ride-hailing services under Radio Taxi Scheme, 1988, Uber and Ola were not covered under the law, as they were aggregator services and not companies that own and operate vehicles for hire. However, as the app-based on-demand cab aggregator companies became increasingly popular, the government sought to bring them under the regulatory ambit.

The policy has introduced a few concessions for the cab aggregators, in a move to increase the supply of cabs. They have dropped the restrictions on the age of the vehicles, reduced the number of years that a driver had to be a resident in Karnataka from five to two, and has allowed drivers to switch between the ride hailing apps, as per their choice. They have also halved the license fee and security deposit. All of these moves will benefit the companies and the customers alike.

However, the biggest policy that will have a detrimental effect on the state of urban transport in Bangalore is the decision to disallow surge pricing for these companies. Both Uber and Ola use an algorithm to determine the prices based on real time demand and supply. If the demand for cabs were considerably higher than the supply, then the app would tell the customer that prices have surged. The surge pricing not only reduced demand, but is also a tool to increase the supply. A higher price will automatically incentivise more drivers to go to the area with surge pricing. However, the surge prices can, at times, be quite ridiculous, which is what caught the authorities’ attention. On New Year’s Eve, for example, Uber had a surge pricing of 10X, that is, ten times the normal amount.

7u

Effectively, the government has put a price ceiling on what these companies can charge the customer. It has given a band with a fixed upper limit, within which the price charged to the customer has to fall. While, this might seem like something to cheer about for the customer at the first glance, a closer inspection will reveal that it will actually end up hurting the customer as well as the companies.

Price ceilings simply do not work, as economic history has repeatedly taught us. A price ceiling will simply create a shortage in the supply of the good in question and create distortions in the market, which will hurt the very customer that such laws are intended to protect. In this case, a ban on surge pricing will lead to a reduction in the number of taxis available in the market, thereby creating welfare loss to the customers who demand the taxis.

The supply of any commodity depends on the price. At each price point, a supplier (driver in this case) will decide whether it is profitable to sell at that price point. Auto rickshaws normally charge 1.5X from 9PM – 6AM, in a bid to be compensated for working late hours and at times that other would not be willing to. Imagine if a similar price cap had been put in place for autos, there wouldn’t be any autos available for hire after 9PM.

Similarly, during peak hours and other times of high demand, in the absence of surge pricing, an Uber driver would not consider it worthwhile to switch on the app or accept ride requests and thus, leading to shortages.

Another major impact of this ruling would be that Bangalore would lose out on the new investment that these companies had pledged. Uber, which has now partnered with 30,000 cabs in the city had planned to expand to about 1,00,000 cabs in the next few years. Uber and Ola combined had pledged to invest around Rs. 15,000 crores in the next few years in Karnataka. With regressive laws such as this, the state could easily lose this investment to neighbouring states. The other worry is that other Indian states could follow this bad example. Maharastra was considering a similar move and it could get buoyed by the Karnataka move.

Finally, the government must rethink whether this is the best method to achieve its objectives. The intention behind this move is to increase the supply of public transport at affordable rates for the consumers. Instead of creating distortions in the market by implementing a price cap, the government should look at other ways to make the market more competitive and remove entry barriers. The government could consider allowing flag down taxis on the streets, like they have in all other major metros in India, which will surely increase the supply of taxis. It could also allow shared autos to ply on Bangalore roads for fixed routes, which will ease the demand for taxis. Another related measure is to allow private busses of all sizes on Bangalore roads, which is currently disallowed. In short, the government should look at all ways to improve public transport in Bangalore and ways to increase the number of options available for customers to travel in the city. This will surely reduce the excess demand for Uber and Ola, which will automatically make surge pricing redundant.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

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8th Standard Pass Yaake?

Drivers of autorickshaws must have passed 8th standard in order to obtain their licence and badge. Is there any merit in this policy?

By Anupam Manur (@anupammanur)

Auto drivers across the country have staged many protests against the central government with regard to a specific rule in the Central Motor Vehicles Act. Section 8 of this Act after the 2007 amendment specifies: “Where the application is for a licence to drive a transport vehicle, no such authorisation shall be granted to any applicant unless he possesses such minimum educational qualification as may be prescribed by the Central Government…”.

The point of contention between the auto drivers and the central government is the prescribed minimum educational qualifications required in order to obtain a driver’s licence and a badge, which is set as passing 8th standard. The rationale behind this rule is that the auto drivers and to a larger extent, drivers of transport vehicles, which includes cabs and other “public service vehicles”, are constantly in touch with the public and thus, it would make them better equipped to serve them. The other reason given is that it would enable them to understand the traffic rules better.

As can be expected, this rule has not gone down well with many autorickshaw drivers and they found political support last year when Arvind Kejriwal of the Aam Aadmi Party rallied to their cause. In fact, AAP designed the stickers that are put up behind many autorickshaws in Bangalore, which reads “If it is fine for you (politicians), why should we pass 8th standard?”

The sticker translates to: "If it is fine for you (politicians), why should we have minimum educational qualification?"

The sticker translates to: “If it is fine for you (politicians), why should we have minimum educational qualification?”

The auto drivers argue that the 8th standard pass clause is quite redundant and discriminatory in nature. Each person, in order to acquire a licence, needs to get an interim learner’s licence first and then a formal driver’s licence. At both stages, the applicant has to pass an exam and while the latter tests the actual driving skill of the applicant, the former is a theoretical tests about road signs, traffic rules and sometimes, even traffic etiquette. Thus, in order to obtain the learner’s licence, the applicant necessarily needs to know how to read and write, which eliminates the need for having a compulsory submission of their educational qualification. In addition, almost all the traffic rules are signs and symbols that are universally understood.

Further, many auto drivers have argued that if they had indeed studied upto 8th standard, they wouldn’t be driving an auto in the first place. Instead, they would have been better placed to be working in higher paying jobs.

In an AAP rally in Bangalore, Kejriwal sympathised with the auto drivers, while simultaneously bringing in the corruption angle. He mentioned that an 8th standard pass certificate can be bought for around Rs.20,000 and thereby, the rule allows for rent-seeking and corruption.

The bigger question is that of equity: whether it is fair to marginalise the uneducated and remove an income earning option available to them. Most auto drivers choose the profession because it does not require them to be educated. By setting a rule such as this, they are being deprived of an honest income earning opportunity.

However, there is one thing to wary of in the AAP campaign on behalf of the auto drivers. While there seems to be no merit in imposing minimum educational qualification to obtain a licence, their counter-argument can be dangerous. “If politicians who run the country do not require minimum educational qualifications, why should we”, is their main refrain. This was witnessed by the statement given by an AAP leader in Bangalore:

“”Going by the logic of Class 8 qualification for auto drivers, a corporator cation for auto drivers, a corporator should at least have passed SSLC as he has the responsibility of interacting with at least 20,000 people in his ward. An MLA should have passed PU, a minister should hold a degree, the CM a master’s and the prime minister should be a scientist”

The merits and demerits of introducing minimum educational qualifications for politicians is best kept for another day. While one would want their law makers to be reasonable educated, it also strikes at the heart of democracy and the Indian republic, which has promised franchise for every citizen of India, without any discrimination. The Indian electoral system allows for any person to stand for election, even if they have not passed primary school. Finally, if an auto driver can obtain a fake certificate for Rs.20,000, the politicos might find it significantly easier to do the same.

While education for all should be encouraged, there seems to be little merit in making it a compulsory professional qualification in this case.

Anupam Manur is a Policy Analyst at the Takshashila Institution

 

 

 

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Geoeconomics Round-up

Global GDP growth has steadily declined in the past few years. Which country can be the engine of global growth? This is a round-up of how different economies are performing.

By Anupam Manur (@anupammanur)

Source: The Economist

Source: Economist.com

Global GDP growth as measured by various international agencies has constantly decreased in this decade falling from about 5% in 2010 to just around 3% now. A 2 percentage points drop in global growth is quite a huge fall, which has alarmed many economists, who are now searching for new sources of global growth. The traditional forces seem to be fading and there hasn’t been any new economic power house to pull the global economy forward.

China has been the engine of global growth for quite some time now. It has consistently managed to grow at around 10% for an impressive 30 years. For the first 20 years, the impressive growth rates were achieved through genuine economic reforms when China moved away from a completely state-run economy to a more liberal, private sector led economy. The next 10 years, roughly the decade of 2000s, saw China post impressive growth rates again (as high as 14% in 2007). However, this time, the growth was unsustainable and was mainly powered by huge borrowings. In the past few years, the unsustainability of the debt fueled growth has begun to show up and China has considerably slowed down. China posted 6.9% in the last quarter of 2015, the lowest growth rate in a long period.

What’s even more worrying is that the Chinese debt burden is manifesting in structural flaws in the economy. Total Chinese debt – government + non-financial corporate + financial institutions + households – account for as high as 282 percent of GDP. In 2001, it was 121 percent of GDP and  158 percent in 2007. Again, the debt problem is compounded by the fact that the Chinese economy is slowing down. This has led to a bond market bubble, a stock market correction, decreased foreign exchange reserves and increased borrowing costs for China.

China is due to slow down further in the coming years and it might not be able to rebound to its previous high rates of growth any time in the near future. Further, China is aiming to reorient its economy from an export oriented, manufacturing dominated economy to an internal consumption led, more balanced one. This can have severe implications for the world economy. Chinese manufacturing accounts for a huge portion of global industrial and manufacturing base. It was a fuel guzzler and was a voracious importer of commodities. Given the slowdown in Chinese manufacturing, not only has the world seen a dip in global index of industrial production, but has also witnessed a massive drop in commodities and fuel prices.

The European Union is now slowly crawling back to positive growth territory. Since the financial crisis, the Euro Area underwent a prolonged recession, with devastating consequences for many of its individual country members such as Greece, Spain, Ireland and Portugal amongst others. The Euro Area posted around 1.5% GDP growth in the last quarter of 2015, largely led by a German revival. However, the Euro Area is faced with some deep structural problems, such as an ageing population and the perennial debt problem (of many of its members). Further, the loose monetary policy maintained by the ECB currently is not sustainable in the long run. Japan is in an even bigger doldrum, with GDP growth rate hovering around 0%. The lost decade of the 1990s has now spilt over for two more decades.

The United States still remains the leading engine of global growth. Though it slowed down considerable after the crisis, it has bounced back gradually. Unemployment rates have been falling and the economy is seeming healthy. It is still the source of most innovations and technological development in the world. Remember, the US economy still accounts for nearly 30% of global GDP and thus, a 2-3% growth of the US economy can be significant for the world.

Most emerging markets have faltered in the changing economic landscape. Commodity exporters like Venezuela, Brazil, South Africa and Russia have been adversely affected by the falling crude oil and commodity prices. The growth rates in these countries have dropped drastically in the past year, with some of  them even facing a contraction of output. The South-East Asian economies are performing moderately well and may continue to do so in the short to medium run.

Finally, India has been seen as the new leader of global growth. Many economists, including our RBI Governor Raghuram Rajan, has commented that India will be the next engine of global growth. However, this must be taken with a pinch of salt. Though it is the fastest growing economy in the world presently, the size of its economy is still too small to make a significant impact on global growth levels. Compare India’s two trillion dollar economy to China’s $12 trillion and US’s $17 trillion economies (nominal GDP). Further, India’s other domestic growth indicators have not been exactly encouraging. IIP numbers have been unimpressive, the size of corporate debt is worrying, the banking sector has been plagued with bad loans, and no significant structural reforms have been implemented in the last few years.

The 3% growth for the global economy should be viewed as the new normal and even for that to remain sustainable requires most of these countries to outperform.

Anupam Manur is a Policy Analyst at the Takshashila Institution. 

 

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Allocative Efficiency vs. Social welfare

If perfect competition always leads to allocative efficiency, does it also lead to increased social welfare? If so, why does the government intervene in the markets in the first place and why does it have monopolies of its own?

By Anupam Manur (@anupammanur)

 

Source: Cox and Forkum

Source: Cox and Forkum

Perfect competition, by definition, will produce the truest price of goods and services. Due to existence of a large number of buyers and sellers and the competition among them, the market forces of demand and supply alone will determine the price levels in the economy. And it is through the price mechanism that resources are allocated most efficiently: all those who are willing to produce and sell at a given price point and all those who are willing to buy the goods at the given price point can do so.

One of the reasons that governments intervene is to increase competition in the economy. Remember, perfect competition in reality is a rarity. Very few instances of markets that can be described as being perfectly competitive. Competition in the markets can be seen on a continuum with perfect competition at one end and pure monopoly at the other, both of which are ideal types. In reality, most markets fall somewhere in between and it should be the collective effort of society (including government) to push markets towards greater competition. Many government interventions can actually be seen in this light. Liberalising reforms undertaken by the government are usually made with the intention to reduce concentration of market power and increase competition. Privatisation of certain sectors or allowing FDI limits are examples of such reforms. It should be noted that the reason for the concentration of market power could be the government itself. In India, we have seen how the MRTP Act, FERA, etc heavily distorted the markets, which were then reformed in 1991.

Government intervention in markets in the form of actually producing goods and services should be carefully analysed. In some cases, the government can enter a market as one player to provide competition. When it is just one player in the market, it can act as a balancing force to the private player and thereby, increase efficiency due to the added competition (provided, it is a fair market player). The existence of BSNL in the telecom sector is perhaps the best example for this. However, many other instances in history have proved the opposite: that government owned public sector units usually lead to distortions in the economy. Examples range from when the government is the only player (eg. electricity distribution companies) or when the government is part of many players, but fail to produce efficiently (Air India). Bank nationalisation is one of the better examples of how government intervention has resulted in considerable inefficiencies. The reasons for nationalisation was to have greater control over this sensitive sector, to force banks to lend to priority sectors and to the government.

The government can also intervene in markets to correct other forms of market imperfections. Apart from concentration of market power discussed above, market imperfections can take other forms: under production of public goods and merit goods (goods with positive externalities), overproduction of demerit goods, etc. Government intervention in these aspects can lead to higher social welfare. It must be noted, however, that any form of government intervention, if it does increase social welfare in the short run, should be of a temporary and least intrusive form. It should aim to correct the market imperfections and withdraw as soon as possible. If not, in the long run, the intervention will eventually lead to a reduction in welfare.

While these interventions tend to increase economic efficiency, other interventions will be detrimental to it.  When the government intervenes in the market in order to meet its social objectives or for certain political reasons, it will lead to a reduction in economic efficiency and even reduces social welfare in the long run. These interventions are undertaken when the government believes that the economically efficient outcomes may not lead to social welfare or that the aggregate social welfare might not accrue proportionately to targeted sections of society. For example, imagine if the railways were completely privatised, then, at equilibrium, the tickets would shoot up by 4-5 times at least and this could make it unaffordable to the poor. This prompts the government to run the Indian railways itself, such that it can have better control over the price mechanism.

When the government uses the price mechanism to achieve political and social objectives, it will lead to a reduction in economic efficiency. High ‘sin taxes’ are used in order to curb activities such as smoking and drinking. Taxes are also used as a tool for redistribution of wealth: high tax on ‘luxury’ items in order to fund welfare schemes.

The gray areas in government intervention occurs when there is a clash between economic efficiency and social welfare. Sometimes, economically efficient outcomes may lead to a reduction of social welfare. Imagine the market for essential drugs. An economically efficient solution might price a life-saving drug too high and out of reach of most citizens, thereby reducing social welfare. Else, imagine if there is a sudden drought this year with the failure of monsoons and the prices of essential commodities soar. The markets might not price in the extreme consequences of such events, which might even be death. In each of these cases, it might be justifiable for the government to intervene. The challenge is to find the least distortionary method to do so.

Anupam Manur is a Policy Analyst at the Takshashila Institution.

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Why are petrol prices not decreasing?

Why are petrol prices not decreasing with the fall in global crude oil prices?

Why are petrol prices not decreasing with the fall in global crude oil prices?

A common refrain from most motorists is that petrol prices should have reduced considerably with the fall in global crude oil prices. Even though global prices have fallen from well above $100 per barrel to less than about $30 per barrel in the past 1-2 years, the price that we pay for a litre of petrol in India has not reduced proportionately. Are the oil PSUs fleecing the consumers and raking in super-normal profits by buying low and selling high? Not quite.

Firstly, it is extremely important to understand that petrol prices in India is highly regulated and controlled by the government. The individual firms (be it private or government) have little say in fixing petrol prices.

Also, it should be noted that global crude oil prices is just one side of the coin. All oil imports are priced in dollars, which makes the exchange rate of the rupee with the dollar extremely important. The rupee has been depreciating continuously against the dollar and this affects the price of petrol as well. Let’s assume that the price of 1 barrel of crude oil is $30. At an exchange rate of Rs.60/$, it would be Rs.1800, where as it would jump to Rs. 2100 per barrel, if the exchange rate jumps to Rs.70/$ (where we are inching towards).

Second, only about 40% of the price you pay is for the actual price of petrol. The rest of it is taxes. The cost of a basic litre of crude oil is around Rs.13.5. Then, of course, the crude oil has to be refined and there are various costs involved in this. At the first level, there is entry tax, refinery processing, margin and landing cost from refinery to the Oil Marketing Companies (OMC). Then, there are costs which the OMCs have to bear such as transportation, freight, landing to the dealers and finally, their own margin. All of this put together adds Rs11 to the price of oil, of which the OMC margins are less than Rs.2 per litre. The petrol pumps takes a commission of about Rs.2.25 per litre.

Then comes the first of the big taxes – the excise tax. The excise tax charged on one litre of petrol by the Union government is close to Rs.20 (which was hiked recently by the government). Thus, the dealer (the petrol pumps) pay about Rs. 45 for one litre of petrol . Then, there are a flurry of state taxes and cesses. Around 33% of what you pay for one litre of petrol goes towards state taxes, of which, state sales tax accounts for 25%, state entry taxes account for about 5%. All of this broadly falls under the state VAT. Additionally, there are other various cess that are levied both at the centre and the state. (Karnataka levied a monorail cess in the 1980s and though the project has been shelved in the early 1990s, the cess continues to this date).

Petrol Prices Breakup

One question that can always be asked is why does the government charge such a high rate of excise duty? The simple reason is to balance its fiscal books. Excise duty on oil is one of the major sources of revenue for the central government. When faced with a scenario of an impending fiscal deficit, the central government tends to raise excise duty. By a recent hike of excise duty by 75 paisa, the government hoped to raise Rs.17000 crores in revenue for the purpose of infrastructure. The government aslo used revenues from these taxes to cross-subsidize other fuel costs (diesel). Further, the PSU oil companies understand that they are in this for the long term. When prices were high, many oil companies witnessed significant losses and petrol prices were subsidised by the government. When oil prices fall, the government does not quickly pass the benefit to the consumer, instead it prefers to allow the oil companies to build a cash reserve for the next hike in prices.

Now, back to the question at hand. With the paying nearly 60% of the price towards taxes and nearly 35% towards operating costs, there is not much room to cut prices. The only way that the price that consumers pay for petrol can come down is when the government reduces the taxes it levies. For that, its budget has to be in a much better shape than what it is now. And for the budget to be in a better shape, it has to decrease its spending on the myriad of welfare schemes and subsidies: it can remove the LPG subsidy and decrease the price of petrol, but not many would favour that either.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

Note: Figures are approximate and keep changing with the change in oil prices, as taxes are a percentage of the price.

Tax rates and calculations derived from: Know how fuel cost is computed to Consumer.

 

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Growth, Urbanisation, and Poverty Reduction in India

Despite a few issues in inequality, the process of urbanisation has been clearly important in poverty reduction in urban and rural India post 1991 reforms

In light of a new and more comprehensive data-set, spanning 60 years with 20 years of post-liberalisation data, Gaurav Datt, Martin Ravallion, and Rinku Murgai revisit the important linkages between growth, urbanisation, and poverty reduction in India in their NBER working paper.

Broadly, there has been a downward trend in poverty measures since 1970, which has accelerated post-1991, when India undertook liberalising reforms. An interesting finding of the paper is that declines in rural poverty has been greater than the decline in urban poverty, which has led to a convergence in the poverty rates in the two areas. Part of this is explained by a significant decline in rural poverty and increase in real wages and part of it is explained by a sharp urbanisation of poverty in urban areas: from about one in eight of the poor living in urban areas in the early 1950s to about one in three in 2012.

There's a decrease in absolute poverty levels in both urban and rural areas in India.

There’s a decrease in absolute poverty levels in both urban and rural areas in India and a convergence between the two numbers.

The evidence also bears out what is common knowledge today – that much of the growth and consequently, poverty reduction, has come from growth in the tertiary sector and to a much lesser extent, the secondary sector. There has also been significant increase in inequality in the urban areas and a decrease in inequality in the rural areas.

There has been an increase in urban inequality and decrease in rural inequality

There has been an increase in urban inequality and decrease in rural inequality post 1991 reforms. Source: Growth, Urbanisation, and Poverty, NBER working paper. 

While rural growth was the most important contributor to poverty reduction pre-1991, it has been replaced by urban growth after the reforms. A more important finding is that urbanisation has impacted poverty reduction not just in urban areas but also in rural areas. This phenomenon of inter-regional effects of economic growth is applicable to the post-reform period only. Before 1991, urban growth had no effect on rural poverty.

The authors have also shown that the classic Kuznets process has not had significant impact in the poverty reduction in India. As per Kuznets process, the growth in poor countries leads to increase in inequality in the beginning, which eventually declines as rural poverty measures exceed urban measures. However the low impact of Kuznets process in India signifies that the difference between rural and urban poverty rates is small.

It was also found that there are strong inter-sectoral linkages post-1991. Growth in one sector has had a positive impact on the other sectors. It is also quite interesting to note that the secondary sector which had minimal impact pre-1991 has contributed to poverty reduction in the latter period, along with the primary and tertiary sectors. The role of the tertiary sector, however, remains the most important, with its contribution to poverty reduction as high as 60%.

There has also been significant changes in growth elasticity (responsiveness of poverty reduction to economic growth) in the three sector between the two periods. The tertiary sector has the highest (absolute) growth elasticity for both periods, implying that poverty reduction is highest in response to growth in the tertiary sector. The elasticity for the primary sector has been decreasing since 1991, reflecting its lower share of national income. The most important change has been in the secondary sector, which has changed signs from negative to positive since 1991.

Apart from decrease in poverty levels, India’s labour markets are also undergoing structural changes. According to the authors, there has been a tightening of rural casual labor markets, with rising real wage rates, and also a narrowing of the urban-rural wage gap. The three main factors explaining such a change are: reduction in the supply of unskilled labour due to the expansion of schooling, decline in female labor- force participation rates, and the construction boom across India. This mismatch between lower supply of unskilled labor and rising demand for that labor has increased the casual wages and thereby reduced the urban-rural wage gap.

If the urbanisation process in India is seen as both urban economic growth and increase in urban population, its contribution to poverty reduction in post reform India is clearly significant.

Anupam Manur and Devika Kher are Policy Analysts at the Takshashila Institution and they tweet at @anupammanur and @devikakher respectively.

 

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Price of Dosas

In an event hosted by the Federal Bank in Kerala, RBI Governor Raghuram Rajan was asked an unexpected question. Just when he had proclaimed that the central bank had won the war on inflation, a student asked him “In real life, I have a query on Dosa prices — when inflation rates go up, Dosa prices go up, but when inflation rates are lower, the Dosa prices are not lowered. What is happening to our beloved Dosa, sir?” she asked. His response revolved on technology. There has been no significant improvements in the technology involved in making dosas and thus, the prices have remained constant.

The same question was then posed in our GCPP forum. Here’s my response:

First and most importantly, inflation is the rate of change of prices and thus, when Rajan says inflation has come down, it means that the rate of change in prices have slowed (prices are increasing less rapidly).  It does not mean that prices have decreased and thus, the Dosa prices will not come down. So, the input costs and labour costs are still increasing, but at a slower rate, and thus, dosa prices stay the same.

Also, remember that prices do not react to inflation. Rather, the inflation number is an index of how prices of different commodities are moving.

Second, there is always a considerable lag in the macroeconomy for changes to take place. Even if all the input costs are decreasing, it takes time for it to travel through the economy. The more complex the product, the greater the lag for the transmission. The only things that you see where prices fluctuate often is farm produce (fruits and vegetables). This is so because there are very few people in the chain between the producer and the consumer. Thus, prices go up and down quite quickly reacting to demand and supply.

However, wages for labour are usually very sticky (read the concept of sticky prices by Keynes). No worker would agree to get a reduction in nominal wages even if the economy is in a deflationary (negative inflation). Newer contracts may be signed for lesser wages, but that takes time. Other aspects, such as rent, interest rate, etc will also not change immediately. Thus, our Dosa chap cannot reduce the price of his Dosa following a lowering of inflation.

Finally, prices of common commodities do come down after a sustained period of low inflation. When people expect inflation to stay low for a long period, they might be willing to renegotiate contracts. So, inflation expectations are also extremely important for this.

Raghuram Rajan is also correct in saying that technology plays a huge role. We can see in the field of electronic products that prices are continuously dropping or you are getting better models for the same price, which amounts to the same thing. That is due to the usage of better technology in producing these products.

There are a few restaurants in Bangalore who have optimized the technology, streamlined the production process for quicker turnaround and turned it into an assembly line production. They seem to offer dosas at the cheapest prices (Rs.20 in Jayanagar 4th block).

Anupam Manur is a Policy Analyst at the Takshashila Institution and teaches Economic Reasoning for GCPP students. He tweets @anupammanur

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