The Indian Economy Blog

November 28, 2005

Bad Economics Can Kill

Filed under: Regulatory reforms — Amit Varma @ 4:59 pm

In an excellent Op-Ed in the Indian Express titled “Who killed Manjunath?” Ila Patnaik writes:

It is well understood that the structure of economic incentives is a far stronger force than policing. It is easy to blame the law and order situation for the murder. But the real blame lies with the petroleum price policy that created incentives for adulteration. When diesel costs Rs 35 per litre and kerosene is available in PDS shops for Rs 11 per litre, there is a very powerful incentive for petrol pump owners to adulterate diesel with kerosene. If a mafia has arisen, it is a creation of government policy. In the same way that the smuggler gangs of the 70s were the inevitable consequence of restrictions on imports, the mafia that murdered S. Manjunath is the by-product of the pricing distortions in the petroleum sector.

Dead right. And here’s a question for our readers: can you give other examples of similarly bad economic policy in India, and prescriptions for how to fix them?

22 Comments »

  1. That’s easy. Cotton farmer suicides in AP are very largely a product of the monopsony status of the APMCs. When you don’t have assured buyers for your low-risk crops, you move into high-risk crops like cotton. And after that, the absence of contract farming means no assured buyers, and you can end up losing everything on one crop.

    Contract farming still isn’t perfect, but at least it also gives the purchaser an incentive to ensure that the farmer’s crop doesn’t fail.

    Comment by Aadisht Khanna — November 28, 2005 @ 6:14 pm

  2. [...]

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  3. I think this argument about economic incentives is slightly flawed. The problem is more of legal incentives than the economic ones. The guy was murdered because the murderer obviously thought he would somehow get away with it, perhaps quite rightly so. That’s how premeditated crimes like this happen anyway.

    Much as you “anarcho-capitalists” would want otherwise, we need more strict law enforcement, a stronger state and better policing to ensure that these things don’t happen in future.

    Comment by Alok — November 29, 2005 @ 4:07 am

  4. Alok,
    I think the key for economic incentives to work (in a way that maximises welfare gains to society) is to have a real enforcement mechanism, and that may well be the missing link in the context of emerging markets. In the absence of the institutions that enable the working of a free market economy, we may well end up with serious distortions.

    And just so you know, not everyone who writes on this blog is an anarcho-capitalist :)) Perhaps the glue that holds us together philosophically is a firm belief in liberalisation and the merits of private enterprise.

    Comment by Reuben Abraham — November 29, 2005 @ 5:09 am

  5. In the absence of the subsidy, there would still be an incentive to adulterate – as long as kerosense is cheaper than diesel. So it’d be wrong to blame the petro price policy for Manjunath’s death. The policy might have strengthened the incentive for adulteration – but it definitely did not create the incentive.
    Alok’s argument on this incident being a result of poor law enforcement makes more sense.

    Comment by eV — November 29, 2005 @ 6:27 am

  6. Alok, it goes without saying that no economy can function well without law enforcement. But equally, it is perverse to have economic incentives of this sort.

    Only one of the 12 contributors of this blog is anarcho-capitalist (not me!), and as he would tell you, you mischaracterise anarcho-capitalism completely by assuming that anarcho-capitalists don’t want law enforcement.

    Comment by Amit Varma — November 29, 2005 @ 11:55 am

  7. I like the way Alok describes some of the blogs(blogerrs) here ;-)

    Yes, I think lot of times people here seems to take a single dimensional view about all the problems. There is no doubt that the price difference is one reason in this gruesome incident, but that does not mean that if price of kerosene is brought equal to petrol pump owners stop adulterating, they might stop using kerosene but they’ll find something else!!.

    In a way India was a libertarian country before the independence, poor remained poor then! Even now for few rich it is still libertarian! they dont pay taxes, they think they can control the law and order by their own fire power. (Isn’t right to bear the arms one of the important criteria for libertarians?)

    Anyway, only new breed of techies think that libertarian way is a new thing to solve all the problems because they pay too much taxes. Reality is it comes with it’s own set of problems.

    Generally, I like the thoughts put forward about abolition of public sector enterprises and picking left parties on their stupidity. But, getting drunk on capitalism is not something that will fly for India at this moment. It is like Churchill said about democracy (democracy is the worst form…), capitalism is not perfect, but nothing else has stayed.

    However screwed up things are with socialism experiments done in India, it has done some good things in our social system. Even though there is long way to go, it would not have been possible without some dose of socialism. Ideally, socialist leaders should have guided people to capitalism in slow doses. But alas, socialist leaders got lost in their false sense of ideology and/or with their political aspirations. Capitalism works very well when everyone can compete on eqaul grounds, however today there is huge gap between different sections of socity (urban/rural, caste based etc). That’s why pure capitalism does not fly politically. It is pretty common with all developing countries, those who embrace capitalism too soon has lost it’s character and has become too dependent on western world.

    Comment by sanjath — November 29, 2005 @ 1:01 pm

  8. I don’t agree entirely.

    Correct me if I am wrong, your argument (and the author’s argument) is “Since Kerosene is subsidised it is cheaper than Diesel. Since it is that much cheaper, it provides a powerful incentive to adulterate diesel. Therefore subsidising Kerosene is bad economic policy”. However, if you were to bring the price of Kerosene up to Diesel levels to remove that incentive that would not stop the adulteration of Diesel. I am sure those culpable will find another way, another substance to adulterate with. The incentive to adulterate will still be present.

    Having said that, the Economic policy is still bad, not because it provides incentive to adulterate, but because the subsidy isn’t reaching those who really need it (as the original author pointed out). Let’s assume that it were really helping the poor. I wouldn’t call the policy a bad one because it provides incentive to adulterate. On the same line of thought, making Diesel as cheap at Kerosene might work better at getting rid of that incentive.

    Comment by Santosh — November 29, 2005 @ 9:31 pm

  9. Hi Amit: There seems to be a flaw in the reasoning of article regarding the adulteration. The problem here is the propensity and ability to cheat on part of the petrol pump owners. According to the author if the price difference between kerosene and deisel is the cause of the propensity to cheat on part of the petrol pump owners, they would cheat regardless of whether the lower price of kerosene was set by government subsidies or by market forces.

    So, if the government stopped subsidizing kerosene and its price still settled at say Rs 15, would the aldurteration be any more desirable?

    The concluding para provides a more plausible explanation and cure, the lack of competetive pressure. In a more competetive atmosphere, customers would recognize the adulterors and put them out of business.

    Comment by Vivek G — November 30, 2005 @ 9:46 am

  10. Vivek G, I’d expect that killing people is a bit of a hassle. Saying that petrol pump owners will have the same tendency to kill IOC officials whether the profit to be made is 40 bucks or 20 bucks is uneconomic thinking. Of course multiple things matter. But the artificial price difference matters too.

    Comment by Ravikiran Rao — November 30, 2005 @ 10:41 am

  11. This touches the issue of subsidies.
    The kerosene/LPG are subsidised for domestic purposes and targeted at middle, lower class and for those below poverty line.
    Should Govt withdraw this subsidy?
    What will be the environmental-cost of increasing the price of kerosene when people, who cant afford kerosene at increased price, start using wood?
    what will be the Optimal solution?
    too many questions, I guess :-)

    Comment by Mani RK — November 30, 2005 @ 1:25 pm

  12. Ravikiran Rao: You miss my point. The petrol pump owners will have a tendency to “adulterate” regardless of whether the incentive is created by government subsidies or market forces.

    Subsidies are bad economic policy for various reasons. They are definitely the cause of black markets. But it does not follow that removing subsidies will make honest men out of the petrol pump operators who will adulterate if there is an economic incentive to do so regardless of its source.

    Comment by Vivek G — November 30, 2005 @ 5:07 pm

  13. Well, the basic fact remains that the petrol pump owner is not running his pump to do some social service. It is entirely rational for him find anything with which he can adulterate the petrol and sell it. Whether he chooses kerosene or something else hardly matters.

    What we need is a set of legal disencentives so that this behaviour can be moulded. I know the inspector raj that we had didn’t work very well but the original intent was the same. We need to find out a better way for regulating these things and putting a more rational incentive struture through regulation of petrol pumps, you cann call it the “new inspector raj”! I am not sure what kind of regulations we already have though!

    I know many of you libertarians will say…but in the longer term consumers will drive the shady dealers away from the market (that’s assuming we have an efficient way of dispersing information, which again calls for more regulation)…but in the longer term perhaps some more people like that guy will have to die.

    Comment by Alok — November 30, 2005 @ 11:18 pm

  14. That is an absurd argument..

    As good as saying a beautyfull women was on the road unprotected at the middle of the night and some one raped her, because she was standing on the road.

    I just can’t belive this argument..

    Comment by nirav — December 1, 2005 @ 2:03 am

  15. That might sound absurd but that’s how economists think (I am not one though).

    There are incentives to rape a lone woman standing on the road in the middle of the night but generally men won’t do it because the disencentives are far stronger — fear of going to jail, fear of getting kicked in the groin by the girl, fear of that painful feeling that comes after you have done something wrong (pangs of conscience) etc etc. For rapists obviously, these disencentives are not strong enough.

    It actually helps when you view human beings as rational agents responding to incentives rather than some fictional creatures responding to some higher spiritual stimulus!

    Comment by Alok — December 1, 2005 @ 2:46 am

  16. Hi Nirav:

    Your analogy about the lone woman on the road does not correctly portray the argument put forward. Here is a better version. What if the government imposed high tarrifs on most busy streets to reduce crowding, leaving only a few desolated streets tarrif-free. Lets say the woman in your example, being of limited means chose to use the desolate street and was attacked by a man waiting to take advantage of the situation. In this case the flawed tarrif law is the root cause of the attack on the woman.

    No one here is condoning adulteration or murder. What is being pointed out is how the “unintended consequences” of seemingly benign laws can have fatal results.

    For example, liquor prohibhition creates a thriving black market in liquor. As Ila Patnaik points in the article, high import duties make smuggling economically worthwhile. Laws like the rent control act have made theives out of many otherwise honest people.

    Comment by Vivek G — December 1, 2005 @ 7:29 am

  17. I agree with Alok. Trouble is, lot of people indulge in crude and perverse Economics where everything depends on private gains and losses. Even undergraduate students on the subject will tell you that without a judicial, enforcement and social environment no economic analysis carries any meaning. And here we have guys like Ila and Jayram Ramesh grinding their axes, and theorising: “hey, it is the wrong prices which have to be corrected.” As if, this done, we would be able to do away with police, judges and army as well. As someone said, by their argument, lowering diesel price is equally effective in saving IOC officials. This is essentially a feel good argument, which does not point fingures at persons, does not ask hard questions and blames the all too convenient “pro-poor government policy”.

    Someone immediate and obvious has to take the blame. We cannot scapegoat the subsidies for all that is wrong in us.

    Comment by aman k — December 1, 2005 @ 8:38 pm

  18. I am glad to see so many readers (her) are questioning this logic by IE’s Op-Ed. Think for a minute, will there be enough political will to abolish the subsidy right away? No, but IE has to come up with their elitist ideas without checking the reality of it, so that the focus is shifted from (greedy capitalist) criminal petrol pump owner to government policy, which we are so fond to keep blaming for all the things that happens in India.

    All these blogs are quick to question the compulsion for petrol pump owner to adulterate or even kill and too happy to point it to economics behind it. Why dont they kind of take same effort in studying the compulsions of accomplice (helpers of pump owner) in this case or even compulsions of politicians in forming the policies they write (subsidies or otherwise). It is all to do with inequalities (social and economical). We urbanites dont know the ground realities, we keep blogging away to glory on imaginary policy changes, which will never happen. I do agree that policies need to be changed in timely manner, but things have to change slowly giving due considerations to those who are unable to compete either because of their location (ruralites who lack exposure to quality education or other things) or social structure.

    Comment by Sanjath — December 2, 2005 @ 12:32 am

  19. Typo in the first line. It should be read as
    I am glad to see so many readers (here) are…

    Comment by Sanjath — December 2, 2005 @ 12:35 am

  20. Not only can it kill it can render peoples life without soul and kill the urge to seek a much “stable” life.The economy is not dependent on how people earn, itis how they spend is what i think drive economics.

    Comment by Tarun — December 6, 2005 @ 2:58 pm

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